Archives for the month of: December, 2012

I dashed off a letter in response to a rather odd article by Jeffrey Sachs in yesterday’s FT [£] (We must look beyond Keynes to fix our problems), which mixed a sensible call for increased investment with an assault on the Keynesian ideas which underpin it:

Every British Keynesian would agree with Jeffrey Sachs that the UK needs “increased infrastructure and educational investments” and that spending cuts should not be the main tool of deficit reduction.

But why does Professor Sachs insist on setting out his sensible stall in opposition to what he calls the “Keynesian model”?

Is it the odium theologicum of economics that makes natural allies attack each other?

Keynes said one very simple thing. An economy hit by a serious shock to demand may remain stuck in a low investment trap. In these circumstances, the government needs to boost investment spending. Why does Prof Sachs find this so shocking? It’s exactly what he says!

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The British government has congratulated itself on the employment figures released two days ago: 628,000 more jobs in the private sector, compared to 127,000 fewer in the public sector over the past year. There is a big discussion going on as to why the total number of unemployed has fallen slightly, from 8% to 7.8, even while the economy has been sliding. The most popular current explanation – though these explanations change from day to day – has to do with the unexpected flexibility of the British labour market. Real wages have fallen as money wages failed to keep pace with inflation. This is how neoclassical economists expect full employment to be regained. However, there is a snag, which Keynes pointed out. A reduction in real wages – i.e. an increase in profits – also reduces employees’ spending power. So the real question is whether the confidence created by the increase in business profits offsets the effects of the reduction overall in demand.

We have to take something else into account. Aggregate demand is not only being reduced by lower real wages, but also by the government’s deficit reduction programme. So we have another condition: recovery depends on confidence in the government’s fiscal policy being sufficient to offset the reduction in spending power which fiscal austerity produces.

The hopes of recovery seem to me to be disturbingly over-dependent on psychological factors, while ignoring the common sense view that if total demand is being reduced, there economic slide will continue and, moreover, unemployment will start rising again.