Post-Keynesian Observations

Understanding the Macroeconomy


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This seemingly innocuous statement is critical to explaining why the current financial crisis has hit us so hard. Keynes made this point in his General Theory in 1936: “Time usually elapses, however–and sometimes much time–between the incurring of costs by the producer (with the consumer in view) and the purchase of the output by the ultimate consumer.” He, too, was terribly concerned about the effect of the financial system on output and employment.

To say that production takes time is to point out that 99.9% of entrepreneurs must go into debt in order to hire workers, buy inputs, rent or purchase physical capital, and so on. Only after the output is produced and sold at market can the entrepreneurs repay the debt and (hopefully) take home a profit. The process works as follows:

debt => purchase of working capital => production => sale of output => debt repaid

Unless profits were well out of line with what we normally observe in the economy, a new round, starting with debt, follows.

Notice, as Keynes did, the critical position held by banks. If they are unwilling to finance firms’ purchases of working capital, the process stops. It doesn’t matter whether the banks are correct or not: if they decide that conditions do not warrant the extension of loans to firms, then it doesn’t matter how high output and employment could have been given our resources, technology, physical capital, and population–we will suffer an economic contraction (traditional economics, incidentally, spends little time discussing these issues since they view the financial sector as always accommodative to the needs of industry).

This begs the question of how banks make such determinations. Also left unsaid here is how the firms, themselves, decide what and how much they want to produce and, which is generally a much more critical issue, whether or not they would like to expand their operation by building new physical capital. That comes in part two, Uncertainty. If banks base their forecasts on well-documented, carefully considered data, then the fact that they play such a critical position is actually a benefit and not a problem.

But they don’t, and nor do firms…

Written by rommeldak

January 9, 2009 at 4:06 am

Posted in Uncategorized

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