Barkley Rosser, addressing me along with Pat Gunning, raised some issues and asked some questions. These are my replies.


BR: "OK, I may be willing to buy that Keynes invented AS and AD analysis. Good for him."

If you actually do think it plausible that the essence of the Keynesian Revolution may well have been the introduction of aggregate demand and supply into economics as a refutation of Say's Law, then we are in some kind of accord. It is very very far indeed from the standard story one finds within HET. Whether this was "good for him", or for anyone else, is a matter of economic theory itself, and so we can for the time being ignore that side of things. But if one wants to understand economic theory as the classics did, then no manipulation of IS-LM or AS-AD will get you there. 



BR: "If you eschew talking about AD, then how do you explain the Great Depression?  Did the natural rate of unemployment suddenly fall?  Even if Pat is right that Germany just bounced back on its own after 1932, how and why did it fall so far down in the first place?  Milton Friedman says it was monetary contraction, and I think that was a lot of it also.  But to get from that to a collapse of real output involves most easily assuming that this decline of M pushed back the AD curve along a non-vertical AS curve.  What is the classical explanation again?  Are we going to hear about lazy workers not willing to accept wage cuts?  Please."

I explain the Great Depression much as the classics themselves did. Economists today view these events through the prism of the General Theory so that demand failure is regularly at the core. By the end of the "Roaring '20s" economies around the world were still struggling with the consequences of the Great War, but for the most part were doing quite well, thank you very much. What brought on the Great Depression were two factors, both of which were institutionally driven and utterly unnecessary. 

The first was the mutually agreed decision by the Chairman of the Federal Reserve in the United States and the Governor of the Bank of England in the UK to raise interest rates to slow what they perceived as an overheated economy (how little things change!). Rates were deliberately raised progressively throughout 1928 and 1929 with the explicit intention of slowing economic growth to prevent inflation from getting out of hand. The fact that there actually was no inflation at the time in either country seemed to make no difference. 

The second, and probably more important cause in terms of the depth the Depression eventually reached, was the Smoot-Hawley Tariff which took protection levels in the United States to unheard of levels. It was on its way through Congress in 1929, and was therefore having a very pronounced negative effect on business expectations, and was enacted early in 1930. The consequences were as you might expect, as outlined in the on-line Britannica: 

     "Smoot-Hawley Tariff. U.S. legislation that raised import duties by as much as 50%, adding considerable strain to the worldwide economic climate of the Great Depression.  Despite a petition from 1,000 economists urging Pres. Herbert Hoover to veto the act, it was passed as a protective measure for domestic industries. It contributed to the early loss of confidence on Wall Street and signaled U.S. isolationism. Other countries retaliated with similarly high protective tariffs, and overseas banks began to collapse."

Try that combination of higher rates of interest and a 50% increase in tariffs today and see what you get. If you want to think such events can be analysed as a fall in aggregate demand, then I will merely point out what John Stuart Mill and Say himself pointed out, which is that recessions are so called because goods and services remain unsold. Recessions are experienced by business as an inability to sell, but to take the symptom for the cause is the worst imaginable error. 

Keynes, of course, explained the sudden collapse of economies across the world as due to a fall off in aggregate demand. For him, the cause of the worldwide mayhem of the Depression was that business had hit the limit on the amount that could be profitably invested so that the demand for new investments ground to a halt. It was demand deficiency pure and simple. 

The following is from the General Theory. This is how an argument about demand deficiency is structured and this is along lines in which economists have been instructed ever since. It is centred on the unwillingness to spend all of the income one has while these savings lie dead because investors no longer want to invest to a sufficient amount to soak those savings up: 

     "The post-war experiences of Great Britain and the United States are, indeed, actual examples of how an accumulation of wealth, so large that its marginal efficiency has fallen more rapidly than the rate of interest can fall in the face of the prevailing institutional and psychological factors, can interfere, in conditions mainly of laissez-faire, with a reasonable level of employment and with the standard of life which the technical conditions of production are capable of furnishing.

     "It follows that of two equal communities, having the same technique but different stocks of capital, the community with the smaller stocks of capital may be able for the time being to enjoy a higher standard of life than the community with the larger stock; though when the poorer community has caught up the rich * as, presumably, it eventually will * then both alike will suffer the fate of Midas. This disturbing conclusion depends, of course, on the assumption that the propensity to consume and the rate of investment are not deliberately controlled in the social interest but are mainly left to the influences of laissez-faire." (GT 219)

The difference is to my eyes profound. Classical economists looked at the structure of the economy and to the impediments to the free flow of resources into their highest valued uses. If you think in terms of aggregate demand, however, your thoughts flow to what can be done to stimulate spending. That is the Keynesian approach alive today in AS-AD and I, like my classical forebears, think it is economically unsound and dangerous as well. 



BR: "Also, Steve, when are you going to fess up that Say did not always accept his own 'law'."

The name "Say's Law" is a product of the 1920s. No one referred to this classical principle in that way before then. Say in 1803 took some steps to isolate a set of principles which were developed by others during the course of the next forty-five years. It probably was not until the end of the General Glut debate, which occurred with the publication of John Stuart Mill's Principles in 1848, that the issues were finally settled, and remained settled until 1936. 

In my book, which I commend to you, I make it clear that Say only very poorly understood the principle that now bears his name. There I wrote: "Say's discussion had many gaps in its logic, and has contributed to the misunderstanding of the law of markets" (Kates 1998: 34) but if you are intrested you really should read the whole chapter. There is also interesting correspondence between Malthus and Ricardo in which they comment on Say's inability to follow the logic of the set of principles posterity has chosen to name in his honour. If you want to understand Say's Law from amongst classical authors, do not read Say, read Mill. If you can find holes in his logic, then you really do have a story to tell. 

Dr Steven Kates