I was sitting with a bunch of economists the other day when I mentioned something that had occurred to me in writing my Defending the History of Economic Thought. The book has to be at the publisher on New Year’s eve which is why blogging is now at a virtual standstill. Anyway, I said that one of the main differences between the way we teach economics “today” (ie, since about the 1930s) in comparison with previous eras is that we today depend on diagrams rather than logic and reasoning. We therefore manipulate these diagrams up and down, back and forth without ever learning the economic logic that lies behind. It is therefore easier to teach and learn but superficial and usually indefensible if someone tried to explain the actual economic logic and relationships, which no one does. Micro, macro – all the same. Everything of importance is explained using some kind of diagram. Keynesian economics was to me the most obvious case in point. It is impossible to tell a coherent story about how the goods and services materialise from an increase in the mere spending of more money. The Y=C+I+G+(X-M) diagram did not even attempt to explain the economics. It just showed the result in a kind of before and after way without really explaining what went on underneath.
So, I was asked, don’t you think that those chaps who did all the work on the national accounts were right? Yes, of course, the national accounts are exactly right since the equation is then an identity, Y≡C+I+G+X-M, true by definition. But with Keynesian economics you cannot simply raise G and assume that Y goes up by the same amount since the elements, C,I,G,X and M are not independent of each other. If you raise G there may well be an increase in M so then where are you, same with the increase in any of these? And you know what, the conversation died right then and there, instantly. My point proved in two different directions, that using diagrams stops people from understanding the logic of the economics and that Keynesian economics cannot be defended and explained in words.
Not being an eh-con-oh-mist, my feeble – as I’m approaching that magic buy-bull number – engineer’s mind says that each parameter in the equation has many variables and that, most likely, those variables are largely independent of each other and non-linear, anyway.
I prefer pictures to words as the ‘picturer’ can show as many untold words as the beholder wishes to see (or not see) rather than the latter which can contain as many words as the author wishes to use, as deceptively as necessary, in order to highlight to meet their needs.
I shall wait with bated breath for your new missive on how to make ‘us’ plebs spend our money for the benefit of all.
Best wishes for the coming festive season.
amcoz
1 Dec 12 at 9:33 am
Spot on Steve.
I’m gobsmacked that people still believe Krudd and co ‘saved’ Australia from the North Atlantic financial crisis because they increased government spending.
Well duh! If you define GDP as C+I+G+X-M and you increase G, whatda know, GDP goes up. Doesn’t mean you ‘saved’ Australia and doesn’t mean that increasing G was a good idea.
johno
1 Dec 12 at 9:44 am
Try it as:
I = S + (T – G) + (M – X)
Investment causes an increase in capital, and is desirable as labour that works with more valuable capital is more highly paid. The reason it is desirable is not because it is a component of demand, that is crazy Keynesian talk.
I like the identity this way, because it outlines the three ways to get investment:
1. Encourage people to save more.
2. Run a government surplus (or reduce the deficit);
3. Borrow or encourage investment from overseas. If one expects this to happen, foreigners will need assurances their money is safe.
2dogs
1 Dec 12 at 9:47 am
One thing that I do not understand in the GDP calculation is how they believe a hurricane can increase GDP. Doesn’t I(nvestment) go down as insurance companies pay out the money that then becomes part of C(onsumption) during rebuilding?
Brian J. Gladish
1 Dec 12 at 10:23 am
BJG; the big issue for me about Gee-Dee-Pee is that it is, as I understand ‘it’, based largely on just one dollar being passed around many times, the sum total of which is taken by some (sum?) to be the total (gross?) of all production that ‘creates’ wealth. It’s not a balance sheet issue, which is what my feeble brain tells me is a more sensible basis upon which to measure the wealth of anything.
amcoz
1 Dec 12 at 10:43 am
there is ‘Famous Figures And Diagrams In Economics’ edited by Blaug and Lloyd with 50+ chapters.
Jim Rose
1 Dec 12 at 11:02 am
Y=C+I+G+(X-M) could be defined as the axiom of central planning, and hence nothing to do with an unhampered market. Little wonder it cannot be explained in words.
Louis Hissink
1 Dec 12 at 11:46 am
JR; don’t-cha just love those graphs, with all the calculus based on differential equations (partial at that), and all the lovely suppositions that might really amount to suppository positions.
amcoz
1 Dec 12 at 11:53 am
Johno – I am seeing “inverse” versions of this also where the argument is “austerity caused GDP to shrink” Well yes if you spend money on say pink batts and you count it as GDP and then you stop spending on pink batts then yep GDP falls. So you see arguments literally in favour of wasting money becuase if we stop wasting money GDP will fall.
kingsley
1 Dec 12 at 5:35 pm
GDP is income. Falling income in a high debt economy is likely to see that economy move further away from equilibrium.
If you want to maintain cash flow in an economy when the credit transmission mechanism is impaired then the government running a deficit is an efficient means of doing so.
sdfc
1 Dec 12 at 6:18 pm
“Falling income in a high debt economy is likely to see that economy move further away from equilibrium.”
What, exactly, is equilibrium, in Keynesian economics? How can one tell whether an economy is in equilibrium or not? Can you identify which periods in Australia’s economic history have been times of equilibrium or disequilibrium?
Using Say’s law, I might describe a lack of equilibrium as unsustainable prices, but Keynesianism does not have the same view of prices.
2dogs
1 Dec 12 at 7:26 pm
I’m referring to full employment equilibrium. Falling prices in a high debt economy will drive an economy further away from full employment. Is that easier for you to understand?
Says Law is essentially long run barter economy analysis. Keynes was a monetary economist. Monetary factors dominate in the short-run.
sdfc
1 Dec 12 at 7:37 pm
“Falling prices” – which prices are you referring to – wages? good and services? Forex basis or PPP?
2dogs
1 Dec 12 at 7:47 pm
I think what you may be saying is “deficits inflate goods and services prices in forex terms”. I am inclined to agree with that, but I note it is very much a short run approach.
But the further implication that this moves the economy towards full employment, would depend on the degree to which the economy is open. Local businesses may have more money to spare, but this is offset by presenting higher prices to foreigners, reducing their demand. In an open economy such as Australia’s, the foreign impact would be more pronounced than the domestic.
The world has also shifted a quite a bit a bit since Keynes’ day, and in general jobs aren’t created in the short run any more – lead times between identifying a new position and getting an employee on the floor are getting quite long. Consequently, the impact of monetary policy on employment is starting to disappear. Its still present, but needs larger measures for longer times to work. Is it really worth it?
2dogs
1 Dec 12 at 8:40 pm
If Y = C+ I + G + NX
and Y = 1735103
Now, G is increased by 10 (through Government spending), and as a result, C falls by 14, so now
Y = 1735099
1735103
1 Dec 12 at 9:03 pm
Two dogs says
“What, exactly, is equilibrium, in Keynesian economics? How can one tell whether an economy is in equilibrium or not?”
Yes Says law says the emphasis is on prices whereas Keynesianism takes a different view. They assume the first person to notice disequilibrium is “the production manager” or the “buyer of stock”. These people see that as a result of recent sales being more or less than planned they either have a shortage of goods to sell or they have too much on their shelves. This is disequilibrium in the Keynesian sense (when the quantity is wrong) ie surpluses or shortages and in some ways it makes sense to me because the guy noticing the buildup of excess surplus stock in the shop or factory, is likely to notice much faster than the guy upstairs who has to reduce the price to clear the surplus.
So its all about the Q in Kenynesian view, rather than the P (which in fact follows from the response to the Q being wrong).
Alice
1 Dec 12 at 9:10 pm
Well done. You got it!
johno
1 Dec 12 at 9:20 pm
Rubbish Johnno
“G increases by 10 and C falls by 14″
Go to the absolute bottom of the class.
That is a total fail. Dismal student of econ.
Alice
1 Dec 12 at 9:24 pm
Johnno
If G increases by 10 then then Y increases by the multiplier X ten and C increases ny the marginal propensity to consume times the Change in Y given mpc = change in C/change in Y.
As Y has clearly gone up and the marginal propensity to consume is a posiitive number between 0 and 1 that is never nedtaive (meaning people would be saving a percentage greater than one hundred percent of what earn from each income receipt)
then you speak utter and complete rubbish. Hasnt got a clue about Keynesian economics.
Alice
1 Dec 12 at 9:32 pm
sdfc says
“Says Law is essentially long run barter economy analysis. Keynes was a monetary economist. Monetary factors dominate in the short-run.”
Since when was keynes a monetary economist sdfc? This is bullshit too. I am shocked at the level of misunderstanding in here.
Keynes at least recognised economies were not always at the long run equilibrium (and I think we have proved that time and time again) unlike Say.
Alice
1 Dec 12 at 9:39 pm
2dogs says
“But the further implication that this moves the economy towards full employment, would depend on the degree to which the economy is open”
Let me just remind you what Keynes said “trade your goods and services, let your people go overseas but keep your banks at home”.
What the fuck did we all do wrong? We let the banks go overseas, kept the people at home, and as for trade in goods and services it accounts for 10% whereas capital flows (the stuff that gambling banks are made of) accounts for 90% of the value of any exchange rate. In short we now have so much volatility in capital flows there are a lot of nations that just cant handle it.
But we made the banks the supremos they have become (destroyers of whole industries and now whole nations) and now they rule us all and can crash us all. We let this happen. We ket one industry with heavy subsidies and lax regulations get too fat. We didnt listen when someone smart was doing the talking and instead listened to a bunch of irresponsible free market mad scientists who got oit all wrong (Friedman, Greenspan, Bernanke, Rubin, Summers and their political dogsbodies / followers / etc).
We did it to ourselves.
Alice
1 Dec 12 at 9:47 pm
Alice
Steve’s initial point was that the terms on the RHS of the identity are not independent. If one changes, it can cause a change in the others. At least that was my interpretation of these sentences in his posting.
1735103 was making the same point. If you have a problem with his example, take it up with him.
I know enough about Keynesian economics to know it is largely crap.
johno
1 Dec 12 at 9:49 pm
Im done here. Im going to bed. I am surrounded by people who speak utter garbage and I am truly disgusted.
Alice
1 Dec 12 at 9:49 pm
Thanks for posting this Alice. I didn’t realise you were a complete nutter.
johno
1 Dec 12 at 9:52 pm
Johnno
I hate to inform you but you are the nutter
Alice
1 Dec 12 at 9:56 pm
The phrase “Alice in Wonderland” comes to mind……..
Louis Hissink
1 Dec 12 at 10:06 pm
Well Johnno
You may raise one valid point here after all
Exactly what percentahe of an individuals consumption is on imports
ie M rises when Y rises – you have that correct.
If we take the United States for example – they freed their entrepreneurs to go where they likes with bank financing of course to anywhere in the globe and most US producers along with their banks pissed off to whereever they could get cheap labour and tax free status. Then they started yelling at US wrkers to “get more productive” (read get as cheap as other nations).
End result is US consumption falls, because the Y falls and also because a large part of what used to be produced in the US for the US is now offshored.
Yes, Johnno you are quite right. Imports do matter and they do drain a domestic producing country – so much so that Mr Ben Bernanke has with a flick of his pen airbrushed imports out of the C+I+G+X-M in his latest textbook for undergrad US students.
ie the – M is gone completely.
What an arrogant bastard. He thinks if he makes the problem of imports disappear in his uundergrad textbook no new US student undergard student will realise the US is sliding (has slid) into an import sinkhole it cant get out of.
But the elite producers (US) have never been happier or jollier. Labour is so cheap offshore and well tax is a thing of the past. Hence the rising inequality in the US, A few are doing just hunky dory dandy while the majority are seeing nothing from it and dong worse because of it.
Alice
1 Dec 12 at 10:08 pm
Yep. Previous hunch has been confirmed.
Night night Alice. A good nights sleep is what you need.
johno
1 Dec 12 at 10:14 pm
Alice, the blokes up top are never in the position of wondering what to do with their excess stock – you always make sure that whatever you produce or manufacture is pre-purchased. The exception is in the totally entrepreneurial case when no one else is producing something specific that then involves producing stuff that has yet to find a market.
Case in point – electric toilets, where human effluent has to be disposed of efficiently, safely and cheaply. No one in Australia has developed such a dunny but the Americans have – but the dopey Aussie entrepreneurs are so risk averse that they will only import the dunnys when they have orders for a container-full.
Buy one in OZ? Not on your sweet nelly.
You write rubbish here.
Louis Hissink
1 Dec 12 at 10:28 pm
Louis
So you think there are no Australian entrepreneurs Louis – is that what you are saying?
Maybe you can look to Aussie banks who will only lend to a new entrepreneur (preferring to sink the weight of heir excess funds into sharemarket movements – and dont tell me they dont – they are like a pack of sheep – when the Aussie has a container full of dunnies to import?
I dont write rubbish but you could be mistaken for thinking all entrepreneurs are born and bred in the US. They do have a bigger market but they are killing it fast.
You talk rubbish yourself. Every entrepreneur needs a market but the current crop of US entrepreneurs arent much either. They are cannibalising their own markets and each other in a race to the bottom (because they have been given the go ahead regulation wise or should I say deregulation wise to do so by stupid governments and stupid economic policies). This sort of entrepreneurialism doesnt actually deliver better stuff, just cheaper nastier stuff. Is that real entrepreneurialism?
You speak crap yourself Louis.
Alice
1 Dec 12 at 10:48 pm
I totally disgree with this post
“My point proved in two different directions, that using diagrams stops people from understanding the logic of the economics and that Keynesian economics cannot be defended and explained in words.”
The diagrams are simply an easy way to uinderstand the underlyin maths which explains the underlying theory which can only be expressed in words (or mmaths etc) and any student who just tells their lecturer which way the curve shifts should be failed because they dont understand how and why the economy responds and what is underneath the diagrams (which is the maths and the theory) and ipso facto they cannot understand the theory of the model without the mathematics and in simply saying how the curve eg shifts they are missing how and why economies respond to disequilibriums.
Whoever wrote this post also should fail econ.
Alice
1 Dec 12 at 10:59 pm
And furthermore Keynesian economics can be explained in words and has been since 1936. What cant be adequately explained is the bastardisation of keynesian theory that came out of the Chicago School who couldnt even write a decent theory (unless you think the hapless EMH is a good theiry).
Alice
1 Dec 12 at 11:02 pm
Hi Alice.
The question is about the equilibrium model.
If demand is down and G government goes up then where does I investment go? Is it crowded out by G or has it already been crowded out by demand (don’t recall the letter for it) during the boom which caused the recession?
Or is it likely malinvestment by the government caused the recession meaning I is to hell in a handbasket anyway?
DaveF
1 Dec 12 at 11:23 pm
C is demand, I knew it was non obvious.
DaveF
1 Dec 12 at 11:24 pm
Wait, Alice is touting economic orthodoxy and bemoaning globalisation? At the same time???
wreckage
1 Dec 12 at 11:50 pm
No, no my friend, Alice does not do that.
DaveF
2 Dec 12 at 12:07 am
No, she touts mainstream economic theory, plus regulation, plus isolationism.
Dear merciful God, please make the illiteracy stop.
wreckage
2 Dec 12 at 1:03 am
Alice – the MPC is not necessarily > 0. In fact, if delta G > 0 then almost certainly delta C < 0. That is, if government spending increase, it is generally more than offset by a reduction in C and/or I.
1735103
2 Dec 12 at 2:46 am
Spuds
You’re an expert in economic equations now? How interesting.
JC
2 Dec 12 at 2:53 am
Alice, the explanation of equilibirum you gave at 9:10 pm is more in tune with what Keynesians usually say than the explanation given by sdfc at 7:37 pm.
It’s still a bizarre concept, though, so I need to repeat to you the second part of my question to sdfc:
How can one tell whether an economy [in general, as a whole] is in equilibrium or not? Can you identify which periods in Australia’s economic history have been times of equilibrium or disequilibrium?
2dogs
2 Dec 12 at 8:23 am
Also, in your answer, please keep in mind that the “multiplier” mechanism you referred to at 9:32 pm depends on the Keynesian equilibrium concept.
2dogs
2 Dec 12 at 8:29 am
Davef – no I dont do that LOL tout orthodoxy and globalisation in the same breath because we all now the old orthodoxy aint what she used to be – there has been way too many unorthodxies running the show and making a mess. As for Bernanke rewriting economics to make imports disappear from consciousness to suit his banking mates – well thats just what happens when the unorthodoxies take pver with their hair brained schemes for running the show.
What a stooge he is!
All I said is I agree with ” keep the damn banks at home” and seeing as its before breakfast and Im hungry some industries could do with a bit of protection here also. This free trade nonsense was always going to be a recipe for some countries to screw others and we all sit back and let that happen to our (rich) country – then we are a bunch of naive idiots and what will we have to offer the global economy?.
Who exactly is orthodox around here anyway?.
Im thinking quite a few of you are decidely unorthodox.
Alice
2 Dec 12 at 9:21 am
2dogs
I know this is getting off the track a bit, but using the concept of an economy in equilibrium, whether a Keynesian marco (full employment) equilibrium or a mainstream micro (general) equilibrium, is where most of the crook thinking in economics starts.
Real world economies are too dynamic to ever be ‘in equilibrium’. Using the idea of an ‘equilibrium’ might be useful in assisting to understand how real world economies work, but a good economist will know when to move beyond this simplistic idea and start to tackle the really difficult task of understanding the operations of complex social phenomena like real world markets.
johno
2 Dec 12 at 9:24 am
2dogs
asks me
” Can you identify which periods in Australia’s economic history have been times of equilibrium or disequilibrium?”
Yeah I can. When there are rows of shops with for lease signs up. When the nomadic cash sale outlets are more visible when the construction industry is doing it tough (like now) When the for sale signs are up relatively more in the wealthy suburbs….
Conversely – the old story – (go back to the mid late 90s when every person and their dog was pushing up real estate prices, buying doing up and flicking, every dinner party people were gloating that their share funds were makiing 20% year after year,
I think you can tell when there is a a divergence from disequilibrium and but cant tell by listening to the central bank or governments or their numbers (because they lie).
Alice
2 Dec 12 at 9:34 am
Dave f asks (this is really too much econ before breakfast. It will ruin my digestion and the day Im sure).
“If demand is down and G government goes up then where does I investment go? Is it crowded out by G or has it already been crowded out by demand (don’t recall the letter for it) during the boom which caused the recession?
Or is it likely malinvestment by the government caused the recession meaning I is to hell in a handbasket anyway?
The way I see that issue of crowding out is that G is used as a kick start for a cold engine until the engine takes over of its own accord. Why whinge about a rise in Y (caused by a rise in G) if that leads to both C and S up. This whole argument about the shares of G/Y and I/Y is a furphy as long as the G/Y isnt so huge it takes over because there are clearly times when the I/Y is weak and that can drag the whole joint dowm. To deny us another method to fix it is just crazy by constraining the G.
Put it this way if Y rises ten percent and crowding out is only say 8% of that rise why bitch about it? More people will have jobs and more jobs means more spending and Id be in favour of pushing a bit of that spending back to the hands of beleagured households.
Chinese Government spending isnt exactly hampering their growth is it? Its only that we chose to follow the lunatics in the US that want to dump the G completely (good luck with that one) that sees us behaving in the same silly fashion.
No-one wants a large G but no-one wants no G at all. Take your pick (or maybe some in here do want no G at all?)
I know all you lot like lowering T but G has a function in that it can deliver large useful projects. Using T only sends people down to the mall pretty quick (but does its effect last?) and that doesnt get us better infrastructure.
Im not so sure whether I believe malinvestment by governments causes recession but I do beleive malinvestment in the financial sector is a sure sign that the economy needs to have its temperature taken.
Alice
2 Dec 12 at 9:51 am
ie 8% of 10% above
Alice
2 Dec 12 at 9:52 am
Alice, if these are disequilibirum states then:
1. There is no multiplier effect; and,
2. Keynesianism is false.
With Keynes, the rows of empty shops situation is an equilibrium state. This equilibrium, as Keynes saw it, meant that the market would not solve the problem itself, and the government had to intervene to get the economy moving again. According to Keynes, this would create a new equilibrium point at a higher level of production than the rows of empty shops case.
But if, as you say, the rows of empty shops indicate disequilibrium, the problem should solve itself – as is generally said by classical economists, prices, high or low, are the solution to problems which cause them.
And so, welcome! With this first admission, you are now on your way to understanding classical economics.
2dogs
2 Dec 12 at 10:16 am
The problem with Keynes is that he treats all his components as if they are in a straight linear relationship, both to the other variables and to the whole. But what we know from non linear dynamics is that small changes can be amplified into very large effects.
Any non linear, complex and dynamic system needs a mix of positive feedback and negative feedback. Unchecked positive feedback leads to explosive growth and chaos. Unchecked negative feedback leads to a system so rigid it can no longer survive in it’s environment.
In terms of the economy the positive feedback is from the private sector because positive feedback is largely based on reward. Negative feedback is largely from the government and is based on punishment. There needs to be a mix of +ve and -ve feedback, but there must be a bias to +ve feedback, or the private sector, in order to continue to grow and create wealth.
When -ve feedback is too strong the economy stagnates and growth slows. This is why a growing public sector, or G, is almost always bad. Europe and California are salient examples of what happens when there is strong growth in G, with its ever expanding complexity, regulations and punishments.
This theory lends itself to mathematical proof and diagrams for the Keynesian lovers of pictures and numbers.
John Comnenus
2 Dec 12 at 11:01 am
2 dogs
I whpuldnt be posting here but like a magnet I am drawn back
I liked this comment of yours very much
“But if, as you say, the rows of empty shops indicate disequilibrium, the problem should solve itself – as is generally said by classical economists, prices, high or low, are the solution to problems which cause them.
And so, welcome! With this first admission, you are now on your way to understanding classical economics.
I understand clearly what you say and yes that is part of recovery 2 dogs – except that I think you misunderstand also…I do not believe Keynes ever suggested leaping in at every opportunity into every disequilibrium with an intervention…as I understand Keynes spoke from the deep heart of the great depression (whereas other famous economists were living in the great times of the 50s / 60s post war boom..- never discount the age when a famous economist lived!!
and didnt he suggest something along the lines …if we waited too long for markets or prices to do their work, the wait time can do further damage..in some (only some) circumstances??
I believe he summed up that situation with his most famous comment.
Alice
2 Dec 12 at 11:04 pm
“I understand Keynes spoke from the deep heart of the great depression”
Keynes saw the great depression as an equilibrium point.
You are saying this is a disequilibirum point (or are you, you appear a bit vague on this matter?).
2dogs
3 Dec 12 at 4:55 am
Not at all 2dogs – Keynes did see it as an equilibrium far below long run and therefore it was one price wasnt solving at all given its duration. Its ironic really – just as in the 1970s the classicals or the latest incarnation accused Keynes of not being able to solve the problem of rising inflation and rising unemployment simultaenously, in the 30s Keynes accused the classicals of failing to solve this deep depression and its high unemployment which frankly according to classical theory apparently cant exist for long (but we all know that is not true dont we? especially as Sinc and I both despise we are being asked to swallow higher and higher levels of NAIRU..
Now if only the two sides of econ both could find an equilibrium in argument we might not lurch from one ego to another ego’s plans for economic nirvana eh?
Get off this thread 2 dogs. Its old now like me.
Alice
3 Dec 12 at 4:09 pm