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Just Increase Aggregate Demand!!!

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EmbraceLiberty posted on Sat, Jul 14 2012 10:07 AM

So, I understand why that isn't a solution, but the conept of it makes sense to me. Where is the falacy in the logic of increasing aggregate demand to stimulate the economy? If say for example, some unemployed were hired and paid $8/hour; wouldn't that increase demand which would result in more production and more jobs? Thank-you.

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1. Where is the money coming from to pay these people 8 bucks an hour?

2. Why not give everyone, man. woman and child, all over the world, a million dollars a day, and that will result in more production and more jobs and we will all be rich to boot?

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Also, check out my blog, in particular:

http://smilingdavesblog.blogspot.com/2011/08/myth-of-aggregate-demand.html

http://smilingdavesblog.blogspot.com/2011/08/myth-of-aggregate-demand-part-two.html

 

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Nice blog, Dave.

OP, savings must come first. If there is demand, it does not mean the necessary resources have been saved. When the government "stimulates" the economy with new money, people spend that money (demand has gone up because people have more money), but the amount of goods has not increased, so the prices for the existing goods are bid up. The economy has not grown, no new wealth has been created. New goods do not come into existence by the mere act of creating demand.

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Rcder replied on Sat, Jul 14 2012 2:31 PM

Smiling Dave,

1. I imagine that it would be a result of debt monetization, public loans, or both.

2. A Keynesian would respond that increasing total spending by such a large figure would shift aggregate demand into the perfectly inelastic portion of the short-run aggregate supply curve, resulting in demand-pull inflation as opposed to increases in real gross domestic product.

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Rcder,

1. Yep. Or taxes.

2. I suppose so. They do say there's a difference between an economy humming along at full capacity and one that's got idle resources.

In any case, the blog articles are where my argument, the standard Austrian one, I think, is laid out.

My humble blog

It's easy to refute an argument if you first misrepresent it. William Keizer

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Rcder replied on Sat, Jul 14 2012 2:53 PM

OP, savings must come first. If there is demand, it does not mean the necessary resources have been saved. When the government "stimulates" the economy with new money, people spend that money (demand has gone up because people have more money), but the amount of goods has not increased, so the prices for the existing goods are bid up. The economy has not grown, no new wealth has been created. New goods do not come into existence by the mere act of creating demand.

I figure I might as well play advocatus diaboli today, so I'm going to put on my new Keynesian hat (get it?) to try and answer your questions like, say, Paul Krugman or Joseph Stiglitz would.

As a result of nominal factors in the economy being "sticky" in the short run a fall in demand for a factor will not result in lower unit costs but will instead only increase unemployment (thus the short-run "L-shaped supply curve").  As a result, not only will a fall in demand increase unemployment of land, labor, and capital, it will also cause a further fall in aggregate demand because total payrolls have fallen as a result; if a wage is "sticky" at, say, $5 and the quantity employed at that price is 4, but then demand falls for the factor such that quantity employed is now 2 then total payroll has declined from $20 to $10, resulting in an amplified fall in aggregate demand.  While it is conceivably true that a fall in the price of a factor will result in a higher total payroll as a result of a movement across an elastic portion of the demand curve for said factor (Lionel Robbins hypothesized just this in The Great Depression) this is extremely unlikely to occur in reality due to individuals in the economy focussing their efforts primarily on the height of their nominal incomes as opposed to real incomes.  Moreover, we now see that the real cash balance effect will not occur because prices will remain just as high or nearly as high as they were prior to the economic downturn (this is sometimes described as a "shortage of money" or an "excess demand for money"). 

As a result, an expansion in total spending as a result of an increase in the monetary base will not engender high levels of inflation because the demand for various factors and goods and services across the economy will shift to the right along a perfectly elastic portion of their supply curve (see above).  While it is conceivable that we may overshoot our target of potential real gross domestic product (calculated by Okun's law) and cause minor levels of demand-pull inflation this can always be handled by a minor contractionary fiscal/monetary policy.  What is more likely to occur is the employment of previously idle resources.  While we New Keynesians certainly recognize that nominal factors in the economy may cease to be so rigid as time marches on, the loss in real gross domestic product caused by a "do nothing policy" or worse, a contractionary policy (this will simply increase unemployment further) is simply unacceptable. 

Take that, Austerians! 

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Rcder replied on Sat, Jul 14 2012 2:58 PM

1. Yep. Or taxes.

To my knowledge most Keynesians would shy away from taxation, presumably because it can have the adverse effect of lowering business expectations and increasing consumer anxiety.

2. I suppose so. They do say there's a difference between an economy humming along at full capacity and one that's got idle resources.

Right.  Unemployment below 4-5% causes "tightness" in the labor market which results in higher levels of inflation as opposed to increasing returns in terms of RGDP.

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EmbraceLiberty:
So, I understand why that isn't a solution, but the conept of it makes sense to me. Where is the falacy in the logic of increasing aggregate demand to stimulate the economy?

How can you "understand why that isn't a solution" if you can't see the fallacy of logic?

 

Not to mention, haven't we been through this?  Twice?  Did you not tell me a month ago you understood?...

Why Doesn't Stimulus Work?

The Multiplier Effect

 

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Rcder replied on Sat, Jul 14 2012 3:30 PM

John James,

Thanks for the links on EMH and RE, by the way; both of those concepts were familiar to me so I don't know why I was so off the mark on that other thread!

In regards to EmbracingLiberty, I think he may be getting tripped on the fact that Keynesians consider government expenditures "investment" because it is an "unstable" function of national income as opposed to consumption which is "stable". 

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Rcder:
John James,

Thanks for the links on EMH and RE, by the way; both of those concepts were familiar to me so I don't know why I was so off the mark on that other thread!

Sure fooled me..."My knowledge of the efficient market hypothesis is sketchy" wink

 

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Rcder replied on Sat, Jul 14 2012 4:05 PM

John James,

Har har.  What I meant (and this is still true) is that my knowledge of the two subjects isn't very thorough.  After re-reading what I posted on that thread, my brain fart wasn't that far off the mark; rational expectations does state that, on average, expectation errors will be zero (they will include all "relevant information").  So to use Wheylous's example, you "beating the market" by posting the low content threads earlier would just be written off as an anomaly (or as I put it ham-fistedly, an "outlier") which when averaged together with other Mises.org members would equal the value of the threads themselves (assuming "strong EMH"). 

 

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