Don’t balance the books: balance the economy

I have sometimes thought that there is a need for a series of pamphlets called “Why didn’t they tell me that in the first place”. More than once I have read “popular” books on a subject and it is only after reading several that the penny finally drops with respect to something fairly basic. Sometimes this might be a piece of information that is assumed by the author to be general knowledge; at other times it is simply that the various explanations are too opaque (eg wrapped up in a clever but confusing analogy).

With this in mind and since this blog is supposed to be about a “literacy” of the present I thought I would set out the basics for one of these “tell me that in first place” subjects. Faced with a global economic crisis it is a subject that is especially important for understanding the present – Keynsian economics.

I have to stress that I am not an economist, nor is this an attempt to make any particular point about Keynes or economics. I am also fully expecting someone who knows more than me about the subject (pretty much most people) to say “yes but….” and point out where I have gone wrong.

This is simply an attempt to help poor idiots like myself get some basic vague grounding in what people are talking about in the media.

OK, here goes……

In response to the mass unemployment in the 1930s Keynes set out a theory which opposed previous ideas of how an economy worked and what governments should do with their budgets. Old style budgets assumed the economy was in a steady state of constant growth. Therefore, all an old style budget had to do was make sure the books were balanced (like balancing your own household income-expenditure). What Keynes proposed was that governments should not just balance the books but balance the whole economy.

So, Keynes = don’t balance the books, balance the economy.

How do you do that?

In the Keynsian economic formula there are three key elements:

  • Two problems: UNEMPLOYMENT and INFLATION
  • One solution: DEMAND (consumption + government expenditure)

In the 1930s the problem was unemployment:
The solution, said Keynes, was to increase demand.
Government expenditure should be increased. This in turn would have a knock-on effect and increase income, which in turn would increase consumption. High consumption meant low unemployment.
So, if problem is UNEMPLOYMENT then the solution is INCREASE DEMAND.

During the Second World War the problem was inflation
The solution, said Keynes, was to reduce demand. With full employment there was too much money chasing after too few things to buy. What had to be done was reduce consumption with high taxes, deferred savings and rationing.
So, if problem is INFLATION then the solution is REDUCE DEMAND.

I’m sure there’s a lot more to it than that but hopefully someone somewhere will have one of those “why didn’t they tell me that in the first place” moments. Is it still relevant in today’s crisis? I have no idea, I’m not an economist, but I do think it might help just a little bit when listening to discussions about debt, cuts, austerity, demand-side solutions etc. Please let me know.

PS (added 6/12/12). It may be that during the current period of slow (or no) growth we need to look at Keynes’s formula from the other direction – “Demand” is now the problem not the solution. However, if that is the case then the same tactics would apply ie stimulate demand through increased public expenditure. What is not needed are those tactics that reduce demand ie high taxes, deferred savings (or deferred investment) and rationing/austerity. In short, no demand no growth.

Of course, increased public expenditure could lead to the accusation that it would be borrowing our way out of debt but that would be making the mistake of seeing national economics functioning the same way as household economics. This might be a convenient analogy for scoring cheap political points but it ignores Keynes’s basic premise of: don’t balance the books, balance the economy.

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4 thoughts on “Don’t balance the books: balance the economy

  1. Hi Pete,
    I agree with you about assumed knowledge. I’m still trying to demystify academia for myself and others!

    John

  2. Just came across your blog and really liked what it proposes to do. I am an economist and would not put the first part of what you said better.
    The part that can lead to trouble is the second one, on inflation. It goes well when what you have is the kind of inflation caused by full employment (demand-pull inflation). But this is not the most common kind: you can have also what we call cost-push inflation – caused, for instance, by an increase in prices of raw materials. In this case, to cut demand will only make things worse.
    Hope I was able to help. Will definitely visit other posts in this blog!

    1. Thanks for the comment. Yes that is very helpful. Just the kind of informed reply I was hoping for. I hope you enjoy the rest of the blog. In later posts it moved very much more towards science rather than a more general literacy of the present.

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