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Wednesday, November 21, 2012

If This Is a Consumption-Based Theory of the Business Cycle...

So, I'm teaching Keynesian economics for the second time. And once again, I'm telling my students that, per Keynesians, recessions occur when intended investment falls short of savings. And the best way to fix this, per Keynesians, is for the government to invest in roads, bridges, parks, education, etc.

I'm fine with explaining all that. What I can't figure out how to explain is why there are people saying Keynesianism is all about consumption and takes no account of investment.

11 comments:

  1. That's interesting that you mention this, because about a year ago I made a statement on Daniel's blog that savings is not always equal to investment, ex post (of course, it holds true ex ante). I became aware of this after Landsburg gave me a Christmas thrashing (mostly due to a misunderstanding of intentions), which forced me to do a lot of thinking whilst staring at the ceiling. Anyhow, Daniel disagreed with me at the time.

    This whole ex ante/ex post thing came to me as I was running through an ERE experiment, and it occurred to me that the ABCT was highly based on this discrepancy (though, I still will not label ABCT an "over-investment" theory, because there's much more going on). However, it had never occurred to me at the time that Keynesian theory also relies on this discrepancy. Considering the focus on hoarding, I don't know why I didn't think of it. So, thanks for pointing that out.

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    1. Joe it's the other way around: Keynesians say saving has to equal investment ex post. But if they diverge ex ante you can get into trouble.

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    2. Woops! Cognition disequilibrium.

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    3. Since I like to be thorough I looked back and found another error in my comment. Daniel's disagreement was with my saying that I=S is an assumption.

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  2. So Gene, what's a good book for an intro to Keynesianism? At about the level of Hidden Order for micro or Economics for Real People -- but one the author 'still stands behind' :)

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  3. Hi Gene: What I get from pop Keynesianism suggests an AD link at the transmission level. The question is whether I can tease that out into an AD-based explanation of the business cycle itself. Tell me how far off this seems.

    1. "Animal spirits" get low. On the supply side, investors hoard cash rather than, you know, invest. But why would they not invest? Because they're afraid they won't make money and may even lose it. Why wouldn't their investments make money? Because investments aim to create stuff (goods or services) for sale, and if people don't buy enough, that's a problem. That people won't buy enough is inadequate demand by definition. We can squabble about causes in sidebars. And hell, there may be any number of causes.

    2. One of the problems with this shortfall in investment is it reduces employment below what you'd get at maximum potential output. And that means, in the Charlie Pierce formulation, "People got no jobs. People got no money." Which exacerbates the demand problem, which increases rich folks' preference for cash. Vicious cycle, hello!

    3. Government investment is basically a twofer. Because it employs people who wouldn't otherwise be working in the current output gap, it puts money in their pockets, increasing demand. Because demand is now higher, rich folks decide it's worth starting to invest again: their cash preference drops. (There's probably an increase in inflation, maybe as an end to deflation, which will also reduce their demand for cash.)

    4. The preceding point is just a one-fer. You could get that far via Ben Bernanke's helicopter drops or Duncan Black's platinum coins or Keynes's own (fanciful hypothetical) paying people to bury cash that they can then dig up again in turn. The two-fer comes in that public investment gives you useful stuff, including stuff that lasts way beyond the business cycle like Hoover Dam or a high-speed internet grid worthy of the name. And the products of public investment can undergird future private investment etc., but that's - to your point - a supply-side story rather than a demand-side one.

    I'm not sure I've gotten you all the way to what you'd be comfortable thinking of as a demand-side explanation. Let me present the Keynesian view as I understand it, of the Great Recession that began in 2007 and out of which we're still climbing.

    As Duncan Black glosses his views of mid-decade, "I didn't know all the ins and outs of the exotic financial products the investment banks were putting together, but I knew not enough people made the kind of money it took to afford all those houses." On the Keynesian view, increasing income inequality got papered over with credit-driven consumption in the early part of the decade (and longer, but that complicates my story!), but by 2007, consumer credit was tapped out. Consumers started deleveraging where they could and defaulting where they must. This put a hiccup in demand, starting with real estate and spreading through durables to other consumer goods. This led to cash hoarding or massive paper losses among the investor class, which reduced employment, which further depressed demand and slowed deleveraging, which and so on.

    Private investment did start coming back, um, after the stimulus started propping up private employment, but starting in early 2010, "anti-stimulus" in the form of cuts to public employment - especially at the state and local level - depressed demand and has kept output below potential to this day.

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  4. In so far that it's suggested that Keynesiasm doesn't account for investment, I agree. But isn't there something to emphasizing the consumption aspect?

    From what little I know, isn't consumption a big driver of investment in Keynesian Theory? And isn't that theory the main reasoning behind the constant monitoring and appraisal of consumer confidence, consumer spending, etc?

    Contrast this with more of a classical or Austrianesque theory, where an increase in C causes a decrease in I.

    I guess that's why I figured the consumption aspect is emphasized. It's one of the main points on which the theories differ...

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  5. Skim my critique of Fazarri. They Keynesians talk of the "paradox of thrift"--in which extra saving won't automatically lead to increased investment spending and thus is bad--and have an important variable called the marginal propensity to consume.

    Tax cuts are justified in a Keynesian framework not because they spur people to work more, but because households might go spend a bunch of the returned money. In fact that's how tax cuts are gauged in their potency--how much is likely to be spent? (And they often talk in terms of going to the mall or buying a new car, not spending it on starting a new business.)

    I'm not saying it's fair to say Keynesian theory literally is focused only on consumption, but this notion didn't spring forth from Rothbard's brow.

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  6. PetePetePete: "The "consumptionist" interpretation of Keynesianism derives from its fundamental principle that parasitism is a source of enrichment to its victims."

    I only had to read that line to know I should delete the comment. This is a "no idiots" blog, thank you.

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    1. "This is a "no idiots" blog, thank you."

      Wow, I feel honored! :)

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    2. How do you explain my presence? ;)

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