Bob Cropf

Why Keynesianism will (or will not) work

In Free-market, Keynesianism on February 26, 2009 at 1:20 PM

This article is a neo-classical take on Keynes. It presents the rationale behind why Keynes’ theory is supposed to work, which is the multiplier effect. In other words, federal spending for infrastructure and other things will result in additional GDP (an increase in the aggregate demand).

The article’s author does not believe this. He articulates a neo-classical response when he says that

Of course, if GDP is adjusted for quality, the multipler is most likely negative, as resource allocation is directed by government officials, not consumer demands.

I am not sure what he means by “quality” and, maybe if you read the article more closely than I, then something will immediately leap out at you. However, I believe it has to do with “consumer demands.” Again, we are faced with the issue that Galbraith raises, that is, can government produce wealth? Skeptics, such as classical economists, doubt this and so argue that only consumer demand can result in “quality” GDP. Presumably, this increase in aggregate demand would not come as the result of more bridges, roads and other public goods rather than increasing output of televisions and cars (i.e., what consumers want). Hence the author’s logic is that only private consumer goods will produce a true multiplier effect on the economy.

  1. Barro says it himself:

    “Unemployed labor and capital can be utilized at essentially zero social cost, but the private market is somehow unable to figure any of this out. In other words, there is something wrong with the price system.”

    Yes, this is something wrong with the price system — there was(is?) a MASSIVE market failure due to asymmetric information… that market failure means that there is simply a lot out there that the market is unable to price… there is no buyer at any price because no one can get any money because no one has adequate knowledge of the risk involved.

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