Blanchard & Krugman are trying to understand Effective Demand

Do these books include Keynes’ precious term, “Effective Demand”? ¯\_(ツ)_/¯

I watch as grand economists explain the current economy… in particular, Olivier Blanchard and Paul Krugman. They miss the eventual fight of labor to increase their share…

Olivier Blanchard wrote an article, Where danger Lurks. He mentions the Dark Corners where the economy can function badly. He centers his analysis around the financial sector as it is connected to nominal interest rates, inflation expectations and macroprudential policy. He cautions that we need to “Stay away from Dark Corners”. Sounds so mysterious. So he makes a call for more research to understand…

“Turning from policy to research, the message should be to let a hundred flowers bloom. Now that we are more aware of nonlinearities and the dangers they pose, we should explore them further theoretically and empirically—and in all sorts of models. This is happening already, and to judge from the flow of working papers since the beginning of the crisis, it is happening on a large scale.”

What are the Dark Corners that undermine the financial system? What causes governments to lose money? What causes firms to hold back on investment which creates money? What causes low inflation? What causes private and public debts to build up? What causes output and productivity to stagnate?

The answer is a plain and simple… Effective Demand. This is a term so rarely used in economic discourse. It is not understood. For me, effective demand sets a “definable” limit upon the utilization of labor and capital. So it follows that lower effective demand leads to lower investment, lower output, lower productivity, lower taxes and less ability to pay debts.

Effective demand is based upon labor’s share of a national income. In Mr. Blanchard’s article, he does not mention labor’s role in the economy. His article does not include the words labor and wage, and he only only used the word demand in relation to fiscal policy to sustain demand… Which brings me to Paul Krugman.

Paul Krugman wrote an article for the IMF, Increasing Demand. He writes…

“For the first time since the 1930s, the world appears to be suffering from a persistent lack of adequate demand;”

Doesn’t it sound like he is referring to Effective Demand which Keynes put as a central idea in his General Theory book during the 1930’s? Chapter 3 in his book was titled, The Principle of Effective Demand. Keynes said that output would fall short of full employment with insufficient effective demand. Krugman says as much here…

“First, we don’t really know how far below capacity we are operating… Nobody knows—and it would be tragic to accept low output and high unemployment as inevitable when they might be simply reflections of insufficient demand.”

As I understand effective demand, we CAN know how far below capacity we are operating. I have presented many graphs to this effect on Angry Bear before. We are actually near the effective demand limit, which means we are reaching the limit in the utilization rates of labor and capital (unemployment and capacity utilization).

Mr. Krugman writes…

“This in turn implies that sustaining adequate demand is hugely important, not just for the short run, but for the long run too.”

So what is his solution? Do we need to raise labor’s share of national production so that they can “demand” a larger percentage of total productive capacity? No, Mr. Krugman points instead to the ZLB and fiscal spending.

“On one side, central banks are constrained both by the zero lower bound—the fact that interest rates can’t go negative—and by concerns over the size of their balance sheets.”

“On the other, fiscal policy, far from helping, quickly began making things worse. It has been hobbled both by asymmetry between debtors and creditors—the former forced to cut, while the latter have no obligation to expand—and by political infighting.”

Funny how these grand economists focus on monetary & fiscal policies, while the struggle of labor seems to be off their radar. That smells of being hoity-toity from MIT (sorry guys). I know they are aware of labor’s struggle, but they should not leave out labor from these high-profile articles.

Meanwhile labor is faced with an economic reality where countries are holding down wage share in order to compete globally with the likes of Germany and China. Both countries have pushed labor share down since the turn of the century, thereby raising their national savings and inflating their trade surpluses.

Neither negative interest rates, nor increased fiscal spending would reverse the global pressure to lower labor share. Lower labor share means lower effective demand. Mr.Krugman writes…

“So inadequate demand is still a very big problem, and looks likely to remain so for a long time to come. We need to find a way to deal with this situation.”

Knowing the writing of Mr. Krugman, I assume his solutions would center around more fiscal stimulus, a higher inflation target and keeping nominal rates very low for a long time.

We must realize that the problem has to do with labor not receiving a healthy share of the income from national production. We must realize how that affects demand, investment, the ZLB, weak government spending and inflation. Then we must realize that monetary & fiscal policies are limited in their ability to increase effective demand because they do not directly increase labor share. Their influence on labor share is controlled by global market forces. and Remember, Germany and China did not push down labor share through fiscal or monetary policies. These policies will not raise it either.

What is the solution? Labor needs to rise in power globally. They need the power to demand more share of national income.

We hear about how wages are rising in China. Does anyone remember the thousands upon thousands of labor strikes across China in the last 10 years. Does anyone remember the beatings of labor organizers in China just within the last 10 years? Labor in China has fought for wage gains. They received some, but still not enough.

So Mr. Blanchard & Mr. Krugman look for answers. Yet, sufficient Effective Demand depends upon labor receiving a larger share of national production than they currently receive. No one is going to just give it to them. Labor will have to fight for it.