Screw Aggregate Demand

Consumption expenditures make up 70% of the American economy.  When there is an economic downturn, spending should be stimulated because it constitutes so much of the economy.  As people consume, businesses receive income and react by producing more.  Therefore, deep economic downturns can easily be averted by government boosting aggregate demand through stimulus/deficit spending.  Common sense right?  Well that's what we should believe according to some economists.

The problem with such easily perceived arguments is precisely because it is so easily perceived.  If we could just spend endless amounts of money to supplement consumption than the Great Depression would have ended a decade sooner than it did and the current unemployment rate wouldn't be hovering around 9%.  To the aggregate demanders, the economy is a circular machine than just needs a measly trillion dollar injection to spin faster.  But as Harvard economist Greg Mankiw points out, if this type of situation were true, then during the summer months when more teenagers are available to work, this shouldn't affect employment:

University of Chicago economist Casey Mulligan offers a challenge to that view.  Casey points out that there is a regular surge in teenage employment during the summer months because more teenagers are available to work (that is, the supply of their labor has increased).  That is no surprise: It is normal supply and demand in action.  But if aggregate demand were the main constraint on employment, this increase in supply should not translate into higher employment during deep recessions such as this one.  But it does!

In the view of aggregate demand, this increase in the supply of summer labor shouldn't automatically constitute a rise in employment, yet it does.  After all, if the economy is chugging along and demand hasn't increased, why would employers anticipate any change in absence of hiring anyone?  Obviously there is something else at work here and its the fundamental concept that Keynes thought he refuted but never actually did: markets clear.  A perceived lack of aggregate demand doesn't mean products won't get purchased.  Every consumer good will get purchased if the price falls low enough, producers must find this price in order to adopt a new production structure to begin meeting this demand.  Think about it: who in their right mind is going to pass up a $5 36 inch television at Best Buy?  Sure the producer might not make a profit on this new sales price, but that is precisely why price signals are so important.  They give a signal to producers so the structure of production can be adjusted in order to meet this new equilibrium.  This may result in the halt on producing 36 inch televisions but it also means that money will be invested in operations perceived as more profitable.

This obsession on "confidence" and "aggregate demand," though seemingly obvious, is way too simple of a mindset to deal with a now global economy consisting of billions, possibly trillions, of transactions a day.  If handing out money drove demand and confidence, we would have been out of this current economic slump a long time ago.  Increased production financed through accumulated savings ultimately drive sustainable growth.  This goes hand and hand with entrepreneurial seeking of unmet demand, not aggregate demand in general.  Did Steve Jobs create the ipod to please the animal spirits not yet familiar with mp3 players?  No, not exactly.  He speculated there was a demand for a portable device that could store a massive amount of music.  He could have been wrong, thankfully for us he wasn't.  It wasn't like he saw an increase of sales at Walmart and figured he should produce, it was a much more complex decision than that.  He designed the product, determined a price he could potentially sell it at (called the marginally profitable price), and decided whether or not to invest his capital to make the whole thing happen.

To reiterate, focusing on aggregate demand misses the whole picture.  Taken to its extreme conclusion, over consumption can ultimately lead to higher prices as supply diminishes and production can't keep up.  Inflation only exacerbates the situation as wages and prices eventually adjust before distorting prices and thus production.

To end: screw aggregate demand.

Admittedly, this post was written on a whim and might not be thought through as much as other posts.  I will probably elaborate on this whole thing more in a future article.

Update- Speaking as a recent college graduate who is struggling to find work, this is not only God awful but painful as well:

At least there is always a bright spot: