ECON 334 - Keynes
Relationship between real and nominal wages
-Move in same direction within a given industry -But real and nominal wages move is opposite directions with respect to general wage levels -Decreasing nominal wage and increasing real wage each tend to accompany unemployment -Labour is more willing to accept lower nominal wage when employment is falling -Real wage increases since marginal return to a given capital investment increases with lower output and lower output is a consequence of less employment
I Two classical postulates (see chart): i. The wage is equal to the marginal product of labour. (You are always on the demand curve for labour.) ii. The utility of the wage when a given volume of labour is employed is equal to the marginal disutility of that amount of employment.
1) ACCEPTS. Keynes accepts the first classical postulate that the demand for labor is the MP curve and he argues that you are never off that curve. Employers are always able to fire people if wages go to high and you can't afford it (not true by law that employers are always on demand curve). 2) WRONG. The problem comes that labor is NOT always on disutility curve. Given economic conditions if you want a job you have to accept lower wages and if you don't its your fault (voluntary). Argument was you have unrealistic expectations about wages (they would say its workers fault.) Keyes argues: Workers understand this, but they can't lower their real wages (nominal wages divided by price level). ***Why? You can take a reduction in nominal wage that doesn't translate into reduction in real wages. ***When all of labor is trying to do this (lower going wage) at same time (in 1930s this was happening.) If everyone lowers nominal wage what happens to the price level? What is principle cost of production is labor. If I am an employer and trying to decide what I sell my product for? I have to lower my price because of competition. So workers do what classical economists say, they accept a reduction, but do they get the effect they want a reduction in real wages? NO, because the price level has fallen. Ex. If econ profs cut nominal wages it will also change real wages because it doesn't change the price level because so insignificant to Canadian economy. But in 1930 it is significant. CPI will come down. Graph: So Keynes argues if you are up here and you slash your nominal wages nothing happens. Prices fall and you slide back up the curve. You cant assume that these people are going to be able to choose any point on the disutility of labor. (only if insignificant market).
How post-2008 does Keynes' analysis of Wall Street seem?
Accurate. He is complaining that capital markets are too sophisticated for their own good and this is 1935. He notes: Confidence of lending institutions in borrowers o Weakening of either investor or creditor confidence can generate collapse in equity prices, but revival requires both
What determines the level of investment? How does money have real effects on the economy (as opposed to the classical view, supposedly, that it has only nominal effects)?
Amount of current investment depends on inducement to invest, which depends on relation between marginal efficiency of capital and interest rates Connection to other chapters: Money is key because interest rate effects investment. But maybe not...animal spirits...? Fundamentally what keeps people doing that is not cold calculation but basic optimism.
What does Keynes think of the stock market?
Basically, he is complaining that capital markets are too sophisticated for their own good and this is 1935. Capital markets are very sophisticated. Keynes doesn't think they are of much use and might be dangerous why: -There are a lot of people chasing the market, not interested in is this a good product. They are interested in is it going to sell at a good price. -What they are interested in is what is the share price of a good firm. -Share price has a lot to do with what do other people think of the firm (has a little bit to do whether it is a good product but not completely about that). -They care about what other people think of the product/share, not whether or not is actually a good product. Self-Reflective Market: Keynes argues you have this sort of self reflective market. They are not interested in fundamental analysis (Benjamin Graham - his student was Warren Buffet). Keynes argues: -You want your investors to be interested in enterprise (like buffet) but you don't want them to be speculators (a little bit is ok). -He argues in 1936 speculators are taking over so the stock market is NOT a good indicator of what is and what is not a good investment. -Keynes argues it is easier to fail conventionally then to succeed unconventionally. Talking about behavior, psychology, how crowds behave, is this economics? Well now yes - behavioral economics. Keynes thoughts on the past (changes in liquidity): -In 1800s it didn't work this way he says - there were not these capital markets. -It was all fundamental investing and its not liquid (factory) so you are tied to it. Unlike capital markets (lots of liquidity) -People investing in capital markets don't know how to run factories - the people who are running things have no idea how the things they are investing in work. -Liquidity is a great thing - but downside is you are not tied down to your investments. Good and bad thing.
How helpful are organized investment markets? Are most investors Warren Buffets?
Buffet - Coke, it rots your teeth but people love it. He doesn't care about fundamental value, just what other people think about it. This is what Keynes doesn't like and thinks is dangerous. BUT also Keynes argues you want your investors to be interested in enterprise (like buffet) but you don't want them to be speculators (a little bit is ok). Note: Speculation is not problematic in and of itself, but becomes so when enterprise investments are based on speculative investments - leads to bubbles
Marginal propensities & multipliers
Changes in consumption are generally in the same direction though smaller than changes in rate of income. -Increase (or decrease) in investment rate brings increase (or decrease) in rate of consumption by increasing (or decreasing) income MPC = change in consumption/change in income Multiplier = change in investment/change in aggregate income = 1/(1-MPC) Change in employment can be inferred from change in investment if employment multiplier and investment multiplier are assumed to be equal -But change in employment is also liable to changes -Value of output will rise with increase in employment, even if wage unit is unchanged -Wage-unit itself will rise as employment increases, therefore increase in price of output will accompany rise in output due to increasing labour costs.
Demand and supply produce equilibrium in the labour market and w = marginal disutility of labour.
Classical Theory which Keynes disagrees with. Employers will always be on MP of labor curve (demand). But labor not always on disutility of labor curve.
Characteristics of the special case "not those of the economic society which we actually live..." solecism (fn. 1): "a grammatical mistake in speech or writing: a breach of good manners; a piece of incorrect behaviour"
Classical theory only applies under certain circumstances, which tend not to be the circumstances of actual society.
What happens if you're at less than equilibrium? What would the classical economists say? According to Keynes, why can't you get back to equilibrium/optimum employment? How can you get stuck there?
Classical: workers lower the wage you are willing to work at. Workers fault. Keynes: They can't, because when they try to lower real wages, they are also lowering the price level and thus their real wages are not changing.It's not the workers fault. PROOF: You will see inflation that takes place and workers don't renegotiate because it's a mechanism by which the real wage can be lowered which will increase possibility of employment. So workers don't always oppose this.
What role do "animal spirits" play in investment?
Connection to investment: Maybe in the end all of this financial stuff is not crucial because given our inability to see the future what makes us optimistic about the future are animal spirits he argues. The thing about animal spirits is how do you control them (probably with drugs more than monetary policy). Doesn't really seem to lend itself too much to economic analysis (confidence) DETAILS: Vitality of investment requires action based on spontaneous animal spirit rather than calculation of expected profits. -Reasonable calculation must be supplemented by animal spirits so that fears of loss are de-emphasized -Implies that economic prosperity is dependent on political and social environment favourable to business men, one that encourages spontaneous optimism (ie. election of high-tax labour party weakens confidence, or Trump) Great Depression: If Keynesian policy had be adopted during great depression might have had negative effects on economy (a stimulus package) because at that time had never been done, would have thought it was "communism" etc...
[T]he volume of employment in equilibrium depends on (i) the aggregate supply function, f, (ii) the propensity to consume, c, and (iii) the volume of investment, D2. This is the essence of the General Theory of Employment" (emphasis supplied).
Consumption function: MPC is less than 1 on average. What does this imply about the multiplier? It depends on the MPC, and because is it less than 1 means the process doesn't continue forever. (if = 1 only 1 dollar would be needed to generate 1 dollar for everyone.) Marginal Efficiency of Investment (MEC): It is downward sloping. First stuff you invest in has a big return, as you continue to invest you don't need as much goods to invest so rate of return to investment starts to decline. When you get to low enough point, all rates of return that were possible you found. You don't usually get out there....Straighten roads etc. But you don't get to there because you have an INTEREST rate and where that intersects MEI you stop. Interest rate: Interest rate is the price of money. Instead of investing I could just lend my money at that point. Interest rate goes down, you do more investment (at the margin what does investment pay). Interest rate comes from money market (D&S of money.) Keynes says interest rate is a **monetary phenomenon.** Very mechanical. Give me the interst rate and MEI and I can tell you how much they are going to be investing. This is D2 (investment) which he adds to D1 (consumption) to find Demand. Demand = I + C
Title: employment, interest and money (not demand or investment: why are money and interest so prominent?); Why the "general theory"? (Who else was writing a "general theory" around this time?) Contents: Six books (vs. Smith's five) Introduction--Definitions and Ideas--The Propensity to Consume--The Inducement to Invest--Money-Wages and Prices--Short Notes Suggested by the General Theory Publication: 1936. What was the world like in 1936? Who was up and who was down?
Context: Gold standard in England. If you are running that kind of system you cant print too much money because when people bring notes to bank in exchange for gold you can't keep up w demand. So Keynes doesn't like the gold standard. No limit without gold standard in your money supply. (Video) Keynes celebrates the end of the gold standard - says don't worry about it. 1931 Britain goes off gold standard. In 30's he wrote the general theory. Analysis of WW2 is all done with Keynsian approach looking at aggregate demand and then he worked on details Book came out in 1936. So unemployment rate was a big concern (in 1933 it had peaked at around 25%, now we are concerned about 4.7%...), interest and money are not so obvious People say he didn't write about inflation, but why would you write a lot about inflation after you have had 10 years of deflation.
What are D1 and D2?
D1 = C = consumption D1= I = investment D1: Relationship between community's income and their expected consumption D1 depends on their psychological propensity to consume -consumption depends on level of aggregate income, thus by extension employment N, unless propensity to consume changes (basically when income goes up you consume less than all of the increase - MPC<1) -D1 = g(N) D2: See flashcard on what determines level of investment.
Effective Demand (D)
D=Effective Demand Amount of labour N which entrepreneurs decide to employ depends on D (effective demand) D = D1 (expected aggregate consumption of community) + D2 (expected amount of new investment) In equilibrium, D2 = h(N) - g(N) -Recall: D1 + D2 = D = Z = h(N) -As established in proposition (ii), D1 = g(N) -Therefore, D2 = h(N) - g(N) Therefore, volume of N in equilibrium depends on: -Aggregate supply function, h(N) -Propensity to consume, g(N) -Volume of investment, D2
Socialism?
Do we need Socialism - public ownership of production: No all we have to do is to make sure when the economy grows there is **sufficient investment to fill gap in consumption and income.** All we have to do is make sure private investment stays buoyant enough to make up for difference between income and consumption - certainly much easier than owning the economy. In SR of course, if higher income than consumption there is a gap, but in LR people start consuming more.
"Is the fulfilment of these ideas a visionary hope?"
Economic approach is to look at people's self interests. But here is Keynes saying no the power of vested interest is slight when compared with the power of ideas. They may be consistent with the idea of vested interest but the ideas themselves will have an independent influence Keynes argues. If you read intellectual history of second half of 20th century - seems pretty Keysian. "Vested interests are slight compared to encroachment of ideas."
V First postulate OK. Real wage always = marginal product of labour. (Why? Whose choice determines that?)
Employers choice. Not workers.
Keynes, GT, Chapter 3: The Principle of Effective Demand Factor cost (?) + profit = Proceeds of output = Total or aggregate income from output
Factor cost: amount entrepreneur pays to factors of production User cost: amount entrepreneur pays to other entrepreneurs for what he has to purchase from him and the opportunity cost of employing the equipment instead of leaving it idle Profit (ie. entrepreneur's income): value of output in excess of factor and user costs -Entrepreneurs maximize profits when determining quantity of factors to employ THUS: Total income: profit to entrepreneur + factor costs=factor's income (proceeds of profit)=Total or aggregate income from output (or a given amount of employment) Aggregate supply price of output from a given amount of employment = proceeds which will just make it worthwhile to produce -Entrepreneur seeks to employ at the level that maximizes his excess proceeds over factor costs
What was the classical assumption about the D and Z functions (terminology not used by the classicals)? What determines aggregate employment?
General Theory of Employment: Increase in employment --> increase in aggregate real income --> increase in aggregate consumption, but not by as much as increase in income. -Given propensity to consume, equilibrium employment level depends on amount of current investment -There must be an amount of current investment to absorb excess output that is not consumed -Amount of current investment depends on inducement to invest, which depends on relation between marginal efficiency of capital MEC and interest rates. -Equilibrium level of employment cannot exceed full employment (ie. real wage cannot be less than marginal disutility of labour) -But does not have to be equal to full employment **-Equilibrium employment = full employment occurs only when current investment provides demand just equal to output in excess of consumption.**
Variables in Keynes Model
Given variables: quality and quantity of existing labour, equipment, technology, degree of competition, consumer tastes ... Independent variables: (i) three psychological factors- propensity to consume, attitude toward liquidity (liquidity preference), expectation of future yield from capital-assets (ii) wage-unit as determined by bargains between employers and employed (iii) quantity of money as determined by central bank Dependent variables: volume of employment, national income measured in wages Note: Labor-unit = The labor unit is an unskilled worker hour. All labor and sometimes all factors of production are measured in terms of unskilled-equivalent worker hours. wage-unit = The wage-unit is the wage received for a labor unit.
Chapter 1: The General Theory Teaching classical special case "misleading and disastrous."
He argues that it is a special case, it holds under some but not all (classical economics) circumstances. He wants to investigate those cases. We don't always get back to full employment (which is classical assumption), so it is clearly a special case.
How could you go back? How could you tie people to their assets?
He says lets make this like a marriage contract.(meaning there's no divorce.) How do you slow down capital markets: -Put a tax on transactions. Puts cost on it. If big enough tax you think more carefully because you can't get out as easily. If its expensive to get out maybe you think more before you get in. -Like international transactions tax -Maybe in the end all of this financial stuff is not crucial because given our inability to see the future what makes us optimistic about the future are animal spirits he argues. Force investor to make long term investments by making investments permanent and indissoluble -BUT may also discourage investment altogether as risk increases if investors can't get out of it. -Radical solution of leaving individuals with consumption or investment as their only options for using money (prevents money hoarding)
What's the Z function? How is aggregate supply function related to expected proceeds? What's the D function? How is it related to proceeds?
How much am I going to supply and what does that depend on? How much money I am going to make, and how much money I have to spend on factors of production, which in turn depends on how much you have employed. Z&D Graph: Z - How much you can produce with the amount of people you employ = AS D - the more people who have jobs the more spending will take place = AD Where Z and D cross is at equilibrium N* which is NOT full employment equilibrium. -NOT full employment b/c: In classical theory it would be the case because D and Z would be the same everywhere because people are going to spend what they save. I.e. The Says Law assumption. **Keynes says: D is separate from Z -The expenditure is greater than the income sometimes (D>Z) -or if income greater than demand for that income (Z<D) So in Keynes you can have equilibrium without full employment. **So what you want to do is shift demand curve up so it intersects supply at full employment.** So what determines AD and AS? Difference: In Keynes you go from employment to wage and in classical from wage to employment Why does D not always equal Z? D = national expenditure and Z = national income In national accounts income always equals expenditure but it's the anticipated income that is crucial. And if actual income is disappointing then they may change their behavior. **They mistake accounting identity for says law being true in practice. What's crucial is intended amount** D is important because it determines proceeds. If no demand no proceeds.
What happens to D as income grows? (MPC and relationship between Z&D)
If D>Z: employment increases and vice versa. For every increase in Z by a dollar D grows less than a dollar. It is flatter. You are not necessarily spending that (consumption). Connection: Money determines interest rate which determines rate of investment which determines AD MPC: Not everyone consumes all their income, economy will grow, higher incomes but consumption will not keep pace (rich people don't spend all their income). STABILITY: given to economy by virtue that you don't respond dollar for dollar by increase in your income by increasing C and I. Good when economy is bad. DETAILS: When employment increases, D1 will increase, but not by as much as D since consumption does not increase as much as income (ie MPC < 1) -**The greater the volume of employment, the greater the gap between Z and D1** -**Employment cannot increase unless D1 (propensity to consume) increases or D2 (investment) increases to close the growing gap between Z and D1** -**Thus, equilibrium can occur at an N below full employment** -Thus, volume of employment is not determined by marginal disutility of labour measured in real wages -Only gives maximum level of employment (ie. lowest possible wage) -**If D1 and D2 are small, D for labour is low, therefore actual level of employment will fall short of the supply of labour willing to work at that wage** -That is, equilibrium real wage will be greater than marginal disutility of labour Note: Wage goods If you are not consuming only the goods you are producing, then your real wage will decline (not just your nominal wage). It will not affect all other price levels. Often what is true for individual market is not always true for the economy as a whole. So you can end up not on the supply curve of labor and then you get into situation where you have involuntary unemployment.
VI Say's Law: Supply creates its own demand. Mill: "All sellers are inevitably, and by the meaning of the word, buyers." ("Sell" means "buy"?) How does saving mean buying, too? The whole classical theory collapse without Say's Law too. Why?
If you are selling you are probably eventually or immediately buying. How does saving mean buying? People spend the money you save - i.e. financial institution lends out your savings. As far as Keynes is concerned there may be a disconnect between savings and spending and if this is the case - circular flow model fails - some people have less income and a collapse of the system. Whole of the costs of production must necessarily be spent in the aggregate, directly or indirectly, on purchasing the product (ie. Say & Mills- supply generates its own demand) -Implies individual act of abstaining from consumption causes decrease in employment, resources for which are subsequently invest in capital wealth (Saving = investing) -Classical and contemporary theories based on classical theories contend that all money will be spent -If people do not spend in one way (ie. consumption), they will spend it in another (ie. investment) -Though post-war experience shows this condition does not hold, contemporary economists have not revised their theories -Though it is undeniable that aggregate income = value of output and that any enrichment of an individual that does not reduce well being of others necessarily increases wealth of community, the claim that the motives behind reducing present consumption are linked with decisions to increase future consumption is not clear **How can we reconcile this micro and macro distinction? Chapter two says thinking about microeconomics of labor markets is not useful because what happens in individual markets doesn't translate into what happens in all markets(macroeconomics). (if all people want lower wages, price level goes down etc.) You cant use microeconomics to analyze the economy as a whole because it just doesn't work like that. Separate but all the same people behaving in microeconomic sensible way so we should be able to explain their behavior in models. Simple idea that C is a fixed percentage of income is more sociology not economics, we want to get back to are people maximizing, people maximizing at micro level.
Do we need as much inequality as we have (or had in the 1930s)? For saving? For effort?
Inequality: Society needs people to save because you need investment but who saves? Rich people. You need rich people to save and provide investment. (So you need some inequality - but as much as we have now?)
Involuntary Unemployment
Involuntary unemployment: Occurs when a small rise in the price of wage-goods relative to nominal wage (i.e. decline in real wages) results in aggregate supply and demand for labour greater than the existing volume of employment. Both go up, so you are off the supply curve.Supply should not be greater because if workers are on their supply curve it shouldn't work that way. (downward sloping) Small rise in price of wage goods .A given money wage at a given price level, but then the price level goes up, what happens? The real wage goes down (same nominal wage but price level goes down) so employers are going to try to employ more people and is a condition. Not just involuntary unemployment its always true. The Aggregate Supply with be greater than existing volume of employment. Surprising b/c supply of labor is upwards sloping and the wage has fallen. **What this implies is that you are off this supply curve of labor. ** So the AS of labor willing to work will go up as the real wage goes down, meaning that people are willing to accept these jobs because there is a excess supply of labor. (unemployment) He argues you don't observe big changes in employment as a result of a change in the price level. Major depression and existing model says you can't have that really. Involuntary unemployment is possible. ***Note: Wage goods are goods that workers consume. From Ricardo, price of gruel, pair of pants etc. And there are other goods like rolls Royce, horses, that don't effect a lot of people.
Classical theory: distribution, potential output, but not actual output.
Labor Market - Demand and Supply DEMAND Demand curve for labor is the MP (marginal product) of labor. The employer pays by MP so he wants to know what you produce (not necessarily the quantity, but the money). How much marginal revenue, so that is up to how much he will pay you. Demand downward sloping and is determined (it comes from somewhere) in competitive market you want to make money so you have to pay attention to MP. SUPPLY Labor supply curve marginal disutility of labor. Marginal disutility of labor rises, so it isupward sloping. EQUILIBRIUM Where these cross is equilibrium and you are going to pay people equilibrium wages. So if you want people to work more you have to pay them more . Employment/unemployment: What happens in terms of employment and unemployment (at each wage)? At wage 1 the number of unemployed exceeds those employed, excess supply at that wage level. How do you solve this problem? By lowering wages. And vice versa, excess demand gets competed away. WHAT IS WRONG: Under what circumstances is this not going to work? When wages are artificially fixed (if wages low, we know this is because of low productivity. But people say we need higher wages...i.e. minimum wage). Obviously interference in any type of market is going to create unemployment Government interference. If you pick wage and price levels they often will not give you full employment. ***So what's wrong with this model? It does recognize unemployment - you can have frictional unemployment and structural unemployment. Its ANOMALOUS that unemployment shoots up, so?
What is the liquidity trap? What is liquidity-preference? When will it become absolute? (When will everyone wish to hold cash rather than bonds? Are we there now?)
Liquidity trap: When monetary policy doesn't work. Keynes says no we have never been in liquidity trap. (...) What particular behavior causes this problem: In liquidity trap interest rates are low, so low people think they are going to go up, no one wants to hold any bonds. So if central bank puts more money into economy people are going to hold it - they don't need to be persuaded to hold it. I don't need lower interest rates to persuade me to hold cash, so nothing happens to interest rate when you inject money in to economy (supply of money shifts). Extreme liquidity preference: It's a case where monetary policy ceases to be effective and people say yeah bring it on - we want more money. So central bank puts a lot of money in and nothing happens to interest rate. Intended to lower interest rates and encourage investment, but people have an extreme/absolute preference for liquidity (ie. to hold money instead of bonds, no increase in investment). Liquidity preference: You want to hold money, as opposed to some sort of financial asset (bonds). So when do you need fiscal policy and when is monetary policy efficient: When in a position where everyone thinks interest rates are going to go up, this is a precondition for a liquidity trap. If you are in a liquidity trap you need FISCAL policy. Gov needs to work on G. Inducement to push rate of new investment to point where marginal efficiency of capital is approximately equal to interest rate
Ch 24: Concluding Notes on the Social Philosophy Towards which the General Theory Might Lead
Major faults of economic society: (i) failure to provide full employment (ii) arbitrary and inequitable distribution of wealth Addressing failure to provide full employment: -Socialism is not necessary, just have to manage investment to make up for any gap between consumption and income
What is the "marginal efficiency of capital"? What does the MEC curve look like? What does it depend on mainly?
Marginal efficiency of capital is downward sloping. -Gives investment quantity (D2) given some market interest rate. -Depends on: 1) Existing stock of capital assets 2) Existing consumer demand for capital intensive goods 3) State of long term expectations: future changes in the type and quantity of capital-asset stock, in consumer taste, in strength of effective demand throughout investment's lifetime, changes in nominal wage throughout investment's life.
What determines the real wage?
Marginal productivity of labour for any given N determines real wage. (MPL) Proposition (v) is subject to the condition that N cannot exceed the value which reduces real wage such that it is equal to marginal disutility of labour (V) Therefore, volume of N in equilibrium depends on: -Aggregate supply function - h(N) -Propensity to consume - g(N) -Volume of investment - D2
Can monetary policy offset all swings in the MEC? What role should the state play?
Monetary Policy: -Management of interest rate is important but not decisive to stimulating investment -Keynes predicts increasing role of State industrial policy to influence investment rather than management of interest rate.
Does it follow that real wage = marginal disutility of labour? Would workers quit if price of wage-goods rose (i.e., real wage declined)?
No. If any one of the aforementioned assumptions falls, all three fall (i) real wage = marginal disutility of existing employment (ii) involuntary unemployment does not exist (iii) supply creates its own demand
What happens to employment if D = Z?
Not necessarily full employment (only in classical model is this true), when you are at equilibrium N*.
How stable is the MEC curve?
Not stable. In reality, MEC curve is unstable, shifts frequently: 1)Contribution of real knowledge guiding investments has significantly decreased due to increasing investment by individuals not involved in the fields of their investments (i.e. we invest in factories not knowing how they work) 2)Day to day fluctuations in existing investments' returns exert disproportionately large influence on the market. Ex. shares of ice manufacturers increase in summer 3) Lack of strong roots of conviction in investments leads to instability -Valuation based on a large number of ignorant individuals is highly volatile as their opinions change based on factors irrelevant to the investment's yield. 4) Speculation -Skilled, knowledgeable investors exploit rather than correct volatility caused by ignorant investors -**Engage in anti-social short-term speculation by anticipating changing opinions of masses rather than long-term enterprise that perpetuates social goals** -Inevitable outcome of investment markets oriented toward "liquidity" -Skilled investors are no longer driven based on personal judgments regarding an investment's merits, but rather *predicting what the masses will perceive as the best investment* -There remain investors seeking fundamental investment based on genuine long-term expectations (eg. Warren Buffet), but incentive is limited b/c it: -Requires more skill, time, risk, effort -Is not necessarily more profitable -Subject to more criticism for short term failure -Contradicts human nature's preference for immediate gain 5) Confidence of lending institutions in borrowers -Weakening of either investor or creditor confidence can generate collapse in equity prices, but revival requires both. Trump: Stock market when trump got elected, big surprise - MEI curve shifted out to right. Supposed to be good for economy because he is supposed to decrease taxes, looser regulations.
A more fundamental objection to the classical view: Can labour lower its real wage if it wants to? An individual clearly can: Lower money-wage for him does not affect the price level. Labour as a whole cannot. In fact, a very classical notion:
Real wage is not a minimum under which no additional labour would be willing to work. More labour than is employed is usually available at some money-wage even though real wage may be falling as prices rise. Thus, utility of wage-goods/real wage is not an accurate measure of marginal disutility of labour and second postulate does not hold
Would the "euthanasia of the rentier" (from lower interest rates) be a bad thing? (What do lower rates mean for retirees?)
Rentiers = a person living on income from property or investments (i.e. living off of returns of savings) Keynes argues: You don't need higher interest rates to get people to save. He argues that savings is a function of output (increased income). A big effect on people on saving is what is their income. Saving is a funciton of income. If you focus on income, getting close to full employment, then you don't have to worry about it. If you can get to full employment and provide people with jobs, MPC will kick in and you have savings. So don't go after interest rate. If that's the case you can do away with folk who are trying to live of interest rates on accumulated savings - RENTIERS. You should be working. Not making money from owning capital (retirement savings). Just like landowners who got rents. **We are treating capital which is not by nature scarce as if it is land which is by nature scarce**. We are causing the rate of return to be higher than it should be - "dead capital" Details: -Previously believed that economic growth required high interest rate to induce rich people to save -But General Theory shows that required level of saving is determined by income/output -Maintaining income close to full employment results in greater EQUALITY -Furthermore, output/income depends on investment and scale of investment is encouraged by LOW interest rate -Interest rate should be reduced to increase investment and achieve the marginal efficiency of capital (MEC) that corresponds to full employment. -Caveat: unless there's a significant change in propensity to consume, including by the State. -Increasing availability of capital by decreasing interest rate until "functionless investor" no longer derives bonus (ie. "euthanasia of the rentier")
Taxation?
Resulted in significant improvement in income distribution but further taxation is limited by: -Fear of making tax evasion too worth while and of diminishing motive towards risk-taking -Belief that growth of capital depends on motives of the rich to save, which would diminish with taxes -But General Theory shows that growth of capital depends on high propensity to consume. Implement tax scheme that encourages financiers and entrepreneurs to service the community instead.
How Knightian is Keynes?
Rumsfeldian: Rumsfeld was defense secretary of US during invasion of Iraq. "the unknown unknown" - not only do I not have a value for them but I don't understand how they will affect the model because I do not even know they exist. (Complete uncertainties where probabilities can't even be estimated and variables are given no consideration at all ) Knightian: Reflects Knightian thinking. Knightian thinking reflects Keynesian theory that what you learn in business school etc is kind of helpful maybe if pricing bond, but in real world there are all these unknowns and so uncertainty is what dominates investment. Uncertainty vs. Risk assessment: Uncertainty (ie. unknown unknowns) dominates investment, not risk which can be relatively easily calculated and estimated. Risk assessment is relatively easy. You have parameters you just don't know their values (like counting cards). In real world you cant even calculate the odds. Basically, Keynes is arguing that it is very difficult to predict the future, but the convention is to assume present trends realizing that what we plot is not correct and we have to take this into account. BACKHOUSE Details on Knight: -was a social scientist with wide-ranging interests, spanning ethics and political philosophy, but was a traditionalist in economic theory. -most well-known analytical contribution was his separation of risk and uncertainty. -Risk is measurable and can be expressed in terms of probabilities. Thus games of chance involve risk - it is impossible to predict which card will be drawn from a well-shuffled pack, but the probability of a particular card is precisely 1 in 52. -Uncertainty, on the other hand, cannot be measured. For example, it is impossible to calculate in the same way the probability that a particular new product will be successful, because it depends on too many unknown and unpredictable factors. -went on to argue that there was a connection between uncertainty and profits. Given that the main difference between theory and reality that required explanation was the existence of profits in excess of the normal return on capital, Knight could claim that his theory explained the difference between competition as described in theory and competition as experienced in the United States.
What explains "the paradox of poverty in the midst of plenty"? Why do rich countries face especially difficult C, I problems?
Since insufficient effective demand (D) results in equilibrium employment below full employment, this results in PRODUCTION below society's potential -The richer the community, the wider the gap between actual and potential production (spend smaller proportion of their income) -Poor communities have higher propensity to spend, therefore require lower investment levels to provide full employment -Rich communities require more investment opportunities to fill the Z-D1 gap, but: -Their MPC is lower - small D1 -Investment is less attractive due to already high capital accumulation - smaller D2 -Weak inducement to invest will decrease output and diminish wealth unless INTEREST rate decreases to make investment more attractive.
Sticky downward wages?
Standard human reaction. We don't like to see our wages decline, especially if others wages aren't declining. (We care more about relative wages, than we do about real wages) So yeah there probably is resistance to downward nominal wages, but that is not the problem. Its fortunate that the workers are more reasonable than the classical school, they resist reductions in wages...
Is "State Socialism" necessary? Leave micro alone? (Did Keynes save capitalism?)
State Socialism: No use monetary policy to keep interest rates low and then people will invest. Monetary policy is state action not ownership. It doesn't have to run the economy, it has to build sewers, bigger and better schools, to invest. Leave Micro alone: Problem they face is that only 9 mill employed out of 10 mill. The problem is you have extra 1 mill who want to be employed. There is no quarrel with what exactly they are doing (micro). Maybe in some spots market failures (etc.) so room for intervention (ex.making heroin production illegal.) ***Basically capitalism works, people are making the right things, just not enough. So the problem is to make more by getting to full employment.** Details: -State socialism is not necessary, socialization of investment through it is sufficient -Fixing interest rate through banking policy is not adequate to achieve optimum investment and full employment- requires State "socialization" of investment (increased G) -State intervention is required to influence volume not direction of employment -State can act through fiscal policy (increase gov't spending- ie. infrastructure projects) -Not directing employment to certain industries. Leave MICRO alone -Involves some regulation on free market forces, but will still allow traditional advantages of free economic individualism (eg. efficiency) -Most notable advantage being exercise of personal choice, which leads to variety of life -Unemployment under existing capitalistic individualism will no longer be tolerated, but problems of capitalistic individualism can be solved while maintaining efficiency and freedom
State of confidence (what it is and how we determine it):
State of Confidence: -Tendency to place disproportionate weight on present conditions in formation of long term expectations (This is how we forecast) Connection to investment: -Investment decisions are based on long-term expectations, which depend on both 1)the most probable forecast and 2) state of confidence- how highly we rate the likelihood of our best forecast -Ex. expect large changes with low certainty regarding nature of changes - weak confidence Determining Confidence: -Stock Exchange's constant revaluations of investments exert significant influence on rate of current investment -Certain types of investments are governed by avg. expectation of stock market investors rather than beliefs of "professional entrepreneurs" -Constant investment revaluations are based on convention that assumes existing state of affairs will continue indefinitely unless there is specific reason to expect change -"Investments which are 'fixed' for the community are thus made 'liquid' for the individual" -As long as convention holds, investors need only consider change in near future -Thus, investment is reasonably safe for individual investor if he can rely on convention and his ability to revise his investments based on his judgments before long term changes occur
III Why resist reductions in money-wages? They involve a reduction in relative wages. (Why are relative wages important? See Smith.)
Struggle over nominal wages between individuals and groups affects distribution of total real wages paid, not general level of real wages (ie. average pay per unit of employment). Unions protect their relative real wage but the general level of real wages depends on other economic forces
Ch 18: The General Theory of Employment Re-Stated Y = C + I + G
Summary chapter of what is going on. Understanding the formula and what's behind it: If C and I fail or don't add up to Y (productive capacity of economy) then you can supplement C and I with G (fiscal policy). If we raise G will that terrify investors and cause I (investment) to fall? People understood that this was an option to go out and buy the stuff that people didn't want to buy but people were fearful of communism, overthrow of system, socialism (increased G may mean increase Tax) etc. (Great Depression). Tax system - You work on C through tax system. You can also work on I with changes in tax system. **Key is to manipulate investment through interest rates, which is manipulated by affecting demand and supply of money** Investment - The main way of manipulating investment though is with the interest rate (r). If you take MEI as being relatively stable and you move (r) up or down you can change total amount of investment. Monetary policy - mechanism for brining REAL changes to economy. Where does r come from? The money market. The government can influence the supply of money (central bank/monetary policy) How about demand for money? What are motives for people to hold money? 1. precautionary motive 2. transactions motive 3. speculative motive: Has to do with relationship between interest bearing assets (bonds) and non interest bearing assets (money) ( i.e. when interest rates are going to go up, don't get caught holding bonds) Bonds - What happens to bond prices when interest rates fall? Bond prices rise. Bond is a promise to pay x amount of money in the future. Interest rate and Bonds - Interest rate is what do I have to pay now (the price of money). Relationship between what I pay now and what it (the asset) pays in the future is essentially the interest rate. INVERSE relationship between interest rate and price of bonds. If interest rate is going up you don't want to hold bonds (price will go down), you want cash. If people are thinking interest rates are going to go down, then don't buy bonds (the will become more expensive). Peoples expectations about interest rates - When do most people think interest rates will go up? If they are low. They can't go down if they are low so then they can only go up. So I'm not going to hold bonds, I'm going to hold money. When interest rates are high you tend to think they are going to come down and bond prices will go up. **So what you have is inverse demand between interest rate and the demand for money. Where D of money = S of money you get the interest rate.**
VII Summary: w=MPL, no involuntary unemployment, and Say's Law all stand together.
Summary of classic theory beliefs. If one falls they all fall.
Postulates allow for frictional unemployment and voluntary unemployment. But not involuntary unemployment.
The classical postulates don't get you a fix on how much employment there is going to be. So what does? Suppose wages are not changing, Aggregate demand is going to be crucial and is going to tell us our wage because employers are always able to fire people (while workers can't force people to hire you) and will always be on curve. **Keynes its not the labor market that is determining total employment, its reverse, total level of employment will give us the wage DIFFERENCE: In classical scheme you can't have involuntary unemployment
What determines the rate of interest?
The money market. Where D of money = S of money you get the interest rate.
Chapter 2: The Postulates of the Classical Economics Does all that follows sound like something Smith or Marshall would agree with?
Think about it.
Ch. 12: The State of Long-Term Expectation
This chapter is basically about MEI curve. The convention is we assume that things aren't going to change. But things change and he understands that. Although we assume given present trends this is what is going to happen. MEI is a statement about the future. What return am I expecting if I put x amount of dollars in a big new factory? Its hard to predict the future... MEC is same as MEI. I think.
"It is an outstanding characteristic of the economic system in which we live that, whilst it is subject to severe fluctuations in respect of output and employment, it is not violently unstable." True? In 1936?
Though economy is subject to fluctuations in output and employment, it is relatively stable as a whole. Full employment is rare and fleeting. Fluctuations wear themselves out before they reach extremes and eventually reverse themselves He is saying Capitalism is inherently stable. This does not explain why you can get involuntary unemployment but its kind of useful. It creates stability in the system. Nominal anchor in the system. **Its not perfect by any means but typically you operate at less than full employment because interest rates are too high.**
Workers combine to protect relative wages? (Is that what they're thinking when they form unions?)
Two Things: 1) Within some range, demand for labour is for a minimum money-wage and not a minimum real wage -Classical theory does not recognize that unless supply of labour depends only on real wages, supply curve will shift with every movement of prices -Tend to resist reductions in nominal wages, but do not similarly withdraw labour when prices rise, which implies a reduction in real wages -**Labour supply of dependent solely on real wages implies that those unemployed but willing to work would withdraw their labour if there were an increase in cost of living unreasonable and false** -Notion that unemployment during depressions is called by refusal of labour to accept lower nominal wages is questionable -Workers understand but have reasons to avoid cuts in nominal wages- standard human reaction to receive cuts in wages if everyone else in economy does not also suffer wage cuts. Problem is that real wages don't decrease with nominal wages anyway 2)Classical theory assumes that wage bargains between entrepreneurs and workers determine real wage- ie. that real wage depends on nominal wage -Assumes that labour is always willing to accept a decrease in real wage if they accept a decrease in nominal wage -If nominal wage changes, it is likely that price levels throughout economy also changed in similar proportion, therefore wage and employment remain the same -There may be no method through which labour can collectively bring nominal wages in conformity with marginal disutility of employment -It is not necessarily true that labour can collectively reduce its real wage by renegotiating nominal wages with entrepreneurs b/c they cannot control price levels -If all workers collectively agree to accept reduction in nominal wages results in decrease in price levels of similar magnitude no net change in real wages **Employees do not have ability to choose their position on supply curve** This is also why 2nd postulate doesn't hold.
What are the benefits of Capitalism? World peace?
What are the benefits of capitalism? Spiritual: It has a focus on the individual and Keynes thinks that's great. He likes society in which people can express idiosyncrasies. So he believes in capitalism for those reasons. World Peace: He also thinks its going to bring world peace. How? Y= C + I + G + (X-M) If you can't work on C or I and not willing to work on G for stabilization purposes. What's left? (X-M) - the trade balance. So you are going to become aggressively mercantilist. Try to get a trade surplus work on your exports, or you conquer people and force them to buy your goods etc. Now they don't have to use armies to assure markets for their goods. They can use monetary and fiscal policy - world peace. Details: Policies leading up to war (domestic laissez-faire and international gold standard) did not leave room for gov't to relieve economic distress and unemployment -Focus on increasing BoT leads to conflict since BoT is zero-sum game. -If nations can provide themselves with full employment by their domestic policy (and also attain equilibrium population), there is no need to play zero-sum BoT game -Countries don't need to use armies to ensure markets for their goods -Still allows for international division of labour and international lending but without express attempt at undermining other countries, thus avoiding conflict.
What makes it stable?
What makes it stable: 1) MPC being less than 1 hurts in expansion, but in contraction it helps. The poorer they become the higher the ratio of consumption to income. Consequence of MPC being less than 1 is that it tends to be a stabilizer Details: MPC is such that the multiplier is greater than 1 but not very large when output increases (decreases) b/c more (less) employment is applied to capital -i.e. MPC < 1 -Automatic stabilization, as real income decreases, consumption does not decrease by full amount 2) The investment function is relatively stable, as you lower interest rates investment is going to go up but not infinitely. And if you raise interest rates, investment is not going to stop altogether. It is relatively stable Details: Fluctuation tends to reverse itself b/c rate of investment higher (lower) than previously prevailing rate will decrease (increase) the marginal efficiency of capital -i.e. rate of investment falls following new, recent investments b/c of low marginal efficiency of capital associated with large capital stock, but capital assets wear out with time, resulting in increase in marginal efficiency of capital and inducing new investment. (Funny though because- Has he read ch. 12?Doesn't sound so stable.) 3) Labor markets. He argues in Chapter 2 workers are not able to negotiate and they are interested in relative wages. How do my wages compare with people in other industries. This leads to stability. (They don't respond to every change in real wages - i.e. when the price level rises). Am I going to be making more or less than my traditional comparison. Details: Moderate changes in employment do not result in very large changes in nominal wage (recall: change in same direction) -Workers are more interested in nominal wages relative to traditional comparison group (ie. shoe maker consistently earning 1.5 times more than chimney sweeps) -Creates stability since workers don't respond strongly to changes in real wages -Struggle to maintain high relative wage will intensify as employment increases b/c of worker's improved bargaining power and diminished marginal utility of wage & improved financial position make him less risk averse ---------------------------------------------------- 4) Moderate changes in interest rate or prospective capital yield do not result in very large changes in rate of investment -Due to increasing cost of additional output from existing equipment stock (increasing costs) -Investment may increase more significantly with decrease in interest when existing capital is low -Investors/investments of the type that are less interested in immediate return
Will the interest rate produce the rate of investment needed to fill the gap between income and consumption? Can full employment be counted on? Why is this a bigger problem for rich countries?
Will interest rate produce ... ? Not necessarily. Can full employment....? Not necessarily. If consumption doesn't exhaust production, change G (gov spending). Interest rate/investment will not solve the problem most likely. If everyone is consuming everything you don't have to worry about AD and AS. Demand is basically consumption and people are consuming all of their income so AD always equals AS. But then you get to a certain amount of income inequality and distribution where people don't consume all of their income. Basically a Rich country problem that you won't necessarily buy all the stuff that's produced and if that's the case (on average) then you have a problem because people say I don't want to produce this stuff and then less income is generated etc. **Interest rate will not necessarily produce rate of investment needed to fill gap between income and consumption, therefore full employment cannot be counted on** -Bigger problem for rich countries b/c they have lower propensity to consume, bigger gap between income and consumption, requires more investment (ie. through investment type G)
Do people believe Say's Law because it's like the national income/output identity? (There are two people in every transaction.)
Yes - mistaking accounting identity for reality.
Are economists Candides?
Yes.
Can money be made bucking the market trend?
Yes.
