Bow down to the Bubble


New Economic Perspectives has the article Bow down to the Bubble: Larry Summerian Endorses Bubbleonian Madness and Paul Krugman Embraces the Hansenian Stagnation Thesis by L. Randall Wray. I am beginning to develop a real appreciation for the writings of Wray.

The article is long.  The beginning of the article has references to people and theories with which you might not be familiar.  Do not let that bother you.  It is not really important to know who these people are.  After this entertaining, but perhaps disconcerting bit, Wray gets down to revelations that are easy to understand if you know any economics.  These explanations may change your thinking whether you are anti-Keynesian or you think you are pro-Keynesian.

The long excerpt below exposes you to only one of the trains of thought in the article  that is revelatory.

Indeed, if net investment is constant, and if this adds to capacity at a constant rate, it is extremely unlikely that aggregate demand will grow fast enough to keep capital fully utilized. This refutes Say’s Law, since the enhanced ability to supply output would not be met by sufficient demand. As such, “more investment” would not be a reliable solution to a situation in which demand were already insufficient to allow full utilization of existing capacity.

Vatter and Walker carried this a step further, showing that after WWII, the output-to-capital ratio was at least one-third higher than it had been before the war. Due to capital-saving technological innovations, it takes less fixed capital per unit of output so that the supply-side effects of investment will persistently outpace the demand-side multiplier effects (for example, as a constant level of net investment adds to capacity at a rising rate). The only way to use the extra capacity generated by net investment is to increase other types of demand. These would consist of household spending (on consumption goods, as well as residential “investment”), government spending (federal, state, and local levels), and foreign spending (net exports).

Vatter and Walker believed that growth of government spending would normally be required to absorb the capacity created by private investment. Indeed, they frequently insisted that government spending would have to grow at a pace that exceeds GDP growth in order to avoid stagnation.

This should not be interpreted as endorsement of Keynesian “pump-priming” to “fine-tune” the economy. Indeed, Hansen had previously demonstrated that pump-priming would fail. If government increases its spending and employment in recession, raising aggregate demand and thus, economic activity, only to withdraw the stimulus when expansion gets underway, will simply take away the jobs that had been created, restoring a situation of excess capacity. The larger the government, the harder it becomes to cut back spending because jobs, consumption, income, and even investment all depend on the government spending. According to Vatter and Walker, in a well-run fiscal system, government spending will rise rapidly when investment is rising (to absorb the created capacity), and then will still rise rapidly when investment falls (to prevent effective demand from collapsing). They call this a “ratchet”—rather than countercyclical swings of government spending, “government as a share of the economy should rise indefinitely”. Adolf Wagner had argued that economic development leads to industrialization and urbanization, which generates an absolute, as well as a relative, increase in the demand for more government services (of course, J.K. Galbraith made a similar point). Hence, for political and socioeconomic reasons, government should grow faster than the economy. If it does not, not only will this leave society with fewer publicly provided services than desired, but it will also generate stagnation through the Domar problem.


The great thing about this article comes from its explanation of the reason for events that I have observed.  In particular, I have been noticing our state of excess capacity due to increases in productivity and have been wondering what the ultimate, permanent solution might be.  I had never thought of some of the ideas that are in this article.  If I have ever had an AHA! moment, then reading this article certainly had many major such moments.

I know I keep saying this, but this article has the potential of changing my thinking more than any other article I have read recently.

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