Presentation Transcript

1. To the best of my knowledge, John Maynard Keynes never saw the Keynesian Cross nor confirmed nor denied whether it accurately depicted his theories regarding the effects of distribution on macro-economic performance. He died in 1946, and the model first showed up in a textbook by Paul Samuelson in 1948. Samuelson is classified as Neo-classical or Neo-Keynesian. Keynes was generally opposed to models that failed to accurately reflect reality. Keynes was a very smart man who understood how models are developed and used, yet he never developed a model that would reflect his theories. It is unlikely that the concepts could be adequately expressed in a model. Models tend to reflect a universality of behavior that is not found in the real world. IE a person earning $24,000 a year will spend $31,200 a year. Chapter 12 The keynesian cross
2. Decline in wealth: Most Americans can measure their net worth like this: Equity in home + current balance of IRA or 401k = net worth. The value of both of these dropped significantly between 2007 and 2009. Decline in indebtedness: Bankruptcies and walking away from underwater mortgages. Aggregate decrease in real disposable income: increases in unemployment. Lose your job you lose income. 2% decline in spending by households
3. As stated previously, the Austrian School argued that consumption based on savings and consumption based on credit will initially appear to be positive economic growth. Consumption based on savings is sustainable in the long run. Consumption based on credit is not. The Austrian school The textbook discusses dissaving as beginning in the late 1990s, but we actually see it as shifting in the early 1980s.
4. Deep depression, 25% or more unemployed. Crazy to either raise prices or demand higher wages. Keynesian assumption of no inflation
5. Inflation not a concern. Businesses pay no indirect taxes. Businesses distribute all of their profits to shareholders. There is no depreciation. The economy is closed. Unrealistic assumptions Correlation and causation: UE and corporate saving rates. Supply side economists would argue that decreased investment by corporations causes higher unemployment. Demand side economists would argue that decreased demand leads to decreased investment.
6. Fixed investment: Purchase of fixed goods may include a new oven at a pizza joint, a new home by a household, a new tractor by a farmer, or new computer software by a photographer. Inventory investment: Finished goods that have been manufactured but are not yet sold to the public. Inventory levels are a signal to businesses whether they need to increase or reduce production – demand determines business production. Absolutely not an investment. Purchases made in the stock market are neither consumption nor investment. They represent savings, a leakage from the economy. Although in terms of national accounting stock purchases are savings, and there tends to be broad agreement that savings are a leakage, many supply-side economists would argue that the purchase of stocks are still investment; that an IPO provides companies with the capital they need and provides dividends to investors. However, neither capital gains nor dividend income are included in the GDP or National Income accounting. Investment
7. Classical economists believed that the rate of saving was determined by interest rate and that saving would never exceed demand and all savings would be invested (Pg. 232). In a contradictory argument, low interest rates are considered beneficial because then businesses will be able to borrow more, expanding the economy. Data does not seem to back any of this up. With interest rates at record lows we see increased saving (the Dow) and a weak recovery of GDP. Consumption and investment , saving
8. Income determines consumption, both the dollar amount an individual will consume and the percentage of income both consumed and saved. $15,080 is the annual income of a worker at minimum wage who works full time. We might assume that their marginal propensity to consume (MPC) is 1, or they will consume 100% of their income. 100% of their income is put back into the economy with no leakage. To exceed that rate they would have to be either supplementing their income by spending savings (retired person working at Wal-Mart), living at home with their parents (household consumption), be borrowing (loan sharks or stupid credit card companies), or receiving aid from the state (Wal-Mart workers or military enlisted on food stamps). At the other extreme we have Bill Gates. Bill Gates recently lost $1.6 billion in one day. This did not affect his consumption at all. His annual income (salary) is @ $1 million a year. If he consumed at a rate of $6 million a day it would take 33 years to eat through his savings. It is likely that his net worth will change, up or down by $100 million a day without him even noticing. As additional income is unlikely to change the amount he consumes, it might be assumed that his MPC is 0, making his marginal propensity to save (MPS) 0. This would indicate that 100% of any income increases would be saved, a leakage. Keynesian perspective
9. There is currently a glut of loanable funds and a high rate of unemployment. Corporations are sitting on trillions in cash. There is no lack of available funds for investments, just investments worth making when demand is low. Businesses will not invest until demand increases. If demand increases, idle resources will become employed. Cash currently being hoarded will be invested to take advantage of new economic opportunities. Keynesian choice: Do you provide a tax break to businesses that are already sitting in cash and have a MPS of 1, or do you increase the standard deduction of all Americans by $1,000? The bottom 75% of households have an income below $66,000. We are then assuming that each of these households have a MPC approaching 1 and that close to 75% of the population would increase consumption. WC Choice: Or do you provide a tax break at the upper income levels or for corporations that only a select few would even benefit from? Most of these high net worth individuals will not change their consumption habits for a tax break, they will simply save more by sitting in cash, investing in the stock market, or saving overseas. Policy choices
10. That portion of revenues that does not go out as payment to households for labor, rent, or interest is profit. Many corporations are currently posting record profits while workers wages remain stagnant or are in decline. Elizabeth Warren recently stated that if minimum wage had kept pace with worker productivity the minimum wage would be $22.00 an hour. If it just kept pace with inflation (as currently measured) it would be $10.77. Do we raise the minimum wage from $7.25 to $10.00 an hour or from $15,080 to $20,800 per year? WC Choice: Increases in wages cause unemployment. This can be demonstrated in a model based on the perfectly competitive market. Note: the perfectly competitive market contains within its presuppositions that workers earn exactly their marginal productivity of labor (MPL) and profits are zero. Clearly if profits are zero then an increase in wages would cause unemployment, but what about if there are record profits? Keynesian Choice: Workers with an MPC of 1 will provide greater expansion to the economy than corporations or big businesses with a MPC approaching 0. About 25% of American workers work for less than $10 an hour. Roughly 1.6 million work for $7.25 an hour and another 2 million work for less than minimum wage. From that group alone, we increase demand by over $20 billion a year. This does not include those working between $7.25 and $10 an hour. Policy choices
11. Examine the Real Consumption and Saving Schedules in Table 12.1. The textbook states that this is a hypothetical case. Given that this is a hypothetical case, making up numbers are fine, but shouldn’t these hypothetical numbers at least reflect reality? Consumption functions and table 12.1
12. Planned real consumption or even actual real consumption exceeding income by thousands of dollars. Suggestion here is that poor people will consume at higher levels than their income allows, so poor getting poorer won’t hurt GDP much. Real world consumption beyond income either does not happen, is subsidized by government transfer payments, is realized through working multiple jobs, through charity, or through criminal activity. All of these individuals, regardless of income levels will save $20 if they receive $100 more. Does not include levels above $120,000 of income. Where are the folks with an MPC of 0? You have a disposable (after tax) income of $2 million a year. An increase in the standard deduction provides you with an income of $2,001,000 a year. Do you increase consumption by $800? A general problem with the Keynesian Cross that is not present in Keynes’ theory is that not all individuals earning the same income have the same propensity to save or consume. It is one of the items that makes the theory difficult to adequately model. It provides a general idea only in explaining the multiplier effect. Calculus routinely fails to adequately explain or predict human behavior. Are these assumptions realistic?
13. “I can measure the motions of bodies, but I cannot measure human folly.” – Sir Isaac Newton as quoted in Galbraith, John K. (1993) A Short History of Financial Euphoria. Newton would lose the equivalence of over $1 million speculating in a joint-stock company in the early 17th century. - A speculative bubble. http://www.youtube.com/watch?v=Tgo_Sy1uJ1w&feature=related Social sciences are “mushy”
14. When we consider businesses and corporations and marginal propensities it is important to remember that the consumption of these institutions is determined prior to income. Revenues – costs = profits What consumption the business indulges in is not included in the profits, it is their costs. Investments for expansion or R&D are also deductible. By definition then, all profits are savings that are not invested, a leakage from the economy. If only it were true. Businesses utilize accumulated capital to influence the political process, public opinion, the media, and even academia. Destructive uses of capital. Disposable income – consumption = savings
15. Father of monetarism and economic advisor to Barry Goldwater and Ronald Reagan. The godfather of the supply side theorists and routinely quoted by advocates of laissez-faire economic policies. Friedman called for the elimination of the corporate tax. He also called for corporations to be unable to make charitable contributions (contributions to universities increased prior to the paradigmatic shift in economics). Rather than corporations paying taxes, he advocated that all income of the corporation either be reinvested or paid out in dividends. That portion that would be reinvested would also be attributed to shareholders who would be taxed for both the dividends and the increased investment. This would prevent leakages. Friedman and the corporate tax rate
16. This is not in the textbook, but if you have intentions of moving on in economics you should know this. C = c0 + c’y This is how we draw the consumption function on the Keynesian Cross. c0 = Autonomous consumption, or the amount of consumption that would occur if GDP equaled 0. Clearly this is an unrealistic proposition. The idea might be more accurately stated that if each individual suddenly had 0 income, how much would that individual still consume. For this part of the equation we would need to rely on savings. Transfer payments routinely are not factored in. 2013 Social Security payments were $1.3 trillion. Add in the consumption of the top 1% and suddenly $200 billion, as used in the text for autonomous consumption seems pretty weak. Autonomous consumption is where the line intersects the y-axis. Consumption function
17. c’y = The overall marginal propensity to consume. Typically, economists tend to look at averaging the marginal propensity to consume or to save per household to get an aggregate propensity to consume. It might be more accurate to consider the dollar value held by individuals. This would more adequately compensate for maldistribution of income, which was the point of the Keynesian paradigm. The marginal propensity to consume is the slope of the line. It is also a quantitative measure of the multiplier effect. Consumption function
18. The consumption function provides the baseline on which the effect of further stimulus through investment, government spending, and net exports are mirrored. The graph below represents the Keynesian Cross with all components of GDP represented. Consumption function and GDP In 2012, the government spent $3.8 trillion. If we overlaid this data on Figure 12.4, what would GDP be then? Remember the slope is based on a money multiplier of 5.
19. Unrealistic assumptions: The figure 12.4 has an economy with $200 billion in autonomous spending and a GDP of $1 trillion in based on that autonomous saving. The slope of the line appears to be .9 indicating that only 10% of all income will be saved and all else consumed. An interest rate of 5% magically convinces businesses to invest $2 trillion, grossly out of proportion to the economy it is serving. Consumption function
20. The Keynesian cross below is a bit closer to reality, not depicting the US economy, but a smaller economy. Its proportions are closer to reality. In this case, planned investment is twice autonomous comsumption, not ten times autonomous consumption. Similarly, investment is less than GDP where the consumption function intersects the reference line, not twice as much. This is closer to what you will see in most economics textbooks. Also note that the MPC in this graph is .5. Again, probably a little closer to reality. A little closer to reality
21. The Keynesian Cross can be utilized to demonstrate how income effects demand which in turn determines GDP, the effect of marginal propensities, and the effect of the multiplier on the overall economy when using data more consistent with the real world. It is an argument for a more equitable system of income distribution. When the Keynesian Cross is paired with wildly inaccurate assumptions it can be used to “prove” that the rate of interest determines investment, which in turn is the driving force of the economy. What are you trying to prove anyway?
22. When you attempt to base reality on models that contain assumptions that are unrealistic, your model no longer even vaguely reflects reality. Comparing the two charts Question from earlier. $3.8 trillion in government spending given the consumption function of figure 12.4 would result in a GDP (before net exports) of $49 trillion in the WC model and $8.6 trillion in the Keynesian model.
23. The book argues that the sudden increase in business inventories was based on Americans suddenly deciding to save more than previously. Planned investment, particularly planning for Xmas shopping was based on previous consumption expenditures. WC explanation of personal saving increasing: individuals just started saving more. Keynesian explanation: While some higher income households may have become more careful in spending (low consumer confidence) the bulk of this change would more likely be that those who became unemployed were largely low income households whose MPC was one, leaving a larger proportion of income in lower MPC households. Inventory buildup during recession
24. In order to make their models work, supply-side model builders will typically use a flat tax or a lump sum tax for three reasons. 1) To the best of my knowledge they have not yet figured out how to mathematically or graphically represent a progressive tax structure. 2) Flat taxes and lump taxes are regressive and clearly not in the best interest of the economy or the majority of the citizens. And 3) flat taxes and lump taxes are easily shifted from businesses to consumers through higher prices. Thankfully, we have a progressive tax. WC treatment of taxation
25. Ideally, and it can be shown through the data, higher top tax rates and a progressive income tax schedule means that businesses are more willing to pay their employees higher wages in order to avoid paying higher taxes. This is one way that a progressive tax structure increases the disposable income for those with a high MPC while reducing the leakage of saving. If you are unwilling to pay your workers more or reduce the price of your goods and services and are highly profitable. The government will take a larger and larger share of your income. The government spends 100% of revenues. A progressive tax structure moves money leakages (saving) to being an injection (higher wages at the bottom or gov’t spending.. Taxation and consumption
26. Progressive taxation
27. Lump sum of $2.3 trillion regardless of GDP that registers in a net loss of disposable income. Planned real saving and planned real consumption based solely on GDP and not distribution of income. Planned real investment remaining the same regardless of the size of the economy. Based solely on the interest rate. Net exports remaining the same in nominal terms suggesting a proportional shrinkage of this leakage as GDP increases. $800 billion was our worst trade imbalance. Realistic or not?
28. WC: “planned consumption expenditures are determined by the level of real GDP.” Keynesian: GDP determined by consumption. Bottom paragraph: When planned investments are above or below GDP (real GDP levels) real investment levels adjust. In other words, demand and not interest rates determines investment. On page 264
29. The Table shows how an increase in autonomous real investment increases GDP by more than the amount invested. The same can actually be said about personal consumption, government spending, and net exports. How income is distributed influences the rapidity of growth, or how big the multiplier is. The book was somewhat selective in its discussion of the multiplier and implies that investment is the magic bullet of the economy. If a student is not paying close attention they would be inclined to believe that $2 trillion in investment would yield $10 trillion in growth while $2.3 trillion in government spending would only add $4 trillion in growth. The multiplier process
30. “The larger the marginal propensity to consume, the larger the multiplier.” Multiplier = 1/1-MPC = 1/MPS If distribution is changed to have more income going to the bottom, real GDP increases. If income disparity increases, real GDP decreases. Change in equilibrium real GDP = multiplier x change in autonomous spending Increases in income at the high end only where the MPC is approaching 0 does little to change autonomous consumption (where the line intersects the y-axis) and actually reduces the multiplier. The multiplier formula Over 8 million people had lost their jobs. What would be the effect on the economy if the average of their reduction in consumption was $10,000 a year? $20,000 a year? What if the Multiplier is 4? If the multiplier is 2? What if there was no unemployment insurance and 75% dropped to $10,000 or below?
31. The textbook only discusses the effects of increases and decreases in investment spending. Changes in net exports and government spending would have an identical effect. What the textbook does not emphasize, which is the whole point of the Keynesian Cross is that the largest effect on GDP comes from individual incomes and how they are distributed. When individual middle class households accrue household savings accounts (which can then be loaned to businesses for investment) the economy is stronger. The larger the middle class, the stronger the economy. Increased levels of poverty would clearly lower autonomous consumption. Fewer dollars in the hands of those with an MPC of 1 and more money in the hands of those with an MPC approaching zero would reduce the positive effect of investment and government spending. Significance of the multiplier
32. Correlation is not causation. The argument in the textbook is that increases in the price level cause the economy to underproduce. A contrary argument would be that in an economy that underproduces, scarcity is common and prices increase. In Keynesian theory, when consumer and business confidence is low, the government should step in to prevent demand from decreasing so severely that it drags the LRAS to the left. This was the problem with the oil crisis. It was caused by a shift to the left of LRAS due to limitations in the supply of energy. Efforts to increase demand put the intersection of AD and SRAS to the right of the new energy limited LRAS. AD and CIGX
33. The couple discussed in the book were dissaving for years. The decision to spend less was likely based on economic realities of having reached their credit limit. $1,000 in a savings account could have been a requirement for a secured credit card to handle emergencies. Do we consider not going into debt to be savings? It certainly reduces consumption. Is spending more than you earn a responsible strategy? Is it a responsible aggregate strategy to build an economy on? This would be an example of the supply-side argument that Americans decided to start saving more. You are there
34. As income disparity has grown since the 1980s, more money has accrued to the upper incomes with a high MPS. Real incomes at the bottom have stagnated or declined, forcing those HHs with a MPC of 1 to borrow or dissave to maintain the same level of consumption (2nd mortgages, line of credit, credit cards, robbing your IRA) 1) Increased after tax income (more saving) at the top with decreased after tax income at the bottom (more borrowing and little change in demand) explains the bubbles in housing wealth and stock wealth (asset inflation). 2) A sudden and severe recession following on the heels of consumption driven by increased borrowing is consistent with the theories of the Austrian School (Chapter 9 slides 13-15) WC policy preferences make this situation inevitable. Figure 12.9 explained in Keynesian terms