Wednesday, October 20, 2010

Notes from General Theory: Preface

I am attempting to read Keynes signature book - General Theory of Employment, Interest and Money - for the first time. It is a very complicated book, so I am planning to take lots of notes.

My biggest challenge while learning Economics has been a lack of understanding of the chronological order in when different theories emerged. Economics textbooks present theories in a logically cohesive way, rather than in a chronological order. So, I have only a vague understanding of what the prevailing theory of the day was in the 1930's, when Keynes wrote his book. Several elements of the "Classical theory" as we now understand were certainly developed after the 1950's. So what exactly was it that Keynes disproved?

The book is so complicated that I can make notes starting right from Preface. There are actually four prefaces - one each for the British, German, Japanese and French reader.
  • "Classical theory": I guess Keynes himself labelled the pre-Keynesian theory as Classical theory.
  • "A monetary economy is essentially one in which changing views about the future are capable of influencing the quantity of employment and not merely its direction." I guess classical economics did not include the influence of expectations. Which leads to the question - Does neo-classical synthesis postulate that people are rational in their expectations, hence future expectations are already built into today's prices, so lets get back to classical economics? Will explore this later.
  • Alfred Marshall wrote a book "Principle of Economics" in 1890. It was probably the equivalent of Samuelson's Economics today - the standard text book of economics. Why does wikipedia say he is one of the founders of neoclassical economics. I thought it came after Keynes.
  • "The Manchester School and Marxism both derive ultimately from Ricardo." Didn't get this.
  • "While Germany has had its school of economists, they are content with historical and empirical analysis, so there isn't any predominant theoretical framework of economics in Germany."
  • "This book traces its descent from Malthus rather than Ricardo." Didn't get this.
  • "Savings = Investment is a controversial statement. What is true at individual level is not true at the system level, and vice versa."
  • "Many economists believe that the rate of interest is determined by the point of intersection of the supply curve of savings and demand curve of investment. But if aggregate S = I, then this explanation collapses. Interest rate preserves equilibrium between demand and supply of money, not capital goods."
  • Montesquieu was the French equivalent of Adam Smith.
  • "Economics everywhere has been dominated by the doctrines of J.B. Say. His basic fallacy was the assumption that demand is created by supply. Saw implicitly assumed that the economic system was always operating up to its full capacity, so that a new activity was always in substitution for, and never in addition to, some other activity."
  • "This book breaks away from the doctrines of JB Say in the theory of production, and returns to the doctrines of Montesquieu in the theory of interest."
And that's it.

Friday, October 08, 2010

Fed should destroy 2mn homes

If Fed were to buy 2 mn. homes in US at $200K apiece, and destroy them, it will cost $400bn. After that, housing inventory is gone. Housing starts will rise from current 300K odd level to 600K level, and housing growth (to which a lot of things get ultimately linked) will lead to rebound in economy. It will increase employment without a doubt, as construction generates employment.

This is much better than the cost of any other alternative that is being proposed. Print money and we don't know whether it leads to inflation over time. Increase fiscal deficit and we don't know what taxes are over long-term. In this solution, US government will take a one-time hit of $400bn. Because economy will start growing robustly again, that should be more than offset by the reduction in fiscal deficit and anxiety.