Macroeconomics: 4Th Edition

Macroeconomics

4TH EDITION

JOHN LINDAUER

iUniverse, Inc.

Bloomington

Macroeconomics

4th Edition

Copyright © 2012 by John Lindauer.

In conjunction with Claremont-Howard Publishing

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ISBN: 978-1-4759-6240-6 (sc)

ISBN: 978-1-4759-6242-0 (hc)

ISBN: 978-1-4759-6241-3 (ebk)

Library of Congress Control Number: 2012921895

iUniverse rev. date: 12/10/2012

Contents

Preface

A Recent Letter To The American Colonists From Adam Smith

Chapter One

Pragmatic Economics

Chapter Two

Consumer Spending

Chapter Three

Investment Spending And The Stock Of Capital

Chapter Four

Imports And Exports

Chapter Five

Government Spending, Taxes And Debt

Chapter Six

Money And Intermediation

Chapter Seven

Interest Rates And The Financial Markets

Chapter Eight

Total Spending, Income Fluctuations,

And The Spending Multipliers

Chapter Nine

Income Fluctuations And The Business Cycle

Chapter Ten

Product Prices And The Amount Of Goods And Services That Will Be Purchased

Chapter Eleven

The Labor Market And An Economy’s Capacity To Produce Goods And Services

Chapter Twelve

The Growth Of Jobs And Income

Chapter Thirteen

The Many Causes Of Inflation And Unemployment

Chapter Fourteen

Additional Income And Inflation Considerations

Chapter Fifteen

Triggers, Indicators, And Goals

Chapter Sixteen

Conventional Fiscal Policies

Chapter Seventeen

Conventional Monetary Policies

Chapter Eighteen

Other Policies To Fight Inflation And Recessions

Chapter Nineteen

Pragmatic Policies To Quickly End Recessions And Inflations

Appendix A

Identifying Unqualified Economic Experts

Dedication

To my loves: Dorothy, Susan, John, and Mia. Including, of course, Angelo and Tabriz Oremus-Lindauer and Birdy Sanchez-Lindauer.

PREFACE

"General Theories and policies that cannot explain or cope

with specific events are not general theories and policies

and must be either discarded or improved."

This is an updating of an earlier series of books and articles that brought together macroeconomic theories and policies into a pragmatic synthesis integrating the real-world problems, policies, and institutional realities of somewhat-competitive economies such as the United States. The material that follows is as appropriate today as it was years ago because it is an absolute truism of science that general theories that cannot explain specific events are not general theories and must be either discarded or improved.

The theories and concepts presented years ago are updated, rewritten, and re-presented after all these years because of my distress at the poor performance of the American economy during the so-called Great Recession that began in 2008 and continued unnecessarily for years thereafter—and my increasing certainty that a large portion of the recent unsuccessful economic policy decisions made in the United States resulted from the inadequate graduate student educations and lack of worldliness which characterize some of our PhD granting institutions.

As readers shall see, the current Great Recession, and the unemployment and deficits it is causing, can be quickly and permanently ended with appropriate monetary policies based on appropriate macroeconomic theories and realities—policies that can be immediately implemented without additional congressional or White House involvement.

The first edition of my earlier Macroeconomics series of books and articles introducing the macro-pragmatic synthesis appeared in the 1960s and was translated into Chinese, Japanese, Portuguese, and Spanish. Since then, to my amazement, teaching and writing about macroeconomic analysis and its application to problems and realities such as inflation, unemployment, economic growth, monetary and fiscal policies, and governmental deficits, appears to have deteriorated in North America.

Instead of moving up to study the theoretical and policy complexities of the complex real world, and particularly the difficulties inherent in implementing appropriate policies to keep countries such as the United States prosperous, students have all too often moved down to concentrate on unworldly and unrealistic overly simplified quasi-mathematical models that generate over-simplified conclusions and inaccurate explanations and policies.

No wonder the ensuing decades of students became congressmen, journalists, and central bankers who, as a group, all too often purvey absolute nonsense to the public about such macroeconomic conditions as the causes and cures of inflation and unemployment and the significance of governmental deficits.

The decline in the content of macroeconomics is particularly appalling because, absent the complexities of the real world, it appears to have resulted in policies that have hurt many millions of people—instead of sustained prosperity, growth, and stable prices, the United States has all-too-often pursued policies that have resulted in unnecessary inflations and recessions that have caused unemployment, bankruptcies, business and bank failures, mortgage foreclosures, government deficits, and slow rates of growth.

Worse, if that is possible, twice in the modern era, once in the 1930s and again starting in 2008, the lack of appropriate policy responses has resulted in easily endable recessions morphing into serious depressions wherein the conventional monetary policy no longer works even if it finally starts. All of these problems and failures could have been prevented if the politicians and Federal Reserve governors and regional presidents of the United States had been adequately educated about the complexities of macroeconomics and had had a few real world experiences in business or commercial banking to put them in perspective. They did not.

As one of the earliest of the macro-pragmatic synthesizers I took pride in developing the comprehensive multi-market model presented herein and using it to examine the real world conditions and relationships ignored by the early Keynesians and those who followed: both the neo-Keynesian economists who continue to want a bigger role for government and the neo-classical economists who continue to attempt to integrate micro and macro via a neo-classical synthesis that requires an unattainable economy involving isolated individuals bargaining with one another in free markets unfettered by government activities.

The multi-market model used herein to examine the various relationships and policies epitomizes the macro-pragmatic synthesis—because it takes analysts beyond the traditional simplistic models and relationships. It does so via the integration of the various markets and microeconomic considerations associated with aggregate supply with the Keynesian concept of aggregate demand. Then the model is used to depict and explain how the effects of various changes and problems will ripple through the basic markets of an economy as a result of changes in the economy’s institutions and policies; when and how conventional monetary and fiscal policies will work and will not work; and the policy alternatives that exist in the real world when the conventional policies become inadequate.

Conceptualizing and understanding the basic interrelationships that exist between an economy’s financial, labor, and product markets and knowing what will tend to happen as a result of a specific institutional change or policy is important. It is the key to identifying the policies needed to keep an economy prosperous and growing without inflation and unemployment. Pragmatic analysts reading the following pages will quickly understand why I find it quite depressing that the graduates of many of our best universities are so unworldly that they still cling to the overly simplistic and naïve theories and models and solutions that characterize the early Keynesian and neo-classical generations of macroeconomists and their acolytes.

In essence, the economic institutions of countries differ from one another and are constantly experiencing changes and unexpected events. These differences and changes make many of the early Keynesian analyses and policy suggestions, and those of many of their neo-classical successors, to put it gently, rather naïve in terms of being applicable to the United States and other modern economies.

Most pernicious of all are the use of unworldly models and inadequate data. This seems to have resulted in both the early Keynesians and the neo-classical synthesizers, and particularly their present-day followers, effectively ignoring or minimizing the significance of problems and policies because their models could not reflect them in an appropriately scientific manner—as if the complex concepts and relationships of the real world can be ignored as meaningless if a government or central bank has not collected data sufficient for quasi-mathematicians to analyze. In a word, they have let us down by substituting questionable data and simple models for intellect and reality.

The narrowing of macroeconomics during the past four or five decades is a tragedy because, concurrently with the study of macroeconomics being narrowed in its quest for acceptance as a hard science, the world’s ever evolving economic institutions and the burgeoning of ideas, data, and research have, if anything, expanded the concepts and ideas and relationships that might be covered in macroeconomic tomes and classes.

Equally, if not more important, the Keynesian decades of overly simplistic theories and models have produced non-economists holding decision making positions who all too often do not have a clue as to how their policies and actions will actually impact the United States economy and its people. Worse, because they do not have a thorough grounding in the pragmatic real world to which macroeconomics applies, they all too often rely on what passes as common knowledge from the Keynesian and neo-classical eras and even earlier eras.

The results have been horrendous: tens of millions of Americans have had their lives ruined by inflation, unemployment, bankruptcies, foreclosures, and business and bank failures. These terrible events never should have happened and they certainly should not be continuing to this day.

In essence, many of those who today are presented to the public and our politicians as business economists or economic experts do not appear to be sufficiently knowledgeable and worldly to understand how the American economy actually operates, let alone how it can be kept prosperous and fully employed without inflation and unemployment. Their acceptance of government positions and media assignments for which they are unqualified and their lack of economic knowledge and understanding have led to everything from bad investment decisions to well-meaning monetary and fiscal policies that exacerbate rather than correct the problems at which they are aimed.

This presentation is for the analysts who will become the investors, managers, and policy makers of the United States. It presents and integrates the basic concepts and pragmatic realities of modern macroeconomics as part of a comprehensive multi-market model describing the basic macro relationships that exist in the real world and how they interact. That is followed by the use of the model to analyze how various basic problems such as inflation and unemployment come about for many reasons and how such problems might be corrected and prevented.

I think it fair to say that analysts and journalists able to understand the concepts of Macroeconomics will come away with a better understanding of how the American and similar economies actually function in the real world and be better equipped than most of their peers both to explain what is actually happening, and why, and to make better investment and policy decisions. (A description-only version entitled Inflations, Unemployment, and Government Deficits: End Them is available on Kindle and in paperback. It may be useful for members of the public and for students who need additional background; faculty may want to adopt it for their classes and use their own equations and models.)

This edition leaves out certain elements that can still be found in early-oriented macro texts. Specifically omitted is the traditional separate chapter describing the earliest macroeconomists—the classical economists who preceded Keynes and his contemporaries. Their ideas such as the quantity theory of money to explain inflation, so beloved and studied to this day in second tier economics departments, and the role of interest rates to equate savings and investment, so there can never be a recession, are merely summarized and debunked. This is done by examining the actual determinants of savings and investment and by using reason, facts, and the multi-market model both to illuminate some of the numerous possible sources of inflation and unemployment that exist in the real world and to analyze the various policies that might prevent them. (I really thought about leaving in the traditional separate chapter for I have a particular affection for the quantity of money theory of inflation: it’s so simple even journalists and the untrained lawyers and bureaucrats posing as qualified Federal Reserve governors can understand it.)

Also omitted is the traditional chapter describing the national income accounts and the usual extensive source-citing footnotes found in earlier macro texts. These are no longer necessary because the specific concepts which were new in the initial post-Keynesian era are now generally known. Moreover, in this age of Google, Wikipedia, and Kindle readers who want to explore the views of a particular scholar or look up the latest data can easily search them out in much more detail than can be summarized in a few words of text or footnotes.

Because the complexities of the real world and the concepts and policies of the macro-pragmatic synthesis go so far beyond basic ideas and relationships presented in the pages that follow, would-be analysts and journalists should view this material as a starting place. They should also be aware that a model, no matter how complex, merely describes the most basic relationships of the real world in the most oversimplified of terms.

As pragmatic and worldly economists know, and the ever-growing numbers of narrow economic technicians apparently do not, simple graphs and a few hundred simultaneously solved equations populated with the limited and often questionable data that is available can never fully describe the complex economic relationships, institutions, and markets of complex and ever growing and changing economies such as that of the United States and the countries of Europe. In the real world, getting appropriate and accurate data to populate the basic equations is difficult even if writing and solving them is easy. The resulting product is all too often scientifically sound, totally non-illuminating, and often absolutely useless in evaluating an ever-evolving economy—akin to attempting to drive down the winding road ahead by looking in the rear view mirror.

In this, the fourth edition of Macroeconomics the theories and explanations underlying the macro-pragmatic synthesis and its policy alternatives are presented in a more colloquial form and available in both e-book and printed versions. I am doing so because I feel guilty about the poor job I did of informing many of those who became members of our economics faculties of the realities and complexities of macro-pragmatic synthesis—and in so doing left them to mis-educate their now-influential students as to the application of macroeconomic theories and policies to the real world.

Interestingly enough, the theories, policies, and multi-market integrated model contained herein have held up rather well through the years. Indeed, they are even more applicable and unique than I first thought and certainly go far beyond the ideas of Keynes and the post-Keynesians and neo-classical synthesizers who followed him. Unfortunately in my effort to impress my peers and gain academic advancement I obviously wrote too obtusely about the need to fully integrate the concept of aggregate supply and the theories and realities of pragmatic macroeconomies. So some students keep hearing the same old common knowledge nonsense and simplistic analysis from the early post-Keynesian era when students learned about some of the monetary and fiscal policies applicable to the U.K. and its institutions (Keynes) on the premise that they would also be applicable with a few tweaks to the U.S. and other countries. No wonder we have continually had periods of inflation and unemployment long after they are no longer necessary.

Perhaps it’s my fault—after initially developing the ideas and writing to explain the need to fully integrate aggregate supply and the world’s pragmatic realities I became bored and moved on, thinking that it was only a matter of time before a worldly rationality would prevail in macroeconomics as it had in the rest of the economics profession and that it would be followed by the adoption of appropriate monetary and fiscal policies in the United States. Instead many of my macroeconomist peers in the United States narrowed their analyzes so they could be scientists; assumed that the problems and relationships of the future would be the same as those of the past; and then replicated themselves instead of producing worldly economists to guide our policies and staff our central banks. Mea Culpa.

Readers should know that I am indebted to my wife, Dorothy Oremus, for her encouragement and suggestions. Her many years as a director and chairman of a commercial bank provided valuable insights into how the American banking system actually operates in the real world and how it actually responds to monetary and fiscal policies. In a word, it is different from what most of today’s journalists, investors, congressmen, Federal Reserve governors, and business economists think. The same can be said for my business experiences making decisions about jobs and investments and my political experiences making decisions about taxes, spending and public debt. I surely wish I had known then what I know now about the difficulty people have accepting new ideas! Instead, I feel like a doctor who presented a cure for a terrible disease (think recessions and inflations) and then spent years watching in dismay as his peers continued to prescribe the same old treatments that never worked and never will.

And finally, an invitation. This book contains concepts and ideas that are complex and often run counter to the misleading common knowledge typically accepted by those who have not studied the economics and policies of the modern macroeconomic synthesis and/or have not had experience in the real world of business and commercial banking. The author hopes analysts will understand the material and profit from it—and, as a result, make better policy decisions and be more accurate when they reach decision-making positions or positions of influence. Finally, readers are invited to email their questions and requests for clarification to the author via Facebook or LinkedIn. I won’t promise to answer but I will try.

JOHN LINDAUER

Chicago, Illinois

A RECENT LETTER TO THE AMERICAN COLONISTS FROM

ADAM SMITH

Glasgow, Scotland 2012

It’s been a few years but I’m back for a while. I’m really surprised at how far you’ve come—and shocked, just shocked, to see where you are headed.

Your wealth and that of your fellow investors is the wealth of your nation. Frankly, I expected to find you much wealthier by now. But in recent years your nation seems to have ignored some of the basic tenets I tried to teach you and stepped well off the high road to prosperity and even more wealth. Something you call a business cycle and your election of people who want to regulate your behavior seems to have put you off the road to more wealth.

In a word, your nation seems to have let its politicians and journalists forget or distort all my good advice and those of my successors Ricardo, Mill, Keynes, those pompous Austrians, and, of course, the modern macroeconomists such as Samuelson, Krugman, Davidson, and Lindauer who brought it all together for you. (even if Krugman sometimes writes as if he’s in Britain where fiscal policy might actually work).

Instead of listening to us you’ve been listening to other people explain what we meant, people who apparently never even read our works. No wonder they get it all wrong and the wealth of your nation is stagnating.

Business cycles are bad for a nation’s wealth.

One reason I’m writing to you today is because I read about events called business cycles that should never have happened because, as all worldly economists know, periodic slowdowns in the accumulation of wealth are not at all inevitable. Strictly man-made as the saying goes.

I still believe in the pursuit of self-interest as a way to drive your economies forward. It works, you know. So why have you let your politicians stifle it with more regulations and those useless monetary and fiscal policies that allow business cycles? Are you really opposed to bigger incomes and higher share prices and people who are healthier and richer? It is quite amazing.

Just think, for example, where the incomes and wealth of your nation would be if you had not been stuck for the past five years in your Great Recession or whatever you call it. You and your nation would be a lot wealthier had you taken our advice and taken steps to quickly see it off.

What’s to be done.

So what’s to be done to get investors going and your nation’s wealth growth back on track? Three things.

First, listen to what Keynes really said about the importance of customers and where they come from—and ignore what been made up about him by those who either never took the time to read what he wrote or, more likely, couldn’t understand it because of those pesky equations.

And be sure to note that Keynes emphasized fiscal policy because he was writing about our beloved United Kingdom where fiscal policy is workable—perhaps because King James who got the kingdom going was a Scot and had good common sense. In contrast, some of you colonists have set up nations that make fiscal policy totally unworkable by dividing your decisions between something called a President and your parliament, and then re-dividing your parliament into two parts which seem to be unable to act together in a timely manner on anything. So why do you even try to use fiscal policy for such unworkable things such as jobs bills, whatever they are.

But Keynes was right as I tried to tell you years ago—customers are important. Without enough customers your employers won’t hire more workers and produce more to increase the wealth of your nation. Is that so hard to understand? Keynes got it—that’s why he became so wealthy as a trader or hedge funder as you apparently call them these days.

It’s as I described years ago and Keynes clarified. There are four basic classes of customers for a nation’s employers whether they are trying to make profits or non-profits such as charities: consumers, businesses buying plant and equipment, foreigners (those terrible French, for example), and governments buying muskets and roads and schools.

There is nothing inevitable about a nation having a business cycle that is periodically down so businesses fail and workers can’t find jobs. All a business cycle being down means is that your nation’s employers aren’t keeping all your people working because they don’t have enough customers for some reason.

But having a shortage of customers shouldn’t be a problem—because everyone’s wants are insatiable. Remember that? So it’s only a matter of getting money into the hands of potential customers who are willing to spend it.

In the UK we mostly use fiscal policy to keep the wealth of our nation employed and growing. That lets us quickly set things right by spending more or taxing less. (And we often regret it because fiscal policies frequently come with absurd regulations attached as the government’s bureaucrats attempt to fix things they don’t understand.)

A realistic monetary policy is the only answer if a new nation such as the United States is to continually create wealth.

In any event, since Keynes’ fiscal policy suggestions will not work in a nation with a government organized as yours is, it means your nation is limited to using monetary policy to encourage the customers your nation’s employers must have if they are to keep making investments and creating wealth.

Your central bank can use monetary policy to indirectly encourage customers by creating new money as it is needed and flowing it into your commercial banks which, being the good profit seekers they are, will try to loan it out so consumers and businesses can buy even more than they otherwise would. Or your central bank can create it and directly flow it to would-be customers. In the real world, those are your only two choices.

Some unworldly folk think that creating new money when more customers are needed will cause inflation from too much spending. They are wrong. More money is just fine if it is necessary to generate enough customers, but not too much more so prices generally rise nor too little more so unemployment remains. It’s a fine line—that’s why every nation uses a central bank instead of gold flows as we did when I first started thinking about the wealth of nations.

Other unworldly folk think that instead of using monetary policy a nation can fix its exchange rates so it sells more to foreigners. These days I hear the Chinese nation is doing exactly that to yours. The problem, of course, is that nations whose customer spending is diverted abroad can and do respond in kind and quickly get it back. So exporting more is really not a policy a nation can depend on to maintain and grow its wealth.

What I am trying to explain here is that monetary policy that gets money into the hands of spenders or selling more abroad are the only two alternatives when fiscal policy isn’t feasible. And that selling more abroad is not realistic because of the inevitable retaliation.

But that doesn’t mean that a monetary policy that will work for my and Keynes’ nation (the U.K.) will work for your U.S. nation.

Here in the U.K. our central bank sets the interest rate at which commercial banks can borrow money from the central bank and loan it to their customers. The rate our central bank sets is, in effect, the wholesale price of money. When it is reduced our banks tend to borrow money from our central bank and then compete to loan it out by lowering their loan rates—and the availability of loan and the lower interest rates encourages more customer spending.

Your central bank is different. The only interest rate your Federal Reserve tries to influence is the rate your commercial banks charge one another to borrow money overnight to meet their reserve requirements.

One has to be daft to think that one of your commercial banks will loan out more money if the Federal Reserve raises or lowers the interest rate for money the bank has to repay in full the very next day—yet I hear your central bank, the Federal something or other, makes much of it and its governors actually think they are doing something when they change that overnight rate. Amazing—no wonder your nation has recessions and depressions.

So not only is your Congress mistakenly and fruitlessly trying to copy our UK fiscal policy, your central bank is mistakenly and fruitlessly trying to copy our monetary policy as well. Probably the result of the poor educations your policy makers got by using textbooks written by economists from my country. In any event, it won’t work for you.

Of course, your Federal Reserve can do several things to keep the wealth of your nation growing even if changing interest rates is not one of them. One thing it can do is indirectly flow money into the hands of customers via your nation’s commercial banks or your national government. It does this, of course, by buying assets with newly created money or by using newly created money to fund your government deficits so that higher taxes are not necessary.

Another thing it can do is channel newly created money to the recipients of your pension schemes such as Social Security or, God forbid, send it to those abominable bankers in Germany and Greece as your central bank did a few weeks ago.

I just don’t understand why you colonists set up your nation’s central bank so it does not loan out money to commercial banks to be reloaned. But I am absolutely amazed that the people running your central bank, I think you call them Bernankes or Geithners and they must be from Wales, are so naive and unworldly that they don’t realize their central bank is fundamentally different from ours in the U.K. No wonder your nation keeps having those unnecessary business cycles cutting into its wealth.

From what I can see today, if your Federal Reserve used the right monetary policies, instead of fruitlessly trying to copy ours in the U.K, your nation’s wealth would increase faster, your nation’s workers would be fully employed, and your government would probably have surpluses instead of deficits.

Why all the regulations?

Second, if you really want to get your nation back on track to more wealth you really should listen to the Austrians such as Hayek and Schumpeter—encourage investors to add to your nation’s wealth. Don’t discourage them with silly regulations and laws that help a few of your cronies but generally discourage investment spending and the accumulation of wealth.

Employers making investments are important. They increase the wealth of your nation by building new factories and introducing new technologies. On the other hand, as I pointed out in my earlier writings, businesses that are already in existence will inevitably conspire to fix prices and try to use your government to discourage investors from establishing businesses to compete against them.

Favoring one employer over another is bad for investors and the wealth of your nation for, as John Stuart Mill, Alfred Marshall, and I pointed out years ago, competition tends to drive down prices down and cause inefficient producers to fail—and thus frees up their workers and capital to be employed more efficiently elsewhere and increase the wealth of your nation.

It really is important to resist government interference in the accumulation of wealth or its employment. The self-interest of power-seeking government employees may cause them to seek to expand their personal powers with laws and regulations that impede investors. If you remove those impediments people will be motivated by their self interest to save and borrow more so they could set up new businesses and hire more workers.

For example, I have been told the abominable French and Greek governments restrict the number of coaches available to carry visitors to their cities from one place to the other—so service is horrible, prices are high, and the wealth of their nations is less than it could be. (The difficulty and high price of getting around in such places is why I spend all my time in Scotland.)

And finally, don’t be taken in by the unworldly who say that national deficits and the resulting national debt are always bad. Sometimes, of course, they are. It amazes me, but some people wrongly believe they always have the same effect the wealth of your nation as the deficits and debts of people and state and local governments. They aren’t the same. And having more of them or less of them really doesn’t mean much.

In reality, your nation’s sovereign debts are different than all other debts in your nation because sometimes they can be paid with newly created money without causing inflation. That’s why responding to them as if they are some kind of great problem as your parliament or whatever it’s called (congress?) seems to do can make things worse for investors and your nation’s wealth instead of better. As the Austrians would say don’t let your politicians hurt you by worrying about the little things and making much of them. Keep your eye steadied on what counts—which is the wealth of your nation.

A Final Thought

If you’re an investor or ordinary citizen and the politicians and pundits have you confused by their inane speeches and silly policies you might want to read one of my successor’s, John Lindauer will do nicely, books and articles on the subjects of Keynes, inflation, unemployment, and debt. I understand you can find them at seekingalpha.com and in book-form on the Amazon—though for the life of me I can’t understand why books would be on a river.

Hope this helps. Be thrifty and may God keep you from evil.

Adam

CHAPTER ONE

PRAGMATIC ECONOMICS

Millions of people, employers, and governments throughout the world are constantly making innumerable decisions such as whether or not to buy a specific product, or make a specific investment, or put money in the bank, or work more hours if they can find jobs. Sometimes, as is the case in the United States today, their spending does not add up to give an economy’s public and private employers enough revenues—so there is a Great Recession and people along with their businesses and governments suffer from unemployment, foreclosures, bankruptcies, and business failures. Is it inevitable that such things periodically occur? And, more importantly, what will work to turn things around if and when a recession does occur? And what won’t work?

Economists once thought that the individual decisions occurring in a relatively free economy such as that of the United States would automatically result in prosperity in the form of full employment without inflation—by automatically providing whatever is enough customer revenues for its employers, deposits for its banks, encouragements for its investors, stable prices for its products, and jobs for its workers. Obviously that is not the case. But what must a government do (and not do) so that the public and private employers in its economy hire enough people? That is the major economic question that faces every Congress and every administration. How they answer it determines their legacy and their place in history.

The early economists thought a desirable state of full employment would happen automatically if only the economy’s government would stop interfering and let nature take its course. Others, the socialists and communists, thought it could only happen if the government and its bureaucrats regulated and planned everything. Both approaches were tried—both failed miserably: There were periodic great recessions and inflations in the former and great stagnations and an inability to grow in the latter, to say nothing of the repression and corruption that accompanied the bureaucrats and their decisions.

Then along came the Great Depression of the 1930s and John Maynard Keynes’ General Theory of Employment, Interest and Money—and the economic science known as macroeconomics was born. Subsequent analysts, both supporters and bitter critics, refined and expanded his ideas into what is today the body of thought known as conventional macroeconomic theory and the various monetary policies and fiscal policies it suggests.

In essence, the theories and policies of the Keynesians and their conservative critics are quite elegant, very scientific, and perfectly rational—except for the rather inconvenient problem that they neither explain the real world of the United States economy nor suggest viable monetary and fiscal policies to eliminate its periodic experiences with unemployment and inflation, and the hardships and budgetary deficits they inevitably cause. There is a lot of substance to Keynes. But not all his ideas and policy suggestions apply to countries such as the United States whose economic structures and institutions are significantly different from those of Keynes’ Britain. Other ideas and policies are often needed.

Macroeconomics is the area of economics concerned with the prosperity of a nation. It deals with some of the most controversial and challenging problems of our time: inflation, taxes, deficits, unemployment, exchange rates, money, interest rates, and the proper role of an economy’s governments and its central bank. In other words, all the things that make politicians reach for microphones and hardware salesmen make impassioned speeches at their Rotary clubs.*

*Macro is the Greek word for whole as opposed to micro which means something small. Thus macroeconomists study the nature and appropriate policies for a whole economy and microeconomists study the nature and policies appropriate for an economy’s individual parts. Thus a macroeconomist might study inflation and an economy’s total output while a microeconomist might study the prices and production of a specific item or specific market.

In the years following Keynes his supporters and critics attempted to tie together the then-prevailing economic theories into a synthesized body of macroeconomic knowledge. Then in the 1960s the macro-pragmatic economists came along and added new theories and explanations based on the more complex and ever-changing concepts and relationships of the real world to the simplistic ideas of Keynes’ supporters and critics.

In essence, the theories, concepts, and policies of pragmatic macro-economics are merely another stage in the continuing development of the field of macroeconomics. In particular, pragmatic macroeconomics deals with the various policies required to keep a modern economy, such as that of the United States, operating at full employment without inflation and undue regulation. As such it goes beyond the theories and ideas and policy suggestions of both the followers and critics of Keynes.

Everyone has a dog in the fight to keep their economy prosperous. When all the billions of individual decisions made daily in a complex economy add up in such a way that prosperity prevails, jobs are plentiful for everyone, including ourselves, and wages tend to be relatively high and growing. When times are hard, on the other hand, the specter of unemployment, bankruptcy, and destitution falls upon millions of men, women, and children—and every one of us is potentially among them no matter how safe we feel at the moment.

ECONOMIC IGNORANCE

OFTEN PREVAILS

As will become increasingly apparent, the general state of a nation’s economy is a subject in which passions and prejudices and common knowledge often replace facts and pragmatic reasoning as the basis for laws, regulations, and governmental and central bank policies and actions.

Too often well-meaning, but unworldly, theoreticians, congressmen, and central banking placemen advocate and apply simple but unrealistic policies in an attempt to solve complex economic problems in an ever changing world. In essence, they seek prosperity with homemade remedies based on common knowledge and unworldly theories instead of adopting laws and policies appropriate for the real world in which we live.

The consequences of their well-meaning mistakes are horrendous: complex money using economies of prosperous and democratic countries such as the United States and Germany and poor and authoritarian countries such as Russia and China have been plagued and even overwhelmed at times by great inflations, massive unemployment, low or negative rates of growth, and balance of payments deficits.

These are strong terms to be sure, but mild in comparison to the conditions associated with them. People even in the richest countries such as the United States have all too often been periodically unable to afford food and shelter; investments, savings, and pensions have been wiped out or significantly reduced; students have not been able to complete their educations and pay off their student loans; business and banks have failed; and tens of millions of people have lost their jobs and homes.

The tragedy is that all of this suffering was totally unnecessary and could have been avoided by the implementation of the pragmatic macroeconomic policies that are analyzed and explained in the following pages. These are the policies which must be understood by those who would be successful leaders of businesses, banks, and governments—or, after much totally unnecessary human suffering, they will fail and be replaced.

THE ORIGIN OF

MACROECONOMICS

The desire to improve the performance of economies and to understand how and why they operate has led economists to probe numerous economic nooks and crannies. They have long examined both the general economic conditions prevailing in an economy and the nature and problems associated with specific parts of the economy.

The study of economics changed forever in 1936 with the arrival of John Maynard Keynes’ epic The General Theory of Employment, Interest, and Money. It brought macroeconomics to the fore as a separate area of economic theory—and his analysis and explanations established macroeconomics as a separate discipline far removed from microeconomics. In other words, it changed economics and economic policies forever.

Keynes combined being a Cambridge economics professor with being both a very senior governmental advisor and an investor who became one of the world’s most successful money managers and philanthropists. He was a director of the Bank of England, the architect of the IMF and the World Bank, and was ennobled as Baron Keynes. A new borough and city was named after him (and the great English poet John Milton): Milton-Keynes. Importantly, Keynes wrote about monetary and fiscal policies that specifically applied to Britain and its unique political and financial institutions.

Most importantly, Keynes’ policy suggestions for Britain, with their emphasis on rapidly implemented fiscal policies and changes in the interest rate set by the central bank, do not always apply to economies such as the United States which have a very different type of central bank and a very different governmental framework.

The significant errors of

the early macroeconomists.

The now-called Austrian or Classical economists who preceded Keynes, and included Keynes himself prior to 1936, thought that there were market forces in existence such that, unless there were government or other interferences which prevented prices from changing, there could never be a long-term recession or depression caused by employers experiencing inadequate customer spending such that they would have to lay off workers.

More specifically, they thought there could never be inadequate levels of spending. Interest rates would adjust to insure it never happened. They saw interest rates as both the primary motivator of savings and the price investors paid to obtain that savings to use for investment purposes. In essence, they thought an economy’s interest rates would quickly adjust upward or downward to provide sufficient additional investment spending to offset any additional savings (non-spending) that might occur.

According to them, if interest rates were free to adjust all the money coming into an economy’s public and private employers would go right back out to be fully re-spent again—so there would never be a recession or depression with low levels of production and millions of unemployed workers. In essence, according to the pre-Keynesians, an economy such as that of the United States would never suffer from inadequate customer spending, at least not for very long, since the interest rate price of borrowing money would adjust to equate the supply of savings with the investors demand for savings.

To Keynes and everybody living in the real world it was painfully obvious that the Austrians and other Classical Economists were wrong—there was a Great Depression in the 1930s and it did continue for years without ending. And it continued in Britain and the United States despite interest rates reaching all-time lows and despite the forecasts of Keynes’ predecessors that such a depression would be short-lived, if it ever came to exist in the first place. Worse, it happened again in the United States when its Great Recession, which started in 2008, similarly morphed into a prolonged depression.

The idea that recessions and depressions would automatically end led to various policy conclusions: one was that interest rates should be left alone to adjust by themselves; another, that the central bank should not respond to inadequate levels of spending since more money in circulation was not needed because full employment would automatically return. Moreover the addition of such unneeded money would then, it was alleged, cause inflation when prosperity returned. A third was that the only role for government when there is a recession to be the removal of impediments preventing wages and prices from falling—because when wages and prices got low enough everyone will be able to find a job and full employment levels of production would occur.

Very different conclusions.

Keynes rejected and replaced, at least for Britain, the obviously failed analysis and policy conclusions of the Austrians and his other predecessors. He noted, correctly as it turns out, that things were different in the real world: that interest rates were set in the money market by the supply and demand for money rather than by the willingness of people to save and invest; that the amount of savings that occurs in an economy is primarily related to the level of income in the economy rather than the level of its interest rates; and that the total amount of income and customer spending in an economy could be permanently mired at a level too low to generate full employment levels of production—the situation that occurred in the United States both in the 1930s and again starting in 2008.

In essence, the main thrust of what Keynes said is that the total amount of all customer spending in an economy (by consumers, investors, governments, and foreigners) may not be high enough to cause the economy’s governmental, non-profit, and for-profit employers to fully employ all the available workers. In other words, as every American business executive and government department head will tell you, revenues are vitally important. Without revenues employers cannot hire employees and goods and services cannot be produced.

Keynes’ policy prescription for the depression in the U.K. was 180 degrees different from his predecessors—for more government spending so that total spending would rise; and for the central bank to lower the bank rate at which it loaned money to Britain’s commercial banks so that they would have more loanable funds which would, in turn, cause them to compete for customers by lowering the interest rates they charged which would, in turn, encourage more investment spending so that total spending would rise.

The Keynesians who followed Keynes parsed his words and suggested his fiscal and monetary policy suggestions would also apply to the United States. They were wrong.

Today’s pragmatic economists.

The more worldly of the economists of the post-Keynesian era, and today’s pragmatic economists who followed them, have expanded and modified almost all of the original and subsequent Keynesian analysis—except Keynes’ main point that there must be enough customer spending in an economy if its public and private employers are to fully employ its workforce.

Similarly, like Keynes, all macroeconomists including the most pragmatic and worldly are concerned with the aspects and policies of the economy as a whole. And, like Keynes, those among them, at least those who are worldly in their knowledge of how a complex economy actually operates, know that the solving problems such as inflation and unemployment requires policies based on understanding and working within the complex institutions, markets, relationships, and decision making processes that affect an economy’s general level of economic activity.

Such knowledge, and the theories that underpin it, together with the study of the problems that can plague an economy and the monetary, fiscal, and other policies designed to solve them, is the domain of today’s pragmatic macroeconomics.

The concerns of pragmatic macroeconomists are multifaceted and, as shall be seen, quite complex and often controversial. Old ideas about problems and policies, it seems, die hard in the academic world and among politicians and central bankers. But macroeconomists as a group, and particularly those that are both pragmatic and worldly in that they understand there are ever-changing institutions and complexities, want to know about all the many different things that might cause the general level of prices to rise (inflation); and about all the many different things that cause the general level of employment and production to temporarily recede or be permanently depressed below that which the economy is capable of providing (recessions and depressions); and about all the many different policies that could be implemented to prevent such inflations and unemployment.

Worldly macroeconomists, in essence, are concerned with the economic state and general well-being of the many millions of people who participate in the real world of an economy such as that of the United States. As such, they differ significantly both from the microeconomists who study particular economic participants and from today’s all-too-narrow macroeconomic technicians who spend time trying to prove their scientific expertise and encouraging their students to do likewise—and all too often don’t have a clue as to how complex economies actually operate and how they will be affected by various policies and realities.

MACROECONOMIC GOALS

AND PERFORMANCE

Worldly macroeconomists often talk of goals; and they evaluate the policies and performance of economies in terms of them. But what are worthwhile goals for an economy such as that of the United States?

First and foremost, an economy must efficiently produce the maximum amount of the goods and services most desired by its people—if it is to attain the basic Panglossian goal of satisfying as many human wants as possible as would be the case in the best of all possible worlds. But the production of the maximum amount of goods and services does not necessarily occur automatically. And there are a number of related goals—low levels of unemployment, stable prices, and economic growth being particularly important ones. There is also the not insignificant question of who is to get whatever is produced.

Goods and services is economist-speak for things that can be produced that are important enough to people such that they and their businesses and governments are willing to buy them. They include such thing as medicine and hospitals, food and drink, schools and education, roads and traffic police, banking services, cars and trucks and gasoline, law and order, food, research into new technologies, tanks and planes and their use to defend the country and discourage enemies, new plant and equipment to replace that which has worn out as well as add additional capital items so even more goods and services can be produced in the future. The list goes on and on.

And these things are not produced automatically just because they are needed or because there are savings or because an economy has something of a democracy or a charismatic leader or the necessary workers and capital. No matter whether the economy has a democratic or authoritarian government, there must be someone to buy the goods and services—someone or something that will flow money revenues into the economy’s public, non-profit, and for-profit employers so they, in turn, can pay employees and buy the inputs and capital goods needed to produce whatever it is that they are getting money revenues to produce.

Those providing the money revenues are called customers no whether it is someone buying a pizza or the federal government buying a highway upgrade or a city buying a new fire truck or a non-profit buying a new building. They are vital to the success of every economy.

Individuals are customers when they pay the grocery stores money to buy a family’s food; grocery stores are customers when they pay money to the food processors to buy foods for their customers and to truckers to have it delivered to their stores; food processors are customers when they buy farm products and machinery and when they pay to have them delivered to their factories; stores and the processors are customers when they pay money to builders and manufacturers to buy new and replacement buildings and equipment; governments are customers when they use the money they borrow or collect in taxes to buy roads and to pay police to write tickets if the delivery trucks and food buyers drive too fast.

The list of potential public and private money using transactions is endless—billions occur in an economy like the United States’ every day. The goal is to have enough public and private customer spending so the workers and capital of the economy are fully employed producing as much as possible of the medicine, education, food, trucks, buildings, police and defense services, tanks and planes, judges and courts, etc. etc. of whatever it is the people and their businesses and governments want to buy. And we know what they want because it is whatever they and their elected governments buy as they spend the money they earn, tax, and borrow.

In essence, what happens is that money flows into an economy’s public, private, and non-profit employers from the spending of their consumer, business, government, and foreign customers and then flows back to the customers in the form of wages, dividends and taxes. But not all of it flows back to the customers and when the customers get the money they may not spend it all. In either event, there can be a shortfall of customer spending. If that happens, the economy’s employers will not have enough customer revenues the next time around unless something is done to encourage more spending.

Things are obviously much more complex than they are made out to be in this simple description—and understanding those complexities and relating them to realistic policies is the study of macroeconomics.

The first great macroeconomic

goal: full employment.

Labor and production capital (plant, equipment, and inventory) are the factors of production whose employment generates the goods and services that are purchased by an economy’s public and private customers. Ideally all the labor and production capital in an economy will be employed—unless they are moving between employments or being retooled and retrained so they can keep up with the economy’s ever-changing customer preferences, opportunities, and production technologies.

Such a full employment of an economy’s productive capacity, when coupled with its efficient use, means the level of output of goods and services in the economy is being maximized. Unfortunately, as we shall see, no matter what the philosophies and good intentions of an economy’s governments and central bank, a major problem that confronts every economy, whether democratic or authoritarian, is that neither full employment nor the efficient usage of labor and capital occurs automatically. A successful economy, in other words, requires constant care and appropriate policies.

Fully using an economy’s labor and production capital is important in the United States and every other country. It means our economy and our workers and production capital are producing the maximum amount of goods and services and that requires that there be enough customer spending—not too much spending so that higher prices (inflation) result nor too little spending so that some of our economy’s labor and production capacity stands idle (unemployment) due to a lack of customers.

Production capital and financial capital. Pragmatic analysts know that there are two very different types of capital and investments. Production capital in the form of plant, equipment and inventory is acquired by the investment spending of public and private employers and used in their production processes. In contrast, financial capital is money and financial instruments such as stocks and bonds. A company or government may issue a stock or bond and use the proceeds to buy plant, equipment and inventory—or it may use the money for some other purpose such as buying another company or paying dividends or salaries and management bonuses.

Once issued, stocks and bonds can usually be sold back and forth—and those who do so are often called investors even though a more proper term might be trader or speculator. They are very different from the investors who buy plant, equipment, and inventory and use it to produce goods and services.

Pragmatic analysts know that once stocks and bonds are issued their subsequent buying and selling back and forth does not have anything to do with the employer who issued them in the first place or an economy’s capacity to produce. Their prices are, however, somewhat of an indicator as to how well an economy is doing: profits and revenues, and thus the prices of stocks and bonds, tend to be higher when an economy is doing well such that its businesses and governments have sufficient revenues coming in that they can pay dividends and interest and redeem their bonds. More important, however, in terms of how an economy is performing are other indicators more directly related to the things that really count:—jobs, price levels, and growth.

Unemployment and underemployment of labor and capital. It goes without saying that if an economy’s willing and able workers and other factors of production—its labor force and production capital (plant, equipment, and inventory) are not fully employed there will be unemployment and less-than-possible levels of production. In other words, food and medicine and buildings and police protection and tanks and planes that could be produced and made available will not be produced and made available if there is a lack of customers willing and able to buy them.

Such a shortfall in production and employment resulting from a lack of revenues is bad news for governments since people who are unemployed because employers don’t have enough customers tend to be very unhappy voters, and rightly so. Then they must subsist on their savings, borrowings, charity, and any remaining incomes they may still have—until they can turn out the government and its central bank decision makers and replace them with people capable of providing the policies needed to get the economy back to full employment. It is those policies that will actually succeed in doing this, and those that won’t, that are the subject of this book.

Similarly undesirable is when an economy’s labor and production capital is under-employed. For example, when employer revenues are so bad that the only job an engineer can find is delivering pizza, or a factory’s production line only runs six hours per day or only three days per week, or a city worker is cut back so he or she only works three days instead of five days, or when only a few floors of a building are occupied, or when some of an airline’s planes sit on the ground and some of its pilots idled because there are fewer people flying because the economy is in a recession—because not enough customer spending is occurring so that the revenues of its public and private employers are too low.

Using the rates of labor and capital unemployment for policy purposes. Every country in the world (except perhaps North Korea) constantly tries to keep on top of its labor unemployment and unutilized production capacity. That knowledge lets its leaders and policy makers know the magnitude of their country’s idled production capacity and, thus, the size and nature of the monetary, fiscal, or other corrective measures that might be required to get the economy back up to producing at full employment.

For example, pragmatic economists estimate that in the year 2012 as much as twenty percent of the United States’ labor force and production capital that might reasonably be expected to be at work was, in fact, unemployed. As a result, the United States’ in 2012 only produced about $16 trillion of goods and services even though its economy had a production capacity of about $20 trillion. In other words, production and employment had receded or been depressed so far below the level which the United States economy was capable of providing that it left $4 trillion of production unproduced—due to a lack of customer spending to buy the goods and services that could have been produced by the United States’ public and private employers.

And, yes, the United States really was that short of reaching its potential. Every month the Department of Labor publishes an official unemployment rate for unemployed workers. Throughout 2012 the official monthly rates hovered around 8%. For reasons that shall be subsequently discussed in some detail, the official rate is not worth the paper it is written on. Long ago the White House and Congress realized that people would judge them on how successfully the economy preformed under their leadership—so they fixed the estimating procedure to generate a rate far lower than actually exists. As shall be seen, and analysts can calculate, the real rate in 2012 was significantly more than double the reported official rate.

In reality, there were almost five million fewer jobs in the United States in 2012 than there had been four years earlier. Moreover, immigration, natural increases in the population, longer lives, and the need of retirees to return to work, had added millions of working-age adults to the potential labor force.

That’s a pretty sterile analysis. Think of it in more human terms: it means that due to a lack of customer spending in 2012 the United States’ public and private employers did not produce