“In the long run we are all dead”
-John Maynard Keynes
Over the past couple of days I have taken a greater focus on long run aggregate supply (LRAS) and short run aggregate supply (SRAS). I quickly fell upon the arguments posed by both the Monetarists and Neo-Classicists versus those of Keynesians.
I felt quite comfortable with the monetarist and neo-classicist outlook, as it followed what I would consider as logical. The markets will manage to clear themselves, yes there will be unemployment and other economic repercussions, but in the “long term” the economy will be better off. This is on the basis that inefficient and unproductive firms will fall out of the market, whereas the firms that are stronger will maintain their position. The fall in prices will encourage investment and renewal if the industry if there is still demand within that market.
I personally agree with above, but in that sense I could also agree with Communism. Theoretically it is a very sound and strong argument, however when put into practice the results are not as comforting. It will take a long time for the market to clear itself, and during this period there will be social unrest (as a result of unemployment), lack of rational decision making (human quality), and depending on the case an economic standstill until the market forces begin moving again. There is also the issue of downward inflexible prices (sticky) which means that suppliers will wait out the market and won’t drop their prices, thereby further delaying the clearing process.
With continued unemployment there is almost an inevitable drop-off in aggregate demand, so the overall sight of the economy by leaving the market forces to clear it does not seem too bright.
Keynes would argue that it is essential to “prop up” demand through government spending, with this it is important to note that this is the only point at which Keynes argues that government spending is vital (he is a free marketer). Keynes would further mention the need to keep maximum employment, ensuring that there is effective demand which would push aggregate demand along the Keynesian LRAS curve.
As usual with economic theory it is difficult to argue which one is in a sense “correct”, as we tend to always end up intervening. This is a result of the nature of government and democracy, as it is unlikely a party will be voted into power during the market clearing period.
On most occasions, I take a monetarist point of view, but at this point I would prefer to take the Keynesian stance. This is as a result for the overall benefit of the people functioning in the economy, as economics mainly seeks to maximize welfare. A true monetarist would argue that in the long term the market is not better off as unproductive and inefficient firms have been allowed to survive.
This brings me on to an issue that seems to almost be at the heart of all economic theory, and one I find myself running into often. It is the issue of human frailty, and furthermore our inability to truly consider the long term.