One "Struggling" Student's Notion on the Economy

As a “struggling” student of economics, I am lost as to how anything I read applies at all to what I am learning. I know it must apply somehow, but I just don’t see the connection. However, that being said, I set out to read article after article about economics, goods and services, government spending etc.  After encountering a vast number of varying opinions on each topic, I discovered one topic that I found interest in and I “think” I can apply to managerial economics.  

“Government spending and stimulating the economy? Really?” you say. “Haven’t we beaten this topic to death?”  Unfortunately, this student has just begun opening their eyes to the real world and while this is old hat to many of you, it is a very curious subject for me.

The article I read in The Examiner, touched briefly on the United States’ recession and how the government’s response to the recession is related to Keynesian Economics. One thing I determined after reading this article and many more is that I am NOT a Keynesian economist.

Keynesian economists encourage government spending. I don’t understand how encouraging people and the government to spend money that they don’t have will in any way improve the economy.  It seems to me like this is exactly how we got into this situation in the first place. We bought houses we couldn’t afford, we maxed out credit cards and couldn’t pay them, and we didn’t save a dime.

The article discusses what is wrong with Keynesian economics and the government’s attempt to fix the economy. It doesn’t mention, more importantly, what an alternate solution would be. What I do know is that a recession causes demand to fall or is it that falling demand causes a recession? When demand falls, companies end up having to lay off workers, cut costs, and hold on to inventory which further encourages the recession, and as we have learned, lowers prices of products and services. Next, we have high unemployment, which causes workers to be willing to work for a lower wage. Now we start to see the turn around.  Companies will start to produce again because costs are low.  Workers are employed and prices are low so they start spending again. As the economy starts to recover, if we can educate and encourage people to save instead of spend, we can further improve the economy. Every dollar we save, whether we save it in a bank or buy stocks, is an investment and encourages the companies we invest in to spend.  Bottom line: We will see a drastic difference in the health of our economy by allowing laws of supply and demand to work without the added help of fake government spending.


Dr. Tufte said...

Vader: 100/100.

This is more of a macro topic, but here goes ...

1) The Keynesian prescription comes from the idea that one person's spending is another person's income. You are concerned about spending money we don't have. Fair enough. But that's not the goal.* Instead, problem arise when people don't spend money they do have. Note my wording: I'm saying that the problem is the inverse of what you're saying the problem is. If our goal is to maintain incomes by maintaining spending, then it is perfectly responsible for one group to spend money they don't have to substitute for another group that won't spend the money they do have. Families do this all the time, when one parent is tight with money and the other one is loose.

2) The viewpoint you are taking covers only part of the Keynesian policy prescription. Keynes was perfectly content to recommend tax cuts instead of spending increases (he just though their effect wasn't quite as strong). Spending increases tend to be favored by Democrats, and tax cuts tend to be favored by Republicans ... but both are Keynesian. Republicans are in denial about this.

3) Even Keynes did not have a problem with the argument you present in your last paragraph. What he recognized, and which reasonable people still debate, is whether this process takes too long. I think most students (who are typically younger than me) have learned over the last several years is that this adjustment can take a lot longer than they'd like. This is not something the U.S. had experienced since the early 80's.

* A lot of the problems people have with Keynesian macroeconomics is not with the principle but with how it is put into practice. Many politicians act (and probably believe) that spending money is their job. I agree; this is a problem. But it's a problem with the people not the theory.

Bomber said...

I like Vader and his thoughts because I feel much the same way. "If we can educate and encourage people to save instead of spend, we can further improve the economy..." I agree with this statement, but think this can only work in a natural functioning economy. Hoarding was attempted during the great depression, and the results weren't pretty. After doing some research it appears that Keynes felt that when the economic table is down and people are not spending money, there is a need to "prime the pump" in order to increase the circular flow of money, and that is what we have been seeing the last few years.

Dave Tufte said...

Bomber: 47/50 (Great Depression is supposed to be capitalized, counted as one mistake).

Again, this is out of ManEc ... but I don't mind talking about it.

So, Bomber ... saving is just spending later. Why is spending later better than spending now? Alternatively, saving is keeping your wealth in (generally) paper assets, while spending is converting them into real assets. Why are paper assets preferable to real assets?

I think your assertion that saving is better is a knee-jerk one. It can't just be better. There has to be a deeper reason. One basis for judging that might be the risk and return of saving versus spending. The thing is, it's hard to judge the return on some spending. For example, most people value vacations with families because they pay returns in the form of memories for a long time. We clearly value those, but how do we compare that to other values? It's not easy; the thing is, if we don't do it then we'll be biased towards saying that saving is better than spending.