Welcome to this video on post Keynesian on macroeconomics. I'm happy that you're here because now I will present insights from the world's most important macroeconomist that has ever lived, John Maynard Keynes. Did you know that he advised government right after the Second World War to set up the IMF, the International Monetary Fund, and the World Bank. In post Keynesian economics the economy is regarded as an open system, just like the weather or the human body. This means that the system has external interactions and that there are feedback effects, between internal and external levels. Keynes recognized that the economy has interactions with nature, society, human psychology, culture and politics. He pointed at two features in particular. One is the fallacy of composition. This is the wrong assumption that the aggregate is simply the sum of the parts. We can see that particularly in financial markets, which often show herd behavior, simply following what others are doing. You already saw this concept in week five when we discussed financial markets. Herd behavior leads to bubbles and bursts in asset markets from housing markets to currency markets. We can also see the fallacy of composition in the savings behavior of households, which is not under the name of the paradox of thrift. This is the virtue at the individual level of saving income. And simultaneously, its advice at the aggregate level because it lowers consumer expenditure in economy. The more people save, which seems a good idea for them, the less they spend on consumer goods. This lowers aggregate demand and thereby decreases production and employment, which is not such a good idea for all of us. Another feature of the economy as an open system is that it has not only risk, but also uncertainty. If risk is calculable given probabilities of possible options to occur, such as the risk that your house burns down, uncertainty is about unknown uknowns. We do not know which options may occur, and we have no idea about the probabilities. Uncertainty is more like earthquakes, and yes, like financial markets than about your fire insurance or divorce statistics. The major consequence of economies as open systems is that they're often in disequilibrium with either excess supply, as we often see on the labor market and fruit markets. Or excess demand, as we often see in healthcare markets or tickets for popular rock concerts. In post Keynesian economics, aggregate demand, or AD, has a key role. When the amount is low, the economy functions at low capacity utilization. As a consequence, resources remain unemployed, such as labor, which results in unemployment. Why does aggregate supply, or AS, not matter so much? Because its driving force, I for investment, is not determined by the interest rate, but by expectations of optimism and pessimism of investors. Hence, by psychology rather than economic variables, such as the interest rate. But wait a minute, is it the investment funded from savings? Yes. You have a point here. At least a part of investment comes from savings. Mediated by banks who take in savings money, and lend it out to firms. But just like investment, savings also not determined by the interest rate. As we saw earlier, people simply save what they do not consume. So savings is what is left over of income after consumption. S = Y- C. So, in post Keynesian economics, the interest rate does not determine the size of savings and investment, although it has some influence. The economy as an open system undergoes cycles referred to as the business cycle or the economic cycle. In the up-going part, there are positive feedbacks and economies growing faster. But in the down going parts, there are negative feedbacks. And growth slows down or even becomes negative, as in a recession. An example of a positive feedback is that more employment leads to more aggregate income. And hence, more consumer spending, which in turn expands production and employment further. An example of a negative feedback is that during a recession people are uncertain about their job and, hence, save more money. As a consequence, they spend less, and this will reduce the sales of goods, and, hence, also reduce production. This leads to less employment, which reinforces people's fear of job loss even further. The diagram on the slide shows you, AD and AS, which by now you should now what they mean. Note on the axis, the vertical axis is Y, total income. On the x-axis is N, employment. The intersection of the two curves is the point of effective demand. This determines the level of output and employment in the economy. Both aggregate supply and aggregate demand show a positive relationship between Y and N. And they have positive slopes. Do you also see that the slope of aggregate demand is less steep than of aggregate supply? Let me explain why this is. The slope of AD is less steep because for any fixed amount of increase in income, AS will simply lead to more labor hired. This brings no feedback effects on supply and there are no endogenous effects. But the same amount of income increase on the demand side will have positive feedback effect on employment. These are called endogenous effects. More labor implies more investment by firms, I. More employment means also more wage-earnings and, hence, more consumer spending, C. And more employment means higher tax revenue from labor income for the government, T. And this allows for government expenditures, G. This is the multiplier that we see working in AD, but not in AS. So AS a steep because for any given increase in income, there's a similar increase in employment. But AD is flatter, because the same increase in income results in a much bigger expansion of jobs through the endogenous effects expressed in the multiplier. The post Keynesian policy implication is that stimulation of the economy is more effective through the demand side, rather than through the supply side. Let us zoom in on consumption, which, as you know, is a key element of aggregate demand. Low income groups consume much out of their income, and save little, because they need most of their income to make a livelihood. But high income groups, save a lot and consume less as a proportion of their income. They have much more money than they need to eat, to live, and entertain themselves. This is shown in the diagram. The consumers curve levels down at a higher level of income, which is Y on the x-axis. The policy implication is that more pro-poor policies, the bigger the effect of stimulation policies on AD. In other words, policies that redistribute income from rich to poor through higher taxes for the rich and lower taxes for the poor are not only good for poverty reduction but even good for the economy as a whole. So you see that you can be both a socialist and a minister of finance. The opposite of a multiplier is leakages from an open economic system. Macroeconomic leakages are non-consumption uses of income which reduce aggregate demand. These are, savings, taxes and imports. For example, if consumers spend more of their income on imported goods rather than on domestic goods, this will stimulate foreign economies, but not their own economy, even worse. Such a shift may lead to job loss. If people buy imported cars instead of domestically produced cars the domestic car production will shrink. Macroeconomic leakages make macroeconomic policies less effective. Just like a leakage in a bucket of water reduces the amount of water in it. In order to make the multiplier work, we need macroeconomic injections. An injection is a stimulus to aggregate demand, AD. The multiplier, which I told you about just a few minutes ago, is an accelerator on aggregate demand through an initial injection, and it's stimulating effects on other demand variables. This goes particularly through consumer expenditures, c, or technically the multiplier effect depends on the size of small c, the propensity to consume. The higher small c, the more people will spend and the stronger the multiplier effect. This is shown in the multiplier equation. The multiplier is the size of the initial injection to aggregate demand / (1- the the propensity to consume). Complicated? Not really. Check the denominator, the bigger small c, the smaller the denominator, right? And the smaller denominator, the bigger the effect in a numerator. So if exports increase by 40,000,000 pesos and a propensity to consume is 0.6, the multiplier is 40 divided by 1- 0.6, which is 40 divided by 0.4, which makes 100. So an increase in exports of 40 leads to an increase in aggregate amount of 100. That is really nice, isn't it, to have such a multiplier? In this case, it multiplies an injection of 40 million peso to an income increase of 100 million peso, which is 2.5 times the initial injection. I wish I had such a multiplier on my own income. Unfortunately, it only works at a macroeconomic level. The diagram on this slide simply summarizes the post Keynesian circular flow. Do you see what has changed? Now the blue arrows indicate an injection whereas the red arrows indicate a leakage. And of course, I have added the fire sector. As we have discussed in week five, the sector of finance, insurance, and real estate. It is here where savings and investments are mediated, and where credit and debt come from. Thank you for staying with me during this presentation on the important idea of Keynes. There's one more video to go on this topic. Not surprisingly, last but not least, on the neoclassical perspective. See you there.
