I am new to economics and have encountered a problem with theory. When interest rates rise this is said to reduce AD, how does this happen because surely what is not spent is saved and hence invested?
are you using AD in the Keynesian sense? if so then you’d best ask a Keynesian…
What is the austrian view on aggregate demand and what effects would interest rate increases have upon this
How familiar are you with the Keynesian definition? Im interested if you can say what they suppose they are summing up…
Is aggregate demand measured in utils? chuckles Seriously, I don’t know.
so are aggregate demand aggregate supply diagrams keynesian analysis
sure
so how would austrians determine equilibrium output and price level
they are both abstract concepts that can’t be determined, and are not needed for understanding economics.
I have been trying to get my head round it for a long time and i just couldn’t at all i couldn’t see were the relationships were formulated. Is there any introductory books you could recommend to help me that would help me with my understanding of economics
First thing to remember is that the Keynesian regard investment and consumption as additive, in other words, GDP = C + I + NX (+ G). Second thing to remember is that Keyne’s regards the interest rate as the price the equilibrates supply and demand for money, not supply and demand for loanable funds. In other words, the D curve in the Keynesian analysis of interest rates is the liquidity preference curve.
With this in mind the Keynesian analysis goes as follows: when the interest rate goes up, business find it harder to invest (high opportunity cost of borrowing) and people are induced to put their money in their bank account. as a result AD drops (and from here a number of pernicious effects follow: businesses are left with surpluses and decide to reduce their investment and unemployment follows). The important thing to keep in mind is that Keynes work at a high level of aggregation, by simply denoting investment as “I”, he hides the true working of the macroeconomy. To illustrate this one is better off looking at the opposite situation: an increase in savings causes the interest rate to drop. Keynes would argue that when people increase their savings, businesses will be left with surplus stocks and will cut investment, when they do this the businesses be forced to reduce the quantity of labour demanded and unemployment will follow (in other words: the paradox of thrift). The Austrian will point out that this is true enough, but only because you’re aggregating to such an extent, or, you’re simply regarding capital as “K”. In the Austrian analysis capital will be regarded as a structure, more important, it will be regarded as an intricate structure embodying the intertemporal plans of individuals (and crucially, it is the microfoundations of macroeconomics), with the interest rate coordinating the structure. Once this is understood, and the macroeconomy is looked at with less aggregation, an increase in savings will cause a reduction in employment in those industries closest to production (as Keynesian economics says) and an increase in employment at those stages furthest from production (wrt which Keynesian economics is blind).
so is the basics of what your saying that austrians dont regard all investment and consumption as equal and something such as a lower interest rate will have different effects on the different types of consumption or investment. Also why is there a difference in what keynsians and austrians regard as the interest rate and what are the implications of this.
and what would keynes proposed happened to the money that had been saved but not invested?
I don’t think anybody regards them as “equal” the difference is merely that Keynesian analysis assumes they are additive, whereas the Austrian analysis regards them as being “substitutes”. In this regard Keynesian analysis ignores the central economic problem of scarcity (which represents the disconnect between microeconomics and macroeconomics). Provided that individuals continue to consume, the economic problem won’t be felt. This can be seen graphically: the Keynesians would depict the relationship as the Keynesian demand contraint, and the Austrian analysis would depict the two with a PPF. In regard to the Austrian view, one can either consume now, or consume in the future. The former is what is usually regarded as consumption, the latter is what is usually called investment.
Keynes famously argued that investment is really independant of the interest rate, investment is determined by “animal spirits”, the interest rate is the price equilibrating demand for money and supply of money. The implication of this is quite obvious, it allowed Keynes to argued that if people increase their demand for money, the results will be a rise in the interest rate and a drop in investment (and subsequently depression).
It went into individuals cash balances, but whilst it made them better off in this regard, the collective result of everybody saving would be an economic depression. Now, it’s useful to note that in Keynes’ original exposition, the blame of the “bust” phase of the cycle was put on the entrepreneurs who, governed by animal spirits, suddenly stop investing and thus caused the boom. However, most of Keynes’ disciples have put the blame on individuals and their choice to save. as opposed to consume. In Keynes’ analysis, however, the firm closest to consumption is viewed as the representative agent in the economy, so the complexity of the capital structure is ignored. This is what allows Keynes to pull off the argument that saving causes investment to decline, he ignores the interest rate effect of saving and focused on the derived demand effect. So that whilst increased saving would push the interest rate down and spur increased investment in the earlier stages of production, investment in the later stages would decrease. However, this is ignored by Keynes, all one sees is decreased investment in the later stages.
Garrison makes the claim that whereas Hayek referred to money as a “loose joint”, Keynes is essentially stating that it is a “broken joint”.