Voiceover: In the last video
we had a little bit of review of classical economics
and then we talked about how Keynesian thinking was a departure, especially, and why it
might have made sense in the context of the Great Depression, where the economy was operating well below its potential. What I want to do - It may be true anytime that
the economy is operating well below its potential. What I want to talk about in this video is how Keynesian thinking
can sometimes be dangerous. One thing I do want to
emphasize over the course of this video is Keynesian
policies are often associated with people on the left,
with policies on the left, democrats in the United States. The republicans also, for the most part, especially mainstream republicans, especially the last
several administrations, they have practiced what
can only be described as Keynesian policies. When the economy started
to recede, they tried to stimulate it by shifting
aggregate demand to the right somehow and we'll talk about
that they tried to do it in a slightly different
way, through tax cuts, instead of government spending increases, but it was Keynesian in
its underlying thinking. Now just as a bit of a
backup, I'm going to talk a little bit more about that
cycle that we talked about in the last video. If you have person A, person
B, person C, and person D or maybe their firms. B supplies A, A supplies D, D supplies C, and C supplies B, and for
the sake of simplicity, we said that they're all
supplying 2 units of their good and service to each other. Let's just say that C has a
bad dream, feels pessimistic, ate something bad and all of
a sudden isn't feeling good about the future and wants to buy less, just out of caution. Maybe he wants to hoard a bit of cash, just in case C needs it. He buys a little bit
less from D, but D says, "Gee, my business is
bad, now I can't afford "as many goods and
services," buys less from A, A does the same thing from
B, and then B's business is bad, so buys less stuff
from C, goods and services from C, and now C feels
like they're psychic, even though we see that it was actually a self-fulfilling prophecy,
that C's pessimism actually led to that reality actually occurring. In a worst case, it actually
could get worse and worse. C could say, "Wow, I was
pessimistic and I was right. "My business actually did get bad." Maybe it even got worse
than C had expected and then C could then say,
"I'm going to buy even less. "Maybe I'm only going to
buy a half from D now," and then D says, "Maybe I'm
only going to buy a half "from A," and that cycle
could go down and down and down until each of them
are just buying exactly just what they need to get
by, even though they all could be producing more,
the economy could be producing more and could
be wealthier and they all could be way better off. This is, at least in my mind,
a pretty good description of what happens in a depression, especially the Great Depression. So there might be a
rationale to say, "Hey, look, "why doesn't the government
come here at some point "in this economy and stimulate demand?" Why doesn't the government come here? Let's say B is already buying 1 from C, the government comes and
says, "Hey, I'll buy another 1 "from C," and then C says,
"Hey, things are good again. I can buy 2 from D," D can buy 2 from A, and then A can buy 2 from
B and then B can buy 2 from C and so things have gotten back to their potential state. The economy is revving. In an ideal state, the
government would say, "Hey, my work is done now. "I can now take a step
back and I don't want "to overheat the economy. "I don't want to push
aggregate demand too far "to the right and cause
inflation," so they will take a step back. The danger here is that
this is not so easy for governments to do. This was some type of stimulus, some type of government spending. Although maybe it was a tax decrease, so maybe B could've
increased their demand, but either way, once you
do a policy like this, and let's say it was government spending, it's very hard to unwind. This government spending might have been for a project that some people like, it might have employed many, many people. Those people are voters. They're not just going to
sit there while you cancel this government project. There's a risk that maybe
there is a justification for a Keynesian policy,
but when it's time to undo that Keynesian policy,
to undo that stimulus, it's very hard to do it. It's kind of a sticky policy. What you might have is when times are bad, you do Keynesian stimuli,
but when times are good, you're not willing to undo it
and if that Keynsian stimuli involves more and more deficit spending or more and more government spending, then the government size
is just going to grow relative to the economy, or
the deficit is just going to grow relative to the
economy and you're never going to unwind it, because
unwinding is unpopular. I want to be clear that this
is true of both the left and the right. In the stereotypical
sense, the left might say, "Hey, let's do a Keynesian
stimulus by spending more," so the government spends
more and let's hold our revenue constant, our tax revenue, let's hold it constant. Obviously, the government
would have to borrow more money to fund this, or
sometimes they might even increase taxes if they actually
wanted to be more purist about it, but this is
the variety that you see and this would be a true stimulus. This is using the fiscal
lever to put more demand in the economy, but in
the right you often see the other side. You see taxes being
lowered, essentially saying instead of the government spending it, why don't we let people
decide where to spend it and they might spend it
in a more efficient way, but it's going to be a
stimulus, because spending is held constant. Then you have the double
where you do both sides of it, where you lower the taxes, you lower the inbound revenue, and you increase spending. This is true, this has been
done by both republican and democratic administrations. Lowering taxes, but
then going and starting a hugely expensive war and obviously this would increase deficits. There might even be a
justification for doing any of these, a Keynesian
justification if the economy truly is operating well below its potential. The tough thing is it might be justified, you actually don't know
exactly where that potential is and you might not be able
to unwind this once you get to your potential and
then you might overheat the economy, might lead to inflation, and that actually might
undermine the productivity of the actual economy. The other negative of a Keynesian mindset is what happens over the long run. In the short run this
might make a lot of sense. Let's prime the pump, let's
get the cycle to happen in the right away again,
but in the long run, it's essentially just trying
to get people to consume and consume more. You'll often hear, when
the economy slows down a little bit, you'll hear the president, you'll hear politicians
say, "Hey, we're just trying "to get people to spend more "through some combination
of these Keynesian policies. "We're going to lower taxes,
we're going to increase "spending,"but you'll never hear them say, "Hey, we want people to save more, "so that we can invest more, "so that in the classical
sense we can increase "our total productive capacity." The US has gotten a free pass on this, because the US has been
doing, essentially, the deficit spending has been able to do the Keynesian stimuli and
that's why the US consumer keeps spending more and
more, saving less and less. The government is doing the same thing, but the US has also
been getting investment because it's the foreigners
who've been saving and then plowing that
money and they've been, essentially, investing
in the US, so that the US could increase its productive
capacity, but that is a risk for a country if it's not
blessed with that free pass that the US has gotten for
the last several decades is that when you have some resources, so in a given year, you
have some resources. Let's say it's your time. You could either hunt and eat rabbits or you could spend your time to invent new rabbit trapping devices. This is the hunting and eating the rabbits and this is spending some time to go and figure out ways to be more productive at hunting rabbits,
building some bow and arrows or something like this. You always have a tradeoff
between consumption and investment. Keynesian policies,
they're all about, hey, let's get consumption as high as possible and that might be a good
idea in the short run, especially if we are operating
well below our potential, well below our full capacity utilization, but it could be a risk in the
long run, if you don't get the free pass, because you
might have underinvestment and in the classical sense,
you're never able to move your potential to the right.