Does government spending (let’s say not through additional borrowing but simple taxing) affect demand any more than it would have been affected had the government not taken it from the private sector in the first place? Would it affect demand slightly different simply because the government spending would be mostly consumption and private spending might flow more toward capital investment?
And now let’s say the government is going to borrow from its own citizens to spend. Does that increase demand any more than it would have had it not borrowed from the private sector in the first place? This isn’t inflationary, is it?
Lastly, government prints the money to spend or borrows from abroad to spend. These two seem like they really would increase demand. And both would be inflationary, correct?
Can someone help me with this? I constantly hear economists say we need government spending to increase demand, but I can’t figure out how it actually works. I know that to spend the money, the government has to take it first, which is like moving it from one pocket to the other, so I’m confused how demand can be increased by this spending.
Well, it depends what you mean by demand. Do they mean present demand? Future demand? Demand at a certain price level?
Keynesians are afraid of savings because they defer present consumption. However people are saving for future consumption so its not clear why this poses any long term problems for the market. Real consumer savings causes current consumer goods markets to shrink, while investments in future consumer goods grow.
So I don’t think there can ever really be a demand problem, unless people just say “I don’t want to work 40 hours a week i’d rather work 30 and accept a lower quality of life”. This would show up as lower GDP because keyensians don’t put a price on leisure time, so you could “stimulate” the economy by forcing everyone back up to the regular work week.
The counter cyclical remedies are typically just to tax/borrow/inflate and spend though. The counteargument is that they simply crowd out the private sector. And even keyensians will admit that if you don’t spend in the right areas, you WILL crowd out the private sector and it will all be a gigantic waste of time.
But keynesians classically imagine that there is all this idle capital sitting around during a depression, and if they could just appropriate say, closed down factories, they could stimulate things. But to believe this is to believe that whoever owns these factories are systematically stupid enough to put them to uneconomic use. So if a factory is being unused, or a house is not being lived in, the owner is speculating that s/he will be able to get more for it at a future date. And if you know anything about speculation its the reason we don’t have shortages.
In short, keynesianism is very very near sighted. Their aggregate metrics are meaningless because economic value is subjective and has to be handled on an individual level by the individual. You can technically run keynesian policies in a free market if your company uses its own currency, or if you lower wages and increase company spending on employee amenities. No one actually does this in real life because its f*cking stupid Its all just an ad hoc justification for giving big corporations billions of dollars.
Yes, in the short run government spending can increase aggregate demand. This can be true even if the money to fund that spending is taxed away from the public.
This is because people typically hold a portion of their savings as cash (money not spent on goods or invested in assets and therefore supporting no economic activity).
For example, suppose there 1 million people in the economy and they all make $20,000 per year after current taxes and they always save 10% of that as cash through out the year. This means at any given time, about $2,000 of their dollars supports no economic activity. Now suppose this year the government wants to fund a new spending program that will require increasing taxes $5,000 per person. Now everyone makes $15,000 per year and keeps $1,500 as cash. That means about $500 million that was just sitting around before ($500 * 1 million people) is spending spent by the government. That’s where the surge in aggregate demand comes from.
Now, this is a bit of loose example with a lot of specifics purposefully left out (time periods for one thing, like when they recieve money and when it is spent), but I only wanted to write something quickly to help pump your intuition so you see whats going on. If you’re actually interested, you will have to invest a little reading time. I suggest picking up any number of good intermediate macro textbooks–there you will find explainations with all the i’s dotted and t’s crossed. Here is a good online example (check out chapters 3 and 4 - no hard math involved, just some simple algebra).
PS* I am not saying that it is always the case that government spending will increase spending in the short-run. I was just saying that it is possible for it to happen and this is how. You will have to use your own judgement as to when you think this type of story fits reality or not.
The ever-returning, never-dying “hoarding” fallacy. Where do you think the original $2000 savings are going and what happens to them? (Hint: Answer does not involve mattresses of any kind.) Could they perhaps be lent out to (or invested with) an entrepreneur who then spends () them on equipment? Or we’d rather have the government take them away and pay Joe to dig a ditch in the morning, and Schmo to cover it back up in the afternoon, via an efficient “make work” program?
I think thats certainly one way of looking at it. Eventually, we would expect that people would spend their money on something (be it consumption or investment goods). So if we were ignoring potential impacts on capital formation that might result from the new taxes, then we would say that “long-run” economic activity shouldn’t increase or decrease as a result the governments tax-funded spending program. Of course, you can’t really ignore the impact that program would have on economic growth. But what those consequences are will depend on who you ask.
z1235,
I don’t see how you could call hoarding a fallacy. After all, it is 100% possible for people to “hoard” their money (you could bury $100 in the ground if you really wanted to). Maybe “hoarding fallacy” is just Rothbardian double-speak for “its unlikely people hoard that much”. Thats an empirical question that we could try to answer if we were both in the mood, but for now I will just say that I am fearless hoarder. I keep almost all my money in a no-interest checking account. Being an on-demand account, banks have a limited ability to draw on that money to make loans. So any money I keep in there basically just sits there supporting no economic activity. This is actually why on-demand deposits (like those in checking accounts) are typically counted as part of all but the most narrow definitions of the money supply.
Why aren’t you spending your money, and why wouldn’t the same reason apply to whomever takes it from you and spends it instead?
On hoarding… I’m having a slight problem with the definition. Am I “hoarding” asset/good A simply because I am reluctant to exchange it for asset/good B? If so, am I hoarding my house because I rather not exchange it for 100 cows + a TV? Am I hoarding my TV because I’m not trading it for some other appliance more than once a week (day, month)?
there are a lot of reasons people why people wouldn’t spend money. there is the “transaction motive” (holding money for day-to-day transactions) and the “asset motive” (money is a store of value and can be treated as an asset). johnathan mentions one good example for what might be driving the asset motive. if you are highly uncertain about whether the stock market will crash next week because the economy is in a recession, well maybe you will decide to hold more of your savings as cash than invest in stocks for the moment. the return is low (you may even loose money if there is inflation), but the risk is also much lower.
as for how to define hoarding, I don’t know. you introduced the term. i was talking about keeping a portion of one’s saving in the form of cash as opposed to investing it bonds, stocks, etc. what do you think hoarding means? is your definition relatable to what i’m talking about?
Funny thing how people have reasons for performing an exchange (trade, investment, purchase,…action) or not. If I think keeping my money (or TV) suits me better at this moment, or if I cannot find any investments with favorable risk/reward prospects, what makes you think that whoever steals that (“hoarded”?) asset from me would use it “better”? What is your stance on the prospect of an entity coming in and taking away your asset (good) simply because your actions (or lack thereof) with it was not to their liking, or because they were under the impression that they could do something better with it? What is the logic behind the assumption that such a set-up would be helpful to anyone or the market as a whole?
If I think keeping my money (or TV) suits me better at this moment, or if I cannot find any investments with favorable risk/reward prospects, what makes you think that whoever steals that (“hoarded”?) asset from me would use it “better”?
I understand where you are going with this, and I agree wholeheartedly, but for the purpose of answering the OP this is largely tangential. There is no doubt that in the event of a liquidity trap government spending can increase output temporarily. You are talking about a sustainable increase in output. However, if the government gives 1,000 people $1,000 each to spend, then it’s clear that demand has temporarily increased.
If someone takes away assets/goods from the ones that keep them and either spends them or gives them to others who are more likely to spend them, then, by all means, “demand” would increase. So I guess the OP is answered.
“There is no doubt that in the event of a liquidity trap government spending can increase output temporarily.”
Output of what? I don’t but the “temporary” argument.
Perhaps it [the government] could just maintain a bit longer, or even temporarily increase, the output of particular sectors in the economy that would have had to cut back if the market would have taken its natural course. But I’m sure you’ll agree that for each sector stimulated by government, there always has to be a corresponding sector that will have to bare the cost. So total output cannot increase even temporarily except in the realm of government statistics.
Real output in terms of value productivity should actually decrease. Remember, the “Bastiat didn’t go far enough” argument with the Broken Window fallacy. The Broken window causes a net loss and not a zero sum game as originally put forward by Bastiat.
Perhaps it [the government] could just maintain a bit longer, or even temporarily increase, the output of particular sectors in the economy that would have had to cut back if the market would have taken its natural course.
During a recession there is a reallocation of resources, as the structure of production readapts to society’s true time preference. I think we can all agree that this does not occur instanteneously, and there may be periods of high uncertainty (for whatever reason, including monetary policy which slows this readaptation by disallowing deflation) and low investment where not all resources are employed (or even less resources than usual are employed; I don’t mean to be pedantic about the notion of “full employment”, whether of labor or economic goods in general). It is therefore theoretically conceivable for government to employ these resources.
This represents a temporary net increase in output.
I will reiterate that I agree that government expenditure leads to a net loss over time, but Student and I (although, I don’t think Student would agree with this final part) are being highly technical (in the sense that we are addressing a very specific range in time).
While Austrians dislike talking about “aggregate demand”, I think ultimately the point is to increase demand. Where Austrians depart with the mainstream, however, is specificying what type of demand should increase. Demand for consumer goods should not artificially increase. However, an increase in demand for capital-goods is generally healthy. In other words, an increase in demand that leads to an increase in wealth-producing activities is what is sought after, crudely speaking.
Its all just an ad hoc justification for giving big corporations billions of dollars.