Sunday, January 19, 2014

As I See It...

As I see it, Keynes is suggesting that when an economy goes into recession, government spending can offset the loss in private consumption. To show this Keynesians use multipliers that turn one dollar of government spending into more than one dollar of consumption and subsequent production. While at the same time, those that oppose the Keynesian theory have their own multipliers, showing that a deleveraging cycle that usually accompanies a recession, will negate some of the intended effects of the spending, which then filters through to consumption and subsequent production. And, furthermore adds the burden of government spending which can lead to higher taxes to fund the spending or the risk of inflation if the government borrows externally or is financed by the central bank. The effects of which are made worse when the government starts off with a budget deficit.

The monetarists suggest an alternative view of how a stalling economy can be revived. They look at production as a function of the monetary base, the rate at which money is spent or its velocity, and inflation. Their view suggests that through central bank action, changes in the monetary base can offset the slowing of the velocity of money that usually accompanies a recession. With special consideration being paid to inflation and inflation expectations of course. This approach starts to face headwinds however, when the transmission mechanism experiences disconnects between central bank intentions and real world supply-demand dynamics of money and credit. Banks have little financial incentives to lend in the way interest rates and inflation expectations, while most would-be borrowers don’t meet stricter credit standards anyway.

Seems like the one thing that might actually be working, is time. Score one for classical liaises-faire economics.