Wednesday, November 16, 2011

My take on a Keynesian view

Daniel Kuehn writes an interesting piece here, which includes the following (brief) description of his Keynesian views of the business cycle:

What makes me a Keynesian is that I actually think one of the major problems we're facing is that the act of saving and the act of investing are done by separate people, and that while people may want to provide a lot of loanable funds right now, investors don't have work to be done that earns a worthwhile rate of return. To a large extent, this is a vicious cycle. There's nothing to invest in because demand is weak. But demand is weak because there is not enough to invest in. Even if this equilibrates - even if income gets ground down through the paradox of thrift to the point that the loanable funds market clears, there's still no reason to expect that it will clear at a full employment level.

I don't consider myself of a Keynesian mindset and am increasingly drawn to ideas from the Austrian school. One aspect of Mr. Kuehn's statement above I think warrants alternative consideration. If I could edit his first sentence, I would offer additional details that may alter the ultimate conclusions:

...while people may want to provide a lot of loanable funds right now, investors don't have work to be done that earns a worthwhile rate of return relative to its risk, given the existing and expected dynamics of the economy.

With these additional factors included, demand is not the only consideration that can address a downturn. Other factors include:

a) a reduction of the uncertainty on the rate of return on investiment. This factor could include regulatory, health care cost, tax, or other considerations entrepreneurs and firm owners face. Uncertainty about the demand for goods is one of the factors here as well.

b) an increased outlook for the rate of return on investment, exclusive of demand effects. As economic activity shifts between industries and sectors during a transition period, the dynamics of the economy change and new opportunities are presented. I believe Austrian economists have described the continual structuring/restructuring of an economy as "roundaboutness."

Demand definitely has a role to play in a the functioning of a monetary society. The demand for goods, at the very least, provides the signals with which market participants then use to determine profitable opportunities for capital and intermediate goods. As more capital is deployed and specialization occurs, costs will fall and production should expand. I think its important to note that demand is only one variable in the equation of returning the economy to full employment. Additionally, it is not necessarily the default variable to remedy during downturns.

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