Sunday, February 8, 2009

Kegs and Keynes.

We went out to celebrate Chand's belated birthday last night. Apparently, I talk about public policy and falafel when I am inebriated.

I was trying to tell one of Parag's friends about how raising taxes is like gaining weight, but completely butchered it. Now that I'm sober, I can explain:
Raising taxes is like gaining weight b/c:
When you raise taxes, disposable income decreases. Therefore, consumption decreases. When you gain weight, you're like "shit, I need to stop eating." Consumption decreases.
However, when you raise taxes, national savings increases. Interest rates fall, and consumption is also sensitive to interest rates. Low interest rates mean people will be less compelled to save [b/c return on their money is smaller] and consumption may increase. The degree to which consumption goes up depends on the elasticity of consumption with respect to interest rates. When you're fatter, you have to eat more to sustain yourself. How much more you have to eat to sustain your bigger self is like elasticity of consumption with respect to interest rates. Consumption may increase.
Lower interest rates also tend to increase investment [businesses borrow more to invest b/c rates are low]. When you're fatter, you need to invest in a new wardrobe b/c all your old clothes don't fit anymore.

Edit: Someone read this and pointed out that an important assumption is that G remains constant. He's possibly nerdier than I am. Loves it.

On to more relevant things:
Keynes has been brought up a lot since Obama's inauguration.
Fun facts (You know that feeling ppl get when they read trashy magazines? This is like celebrity gossip to me): Keynes was really dirty [like, mind in the gutter all the time], he was gay for a while, but then got married to a woman and stayed faithful to her for the rest of his life, he was really elitist and only respected men from Cambridge [sometimes he made exceptions for Oxford men], he believed that America should be run by a group of guys from Cambridge b/c he didn't think anyone in America was smart enough to run the country.

Ideology: The General Theory of Employment, Interest and Money.
People keep saying that Keynes believed that the gov't could spend its way out of recession. But that's not really true. Keynes just pointed out that you get the full multiplier effect [either (1/1-b)(delta G) or (b/1-b)(delta T)] when investment is inelastic and liquidity preferences are absolute. Someone on NPR called it "kindergarten keynesianism." I thought that was cute.

So I guess people think investment is inelastic and liquidity preferences are absolute. Nobody's really investing, and the Fed has been pumping so much liquidity into the system that the term "liquidity crisis" has been abandoned. There's liquidity, it's just not making its way into the real economy.

I think the most convincing piece of evidence that Keynes was right is FDR's spending during the Great Depression. But was it Keynesian spending that did the trick? Were we even "saved" from the Great Depression b/c of it? Tyler Cowen [Marginal Revolution] points out that the numbers may look good, but we have to wonder why they look so good.

For example, a higher GDP looks good. But what if it just reflects how much money the gov't spent on war materials? [WWII]
Unemployment went down, but that's b/c people were fighting and dying instead of being unemployed in the labor force.

Martin Feldstein thinks the Stimulus Plan could be bad news bears. [inflation will kick in as soon as the real economy gets moving again and we don't want to be like Zimbabwe. They just took 12 zeros off their currency. They have an inflation rate of 231,000,000%!]

This is Greg Mankiw's preferred plan.

I'm having a hard time finding economists who are in favor of the Stimulus Plan in its current form...

There are Keynesian economists to be sure, but they seem to have their doubts. [NPR's Economy podcast from 2.6.09 features a few]

The end!
[I need to recover from last night]

Edit: someone just asked me what elasticity and liquidity were.
Elasticity: If your demand for something is very elastic, you will substitute that good for something else when the price goes up even a little bit. Like, my demand for pocky sticks is elastic.
If you have very INelastic demand for something, then you demand it regardless of increasing my demand for Apple products.
So if there are more substitutes for a good, your demand for that good tends to be more elastic.

Liquidity, or at least the way I used it in this blog entry, is just money. Usually, it's how easily an asset can be converted into money. So an illiquid asset would be like, a painting.


  1. "For example, a higher GDP looks good. But what if it just reflects how much money the gov't spent on war materials? [WWII]
    Unemployment went down, but that's b/c people were fighting and dying instead of being unemployed in the labor force"

    aren't america's war time expenditures an example of keynes' idea. US govt just spent a shit load of money and taxed people to do it.

  2. yes, wartime spending is one of the primary examples of keynesian spending. i guess my point was that people should look at what the money's being spent on, and what the result of that spending is...not necessarily in terms of increased GDP and decreased unemployment.

    also, don't post anonymously. it annoys me.

  3. hey esther- i took intro to econ last semester so i actually understand what you've written! my prof was schooled in keynes, now he does consulting in africa on development. i love blogs. -cheryl

  4. Hmm re: your Keynes info:

    Were you listening to NPR today? I thinks you were...

    Okay, I had to skim because I just noticed this blog and I wanted to procrastinate but I can't procrastinate even though I was writing my own entry and I have to stop doing that and start work. Enough.

  5. i was that someone who asked. i now understand this blog! my demand for apple products is inflexible!