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Macro Theory:
Will Say’s Law Trump the
Keynesian Revolution?
Dr. D. Foster – ECO 285 – Spring 2014
Extreme Version of Keynesian Theory
P
Wages & Prices are
perfectly inflexible when
AD falls.
ASLR
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.”
AD1
AD2
Q1
Q*
Solution is to raise AD by
G (or T or TP).
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.
 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
2009-2013 = $6 tr. = 35% of GDP
 Unemployment rate = 6.6%
(Or, higher if others included and calculations constant.)
 GDP growth sluggish.
2%-3% since 2009; 2013 Q4 rev.  to 2.4%.
 And, the Fed is still money.
Our next story, after the exam.
 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?
Business
HH
Gross private, net private & net gov’t saving.
Total
Private
Gov’t
Net savings as a percent of GDP.
Personal Saving Rate; 1960 - 2013
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 – fed’l regulators 35% since 2006, >300 tax
provisions expired in last 5 years…
Macro Theory:
Will Say’s Law Trump the
Keynesian Revolution?
Dr. D. Foster – ECO 285 – Spring 2014