General Thought on Aggregate Demand Theory

I’m afraid I may be starting to come across as something of an asshole, and if so I apologize. But either I’m blind and close-minded, or I’m not really seeing persuasive arguments against my critiques of what I’ll call AG/Stimulus theory. I am trying to keep an open mind. I’m not absolutely wedded to the critique of it in the same way I am, for example, wedded to the argument in favor of free trade. I think the argument for free trade is intellectually irrefutable absent some nationalistic assumptions I don’t share. But I don’t have the same certainty that the critique of AG/Stimulus theory is that unassailable.

But I do think the critique is very compelling, so what I am looking for is the explanation for why the points of the critique are wrong. So far all I’m seeing–wherever I look–is a restatement, in various formulations, of the original claims that have been critiqued. But a restatement of a fact that has been challenged is not a rebuttal of that challenge. And I don’t mean this as an attack on anyone who reads my blog, but I’m becoming persuaded that you and I are actually in the same boat as regards our real depth of understanding of AG/Stimulus theory. We all both know about it, and know a little bit about the logic that underlies it, but none of us knows enough to meaningfully address any criticisms of that logic.

My essential questions are:
1) Can we really be sure that our economic problem right now is simply lack of demand, rather than a serious problem of dis-coordination between supply and demand (the Russ Roberts argument about disruptions to “patterns of sustainable specialization and trade”)?

2) Assuming the answer to 1) is “no, we can’t be sure,” is it correct to act (policywise) as though boosting aggregate demand will necessarily solve the problem? (What if there are serious dis-coordinations–will a simple boost in demand necessarily do anything to speed re-coordination, or better said, the coordination of new patterns of sustainable specialization and trade”?*)

3) Why doesn’t government spending crowd out private spending? Am I incorrect to say that if there is no pool of private unspent money then government spending must crowd out private spending? And if there is is a pool of unspent money, where exactly is it,** and how much is there (is the pool of unspent money enough to create the kind of stimulus economists like Krugman and DeLong*** are urging)?

4. Since the critique of AG/Stimulus theory comes from economists, most notably Russ Roberts and Arnold Kling, but also David Henderson and Scott Sumner, among others, on what basis can anyone accuse the critique of being based in economic ignorance? That response is either dishonest or amusingly ironic–dishonest if the person knows the argument comes from other economists or amusingly ironic if the person claiming economic ignorance is in fact ignorant of those economists’ arguments. Keynes is by no means unanimously agreed to by all economists (although he is indisputably a force they all must reckon with), and given the paucity of compelling empirical evidence for his theory,**** he’s more than a fair target.

*I have to admit that the same argument applies to my general belief that the Fed needs to pump more money into the economy. If Roberts is right, simply pouring more money in won’t necessarily help, either, and could in fact create further distortions. On the other hand, the wishful part of me wonders if, despite such distortions, simply having more money flowing through the system might not act as a sort of lubricant, greasing the skids for the process of finding the new sustainable patterns by making things less financially tight for everyone. E.g., if what I need is re-training, to move from my old, no-longer-in-demand, job to a new one with more demand, wouldn’t making more money available rather than less make that more possible? Granted there is a long-term inflation risk, but perhaps it would help before inflation kicked in?

**And as I have written in a not-yet-published post (not yet, because I’m trying to find some data on how much real cash reserves there are right now), business cash reserves can’t count, because businesses don’t keep that cash in their own vault, but in liquid investments, meaning it’s available for someone else to use.

***My go-to guys for the Keynesian argument.

*****And, oh, how I love it when someone with a fervent belief in Keynesian stimulus accuses me of ignoring reality.

About J@m3z Aitch

J@m3z Aitch is a two-bit college professor who'd rather be canoeing.
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1 Response to General Thought on Aggregate Demand Theory

  1. My adviser in college was a self-described Keynesian who claimed that Keynesians were rare in the academy and had been since the late 70s stagflation, but then 2008 happened and suddenly the ranks of economists are flooded with born-again Keynesians. I think Keynesianism is an interesting theory, and adjusting monetary/fiscal policy to smooth out volatility is probably far better than the gold standard (or any alternatives that I’m aware of) when it comes to preventing macroeconomic problems from intruding on our lives. Unfortunately, it all regresses to the mean of politics. What politician is going to cut spending to run a surplus in good economic times? Plus, there are good arguments that recessions are good for the economy.

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