In Skousen’s Dissent on Keynes, Chapter 2, John Egger writes:
A five-percent reduction in workers’ wage demands
would not stimulate employment, he [=Keynes] argued, because employers would anticipate
a resulting five-percent reduction in the demands for their products and would
simultaneously reduce their demand for labor. As Peter Clarke puts it, "If prices
and wages simply chased each other down a spiral—since 'one man’s expenditure
is another man’s income’—then in theory there was no means of effecting the
necessary cut in real wages".
Sounds convincing. Is there a response? I think Egger hints at one in the next paragraph, where he writes:
The claim that the market is incapable of achieving a pattern of prices consistent
with demands is Keynes’s rejection of Say’s law.
In other words, if we accept Say’s Law, that products are what pay for other products, then even if wages go down, there is no reason for employers to anticipate a resulting five-percent reduction in the demands for their products, since lower wages does not mean less production. The apples to pay for the oranges Mr X is making are still out there, even if Mr X and everyone else pays lower wages.
Egger later writes:
General economic malaise results from inappropriate patterns of money prices,
which reduce incomes and production and produce unemployment. The total
amount of money that people want to, or actually do, spend is completely
irrelevant. Aggregate demand is an unintended result of individuals’ actions and
has no causal role in determining them. But if aggregate demand is irrelevant
to action and has no meaning in an analysis of the functioning of a market
system, there can be no standard for determining that it falls short of some ideal,
and there can be no such thing as unemployment caused specifically by this
shortfall. All unemployment is caused by mispricing, and none by insufficient
aggregate demand. This, in turn, implies that a policy designed to reduce un-
employment by bringing aggregate demand closer to its ideal is fundamentally
misconceived from the start. The result is typical of well-intentioned efforts to
solve problems that do not exist: the problems that do exist are made worse.
I was blown away by this paragraph. He’s saying that AD is like the spent shells after a gun fight. The amount of spent shells is never a cause for gunfights one way or another, it is an irrelevant variable, a meaningless byproduct, and should be ignored when we study gunfights. Similarly, AD is irrelevent to economic actions.
And why is AD irrelevant? Because what counts is whether prices match what the market [=supply and demand] would like them to be. The prices are what determine economic action. If they are aligned with supply and demand, the economy will thrive. If not, it will stagnate. What effect has AD on prices? It certainly did not determine past prices, because on the contrary, they determined it. As for future prices, AD might determine what the market would like them to be, but it has no say in whether prices will actually match what the market wants them to be. That happens by itself in a free market, or is hampered by govt interventions in an unfree market. But AD is indeed irrelevant.
If we assume Say’s law is false, how does that change the picture? Because then we can claim that it’s not supply that gives one ability to demand, but demand that magically determines supply. This makes AD very inportant indeed. Reduce it and you magically reduce production, which means poverty.
Now a Keynesian might argue like this: Forget about prices. They are fixed. Set in stone, they cannot ever change. [Ridiculous as it sounds, there are actually people who claim this]. So if prices do not match what they should be, given the current supply and demand, we have to increase demand. Doing so will raise what the laws of supply and demand indicate the price should be to equate with what they are fixed at.
Stated so baldly, we see some problems.
First, there is not one price for everything. The market, if left to itself, will adjust every single price of every single item. But how can a politician take an action that will set every last price to what will clear every last market? It’s like throwing a bottle of ink on a canvas and hoping that out comes the Mona Lisa. You can’t possibly fine tune your toss to do that.
Second, there is a morality argument here. If peope have chosen not to buy, what right have we to force them to buy, or what is worse, pay for what the govt buys for itself and its pals?
Ramble is long already. Would be glad to see comments.