Wednesday, November 21, 2012

I have trouble with this too, Gene

Gene writes: "So, I'm teaching Keynesian economics for the second time. And once again, I'm telling my students that, per Keynesians, recessions occur when intended investment falls short of savings. And the best way to fix this, per Keynesians, is for the government to invest in roads, bridges, parks, education, etc. I'm fine with explaining all that.

What I can't figure out how to explain is why there are people saying Keynesianism is all about consumption and takes no account of investment."

The idea that it "takes no account of investment" is very tough to justify - and probably can't be justified. But I can see why consumption might get into the mix.

First, Keynes is often taught without regard to government at all, so in the Keynesian cross you have investment and consumption with a standard consumption function. So without government in this, how would you talk about prospects for recovery?

Either investment could increase or autonomous consumption could increase. Those are both curve-shifters, after all. In practice a lot of government spending looks like consumption, right? Some is investment, but a lot is handing out money to people who will spend it: outsourcing consumption to taxpayers. That's not "the problem" from the Keynesian perspective, but it creeps into the solution.

Also, the level of consumption is reduced (along with the level of savings), when income declines. That's a symptom, though - not a cause.

The other thing is the multiplier - higher propensity to consume makes stimulus more effective. That's of course a result of the slope of the consumption schedule, not because consumption is the primary issue. But consumption also creeps into the discussion that way.

Finally, really, really bad treatments of the paradox of thrift get people to say things like "Keynes didn't like savings". Gene and other reasonable people know that the problem with this is that it ignores the distinction between any savings and an excess of savings over investment. But if you persuaded yourself to be mislead on this point, "Keynes likes consumption" is the obvious corrolary to "Keynes does not like saving".

The last two points - about the marginal propensity to consume and about the paradox of thrift - are out an out misunderstandings of Keynes leading to preoccupation with consumption. The first two points - about thinking of government spending as an increase in autonomous consumption or noting the decline in consumption - are not quite as bad but they do seem to confuse cause and effect.


  1. Hey, long-time reader, first-time poster here.

    I just wanted to point out that when I learned the Keynesian Cross, Government spending was included. However, if I recall correctly, it is treated as a constant (after taking into account taxes), just like Consumption. So I wonder if people equate Government Spending and Consumption because they are treated similarly in many classes, and thus see any policy remotely Keynesian as akin to "boosting consumption"?

    That is, G + C is combined to a single constant, while I is a function of the interest rate. Countless problems are done to equate the interest rate in the IS-LM while Consumption and Government Spending is exogenous.

    Am I remembering incorrectly?

  2. Daniel,

    A lot of times that I hear people criticize Keynesianism being focused on consumption is when they reference publications such as this one: "". In the document, the author continuously asserts that a price floor for wages in the retail industry will create increases in GDP and employment. For example, the author states that the increases in GDP and employment will be caused by "reallocating money to workers with a high marginal propensity to consume..." The author also makes the following statement: "High-income households, in contrast, put a larger portion of their money into long term investments such as retirement savings that do not factor into consumer demand." From my understanding, the types of statements that this document is making is not Keynesianism, but a "vulgar" form of it that misses a lot of what Keynesian economic theory is really about. However, when I read documents such as these, it becomes hard not to see that many people see this type of "vulgar" Keynesianism as being focused on consumption and not investment. I would appreciate your thoughts on why people might confuse what the author of the referenced document is proposing, and its focus on consumption, with actual Keynesian theory. Thank you.

  3. I posted this at Jonathan's blog (where he makes a great response to you and Gene I think):

    Yep... Another good example: On the Sunday talk show George Will said investment was sluggish in the 1930s because of regime uncertainty (not his term) just like now under Obama, and Krugman scoffed saying businesses weren't investing because demand for their products was so weak. That is quintessentially a Keynesian point; an Austrian or Chicago School guy wouldn't talk like that.


All anonymous comments will be deleted. Consistent pseudonyms are fine.