THE KEYNESIAN ECONOMIC MODEL

John Maynard Keynes was born in 1883 and died in 1946; he was educated at Eton and studied mathematics at Cambridge as well as taking courses in philosophy and economics.

This Model arose because after the depression full employment did not return. Of course it could be argued that they did not wait long enough or that the Classical Model was attenuated by constant interference with the liaise fare principles on which it rested.

 Keynes posited that total expenditure must be raised to adequate levels to cause full employment. However, it seems to me that total expenditure is already total and axiomatically cannot be increased - another case of Economese.

In any case what are adequate levels? If government spends more by increasing taxation it follows that the public will spend less and therefore no increase in total expenditure can take place. There will only be increases in relative and favoured production at the expense of other things.

In reality, to increase expenditure must mean rather to increase production and this can surely only be done by borrowing - hopefully for productive investment. If the government attempts to do this without fiscal (tax) interference it then must borrow by creating a deficit in its budget and causing an increase in the supply of money and thereby inflation. This led to the old chestnut or conundrum you cannot have full employment and no inflation at the same time.

Keyne’s critics pointed out that focusing on increasing expenditure is like flogging the wagon instead of the horse, or to extend the analogy, it is using the stick instead of the carrot. For expenditure to increase (and hopefully thereby to soak up unemployment) there must be savings available to be borrowed - together with incentives such as a drop in interest rates.

This expectation can be realised up to a point but when that point is reached, and savings have been all invested, and it is then found (as it was found during the depression) that these savings were hopelessly insufficient, the momentum could only be carried forward by borrowing or creating more funny money. (We will return to Funny money later)

This is likely to be expensive and will tend to force interest rates up rather than down (as one of the incentives demands). The exchange rate will also go down, particularly if the borrowing is done from abroad, adding further to the cost of money and thereby once again putting upward pressure on interest rates. This will have the consequence of stopping further spending - the exact opposite of what Keynes hoped for. Thus the Keynesian Model is contradictory. It is of course implicit that by increasing expenditure borrowing must be increased beyond what is naturally available.

None of this seemed to bother Lord Keynes. Real increase in expenditure requires borrowing and foreign borrowing introduces more money into the economic system which causes inflation. Alternatively the government Monetizes its own debt which increases the money supply, and because this happened, and we should not be surprised by it, an impatience began to develop with Keynesian fiscal policy after the war. This led to a new theory of Monetarist Economics, developed by Milton Friedman.

Disclaimer: The views expressed in this article are not necessarily those of L.J Armstrong Booksellers C.C. , its owners, staff or management. 

This blog is managed and maintained by Express Eloquence (Pty) Ltd. on behalf of L.J Armstrong Booksellers C.C 

Economic Models - Part 1 - The Classical Economic Model

ECONOMIC MODELS

There are three basic economic models.

1. The Classical Model

This covers a period form 1776 when Adam Smith published his Wealth of Nations, until 1848 when Mill put before the world his Principles of Political Economy. Between the publication of these two works lay the astonishing career of Ricardo, who like Mill, was a child prodigy. Unlike Mill, he had little formal education.
He was born in 1772 to Jewish parents who settled in London.

His parents had been involved with the money market and it was there that he followed them at the tender of fourteen years. Such was his ability that he was able to retire at the age of 42 and was persuaded by Mill to commit himself to writing. This he did, publishing some half dozen important works during the first twenty years of the 19th century. His retirement was disappointingly short, only nine years, before he died at the early age of 51.

Although the writings of these classical economists were diverse, they are mostly remembered for belief in free and unfettered competition within the economy - that the government that interferes least does the most good. Such a laisse faire doctrine informed most of the political thought of the last century.

The Classical Model was thus the earliest and simplest generally-accepted model and held sway for many years. But what may be suitable for the comparatively simple economies of 18th and 19th Century Europe, may be simplistic in a more complicated modern economic environment - or so some thought.

By way of example the Classical Model states that when interest rates are low (the cost of money is low) it should follow that production should increase. But between the World Wars it did not, and for this reason Keynesian economics distrusted the Classical Model and preferred fiscal policy as opposed to Monetarist Policy.

 But why should anyone want to increase production because money is cheap? Production should only increase if demand increases. Increasing expenditure/production in the hope that the goods so produced will be sold is naive. Full employment can indeed be achieved by this method - making goods which cannot be sold - but the end result would be bankruptcy. Surely it would be better to increase demand first and increased production would surely follow.

The classical way of doing this would be to decrease the price of money and consequently the price of goods with it. Demand should increase, and with it production, as night follows the day. The trouble with such a purist view is that under normal circumstances this should indeed apply but after the depression things were anything but normal.

Once businessmen have suffered substantial losses it will require more than cheapness of money to entice them back into production. A man who has nearly drowned in a deluge may become afraid of his own bath tub. The reason why economists so occasionally agree with each other is because they take no account, or different accounts, of the psychological factors involved.

Out of this equation must not be left cultural factors such as the work ethic or the absence of it. Economics is a soft science (according to students in the Engineering faculty) and because it deals with man it is more of an art than a science. Or at the point it touches man it ceases to be a science at all and becomes an art.

Disclaimer: The views expressed in this article are not necessarily those of L.J Armstrong Booksellers C.C. , its owners, staff or management. 

This blog is managed and maintained by Express Eloquence (Pty) Ltd. on behalf of L.J Armstrong Booksellers C.C 

Cash is Trash ! ? - Unisa Economics

Oh Dear - World Economy Woes (Unisa Economics Students are invited to comment)

Now, an economist - I am not. I’m just an ordinary guy trying to make a little sense of it all. Why? because the affects and effects of the economic climate affect us all. Judging by the headlines in yesterday’s and today’s papers it seems that the affects for the next few years/maybe longer will be negative.

Credit Crunch

So, is the current situation a direct result of the ‘08 credit crunch? Is it that the world economy is simply not recovering from the idiotic lending of U.S banks?. I call it idiotic as it is surely idiotic to lend money to people that can clearly not service the debt. This, as I understand it was the basic cause, of the sub-prime crisis. You don’t need to be a banker or a financial expert to know that it is careless (at best) and “criminal” at worst to lend money to people that are more or less broke.

The Hold of Gold.

I invite learned people (especially from the releveant departments at Unisa) to disagree with me (and explain the reasons for their disagreament) but I think the whole problem with the world economy began long before the credit crunch. I think that the cause of the problem started way back - when the major world economies went off the gold standard.

For thousands of years all money was either gold or silver. Then, it was at least backed by gold - meaning that any bank note could be exchanged for its equivalent value in “real”gold. You could argue that gold & paper (bank notes) are ultimatley just things; neither of which in the “grander shceme of things” have any real value. Yet, it seems that gold (maybe because people like shiny things) has a deep rooted psychological significance within the collective psyche. This has been proved (yet again) recently as investors flee to gold causing it to reach a record high.

Having a currency that is not backed by gold allows governments to impliment foolish economic policies. I am aware that this is an over simplification of a complex issue but, just printing money (not backed) by gold is almost the same as the manufacture of toiletpaper. Is this not what caused the astronomical rate of inflation in Germany after WW1?

To follow shortly: (probably later today or tomorrow) a consideration of the impact that the economy is likely to have on Unisa and Unisa students.