Aggregate Demand – Components and Internal Ratio

Before going on any further it is necessary to discuss the term aggregate demand.

Aggregate demand is the sum of two components – investment spending and consumer spending. It would be better if these were treated separately as independent channels through which money flows, since the relation between them is by no means constant in the sense that they can be lumped together and boosted or damped down together.

During the Great Depression, investment and consumer spending power were both very depressed. At other times, investment was high with wages low, so that aggregate demand was adequate. In the stagflationary 1970s and 1980s, consumer demand was too high but investment spending too low, so that aggregate demand may appear to be at least not badly depressed. But the internal ratio of aggregate demand, between consumer and investment demand, is crucial in determining the effect of the level of aggregate demand on economic activity, employment, and the rate of price increases.

Investment was depressed because (apart from disincentives) too little money capital was being accumulated; this was caused by the flow of money through the profits and savings channel being too small. This widened the margin by which interest rates had always to exceed the price increase rate. Interest rates are the mechanism whereby borrowing demand is matched to the amount of money available for borrowing.

There were several effects of this.

Depreciation of plant and equipment was not being made good fast enough. Capital goods were not being improved, and technology was not developing as fast as might have been. This was true even of go-go areas like microelectronics.

Also, the ever-widening difference between gross and net throughput resulting from steady wealth (resource) depletion required that the proportion of money flowing into capital accumulation for investment had steadily to rise, not fall. This increasing flow would be felt as value inflation as discussed earlier.

During the Great Depression, money capital was plentiful but demand for it was low because wages were too low to provide enough consumer demand to stimulate enough investment to employ the money capital (this implies, correctly, that the two components of aggregate demand are determinants, though not the sole determinants, of each other).

In a stagflationary situation, wages are too high and money that should be accumulating as loanable funds is going into the consumer demand channel. This implies two other possible methods of regaining full employment by adjusting the proportionate flows of money, apart from the already mentioned one of cutting wages.

One is to turn the Keynesian Great Depression remedy on its head. Instead of putting more money into consumers’ pockets, transfer money to companies to increase their profits and stimulate investment.

This could not be done by borrowing idle capital, since this is not plentiful as in the depression. Money would need to be printed, deliberately created by the monetary authority, and added to the capital pool for borrowing or given to companies to pad profit margins.

The contrived nature of this arrangement could encourage waste and inefficiency in business, and the required large increase in the money supply could be inflationary by being greater than any increase in economic activity that it might stimulate. The inflation would then discourage investment.

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