You must wonder why when Supply Side economist are confronted with evidence day after day, month after month, why they still dig in to their theories. These theories have caused us to effect policies that have made this economic collapse worst. Under their theory interest rates should have been very high since last year while they are at record lows. Under their theory inflation should be at record highs while we are bordering on deflation as nobody has pricing powers.
What we need is a simple explanation of these theories to the American middleclass so that we do not allow the Right (Supply Side) to make Keynesian Economic policies to be one of their boogey men like they’ve attempted to make Liberal a bad word. Just like all that is progressive and good in this country came about by Liberal thinking, Keynesian Economic Policies are the only solution to get us out of this depression in due time.
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October 2, 2010, 9:33 am
How The Other Half Thinks
Once you have a more or less classical view of unemployment, you naturally have the classical theory of the interest rate, in which it’s all about supply and demand for funds, and something like a quantity theory of money, in which increases in the monetary base lead, in a fairly short time, to equal proportional rises in the price level. This led to the prediction that large fiscal deficits would lead to soaring interest rates, and that the large rise in the monetary base due to Fed expansion would lead to high inflation.
You can see the classical theory of interest and the soaring-rate prediction clearly in Niall Ferguson’s remarks:
After all, $1.75 trillion is an awful lot of freshly minted treasuries to land on the bond market at a time of recession, and I still don’t quite know who is going to buy them … I predict, in the weeks and months ahead, a very painful tug-of-war between our monetary policy and our fiscal policy as the markets realize just what a vast quantity of bonds are going to have to be absorbed by the financial system this year. That will tend to drive the price of the bonds down, and drive up interest rates
and, of course, in many WSJ op-eds, in analyses from Morgan Stanley, and so on.
Meanwhile, you can see the high-inflation prediction in pieces by Meltzer and Laffer — with the latter helpfully titled, “Get Ready for Inflation and Higher Interest Rates”.
While the other side was making these predictions, people like me were saying that classical economics was all wrong in a liquidity trap. Government borrowing did not confront a fixed supply of funds: we were in a paradox of thrift world, where desired savings (at full employment) exceeded desired investment, and hence savings would expand to meet the demand, and interest rates need not rise. As for inflation, increases in the monetary base would have no effect in a liquidity trap; deflation, not inflation, was the risk.
So, how has it turned out? The 10-year bond rate is about 2.5 percent, lower than it was when Ferguson made that prediction. Inflation keeps falling. The attacks on Keynesianism now come down to “but unemployment has stayed high!” which proves nothing — especially because if you took a Keynesian view seriously, it suggested even given what we knew in early 2009 that the stimulus was much too small to restore full employment.
The point is that recent events have actually amounted to a fairly clear test of Keynesian versus classical economics — and Keynesian economics won, hands down.
