A Keynesian Look at the Great Recession

               Recently there has been a prolonged period of productivity increase without a corresponding increase in labor income.   The result is that the supply of goods and services throughout the economy has increased, while the purchasing power of labor has not. We analyze  the consequences of this from a Keynesian point of view.

In Diagram  0 we show the classical Aggregate Supply curve AS. It is just a vertical line at the size of the economy, the size of the Gross National Product of the economy.  The thinking behind the classical AS curve is that production is independent of price level.  If money is added to the economy, or the velocity of money increases, prices merely rise, or inflate, but production does not increase.  Similarly, if money leaves the economy, or the velocity of money decreases, prices merely decrease, or deflate.  Production does not decrease.  The actual price level at e is set by the intersection with the Aggregate Demand Curve AD, which is the relationship between the total demand for goods and services and the price level.  If the price level goes up, things are more expensive, and people can buy, or choose to buy,  a smaller quantity of goods.  If the price level goes down, things are cheaper, and people can buy, or choose to buy, a larger quantity of goods.  So for a given quantity and velocity of money, at a given supply of goods and services, there is feedback: An increase in quantity demanded, above Q drives the price level back up toward e, and a decrease in quantity demanded  below Q drives the price level back down toward e.  

This is the same sort of feedback that sets the equilibrium for the intersection of ordinary supply and demand curves:  If the price of a good goes up, manufacturers want to make more, but people want less of it.  If the price goes down, manufacturers want to make less, but people want to buy more.  These two tendencies settle where the supply and demand curves intersect.

Diagram  1  shows the Keynesian Aggregate Supply   AS curve, as opposed to the classical Aggregate Supply curve.  The rationale for the Keynesian AS curve bending  back is the idea that, if the price level goes below this level, production decreases dramatically because wages (and actually some other prices, too, under oligopoly,) do not decrease rapidly.  They are considered 'sticky,' for various reasons, and so instead of wages going down, employment decreases.  That is unemployment increases. Fewer workers implies, in the short run, production of goods and services decreases.  That is, Aggregate Supply decreases.  Meanwhile, the Aggregate Demand curve shifts to the left, because fewer workers have  money to purchase things. This is the situation during a depression or recession.   (Shown in red. The AD curve is about in the position it was during the Great Depression, when first demand, and then production, decreased by about a third.)  The capacity to produce is still there.  It is still at Q, but it isn't being utilized. Actual production is reduced to Q'.  The GNP is smaller than it could, and should be.

The curved region of the AS curve represents the idea that, as the economy approaches full capacity, resource bottlenecks appear, as some sectors reach full capacity before others, driving up the price level. The closer to full capacity, the greater the number of bottlenecks, and the more the price is driven up.  We show the equilibrium point, where the economy is actually performing, part way up the curve, at less than full employment, and at less than full utilization of capital and resources. We would expect this situation in a growing economy. An economy only rarely operates at 'full' capacity.

In Diagram 2 we see what happens when wages increase along with labor productivity.  More is being produced, so the AS curves shifts to the right, and more is being demanded, since wages have also increased.  Both curves shift a comparable amount , so employment remains  high, as does the utilization of capital.  Other things being equal, the price level stays the same, while the economy, the GDP, grows from Q to Q'.  (We are implicitly adjusting for any inflation.)  

   

 Next, in Diagram 3,   we consider when wages do not increase at a rate equal to the increase in labor productivity,  Since productivity increases, more is being produced, so the AS curve shifts to the right.     The Aggregate Demand curve also shifts to the right, but not as much.  This is because income which would have gone  to labor instead goes to the owners of capital, who save a greater proportion of their income.  Saving more, they spend proportionately less.

  Since it moves less, it is now further back along the backward bend of the Aggregate Supply curve, into the recession region.  Because labor borrows, in order to maintain its living standards, this does not happen gradually.  This borrowing temporarily shifts the AD curve along with the AS curve, as in Diagram  2.  But this can only be temporary, because eventually labor's credit runs out, and this happens suddenly.  When it happens, the AD curve shifts back to the left (the red AD" curve), and we have a recession. (Diagram  4.) 

       

            Here the economy produces at quantity Q", less than the potential Q', which the real economy has grown capable of producing.   With labor productivity increased, but demand down, the economy becomes locked into a high unemployment mode, with reduced demand.  It also becomes locked into a mode of low capacity utilization of capital and resources.  This discourages investment.  

            There still remain questions. One is why haven't prices declined significantly?  Well, one of the things that has been happening is that the economy has been running a trade deficit for a number of years.  So for a long time now, many sectors have already been running at below capacity.

           Another, more ominous possibility is that the consequences of Quantitative Easing are slowly being felt in the real economy.  People have wondered why, with an apparent increase in the money supply, there hasn't been inflation.  But if the money is trapped outside of the real economy,  then the quantity (M x V) hasn't changed much.  This is  because although M has increased, V, in reality, counting all the QE money outside of the real economy which has zero velocity, has become very low, and is only slowly increasing as more money slowly enters the real economy.  One of the reasons this money is slow to enter the real economy is the dearth of investment opportunities, a consequence of the fact that, although nominally the economy is growing, from the point of view of employment, and labor income, and thus consumer demand, it is still in recession.   

Concentrated Wealth as an Enemy of the People and their Liberty

Some obsess over the idea that the only enemy to a person's liberty is a tyrannical government.  This seems to be a carryover from the Cold War, where, in the East, the government was indeed its own instrumentality. Disallowing the private accumulation of capital, the governments of the Soviet Union and the Peoples Republic of China had no rivals in their power to oppress their people.

In the United States, in 2014 however, the government has become the instrument of wealth, and it is the wealthy who use it to oppress the people. Thus the source of this oppression, and the ultimate enemy to a person's liberty, is concentrated wealth.  

A person's liberty comes in different forms.  First is the time to do things.  Time spent in labor is time spent which cannot be spent doing other things.  

Second is the freedom to do things.  The nation's laws forbid some activities, mostly those that harm other people.  And the law grants persons the freedom to do other things, things which a person finds desirable to do, which do not harm other people.  

Third is having the resources, or the money,  to do things.  There are many things a poor person cannot do, that a rich person can.  A poor person cannot pilot his yacht, or vacation in distant places, or buy expensive cars and houses.  Neither can he invest his financial capital, since he has little.

The laborer gives up his liberty for his labor. He may enjoy his labor, but it is a loss of liberty all the same.    In exchange for this liberty, he is paid.  Depending on  how much he is paid, and how he values the liberty his time provides him, he gains or loses liberty.  Indeed, it might be said he exchanges one form of liberty for another.  He exchanges some of his time for money.  But money is necessary for him to profitably employ his time. What is time, when you have no money, and no resources? 

Some of what he is paid he must spend on his subsistence.  The longer he has to work for his subsistence, the more liberty he must surrender.  If he is paid above his subsistence, and he has the time to do things, he gains liberty, for that money he may spend on what he chooses.  It grants him the resources to do things.  If he is paid less than his subsistence, he must make up the difference, somehow, if he is to survive.  If he makes up the difference by borrowing, he loses liberty, for he must pay back the lender, with interest.        

So when the wealthy take an increasing share of his income, they are taking liberty away from the worker.  First, by making him work longer for his subsistence.

Second, by leaving him less income, and fewer resources to do and buy things.

Third, by charging rent, by taking more than normal profits on all activities, they reduce the quantity of the goods and services his money purchases.  He must work even harder for his subsistence, and has less discretionary income.  

Further, the goods and services his discretionary income buys are less, thus reducing his liberty in a fourth way.

Fifth, the wealthy, by avoiding taxes, reduce the common wealth, which is the liberty shared equally by all.  

Sixth, the wealthy run up the national debt.  Much of what the government spends is on them.  Since they are responsible for it, as they effectively  control the government, they thus devalue the commonwealth.  

And who is the debt owed to?  Why, the wealthy.  So seventh way they take from the liberty of the people is by charging rent on this money, which interest reduces the amount available to the people. They are charging rent on money, loaning money to the government which they should be paying in taxes.  

Eighth, they force the worker to pay more for his government, for the commonwealth.

Ninth, by privatizing public services, and taking extra-normal profits for them, they further reduce the liberty of the people.    

Tenth, by compromising the regulations, the wealthy enable themselves to charge more and deliver less in the way of goods and services. 

In each of these ways, the wealthy take from the liberty of the people, using the government to oppress.  Yet the wealthy are not oppressed.  They grow even wealthier, while the people do not.  And the laws that seek to bind the wealthy, to limit their depredations on the people, grow ever looser. Their crimes, the harm they do to society, is ignored or pardoned, while great numbers of t he people lose liberty for doing small or even no harm to others.  And from even this imposition of tyranny, some of the wealthy profit.