The US Economy: Greenspan and Bernanke Have a Lot to Answer For

By: Gerard Jackson | Mon, Oct 15, 2007
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Because I haven't read Greenspan's book The Age of Turbulence: Adventures in a New World I'll have to confine myself to those parts that some commentators have fastened on to and hope they are accurate. It has been reported that Greenspan believes that the collapse of the Soviet Union made the job of fighting inflation much easier because the output of millions of workers who had been freed from communism exerted a downward pressure on the prices.

On the face of it, this pretty plausible. After all, we all know from basic economics that if we increase the supply of something its price falls. Like so many things in economics, it's not as simple as it looks. The fallacy here -- and it's a very dangerous one -- is that the prices level is the real indicator of inflation trends. If the price level is stable then there is no inflation; if it falls then we have deflation. It follows from this reasoning, which Greenspan adheres to, that increases in output that appear to stabilize prices must be anti-inflationary.

The classical approach, the one based on Say's law, is far more sophisticated than this. It recognizes that irrespective of any effects of changes in output on general prices, these changes can never be inflationary or deflationary. The economists of old fully understood that when labour increase its output it is in fact expanding aggregate demand, but not in the way it is usually understood. One expects a general rise in prices to occur if aggregate demand exceeds aggregate supply.

Not so. In a progressing economy, meaning one in which per capita investment is rising, increased output will exert a downward pressure on prices. This is because supplies -- as John Stuart Mill aptly said -- constitute demands. (John Stuart Mill, Principles of Political Economy, University of Toronto Press, 1965 p. 80). Irrespective of the opinions of most economists, Say never said that "supply creates its own demand". He did say:

When men are once provided with the means of producing, they appropriate their productions to their wants, for the production itself is an exchange in which the productive means are supplied, and in which the article we most want is demanded in return. To create a thing, the want of which does not exist, is to create a thing without value: this would not be production. Now from the moment it has a value, the producer can find means to exchange it for those articles he wants. (Second letter to Malthus 1821).

It is pretty clear that Say means that "supply constitutes demand" by the fact that what is produced is used to demand other goods. Therefore we deduce that demand springs from production. Without production there is nothing to exchange. Say made this fact abundantly clear in a number of places. For example:

A man who applies his labour to the investing of objects with value by the creation of utility of some sort, can not expect such a value to be appreciated and paid for, unless where other men have the means of purchasing it. Now, of what do these means consist? Of other values of other products, likewise the fruits of industry, capital, and land. Which leads us to a conclusion that may at first sight appear paradoxical, namely, that it is production which opens a demand for products. (A Treatise on Political Economy, Transaction Publishers, 2001, p. 133, originally published in 1836 by Grigg & Elliot).

In his vigorous defence of Say's law William H. Hutt took a blowtorch to Keynes' dishonest treatment of Say, stressing that the authors of economic textbooks

...tell their readers (without mentioning Keynes) that "supply creates its own demand". But the supply of plums does not create the demand for plums. And the word "creates" is injudicious. What the law really asserts is that the supply of plums constitutes demand for whatever the supplier is destined to acquire in exchange for the plums under barter, or with the money proceeds in a money economy. (A Rehabilitation of Say's Law, Ohio University Press: Athens, 1974, p. 3).

I realise that all of this has a tendency to come across as near-forgotten musty theories that have no bearing in the modern world. Quite the contrary. The failure to recognise the validity of Say's law is, in my opinion, the principle reason why government spending has marched relentlessly upward. Any country that took serious account of Say's economic insights would do everything within its power to contain the level taxation and government spending. This is something that Keynes understood and that is why he set about discrediting Say's law.

We can now see that the introduction of more workers expands demand by adding to total output which in turn tends to put a downward pressure on prices. This is what supply-siders and Greenspan mean about the flow of goods keeping a lid on inflation. But this is not what Say meant. He made it very clear that falling prices was the natural order in an economy that was quickly accumulating capital and that any "the reduction of price, consequent upon-a real variation, does not occasion even a nominal diminution of wealth". (Say, ibid. p. 302).

Once we grasp what has been said we can see that falling prices brought about by increased efficiency (increased productivity) are a very important means of creating additional demand. The failure of Greenspan, Bernanke, etc., to understand this is revealed by their stated belief that masses of cheap consumer imports are helping to contain inflation. They are doing nothing of the kind. By defining inflation as a rising price level economists have blinded themselves to the fact that any attempt to maintain a stable price in the face of greater efficiency of production requires a continual monetary expansion. In plain English: an inflationary policy.

For those of you who adhere to the fallacy that falling prices due to greater productivity depressing business activity and hence the demand for labour, let me refer to conditions in Britain in 1904. From 1886 to 1902 real wages rose by about 40 per cent. The price level in 1874 stood at 102. By 1896 it had fallen to 61.

The lowest year was 1896, when it touched 61. For the ten years, 1888-1897, it averaged 67, and for the ten years 1893-1902, it averaged 66. This was a stupendous fall of prices. (William Smart, The Return to Protection, Macmillan and Co., LTD, 1904, pp. 191-192).

The real curse is not falling prices but the current state of economics.



Author: Gerard Jackson

Gerard Jackson

Gerard Jackson is Brookes economics editor.

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