Keynes you feel me?

I’m hearing a lot about this dude named Keynes lately. Pretty strange since the guy’s been dead for over sixty years. But he must have made a huge impression on Obama’s economic team, cause he’s the one calling the shots on the stimulus plan.

So I had to go dust off my old Macroeconomics textbook to remember what exactly this guy was all about. Okay, I really just Googled it, but I’m pretty sure his name was mentioned in that book somewhere.

So, Keynes was this English economist who talked about this concept of aggregate demand or total spending in an economy. Basically he said that lots of things affect aggregate demand, but there is a certain optimal level of spending in a society. When you hit a recession the aggregate demand is below the optimal level. This leads to lower production levels and higher unemployment.

Sounds reasonable.

Here’s where a lot of folks disagree with Keynes. He said that if the economy gets in too much of a funk it feeds on itself. The private sector is no longer able to increase aggregate demand and the economy falls into malaise. Unemployment stays high and production stays low.

A lot of economist think that a recession is a natural part of the economic cycle. You can’t cure a recession, because the recession is the cure itself. Keynes didn’t buy it.

He said when the private sector could no longer spend enough to bring the aggregate demand where it needs to be the Government could step in and do it for them. He even had a multiplier that you could apply to government spending to show how much that spending would increase output.

If the multiplier is 1.5 the economy shows a $150 increase in output for every $100 the Government spends. Pretty cool. Of course you can also have a multiplier of less than 1 which is not near as cool, but what are you gonna do?

Bringing us back to our current economic circumstances, Obama’s team thinks they need to spend in the $800 billion range to get output back where it needs to be. There’s a bonus. Not only do they think this will kickstart the economy and increase output, but we’ll also get the benefits of all of the additional infrastructure that these dollars will fund.

This all sounds pretty good right? Where do I sign up?

There are a few problems. You have to worry about things like inflation and interest rates. Keynes thought that employment and output responded much more quickly to increased spending than do prices. He thought prices were somewhat “sticky”. In other words they tend to hover in a certain range and are much more rigid in the short-term.

His critics said in the long-run inflation will catch up to you to which Keynes replied “In the long run we’ll all be dead”.

I like this guy.

Will any of this work? Who knows? It’s certainly an interesting approach. If it doesn’t work out at least we’ll have some roads, bridges, and fiber optics to play around with while we’re all unemployed.

I’m betting that Keynes was on to something, though.