Will Say’s Law Trump the Keynesian Revolution? Macro Theory: Will Say’s Law Trump the Keynesian Revolution? Dr. D. Foster – ECO 285 – Macroeconomics

Extreme Version of Keynesian Theory Wages & Prices are perfectly inflexible when AD falls. A lack of “animal spirits” results in a fall in AD, overproduction and a sharp recession. AS may never correct for this problem and the economy comes to rest with an “unemployment equilibrium.” Solution is to raise AD by G (or T or TP). P ASLR Q* Q1 AD2 AD1 Q or R-GDP

So, What’s Wrong with this Story? It violates Say’s Law: “One’s ability to demand goods and services from others derives from the income produced by one’s own acts of production. Wealth is created by production not by consumption.” There can’t be a glut of all goods! Recessions show that we are producing the wrong mix of goods (producer error). Prices can clear all markets! Note: Say’s Law is not supply creates its own demand.

Say’s Law – Simple Version Goods are only supplied because they are demanded!!!

Say’s Law in Action Supply Demand

Say’s Law – From Beginning to End of the Process I want something! To get it, I must produce something of value to others! So, I produce something. I sell this in the market for money. I take the money and buy the stuff I want. End of story ... ? No, repeat over and over and over and …

What Keynes Says. We are making too much stuff; of everything! (But, how is that possible? We do live in a world of scarcity!) It must be that people don’t have enough money to buy all this stuff! (As opposed to the idea that we are making the wrong stuff!) So, let’s just give people money! (Even if it is just to dig holes and fill them back in again.) This will restore full employment. (And, we’ll still be producing the wrong stuff!) End of story ... ? No! We must repeat over and over and over …

Has Keynesian Policy Worked? ARRA of 2009 - $800 billion Budget deficits 5% - 10% of GDP 2008-2015 = $7.15 tr. = 40% of current year GDP Unemployment rate = 4.9% (Or, higher if others included and calculations constant.) GDP growth sluggish. 2.05% ave. ann. growth since 2009; 2016 Q2 1.4% And, the Fed is still money. The promise of Keynesian Theory: Business Cycles are History!

Is the economy really even growing at all?

What’s the Deal with Saving? Keynes: ** It has a negative effect on the economy. (Contemporary Keynesians don’t hold this extreme view.) ** It isn’t necessarily channeled into investment. ** What we need is more spending, not more saving. (Contemporary Keynesians do hold this view.) Say: ** You can’t have economic growth w/out capital. ** You can’t have capital without investment. ** You can’t have investment without saving. ** Because of producer error we need to re-direct resources. ** To encourage capital formation, we need more saving. ** There is automatic adjustment during recession – more saving will lead to more production.

Who saves more – households or businesses? HH

Gross private, net private & net gov’t saving. Total Private Gov’t

Net savings as a percent of GDP.

Personal Saving Rate; 1960 - 2016

What about the Great Depression/Recession? Keynes: Given severity of unemployment, proves overproduction cause. Collapse of investment proves saving is futile. Given length, proves that adjustment isn’t automatic. Tepid improvement indicates that more needed to be done. Rapid “improvement” during/after WWII proves prescription. Say/Higgs: That markets can’t clear is sign of government intervention. Existence of unions & gov’t price fixing policies worsen outcome. Long run economic health = f(saving, investment, capital) Collapse of investment is due to “regime uncertainty.” ** It’s not negative changes, but uncertain changes! ** 2012 – federal regulators 35% since 2006. ** 2007-2010 more than 300 tax provisions expired.

Will Say’s Law Trump the Keynesian Revolution? Macro Theory: Will Say’s Law Trump the Keynesian Revolution? Dr. D. Foster – ECO 285 – Macroeconomics