Explaining the Aggregate Price Level with Keynes's Principle of Effective Demand
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The Principle of Effective Demand and the State of Post Keynesian Monetary Economics
The University of Adelaide School of Economics Research Paper No. 2008-04 The Principle of Effective Demand and the State of Post Keynesian Monetary Economics Colin Rogers The principle of effective demand and the state of post Keynesian monetary economics Colin Rogers (Revised 20/08/08) School of Economics University of Adelaide Introduction Keynesians of all shades have generally misunderstood the theoretical structure of the General Theory. What is missing is an appreciation of the principle of effective demand. As Laidler (1999) has documented, Old Keynesians largely fabricated the theoretical basis of the Keynesian Revolution and retained the `classical' analysis of long-period equilibrium. Old Keynesians generally took Frank Knight's (1937) advice to ignore the claim to revolution in economic theory and interpreted the General Theory as another contribution to the theory of business cycles. This is most obvious from the Old Keynesian reliance on wage rigidity to generate involuntary unemployment. But for Keynes (1936, chapter 19), wage and price stickiness is the `classical' explanation for unemployment to be contrasted with his explanation, in terms of the principle of effective demand, where the flexibility of wages and prices cannot automatically shift long-period equilibrium to full employment. New Keynesians have continued the `classical' vision by providing the microeconomic foundations for the `ad hoc' rigidities employed by Old 1 Keynesians. Generally, New Keynesians do not question the underlying `classical' vision. Post Keynesians have always questioned the `classical' vision but have not succeeded as yet in agreeing on what the principle of effective demand is1. There should, however, be no grounds for misunderstanding of the principle of effective demand given Keynes's exposition in the General Theory and Dillard's (1948) synopsis. -
Estimating the Effects of Fiscal Policy in OECD Countries
Estimating the e®ects of ¯scal policy in OECD countries Roberto Perotti¤ This version: November 2004 Abstract This paper studies the e®ects of ¯scal policy on GDP, in°ation and interest rates in 5 OECD countries, using a structural Vector Autoregression approach. Its main results can be summarized as follows: 1) The e®ects of ¯scal policy on GDP tend to be small: government spending multipliers larger than 1 can be estimated only in the US in the pre-1980 period. 2) There is no evidence that tax cuts work faster or more e®ectively than spending increases. 3) The e®ects of government spending shocks and tax cuts on GDP and its components have become substantially weaker over time; in the post-1980 period these e®ects are mostly negative, particularly on private investment. 4) Only in the post-1980 period is there evidence of positive e®ects of government spending on long interest rates. In fact, when the real interest rate is held constant in the impulse responses, much of the decline in the response of GDP in the post-1980 period in the US and UK disappears. 5) Under plausible values of its price elasticity, government spending typically has small e®ects on in°ation. 6) Both the decline in the variance of the ¯scal shocks and the change in their transmission mechanism contribute to the decline in the variance of GDP after 1980. ¤IGIER - Universitµa Bocconi and Centre for Economic Policy Research. I thank Alberto Alesina, Olivier Blanchard, Fabio Canova, Zvi Eckstein, Jon Faust, Carlo Favero, Jordi Gal¶³, Daniel Gros, Bruce Hansen, Fumio Hayashi, Ilian Mihov, Chris Sims, Jim Stock and Mark Watson for helpful comments and suggestions. -
Introduction to Macroeconomics Lecture Notes
Introduction to Macroeconomics Lecture Notes Robert M. Kunst March 2006 1 Macroeconomics Macroeconomics (Greek makro = ‘big’) describes and explains economic processes that concern aggregates. An aggregate is a multitude of economic subjects that share some common features. By contrast, microeconomics treats economic processes that concern individuals. Example: The decision of a firm to purchase a new office chair from com- pany X is not a macroeconomic problem. The reaction of Austrian house- holds to an increased rate of capital taxation is a macroeconomic problem. Why macroeconomics and not only microeconomics? The whole is more complex than the sum of independent parts. It is not possible to de- scribe an economy by forming models for all firms and persons and all their cross-effects. Macroeconomics investigates aggregate behavior by imposing simplifying assumptions (“assume there are many identical firms that pro- duce the same good”) but without abstracting from the essential features. These assumptions are used in order to build macroeconomic models.Typi- cally, such models have three aspects: the ‘story’, the mathematical model, and a graphical representation. Macroeconomics is ‘non-experimental’: like, e.g., history, macro- economics cannot conduct controlled scientific experiments (people would complain about such experiments, and with a good reason) and focuses on pure observation. Because historical episodes allow diverse interpretations, many conclusions of macroeconomics are not coercive. Classical motivation of macroeconomics: politicians should be ad- vised how to control the economy, such that specified targets can be met optimally. policy targets: traditionally, the ‘magical pentagon’ of good economic growth, stable prices, full employment, external equilibrium, just distribution 1 of income; according to the EMU criteria, focus on inflation (around 2%), public debt, and a balanced budget; according to Blanchard,focusonlow unemployment (around 5%), good economic growth, and inflation (0—3%). -
Dangers of Deflation Douglas H
ERD POLICY BRIEF SERIES Economics and Research Department Number 12 Dangers of Deflation Douglas H. Brooks Pilipinas F. Quising Asian Development Bank http://www.adb.org Asian Development Bank P.O. Box 789 0980 Manila Philippines 2002 by Asian Development Bank December 2002 ISSN 1655-5260 The views expressed in this paper are those of the author(s) and do not necessarily reflect the views or policies of the Asian Development Bank. The ERD Policy Brief Series is based on papers or notes prepared by ADB staff and their resource persons. The series is designed to provide concise nontechnical accounts of policy issues of topical interest to ADB management, Board of Directors, and staff. Though prepared primarily for internal readership within the ADB, the series may be accessed by interested external readers. Feedback is welcome via e-mail ([email protected]). ERD POLICY BRIEF NO. 12 Dangers of Deflation Douglas H. Brooks and Pilipinas F. Quising December 2002 ecently, there has been growing concern about deflation in some Rcountries and the possibility of deflation at the global level. Aggregate demand, output, and employment could stagnate or decline, particularly where debt levels are already high. Standard economic policy stimuli could become less effective, while few policymakers have experience in preventing or halting deflation with alternative means. Causes and Consequences of Deflation Deflation refers to a fall in prices, leading to a negative change in the price index over a sustained period. The fall in prices can result from improvements in productivity, advances in technology, changes in the policy environment (e.g., deregulation), a drop in prices of major inputs (e.g., oil), excess capacity, or weak demand. -
Chapter 19 the Theory of Effective Demand
Chapter 19 The theory of effective demand In essence, the “Keynesian revolution” was a shift of emphasis from one type of short-run equilibrium to another type as providing the appropriate theory for actual unemployment situations. Edmund Malinvaud (1977), p. 29. In this and the following chapters the focus is shifted from long-run macro- economics to short-run macroeconomics. The long-run models concentrated on factors of importance for the economic evolution over a time horizon of at least 10-15 years. With such a horizon the supply side (think of capital accumulation, population growth, and technological progress) is the primary determinant of cumulative changes in output and consumption the trend. Mainstream macro- economists see the demand side and monetary factors as of key importance for the fluctuations of output and employment about the trend. In a long-run perspective these fluctuations are of only secondary quantitative importance. The preceding chapters have chieflyignored them. But within shorter horizons, fluctuations are the focal point and this brings the demand-side, monetary factors, market imper- fections, nominal rigidities, and expectation errors to the fore. The present and subsequent chapters deal with the role of these short- and medium-run factors for the failure of the laissez-faire market economy to ensure full employment and for the possibilities of active macro policies as a means to improve outcomes. This chapter introduces building blocks of Keynesian theory of the short run. By “Keynesian theory”we mean a macroeconomic framework that (a) aims at un- derstanding “what determines the actual employment of the available resources”,1 including understanding why mass unemployment arises from time to time, and (b) in this endeavor ascribes a primary role to aggregate demand. -
Some Answers FE312 Fall 2010 Rahman 1) Suppose the Fed
Problem Set 7 – Some Answers FE312 Fall 2010 Rahman 1) Suppose the Fed reduces the money supply by 5 percent. a) What happens to the aggregate demand curve? If the Fed reduces the money supply, the aggregate demand curve shifts down. This result is based on the quantity equation MV = PY, which tells us that a decrease in money M leads to a proportionate decrease in nominal output PY (assuming of course that velocity V is fixed). For any given price level P, the level of output Y is lower, and for any given Y, P is lower. b) What happens to the level of output and the price level in the short run and in the long run? In the short run, we assume that the price level is fixed and that the aggregate supply curve is flat. In the short run, output falls but the price level doesn’t change. In the long-run, prices are flexible, and as prices fall over time, the economy returns to full employment. If we assume that velocity is constant, we can quantify the effect of the 5% reduction in the money supply. Recall from Chapter 4 that we can express the quantity equation in terms of percent changes: ΔM/M + ΔV/V = ΔP/P + ΔY/Y We know that in the short run, the price level is fixed. This implies that the percentage change in prices is zero and thus ΔM/M = ΔY/Y. Thus in the short run a 5 percent reduction in the money supply leads to a 5 percent reduction in output. -
Inflationary Expectations and the Costs of Disinflation: a Case for Costless Disinflation in Turkey?
Inflationary Expectations and the Costs of Disinflation: A Case for Costless Disinflation in Turkey? $0,,993 -44 : Abstract: This paper explores the output costs of a credible disinflationary program in Turkey. It is shown that a necessary condition for a costless disinflationary path is that the weight attached to future inflation in the formation of inflationary expectations exceeds 50 percent. Using quarterly data from 1980 - 2000, the estimate of the weight attached to future inflation is found to be consistent with a costless disinflation path. The paper also uses structural Vector Autoregressions (VAR) to explore the implications of stabilizing aggregate demand. The results of the structural VAR corroborate minimum output losses associated with disinflation. 1. INTRODUCTION Inflationary expectations and aggregate demand pressure are two important variables that influence inflation. It is recognized that reducing inflation through contractionary demand policies can involve significant reductions in output and employment relative to potential output. The empirical macroeconomics literature is replete with estimates of the so- called “sacrifice ratio,” the percentage cumulative loss of output due to a 1 percent reduction in inflation. It is well known that inflationary expectations play a significant role in any disinflation program. If inflationary expectations are adaptive (backward-looking), wage contracts would be set accordingly. If inflation drops unexpectedly, real wages rise increasing employment costs for employers. Employers would then cut back employment and production disrupting economic activity. If expectations are formed rationally (forward- 1 2 looking), any momentum in inflation must be due to the underlying macroeconomic policies. Sargent (1982) contends that the seeming inflation- output trade-off disappears when one adopts the rational expectations framework. -
Demand Composition and the Strength of Recoveries†
Demand Composition and the Strength of Recoveriesy Martin Beraja Christian K. Wolf MIT & NBER MIT & NBER September 17, 2021 Abstract: We argue that recoveries from demand-driven recessions with ex- penditure cuts concentrated in services or non-durables will tend to be weaker than recoveries from recessions more biased towards durables. Intuitively, the smaller the bias towards more durable goods, the less the recovery is buffeted by pent-up demand. We show that, in a standard multi-sector business-cycle model, this prediction holds if and only if, following an aggregate demand shock to all categories of spending (e.g., a monetary shock), expenditure on more durable goods reverts back faster. This testable condition receives ample support in U.S. data. We then use (i) a semi-structural shift-share and (ii) a structural model to quantify this effect of varying demand composition on recovery dynamics, and find it to be large. We also discuss implications for optimal stabilization policy. Keywords: durables, services, demand recessions, pent-up demand, shift-share design, recov- ery dynamics, COVID-19. JEL codes: E32, E52 yEmail: [email protected] and [email protected]. We received helpful comments from George-Marios Angeletos, Gadi Barlevy, Florin Bilbiie, Ricardo Caballero, Lawrence Christiano, Martin Eichenbaum, Fran¸coisGourio, Basile Grassi, Erik Hurst, Greg Kaplan, Andrea Lanteri, Jennifer La'O, Alisdair McKay, Simon Mongey, Ernesto Pasten, Matt Rognlie, Alp Simsek, Ludwig Straub, Silvana Tenreyro, Nicholas Tra- chter, Gianluca Violante, Iv´anWerning, Johannes Wieland (our discussant), Tom Winberry, Nathan Zorzi and seminar participants at various venues, and we thank Isabel Di Tella for outstanding research assistance. -
Causality and Interdependence in Pasinetti's Works and in the Modern
Causality and interdependence in Pasinetti’s works and in the modern classical approach Enrico Bellino and Sebastiano Nerozzi Centro Sraffa Working Papers n. 10 January 2015 ISSN: 2284 -2845 Centro Sraffa working papers [online] Causality and interdependence in Pasinetti’s works and in the modern classical approach* Enrico Bellinoa and Sebastiano Nerozzib a Università Cattolica del Sacro Cuore, Milano b Università degli studi di Palermo One of the items that Pasinetti rightfully emphasizes in characterizing the Cambridge school, and differentiating it from mainstream neoclassicism, is causality versus interdependence. (Leijonhufvud, 2008, 537) Abstract. The formal representation of economic theories normally takes the shape of a model, that is, a system of equations which connect the endogenous variables with the values of the parameters which are taken as given. Sometimes, it is possible to identify one or more equations which are able to determine a subset of endogenous variables priory and independently of the other equations and of the value taken by the remaining variables of the system. The first group of equations and variables are thus said to causally determine the remaining variables. In Pasinetti’s works, this notion of causality has often been emphasized as a formal property having the burden of conveying a profound economic meaning. In this paper, we will go through those works of Pasinetti where the notion of causality plays a central role, with the purpose of contextualizing it within the econometric debate of the Sixties, enucleate its economic meaning, and show its connections with other fields of the modern classical approach. Keywords: causality, interdependence, modern classical approach, Ricardo distribution theory, Keynes’s analysis, ‘given quantities’, surplus approach, structural dynamics, vertical integration. -
A Classical View of the Business Cycle
NBER WORKING PAPER SERIES A CLASSICAL VIEW OF THE BUSINESS CYCLE Michael T. Belongia Peter N. Ireland Working Paper 26056 http://www.nber.org/papers/w26056 NATIONAL BUREAU OF ECONOMIC RESEARCH 1050 Massachusetts Avenue Cambridge, MA 02138 July 2019 We are especially grateful to David Laidler for his encouragement during the development of this paper and to John Taylor, Kenneth West, two referees, and seminar participants at the Federal Reserve Bank of Atlanta for helpful comments on previous drafts. All errors that remain are our own. Neither of us received any external support for, or has any financial interest that relates to, the research described in this paper. The views expressed herein are those of the authors and do not necessarily reflect the views of the National Bureau of Economic Research. NBER working papers are circulated for discussion and comment purposes. They have not been peer-reviewed or been subject to the review by the NBER Board of Directors that accompanies official NBER publications. © 2019 by Michael T. Belongia and Peter N. Ireland. All rights reserved. Short sections of text, not to exceed two paragraphs, may be quoted without explicit permission provided that full credit, including © notice, is given to the source. A Classical View of the Business Cycle Michael T. Belongia and Peter N. Ireland NBER Working Paper No. 26056 July 2019 JEL No. B12,E31,E32,E41,E43,E52 ABSTRACT In the 1920s, Irving Fisher extended his previous work on the Quantity Theory to describe, through an early version of the Phillips Curve, how changes in the money stock could be associated with cyclical movements in output, employment, and inflation. -
Chapter 33: Aggregate Demand and Aggregate Supply Principles of Economics, 8Th Edition N
Chapter 33: Aggregate Demand and Aggregate Supply Principles of Economics, 8th Edition N. Gregory Mankiw Page 1 1. Introduction a. We now turn to a short term view of fluctuations in the economy. b. This is the chapter that made this book controversial as Mankiw tends to ignore the Keynesian framework contained in most Principles textbooks. c. I personally find that to be a substantial improvement over those earlier books. d. Here we use the aggregate demand-aggregate supply model to explain short term economic fluctuations around the long term trend of the economy. e. On average over the past 50 years, the production of the US economy as measured by real GDP has grown by about 3 percent per year. i. While this has to be adjusted for population growth, one has to wonder why people tend to view their economic position so negatively. ii. Recession is a period of declining real incomes and rising unemployment. P. 702. iii. A depression is a severe recession. P. 702. 2. Three Key Facts about Economic Fluctuations a. Fact 1: Economic fluctuations are irregular and unpredictable i. They are called the business cycle, which can be misleading. ii. Figure 1: A Look at Short-run Economic Fluctuations. P. 703. iii. Every time that you hear depressing economic news–and they are reported often, remember Figure 1(a). iv. The last 25 years has observed steady real growth with only minor reversals. b. Fact 2: Most macroeconomic quantities fluctuate together c. Fact 3: As output falls, unemployment rises 3. Explaining Short Run Economic Fluctuations a. -
Long-Term Unemployment and the 99Ers
Long-Term Unemployment and the 99ers An Emerging Issues Report from the January 2012 Long-Term Unemployment and the 99ers The Issue Long-term unemployment has been the most stubborn consequence of the Great Recession. In October 2011, more than two years after the Great Recession officially ended, the national unemployment rate stood at 9.0%, with Connecticut’s unemployment rate at 8.7%.1 Americans have been taught to connect the economic condition of the country or their state to the unemployment Millions of Americans— rate, but the national or state unemployment rate does not tell known as 99ers—have the real story. Concealed in those statistics is evidence of a exhausted their UI benefits, substantial and challenging structural change in the labor and their numbers grow market. Nationally, in July 2011, 31.8% of unemployed people every month. had been out of work for at least 52 weeks. In Connecticut, data shows 37% of the unemployed had been jobless for a year or more. By August 2011, the national average length of unemployment was a record 40 weeks.2 Many have been out of work far longer, with serious consequences. Even with federal extensions to Unemployment Insurance (UI), payments are available for a maximum of 99 weeks in some states; other states provide fewer (60-79) weeks. Millions of Americans—known as 99ers— have exhausted their UI benefits, and their numbers grow every month. By October 2011, approximately 2.9 million nationally had done so. Projections show that five million people will be 99ers, exhausting their benefits, by October 2012.