Russ asks for some clarification on Aggregate Demand

Does an increase in aggregate demand increase employment?

Yes, if by an increase in aggregate demand you mean people buying and selling more from each other where buying and selling includes consumers and manufacturers.

The above statement has virtually no informational content. It is equivalent to saying that when the economy is healthy, there is lots of exchange going on. When an economy is not healthy, there is less exchange. There is less buying and selling of goods and services and labor. To describe that unhealthiness as less aggregate demand is just to put the problem into different words.

It does not follow that an increase in government spending increases the amount of buying and selling or the health of the economy. It is an empirical question. It would surely depend on what the government buys when it increases spending.

In the end he asks for something to read, but based on what Russ wrote I think this is better done as a conversation.

In part, because I think there are a couple of things we will want to clear up from the start.

First, like ordinary demand, Aggregate Demand is not a quantity but a relation. It matches the total amount of goods and services people want to buy with the price level. So, saying Aggregate Demand has increased, in-and-of-itself doesn’t say anything about the volume of transactions in the economy. That depends on the equilibrium between Aggregate Demand and Aggregate Supply.

Second, the volume of transactions in the economy is not tautologically equivalent to its “health.” I suppose it depends on what you mean by health but there are lots of unfortunate macro-states that are independent of the volume of transactions.

For example, the value of the transactions matters. This will probably become important later in the conversation, because it is common to confuse the value of the total transactions in the economy with the economy’s position in the business cycle. However, one can easily have a very poor economy at full employment and output and a very rich economy mired in a horrible recession.

Third, not to get too far ahead of ourselves, but there is something important in the observation that lots of elements in the economy rise and fall together. So, that to say the economy is unhealthy is actually saying something about the economy. It is not merely a statement that the unhealthy subparts outnumber the healthy ones.

Fourth, I think its extremely important to remember that the concept of Aggregate Demand exists independently of any claims about the government. It is not even necessary to have a government in order to have Aggregate Demand. If folks are successful in creating an Anarcho-Capitalist society then presumably it will exhibit Aggregate Demand.

This feeds into a clarification about another point Russ brings up

A multiplier of .5 means that for every dollar of government spending, there is a 50 cent reduction in spending by non-governmental sources (private consumption and investment). A multiplier of 2 means that a dollar of spending encourages an additional dollar of spending by non-governmental sources (private consumption and investment).

So, its hard to make sense of the concept of a multiplier without Aggregate Demand. Even if the multiplier is negative, you are telling some story about how nominal shocks propagate themselves throughout the economy and that story is your story of Aggregate Demand.

What would be inconsistent would be a multiplier of zero. If you had a multiplier of zero then either Aggregate Demand falls apart or becomes superfluous.

 

With that as a baseline I would start by asking Russ whether he believes that money is non-neutral in the short run.

The reason I ask is because if you believe that then we can work fairly straightforwardly to both the concept of aggregate demand and fiscal stimulus. If you don’t believe that, then I am going to start by convincing you that money is indeed, non-neutral in the short run.

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