Tuesday, August 25, 2009

Intro to Macroeconomics

I'm not an economist. I'm learning and I admit that I don't know everything. Who's smarter the man that admits ignorance or the man flaunting his superior intellect?

Anyway, in my Macro class that we (My wife and I) taking right now, we are learning the "glories" of Keynesianism. Now to be sure, I don't like Keynesian macro theory in at least how it is applied. It is my believe that Keynesian polices are partially responsible for the current recession and housing bubble. The other half being the Federal Reserve. One thing that strikes me about Keynesian theory is it's "Socialist-lite" influences. Keynes openly touts the need to "smart people" to fix the messes that the "market creates." I believe as do most Austrian and Free Market economists and minded people, that the Government creates "market failures" by interfering with market processes.
Take the Housing bubble, more and more economists (except the Krugmanites) are coming to the realization that Fed funds rates, housing tax breaks, and a reinterpretation of lending practices lead to the creation of the housing bubble and the subsequent collapse. Basically the Government created the problem, thanks to Lord Keynes.

Two of the pillars of Keynesian macrotheory is the notion of the paradox of thrift and the multiplier.

The Paradox of thrift is a situation in which; The paradox states that if everyone tries to save more money during times of recession, then aggregate demand will fall and will in turn lower total savings in the population because of the decrease in consumption and economic growth. The paradox is, narrowly speaking, that total savings may fall even when individual savings attempt to rise, and, broadly speaking, that increases in savings may be harmful to an economy.

Krugman lives by the Paradox. Which only makes me wonder if it hold true or if it can only hold assuming people don't act like people and only act like wild animals, running into fire type of behaviors. Bob Murphy does a pretty good job at discrediting the notion of the paradox of thrift.

Keynes wants everyone to spend. That's it. Always spend and never save. According to Keynes, savings leads to the road of ruin. My macro teacher says this in his lecture notes.
Deficits stimulate, surpluses restrain. Use each accordingly.
How can this be? Well because of the multiplier of course. The multiplier is a nice little term thrown around by Keynesian that somehow "prove" Government spending is so great.
In a Y = C + I + G + NX system, where Y is income or GDP, C is consumption or spending, I is investment or saving, G is government spending and NX is net exports, Keynesian's assumes that if GDP or Y goes down, it "has" to be because of falling spending. The only answer of course is more G. Later on they will talk about how G gets it's money.
The multiplier is m, where; change in income is equal to m times the change in spending. Seems appropriate, but only helps the Keynesian case if the multiplier is greater than 1. If m is less then 1, then any increase in government spending wastes money. If m is less than 1 lets say 0.80, then for every one dollar the Government takes away via taxes, only 80 cents of that dollar will be spent. The other 20 cents is wasted in due to Government inefficiencies. If on the other hand, m is greater than 1, then income will magically appear from the heavens, all thanks to the wonders of Government know how. To think, people called supply side economics, voodoo economics. Keynesian is more pixies dust and unicorn horns than anything else.
So what is the multiplier term? Is it greater than 1 or less then 1? My macro teacher says a good rule of thumb is 2.5. Of course we have to trust him right? No not really, I did some digging around the glorious internets and found an article by Robert Barro. Barro writes that the multiplier is closer to zero. If that is the case, which to me is more plausible, then for every dollar the Government takes away is burned. We get nothing from it except a bloated bureaucracy.
Digging around some more I found an IMF report which say the average fiscal multiplier for the past 43 recessions is more likely around -1.5. Yet they hedge by taking out any outliers + - 5 so that it is only "marginally negative."
It certainly makes the case that multipliers don't really work the way Keynes wanted them to. It certainly makes the case against Government spending stronger.

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