I am traveling so this will be short. In a monetary economy even though real demand is tied to real supply effective demand and effective supply can be far below both. In such cases hansen's law holds-- demand creates its own supply which is what i believe keynes meant which in nuanced terms meant new effective demand creates new effective supply.

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On Dec 11, 2012, at 9:52 PM, "Steve Kates" <[log in to unmask]<mailto:[log in to unmask]>> wrote:


I am really grateful for David Colander’s intervention. I am too well aware that such discussion threads can be a time of sabre cuts and bloodletting. And I am particularly grateful where he wrote:

“What became known as Say's Law was simply an argument that some people's argument against too little demand being the cause of recessions was too simple--that real demand is tied to real supply.”

That is so far from “supply creates its own demand” as to be almost unrecognisable as a statement of what the majority of the profession now believes Say’s Law to mean. We could refine the words but in the end what David has written is near enough identical to the classical statement “demand is constituted by supply”. It may even be somewhat of an improvement since it adds the word “real” on both the demand side and the supply side which was always understood when these issues were discussed.

But it is policy that matters which is why The General Theory was written. And here David writes:

“[Keynes] devised a new framework--it said that sometimes economies could get out of kilter so much so that even if the long run classical model is correct, that is irrelevant because the adjustment is too slow for the political structure.”

In this interpretation, Keynes accepts that real demand is constituted by real supply but the process is too slow so needs a bit of help. If that is what he had said, then The General Theory would have been entirely within the classical tradition. But unfortunately it’s not what Keynes meant or even what he said. But irrespective of what Keynes did or did not actually mean, Keynesian economics is now embodied in the expression Y=C+I+G.

If Keynes had accepted the constraints imposed by Say’s Law and the classical theory of the cycle, then he would have argued that public spending should be on productive value adding forms of output and budget deficits should be avoided at all costs. But that was not the message of The General Theory. Here is one of Keynes’s most famous passages which has been taught to students for generations and which is highlighted because it underscores how wrong-headed classical economists supposedly were. Notice that it is “loan expenditure” that Keynes is advocating which implies spending in excess of tax receipts:


“The above reasoning shows how ‘wasteful’ loan expenditure may nevertheless enrich the community on balance. Pyramid-building, earthquakes, even wars may serve to increase wealth, if the education of our statesmen on the principles of the classical economics stands in the way of anything better. . . .



‘If the Treasury were to fill old bottles with banknotes, bury them at suitable depths in disused coalmines which are then filled up to the surface with town rubbish, and leave it to private enterprise on well-tried principles of laissez-faire to dig the notes up again (the right to do so being obtained, of course, by tendering for leases of the note-bearing territory), there need be no more unemployment and, with the help of the repercussions, the real income of the community, and its capital wealth also, would probably become a good deal greater than it actually is. It would, indeed, be more sensible to build houses and the like; but if there are political and practical difficulties in the way of this, the above would be better than nothing. (p. 129)

If one understood Say’s Law as it was understood by the classics, rather than such valueless expenditure being “better than nothing” it would have been seen as disastrous, shifting resources away from self-sustaining productive activities and into cul-de-sacs that would make recovery even more difficult to achieve because even more of the nation’s resources were being used in unproductive non-value-adding activities.

Say’s Law – the Law of Markets – is not, in my view, a long-run principle. It applies at every moment and in every economy. You cannot make an economy grow through wasteful expenditure. Where activities that do not return enough to cover costs take place economic forces are set in motion to restructure activity, unless the activity is being pushed by governments.

The idea that anyone even thinks it’s possible to increase economic growth and employment through wasteful expenditure, never mind it being the majority of the economics profession who hold this belief, would have seemed fantastic to those classical economists who were brought up on Say’s Law. But there we have it. Because of Keynes, this is where we now are. How we will ever get out of this intellectual dead end I have no idea but that is what needs to happen if the advice economists provide during recessions is to be of any use at all.

--

Dr Steven Kates
School of Economics, Finance
    and Marketing
RMIT University
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Level 11 / 445 Swanston Street
Melbourne Vic 3000

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