Abstract
In today’s economic climate, everyone has an opinion about policy reactions to the current world recession and aftermath of the financial crash. I do not see where government austerity has the potential to bring about the immediate changes that stimulus spending would. We are now trapped in a cycle where an unstable economic environment has made liquid assets more valuable than capital investments. This is not going to change until unemployment levels rise and that is not going to happen without capital investments. It is a catch 22. Austerity makes the problem worse, it adds unemployment by cutting programs and services creating a more insecure economic climate instead of relieving it. Stimulus spending on jobs creation and local capital investment in infrastructure breaks this cycle and turns it into an upwards spiral. This is in part because of the multiplier effect that takes into account the way real people spend money. Employed people spend money in their communities, this allows for small business expansion and staff, who then spend a portion of their money in the community. In this way, a dollar spent in stimulus increases in value each time it is spent locally. The more money that can be kept in local communities the higher the multiplier effect is. Now when there is a dollar paid out in salary not all of it stay in the community, some gets paid out in taxes, some goes to large corporations who reinvest fall less in a local community than a small business does.. Because of this, the fastest way to break the vicious cycle of an unstable economic environment encouraging large investors and corporation to horde liquid funds and create more unemployment and insecurity is to use stimulus spending to create more jobs, lower unemployment and break the cycle.
Keynesian Stimulus to Ease the Strain Of a Recession
There is a classic orthodox economic theory that works well in a stable economic environment, similar to the trickle down theory it postulates that in a stable economic environment, capital investments are more profitable than liquid funds so a savvy investor will make the capital investments and reap the increased rewards. Based on supply and demand, including in the labor market, the demand, or lack thereof, drives prices up or down to keep the general economic picture stable. Under this, salaries would move up and down accordingly and there would be no involuntary unemployment. This worked just fine right up to the Great Depression; then it failed, in a big way. The impossible happened and the country saw widespread unemployment. An economist named William Keynes evaluated the classic orthodox economic theory and adjusted for the increased pressures of involuntary unemployment. Classic orthodox economic theory closely resembles trickledown economics and since it unfortunately is not working it makes sense to look at the classic structure and how Keynes adjusted for involuntary unemployment and evaluate how this can help ease the economy back into an upwards spiral.
Orthodoxy is based upon the problem of people always trying to outstrip the ends with scarce means. In this scenario, resources are scarce in relation to demands. The demand for products always exceeds resources and products. This concept applied universally to rich and poor people in all societies. Therefore, the role of markets was to solve this zero sum problem by generating prices. Then it took this micro-economic issue, applied it to macroeconomics, and utilized special assumptions to facilitate the transition. Classic orthodoxy applies Says Law that saw saving as the motivating economic force. In this way savings determined investment. Capital equipment was financed by saving. Therefore, those who saved instead of consuming accumulated capital and growth. This viewpoint appealed to the affluent elite who saved and loaned and therefore played the dominating force to generate prosperity, and cast them in the morally superior light of being the wise and thrifty rather than the prodigal spenders.
According to Says law saving determined the investment and consumption spending level and the demand for products would not remain as a deficit. Increased saving sparked investment spending just enough to balance a decline in consumption. When savings declined so did investment spend to balance any increase in consumption. In other words, supply created demand, changes in supply would balance demand and so a demand deficiency was impossible. Total employment was derived using an aggregated labor market with flexible wages adjusted both upwards and downwards to equalize the supply and demand of labor, thus guaranteeing full employment. Any unemployment would be voluntary; as long as workers sought employment and accepted the reality of the payment level for their skill sets they would be able to get a job. According to this line of thinking the Great Depression and our current Great Recession could not occur.
Inflation was controlled by the eighteenth century concept of the Quantity Theory of Money. This provided that there was a direct correlate between money supply and price level. As the money supply fluctuated so would prices. This reduced inflation to a monetary phenomenon caused by increases in the money supply. In this way, inflation was subject to control by reducing or increasing the supply of money. Classic orthodoxy assumed both aggregate income and employment were fixed and future expectations were stable. These expectations were necessary to make the transition from microeconomics to macroeconomics.
The Great Depression showed that the soundest economic theories do not always play out in real world practice and inspired Keynes to develop a theory based on a demand for output as a whole. Classic orthodox theory entirely disregarded “ the need for a theory of the supply and demand of output as a whole.” . Keynes, when confronted with the Great Depression, realized the reality of involuntary unemployment that went beyond cyclical unemployment and involved full employment at a market clearing price and involved the human factor and not just the supply and demand issues. Classical theory recognized a certain degree of frictional unemployment of those unemployed who had difficulties finding new employment and suffered time lags, and people who were unemployed because they refused to sell their labor at market prices. Keynes however took into account those who could not find employment and were involuntarily unemployed. During the Great Depression there were wide variation in the amount of work available although there were no changes in the minimum demands of labor or productivity. He also was attentive to the inverse correlations in the relationship of nominal and real wages in so far as nominal wages rise as real wages fall and vice versa. In the classic theory, labor costs are a prime factor in determining the value of goods and changes in nominal wages leads in the same direction to changes in real wages. Keynes argued against this because there was no means by which labor can adjust its nominal wage to match the marginal productivity.
In the present recession we see that although there have been rising levels in the stock market, and additional funds directed towards the lenders it has not provided sufficient stimulus to generate the capitol reinvestment and business growth needed to lessen unemployment. The money market is not responding with confidence, and the governmental cutbacks have further affected and increased unemployment, cutting programs and removing jobs in order to lower spending. Instead of these austerity measures creating a perception of stability to the prime private sector wealth holders in order to persuade them to convert liquid funds into high paying investments, the unsettled labor markets have kept the private sector investment levels static or reduced. In short, the government austerity measures have not worked and there is no reason to believe they will unless the labor market improves. The labor market will not do this unless the private lending sector feels that the economic environment is stable and investment is a better option than liquid assets. Private investments are not going to increase until unemployment drops; private sector unemployment is not going to increase unless investment does, and government austerity cuts public sector jobs and creates more unemployment.
Thus, the only governmental option left is to break this cycle is by governmental stimulus spending to increase employment. Austerity simply has not worked. Tax cuts and programs diverting funds to the private banking and large corporations has not resulted in the necessary lessening of unemployment has not resulted in job creation. Breaking the cycle and stimulus investment in job production also takes advantage of the multiplier effect. As the labor market improves, individuals are more likely to spend their money in their local communities. That money allows smaller business to make capitol investments and hire more staff whose money then gets partially spent in the community, creating in an upwards spiral. In that way the local reinvestment of stimulus spending multiplies itself creating less unemployment, a more stable economic environment and increased investment. Stimulus spending takes advantage of economic multipliers austerity does not do so. This concurs with the observations Keynes made during the Great Depression. At that time the classic model had broken down because there were not enough jobs, contrary to what the model said would happen. Keynes’ theory allowed for involuntary unemployment. By breaking the cycle of unemployment because of an unstable economic environment, and the increased value of liquid assets instead of, but more profitable investments that create jobs. Keynes’ theory would have recognized the potential for stimulus spending to create jobs. This allows the multiplier effect to kick in, breaks the vicious cycle and turns it into an upwards cycle.
Works Cited
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