Back to Basics
By Arnold Kling
Robert P. Murphy and Bryan seem to me to be confusing things.Murphy starts with an illustration of the paradox of thrift from Keynesian economist Steve Fazzari. I don’t like Fazzari’s illustration, so perhaps my quarrel is with him.
To me, the paradox of thrift is simple.
Y = C + I
C = A + cY
Y is income, C is consumer spending, I is investment, A is autonomous consumer spending, c is the marginal propensity to consume out of income.
Fix I at $100, A at $100, and let c equal .9 Then Y = $200/(1-.9) = $2000. Savings, S = I = $100.
Now, suppose that consumers try to increase saving, by reducing A or c. If A goes to $50, then Y = $1500 but saving stays at $100. Instead, if A stays at $100 and c drops from .9 to .8, then Y = $1000 but saving stays at $100. The paradox is that consumers cannot increase saving. Only investors, with their animal spirits, can increase saving.
Let me see if I can put this in terms of a homely example. Our family decides not to go out to eat this week, because they want to save and buy a new TV next year. However, our interest in a new TV does not get conveyed to the TV makers. So, the restaurant cuts back employment and output, but the TV makers do not increase employment and output. Total employment and output fall. Somebody somewhere reduces their saving because they don’t have a job. That person would have bought a TV next year, but now they cannot afford it. So our family gets the TV, and the TV maker does not regret failing to make more TV’s.
Now let’s turn to Bryan.
If the Internet boom never happened, I say that the private sector would have spent on something else, or lent it out to someone else to spend on something else.
In other words, the spectacular increase in employment would have occurred with or without the Internet boom. The Internet boom is nothing but a “just-so” story that we tell about the increase in employment. Maybe, but in my opinion there was a genuine fluctuation in employment, and I think that it was genuinely caused by the Internet boom. I’m with Brad DeLong on that one.
Going back to our homely example. Suppose that the TV makers, instead of failing to realize that our family is saving for a TV next year, over-estimate the number of TV’s being saved for. Consequently, they invest in new TV-manufacturing capacity this year, causing investment, I, to go up, which in turn causes saving, S, to go up, along with employment and output. If the TV makers are lucky, the saving will go toward purchases of new TV’s next year. However, if it turns out that the TV makers were wrong, next year they will have to lay off workers and we could have a general slump (assuming those workers cannot quickly be re-deployed in the economy).
I think it really is possible to have fluctuations in employment. Bryan’s thinking applies in a frictionless economy that is always at full employment, but I don’t think it applies in reality.