I was disgusted again today when market fundamentalist Amity Schlaes got a seat on the APM Marketplace broadcast. It was equivalent to a Neocon talking about the Iraq invasion. Events have so exploded their flimsy ideology that they are reduced to making things up. In this case it was,
"Consumers rule the economic world. That idea comes from the father of modern economics, John Maynard Keynes. If consumers are grumpy, markets get sour. Politicians monitor consumers like hawks. And recovery? It's all about the consumer too. If the consumer is unhappy, the recovery won't come."
(Marketplace)
This is not only nonsense, it is condescending. But mostly it is nonsense. Aside from the consumer, there is the public sector. I believe the public sector is acting to produce recovery. So today I offer Ms. Schlaes a quick "Pundit's Guide to Keynes."
She would probably lose her corporate sponsorship and bookings on clueless radio, if she ranged too far into reality, so it may not help her, but it might help others. A public service.
A PUNDIT'S GUIDE TO KEYNES
Output is determined by aggregate demand. "Aggregate" means "total, combining all elements." With this, Keynes contradicted the most basic tenet of classical economics of his time, known as Say's Law, that the process of supply created the demand to purchase that supply. Adherence to Say's Law was, prior to Keynes, virtually a precondition to be considered a serious economist. Even though the destructive deflation of the Great Depression disproved the idea -- that the process of manufacturing created the wages, payments to suppliers and the profits that were needed to purchase that supply -- economists continued to cling to it. This is still the Supply Side proposition that companies create jobs and begin the cycle of growth. The Demand Side counter is that effective demand will stimulate the supply, both in the aggregate and in specific markets.
Markets are not inherently self-correcting, they are fundamentally flawed. Keynes proposed that by their own internal dynamics, markets boom, bust and break down. The "entrepreneurial animal spirits" which energize markets soon enough translates into effective demand for investment that creates runaway expansions (investment booms), which inevitably stop by reason of the accumulated financial changes' making the system fragile. Thus Keynes is diametrically opposed to the Invisible Hand paradigm, which posits not only self-correction in a capitalist economy, but predicts the results to be the best outcomes . Keynes personally preferred and worked to enable a managed capitalist system, and he is rightly seen as one who saved capitalism from itself, but the flaw he identified is fundamental to the capitalist system and cannot be ignored. Keynes' ultimate answer to this problem was to expand the size of the public sector of the economy so as to minimize the impact when the private, market sector broke down. This in theory allows the salvage dynamism, vigor and vitality of the animal spirits without periodically sacrificing the structure of the society.
Investment has a multiplier effect on output and employment. Keynes borrowed and promoted R.F. Kahn and his development of the investment multiplier. This is the base of the so-called "Keynesian stimulus." Its nut is that an investment from outside the system will increase activity to a degree greater than the simple dollar value of that investment BECAUSE the money paid to create the investment was passed from worker to grocer to baker to farmer and so on creating multiples. The multiplier derives from Keynes' consumption function, which theoretically assumes this multiplier should be reduced only by the savings of each actor at each step. In the real world, we see multipliers much reduced. A savings rate of five percent, for example, should create a multiplier of 20. In practice, we see best multipliers are in the range of 2. This multiplier effect is the root of the Keynesian stimulus which later manifested itself in government spending to "jump-start" the economy. It should be noted here that tax cuts have the lowest multiplier of all government spending, particularly in conditions of uncertainty.
Liquidity Trap. When there is no prospect of profit, investors will not invest. This is often said in a kind of reverse form, referring to an interest rate falling to a very low point, but still not stimulating investment because of dim prospects. The more usual formulation is more confusing than this, but because of its importance in the present downward spiral, the phenomenon is best illustrated and understood from the more dynamic statement. It doesn't matter how low interest rates are, if there is no prospect of profit, entrepreneurs and investors will stay home.
Yes, Amity, the consumer has to come back. But it is not dyspepsia that is ailing her, it is a shot to the midsection from falling incomes. For the short and probably medium term, the consumer is not going to lead recovery. It is the public sector. Since we have a problem with planetary survival, perhaps there is something governments can do while they are leading the recovery.