David Colander concludes his latest contribution with: "As usual, issues
are more complicated that they appear on the surface." I think only if
one makes them unnecessarily complicated.
In the first place, I don't think his attempt to switch Keynes's
discussion of effective demand to "effective supply" is meaningful or
helpful. As Keynes himself writes: "The value D at the point of the
aggregate demand function, where it is intersected by the aggregate
supply function, [is] called /the effective demand/" (/GT/, 25; Italics
original). Keynes also says, "the /effective demand/ is simply the
aggregate income (or proceeds) which the entrepreneurs expect to
receive, ..., from the amount of current employment which they decide to
give" (/GT/, 55; Italics original). So, although Keynes did not draw AS
and AD curves with P on the y-axis, I think it is a reasonable
interpretation of his argument to do so.
Now to understand the classical explanation embodied in Say's Law of
markets, with which Keynes had great difficulty and some of his modern
followers continue to have, one just has to keep two things clearly in
mind. One, that money is currency, not modern M1 or M2, etc. Two, that
saving is not hoarding; indeed, hoarding contracts savings. Then, with
respect to the Great Depression, one interprets the contraction in the
financial markets, especially following the failure of the Bank of the
United States and its subsequent contagion, as a significant flight to
cash on the part of the public as well as banks. Disposable incomes are
spent to hold cash balances, purchase financial assets (savings), and on
consumption. Thus, a flight to cash must mean a reduction in the demand
for financial assets (including bank deposits) and the demand for goods
and services. This is the legitimate sense in which the contraction in
spending during the Great Depression may be described as contraction of
aggregate demand (AD).
But the contraction was matched by an excess demand for cash, to which
the Fed, because of its rules of operations at the time, including
backing its notes by 40% in gold, failed to respond adequately. Thus,
whiles demand deposits declined by $8 billion between 1930 and 1933
(interpret that as increased demand for cash by deposit holders), the
Fed expanded its notes by only $1 billion (from 4 to 5 billion); see
Fisher (1935). It's unfortunate that Milton Friedman and Anna Scwartz
have concentrated attention on M2 and succeeded in persuading most
analysts that the Fed contracted the "money supply." But what
legitimately must be said is that the Fed did not expand its notes
enough to meet the enlarged demand both by the non-bank public and the
banks (economic or excess reserves). Besides, France was withdrawing
some of its gold reserves with the US, and not expanding its own notes
to match according to the "rules" of the Gold Standard.
With the above understanding, one then reads the classics explaining
that there could not be a glut of all commodities at the same time,
keeping in mind that money is itself a commodity. J.S. Mill's
explanations do the job very well. "To suppose that the markets for all
commodities could ... be overstocked, involves the absurdity that
commodities may fall in value relatively to themselves; or that, of two
commodities, each can fall relatively to the other ... A want of market
for one article may arise from excessive production of that article; but
when commodities in general become unsaleable, it is from a very
different cause; there cannot be excessive production of commodities in
general. (Mill 1874, 72B73). "Besides, money is a commodity; and if
all commodities are supposed to be doubled in quantity, we must suppose
money to be doubled too, and then prices would no more fall than values
would@ (Mill /Works/, 3: 572). And, "In order to render the argument
for the impossibility of an excess of all commodities applicable to the
case in which a circulating medium is employed, /money must itself be
considered as a commodity/. It must, undoubtedly, be admitted that
there cannot be an excess of all other commodities, and an excess of
money at the same time@ (Mill 1874, 71; emphasis added). In a modern
economy, a central bank produces the money (currency). (I explain this
argument in detail elsewhere, but I've mentioned those references often
enough.)
Thus, one doesn't need the apparatus of AS-AD to interpret the Great
Depression. The classical Quantity Theory of Money does well enough,
especially given the theoretical problems with deriving the AD curve.
If one thought the contraction was a questions of reduced investment
spending, without linking that to reduced supply of savings or loanable
funds (because of the increased desire to hoard cash), one would then
chase after such fables as "animal spirits." One also would have
trouble dealing effectively with "animal spirits." If one thought the
problem could be solved with government deficit spending to increase AD
= C + I + G, one couldn't succeed unless the deficit were funded by
newly printed money; which is the same thing as increasing the quantity
of currency to meet its increased demand, as the classical theory
explains.
Once again, remember that Keynes resorted to the AS-AD explanation
because he had difficulties with both the Quantity Theory of Money and
Say's Law. With a clear understanding of those two principles, we
don't have to follow Keynes's explanation.
James Ahiakpor
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