TJP

Bertocco’s 2005 paper on “The Role of Credit in a Keynesian Monetary Economy” is interesting and could be helpful in understanding effective demand. Bertocco in discussing Keynes notes that a monetary economy is a system in which the presence of fiat money radically changes the nature of exchange and the characteristics of the production process.  Fiat money has no intrinsic value and is not produced by labor.

According to Bertocco, “The production of fiat money is a prerogative of special entities, such as banks,” p. 494. However, if banks are not loaning money to consumers and entrepreneurs, effective demand will remain low. Bertocco also highlights the link between money and production activity. He notes that the availability of money enables consumers to purchase goods and entrepreneurs to purchase the necessary factor of production (labor, materials, and capital).

In reviewing Keynes (1936, ch. 17), Bertocco notes that Keynes defined the essential properties of fiat money as: (a) zero elasticity, which means that entrepreneurs cannot cause more money to be produced by hiring more labor, and (b) zero elasticity of substitution between liquid assets and producible goods, meaning that when the exchange value of money rises, there is no tendency to substitute producible goods for it.

Thus, merely hiring more people cannot create more money. Money is created in two ways from borrowing and spending and from printing by a central bank. In the past decade, the private sector has created most money through borrowing and spending.

A large portion of middle class savings in the United States was embodied in the value of residential homes. However, due to the unavailability of money, the demand and value of residential homes has fallen. Therefore, homeowners are unable to use the equity in their homes to obtain credit for purchase goods and services.

The choice by policy makers to allow foreclosures to continue unabated reduced the wealth of the middle class. Conversely, the choice to prevent bank failures further increased the wealth of already wealthy bankers, without increasing credit to consumers or entrepreneurs.

Ellis in The Misallocation of Taxpayers’ Funds noted, “It is difficult to see how government transfers to financial institutions would increase autonomous consumption spending.”  He further argued that when government transferred billions of dollars to financial institutions, it does not increase personal income, and hence effective demand does not increase, except if financial institutions receiving government transfers made them available to consumers.

Thus, Ellis asks, if consumer spending is a prerequisite for government transfers to increase effective demand, why give the money to financial institutions?”  It is clear now, that the policy of transferring money to banks was not optimal.

Effective demand depends on income and prices. Thus, if income is low, the level of demand will also be low. Bertocco notes the Keynesian principle of effective demand indicates that the level and composition of income determines firms’ decisions about the numbers of workers to be employed in the production process. It also determines the level of output to be produced in a given period.

In essence, entrepreneurs are reluctant to ramp up production in the absence of effective demand. So, when government representatives promise job creation without having control over the creation of fiat money (banks), their promise is unlikely to materialize. Except, if they can create federally sponsored credit agencies that would create fiat money.

Federally sponsored credit agencies are financial intermediaries created by the Federal Government to supply credit for certain economic purposes, such a housing, agriculture, student loans, and so on.

Had the government created a federally sponsored credit agency for mortgage foreclosures, it would have prevented the foreclosure tsunami in the United State and protected the savings that the middle class invested in their homes. Moreover, it would have ensured a reasonable level of effective demand and continued employment.

Apparently, Obama’s financial advisors either failed to understand the culture of Wall Street or did not perform the proper economic analysis. Thus, their actions continue to adversely affect effective demand.

Obama needs new and more effective economic advisers that can aggressively deal with big and intransigents financial institutions. And, these advisors ought not to come from the entrenched Wall Street culture.

SAVE DARFUR