Keyensian Economics and fiscal policy questions

 I have been reading and listening to lectures on Mises for about a year.  I am now in my first Economics class...Macroeconomics. 

When we covered fiscal policy, we talked about government spending (G) increasing causing consumption to rise( C ) and leading to an increase in investment.  Is this the basic concept of fiscal policy?  Have I missed something?  If so, then there is no point in looking at my other questions.

If I am correct, then we are expecting I to increase by a large enough margin to offset the change in G.  Is this correct?

The original change in G must continue until I has caught up.  Is this correct? 

If I does not ever catch up to G, then the increase in C will force prices higher through demand pull inflation.  Is this correct?

I am using simple numbers to prove this.  For example

GDP = G + C + I     

 (I am ignoring net exports because Keynes does)

80 = 15 + 50 + 15 Base year with impeading recession

90  = 20 + 55 + 15 Increase in G causes an increase in C.

90  = 15 + 55 + 20 Investment picks up the difference and G can return to normal.

Is the above example indicative of a simplified Keynes fiscal policy? 

I just finished up my intro macro course as well.  I think you have it wrong. What I learned is that ann increase in G leads to an increase in AD and AE, but will lead to a decrease in C, which makes sense if you think about it; if taxes go up, people are going to spend less.

No, it's correct. Ceteris paribus a rise in G will cause a rise in C. I can't remember the exact rationale behind it though. A rise in T, on the other hand, will cause C to fall.

-Jon

Whups my bad, I was thinking of an increase in T.

Shagg

From an Austrian perspective, one needs to ask where the Government got the money from in the first place to carry out Government Spending?  This most probably will have comes from taxation, and if it did, it will reduce Consumption.  This is bacause Governments cannot allocate monies on behalf of individuals as well as they can do themselves.  This is the extension of the Mises calculation argument and in mixed economies may be best defined in Hayek's "The use of knowledge in society" paper. 

If it came from legal counterfeiting (creating money out of nothing), then it will lead to inflation which will distort prices (because the price rises are not uniform across an economy and do not reach all people at the same time).  This will cause poorer allocation of resources, which again will reduce Consumption. 

So, even though Government Spending seems to do something to Consumption (see Bastiat's essay on the Broken Window), it always reduces real consumption in an economy.

As an aside, I believe that when government statisticians calculate GDP they they take the whole value of Government Spending as adding to GDP.  In the free economy we know that spend that makes up the amount that individuals have voluntarily exchanged good s for represents more value than they were getting.  With Government Spending we have no similar way of knowing how much value is delivered.  Clearly this method of accounting for government expenditure is fallacious and a government slight of hand.

With kind regards

Remnant.

Slugg:

90  = 15 + 55 + 20 Investment picks up the difference and G can return to normal.

When does government spending ever decrease?

And doesn't an increase in consumption by its very nature lead to a decrease in investment? I mean, isn't investment the very act of not consuming?

I guess G must be monetized debt defecit spending or something... Then wouldn't both I and C fall because no real wealth is being created as the government debt is paid off through increased taxation and GDP will fall back to its original 80 as soon as the inflationary spending boom stops?

Why make the assumption that there is a direct correlation between an increase in I and an increase in C, I can see how G would directly effect C but not I as an increase in I could easily be through buying T-bills to fund the increase in G or foreign investment, any number of things that wouldn't lead to an increase in domestic consumption.

But if all the underlying assumptions are true of this model then why stop at a small increase in G, a 10% yearly increase would lead to massive long term growth and since they don't have to be productive projects we could pay all the socialists to stay on their inefficient collective farms so they don't contaminate the rest of productive society. Win, win for everybody, I think Keynes guy is on to something here...maybe we should put him in charge of the economy so we can get out of this slump.

I just wanted to make sure I understoon Keynes arguments.  I believe the way I described it above is a simplified version of what keynes advocated.  I intend to write my final paper arguing against these ideas.   But before I jumped in I wanted to make sure I understood the assumptions.

Yes, you have the theory correct.  Consumption "increases" as gov spending does.  Then gov spending decreases and the consumption:investment ratio moves towards the investment side.

How does it do this?

I'll save you a lot of time.  G + C + I = MAGIC

Keynsian economics was based upon the idea that the free market could lead to "over-production" and "under-consumption" because those who would demand that which was "over-produced" simply don't have enough money to demand it.  Thus, the solution is for government to resort to deficit spending to finance projects that mostly pay those now "under-consuming".  This "pump-primes" the economy to "get back on track".  During this time, taxes and reduced spending are expected to pay for the former deficit spending.

There are a lot of problems with this. For one, government can't simply increase spending without taxing and thus decreasing either consumption or investment.  Keynesians assume borrowing money will not reduce consumption and investment, but they don't understand that this can cause price inflation.  Also, the later "reduced" government spending doesn't include the debt that needs to be repaid, which means greater taxes and less domestic spending, so basically double less consumption/investment.  That's why this phase is always replaced with "military keynesianism".  We may never know if true Keynesianism ever works; I don't think we've ever gotten to the debt repayment part of the cycle.

Say's Law refutes that "over-production" can occur.  Production is demand for some other form of production.  Thus, "over-production" implies "under-production".   There is no such thing as aggregate lack of demand.

Pricing according to supply and demand fixes the "over-production"/"under-consumption" "problem".  It means deflation of goods that find a surplus.  If some producers don't turn a profit under such pricing, then they stop producing such goods and resources are once again attempted to be used in their most desirable arrangement.  For some reason, this thought scares the crap out of both politicians and Keynesians, who somehow blame everyone for the malinvestments of some.

Keynesians usually hold "liquidity preference" rather than consumer preference responsible for deflation.  Yet, general demand for cash usually only occurs once an economic downturn has already set in.  And obviously, deflation can't continue forever, if many people are sitting on money.  It must reach an end-point, and a free market will find this point the fastest, then allowing cash demand to fall, and prices to elevate back to "normal" levels (except for the goods that consumers don't want that badly).  There are dozens of arguments against this position, many even by (neo)Keynesians.

In short, Keynesianism is a good way to further screw up an already screwed up interventionist market.

For your purposes, just think nominally.  Keynesianism doesn't work in real terms.  It implies that borrowing (funny) money from foreigners and central banks won't cause price inflation.  The whole thing is a money illusion.  You don't allow prices to deflate to clear the market; instead you have the government inflate the money supply, so the market is cleared without changing nominal prices (while deflating them in real terms).  In that in increases any investment, it creates malinvestment.  Only when malinvestment is revealed, Keynesians again sound their siren, demanding inflation - blaming society for not buying the products of "proper" investments at higher cost than they like.