Decore la Casa con Macrofantasías

It’s been a fascinating discussion on the History of Economics website over John Papola’s video on Say’s Law. It’s up near 90,000 hits in less than a week and I suspect by mid next year, Christmas theme or not, around 90% of the economists in the English speaking world will have seen it. This one is the subtitled Spanish version just for variety. But I thought I would share this post of mine in answer to a previous posting by David Colander dealing with these macroeconomic follies. I think this is self-explanatory in that you can work out what David must have said for me to have replied in the ways I did.

I am really grateful for David Colander’s intervention. I am too well aware that such discussion threads can be a time of sabre cuts and bloodletting. And I am particularly grateful where he wrote:

What became known as Say’s Law was simply an argument that some people’s argument against too little demand being the cause of recessions was too simple–that real demand is tied to real supply [my bolding].

That is so far from “supply creates its own demand” as to be almost unrecognisable as a statement of what the majority of the profession now believes Say’s Law to mean. We could refine the words but in the end what David has written is near enough identical to the classical statement “demand is constituted by supply”. It may even be somewhat of an improvement since it adds the word “real” on both the demand side and the supply side which was always understood when these issues were discussed.

But it is policy that matters which is why The General Theory was written. And here David writes:

[Keynes] devised a new framework–it said that sometimes economies could get out of kilter so much so that even if the long run classical model is correct, that is irrelevant because the adjustment is too slow for the political structure.

In this interpretation, Keynes accepts that real demand is constituted by real supply but the process is too slow so needs a bit of help. If that is what he had said, then The General Theory would have been entirely within the classical tradition. But unfortunately it’s not what Keynes meant or even what he said. But irrespective of what Keynes did or did not actually mean, Keynesian economics is now embodied in the expression Y=C+I+G.

If Keynes had accepted the constraints imposed by Say’s Law and the classical theory of the cycle, then he would have argued that public spending should be on productive value adding forms of output and budget deficits should be avoided at all costs. But that was not the message of The General Theory. Here is one of Keynes’s most famous passages which has been taught to students for generations and which is highlighted because it underscores how wrong-headed classical economists supposedly were. Notice that it is “loan expenditure” that Keynes is advocating which implies spending in excess of tax receipts:

The above reasoning shows how ‘wasteful’ loan expenditure may nevertheless enrich the community on balance. Pyramid-building, earthquakes, even wars may serve to increase wealth, if the education of our statesmen on the principles of the classical economics stands in the way of anything better. . . .

If the Treasury were to fill old bottles with banknotes, bury them at suitable depths in disused coalmines which are then filled up to the surface with town rubbish, and leave it to private enterprise on well-tried principles of laissez-faire to dig the notes up again (the right to do so being obtained, of course, by tendering for leases of the note-bearing territory), there need be no more unemployment and, with the help of the repercussions, the real income of the community, and its capital wealth also, would probably become a good deal greater than it actually is. It would, indeed, be more sensible to build houses and the like; but if there are political and practical difficulties in the way of this, the above would be better than nothing. (p. 129)

If one understood Say’s Law as it was understood by the classics, rather than such valueless expenditure being “better than nothing” it would have been seen as disastrous, shifting resources away from self-sustaining productive activities and into cul-de-sacs that would make recovery even more difficult to achieve because even more of the nation’s resources were being used in unproductive non-value-adding activities.

Say’s Law – the Law of Markets – is not, in my view, a long-run principle. It applies at every moment and in every economy. You cannot make an economy grow through wasteful expenditure. Where activities that do not return enough to cover costs take place economic forces are set in motion to restructure activity, unless the activity is being pushed by governments.

The idea that anyone even thinks it’s possible to increase economic growth and employment through wasteful expenditure, never mind it being the majority of the economics profession who hold this belief, would have seemed fantastic to those classical economists who were brought up on Say’s Law. But there we have it. Because of Keynes, this is where we now are. How we will ever get out of this intellectual dead end I have no idea but that is what needs to happen if the advice economists provide during recessions is to be of any use at all.

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8 Responses to Decore la Casa con Macrofantasías

  1. Biota

    As a distant observer of these economic debates it never ceases to amaze me how so many can argue that the laws of simple arithmetic don’t apply to macroeconomics. Keynes seemed to invent 2+2≈10 which is so appealing that it has overwhelmed common sense.

  2. Pedro

    Well, to play the devil’s advocate, think there are some propositions you can advance that support aspects of keynes ideas.

    First, when the recession bites there is a real risk of uncreative destruction and govt spending/action can potentially reduce that.

    Second, in the quote, keynes says that any activity is better than none and I think there is a case to be made that activity is more likely to lead to real production than is enforced indolence and the increase in velocity will have benefits.

    But despite what Krugman sometimes says, I don’t think anyone is arguing for pure GT policies. My problem with the keynesian claims is that the focus on increasing AD and claims about multipliers dont seem to address the real requirements for a recovery, which is that sustainable and desired supply is the key.

  3. Pingback: Macro Follies continue – “demand creates its own supply” at Catallaxy Files

  4. Andrew Reynolds

    Pedro,
    The problem is that the “any activity” part means that the resources are then being used in that “any activity” rather than being redirected to productive activity by the price incentives.
    That “any activity” then at best delays the recovery as well as destroying value.

  5. Skuter

    Second, in the quote, keynes says that any activity is better than none and I think there is a case to be made that activity is more likely to lead to real production than is enforced indolence and the increase in velocity will have benefits.

    Why would you think that? Unproductive activity that is created by government spending (either through direct purchases of consumption goods or doling out money to individuals with the intention of them increasing their own purchases of consumption goods) is activity that would not have occurred otherwise and will cease unless there is a continual flow of taxpayers’ money (or borrowings). Likewise, projects or consumption that become viable due to low interest rates will not be sustained unless interest rates stay low. Unproductive activity is unsustainable. Any gains to employment will be temporary and after the fact, we are left with a depleted stock of capital and resources. Thus unproductive activity leaves society worse off. The Keynesian model applied to the real world is the slow road to hell, where we either create a bigger downturn in future or we face a future with ever greater government interference in the economy.

  6. Pedro

    Andrew, I think its clear from the context that the any activity is in place of no activity as compared to alternative real activity. And prices are sticky.

    Skuter, the essence of the argument is that people on benefits don’t move to productive jobs as easily as people in existing jobs, even unproductive ones.

    “Likewise, projects or consumption that become viable due to low interest rates will not be sustained unless interest rates stay low.”

    Which is of course not true. The projects that start in a low interest environment and would not have started otherwise can easily continue in a higher interest environment. Projects and the surrounding economy are not static. People take risks.

  7. .

    And prices are sticky.

    Really?

    We have an exchange rate that is constantly fluctuating, previously we had a currency which had a base (gold) which appreciated against all other goods.

    Even if prices are sticky, do they stop markets clearing?

    Which prices? Are they mandated from Government?

    Even if say the labour market has a high, artificial price, although not perfect, prices and quantity of goods and services supplied will adjust elsewhere.

  8. Pedro

    Mark, do you disagree that prices are sticky? Even base consumer goods won’t plummet to clear a market. I’m sure the hardest nosed classical will agree that recessions are not instantly cured by the adjustment of prices to market clearing levels.

    My view is that govt and RB policy should be set to allow markets to work and you will notice that I didn’t identify as a keynesian. I merely say that govt action seems easier to justify at the start of a recession to cushion the fall and that in a serious depression, getting the masses of unemployed doing something could well be a better policy than leaving them to do nothing.

    It is obviously a nonsense that building roads (say) is better than burying money but keynes did not say otherwise.

    There’s a lot wrong with the GT, so nobody needs to build straw men on top of it.

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