Keynes on Effective Demand, Income Distribution and Interest Rates
Brad DeLong is great as an educator and a thinker. I bet that even he struggles to understand economics fully. We all have to develop theories to progress the field of economics.
Brad DeLong has a post where he cites a long text from Keynes about rates of interest and effective demand.
Now, I am researching and developing new equations for effective demand, which I base upon labor share of income. Labor share being a percentage limits the percentage utilization of labor and capital for output.
Now Keynes wrote from DeLong’s post…
“effective demand is made up of two items–investment-expenditure determined in the manner just explained, and consumption-expenditure. Now what governs the amount of consumption-expenditure? It depends mainly on the level of income. People’s propensity to spend (as I call it) is influenced by many factors, such as the distribution of income, their normal attitude to the future and-though probably IN A MINOR DEGREE [DeLong’s emphasis]–by the rate of interest.”
Just as Keynes says above, consumption depends mainly on the level of income, and the propensity to spend which is based on distribution of income. That is why I use labor share to measure effective demand. And my equations are holding up so far even in this weird business cycle.
My equations also show that labor share effectively limits the utilization of labor and capital irregardless of the interest rate set by the central bank. Which as Keynes says, the rate of interest is a minor factor in the effective demand limit. My research finds that too.
Yet the rate of interest becomes a sensitive issue at the end of a business cycle which is the effective demand limit. When the nominal rate set by the central bank normalizes to the inflation target and natural real rate, the nominal rate has to be careful not to exceed the growth rate of nominal GDP. If it does, then a recession can be triggered.
But we are in a business cycle, where the effective demand limit was already reached last year, 2014, and the nominal rate is nowhere near normalizing to the level of nominal GDP. My sense is that other factors besides the Fed rate will tip the business cycle into recession because the Fed rate has been taken off the table. And anyway, Keynes says it is a minor factor.
I am doing my part to develop Keynes’ theory of effective demand. So far the economy is following perfectly my basic equation, even with the large fall in labor share… (Link to my post on breaking the code of effective demand)
So as people, including me, argue the correct rate of interest, the over-riding factor is still labor share to determine potential output and the effective demand limit of the business cycle.
The reason I pick on a single word is because I actually LIKE the substance of his post, and do not like to see it so sullied. I would be very happy if he fixed it and deleted all of these comments.