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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Posts in this Series
- Review of 1988 edition of Economics for a Round Earth
- Ends and Means
- Evolution Not Revolution
- Notes on Evolution Not Revolution
- Concepts and Terms – What is ‘wealth’?
- The Throughput Chain
- The Derivatives of Wealth
- Global Inequalities in Wealth
- Economic Growth Redefined
- Misconceptions in Practice
- Borrowing to Invest to Get Rich
- Environment versus Economic Progress
- Digression: Pollution Red Herrings
- Digression: Depletion and Inflation
- Value Inflation – the Trigger, not the Bullet
- Living Standard and Quality of Life
- Digression: Resource Consumption, Jobs, and Hands Off
- When the Boom comes
- The Effect of People’s Expectations
- Hard Work – Virtue or Vice?
- Who needs the Snail Darter?
- More Dollars for Conservation?
- Non-renewable Resources – Leave Them in the Ground?
- Digression: Fast Breeder Nuclear Fission Reactors
- Minerals in National Parks – Leave Them in the Ground?
- Population and Wealth
- Left, Right and The Environment
- Digression: “So Long As We Profit, Costs Elsewhere Aren’t Our Problem”?
- Limits to Growth?
- Solar Energy – a Special Case
- The Solar-Powered Car
- Money Supply, Throughput and Inflation
- Real and Money Wages: Living Standards
- Digression: Caution about “Increases” and “Decreases”
- The Idea of Proportionate Flows Applied to Wages: the Great Depression
- Deficit Financing
- The Optimum Proportionate Flow Condition
- Digression: Thrift versus Spendthrift
- Digression: the Private Motor Car – a Basic Necessity?
- The Idea of Proportionate Flows Applied to Wages – the Stagflation of the 1970’s and 80’s
- Excessive Wages Can Cost Jobs
- Fight Unemployment or Inflation First?
- Digression: Work and Jobs
- Other “Job Creation” Schemes
- Visual and Noise Pollution
- Digression: Renewal and Recycling of Resources; Wages and Jobs
- Ratio Distortion and Consumption
- Aggregate Demand – Components and Internal Ratio
- The Slave Economy
- Employment and the Steady State
- Consumer-Led Recovery
- Interest Rates and Ratio Distortion
- Demographic Trends and Living Standards
- Digression: Bad Economics Good for Conservation?
- Coping with Aging Populations
- Stabilising the Human Population
- Costs – What Really Costs Us and What Doesn’t?
- Digression: Other Comments on Statements in UN Report
- Discussion of Costs Resumed
- Budget Balancing Methods – Cost or Gain?
- Digression: Government Expenditure – Government Employees
- Expenditure on Weapons