Tuesday, November 20, 2012

Keynesian Contradictions, II: Inflation v. Employment

In Keynesian economics there is a presumed trade-off between unemployment and inflation. This assumption is at the heart of all Keynesian monetary and fiscal policy. As Keynes explained,

"For we have seen that, up to the point where full employment prevails, the growth of capital depends not at all on a low propensity to consume but is, on the contrary, held back by it; and only in conditions of full employment is a low propensity to consume conducive of the growth of capital." (General Theory, VI.24.i.)

Keep in mind that Keynes defined "saving" in all cases as reductions in consumption, i.e., "a low propensity to consume": "So far as I know, everyone is agreed that saving means the excess of income over expenditure on consumption." (General Theory, II.6.ii.) It is a principal tenet of all Currency School economics that it is impossible to finance new capital without first reducing consumption in order to accumulate money savings.

That being the case, and given the Keynesian paradox (what Moulton called "The Economic Dilemma" — Harold G. Moulton, The Formation of Capital. Washington, DC: The Brookings Institution, 1935, 26-29) that you can't finance new capital formation without cutting consumption, but you won't finance new capital if consumption is cut, the "solution" is to inflate the currency to induce "forced savings." (General Theory, II.7.iv.) "Forced savings" consists of money pumped into the economy to increase employment temporarily ("pump priming") (General Theory, III.10.vi). (N.B., "pump priming" is not the term in the General Theory; it was used to describe the New Deal deficit spending to increase consumption through make-work jobs, vide Harold G. Moulton, The New Philosophy of Public Debt. Washington, DC: The Brookings Institution, 1943, 14-15.)

The increase in jobs is supposed to increase effective demand (disposable income), which raises prices. The rise in prices means that consumers pay more for less, while producers receive more for less — "forced savings" meaning reductions in consumption presumed necessary to provide the savings to finance new capital. When producers use the increased profits resulting from the inflationary rise in prices (resulting in reductions in consumption) to invest in new capital formation, they create jobs and (presumably) pay wages to sustain the level of effective demand stimulated by the pump priming, i.e., printing money for consumption.


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