Is Y=C+I+nX+G Meaningful?

by Don Boudreaux on February 7, 2009

in Stimulus

The debate between demand-siders (Keynesians and one aspect of monetarists) and supply-siders (Austrians and other aspects of monetarists) is on-going.  (Note that I here use the term "supply-siders" broadly, to encompass not only those persons who emphasize cuts in marginal tax-rates as a means of promoting economic growth, but those who — regardless of their stand on taxes — emphasize that microeconomic conditions are paramount.)  The differences are not easy to resolve.

Keynesianism has three public-relations advantages over supply-side economics.  First, it is instinctively appealing to business people — indeed, to anyone who makes a living by selling goods or services (including labor).  If demand for any firm's output or worker's services were higher, that firm or worker could sell more without lowering prices and would, therefore, likely be better off.  When demand falls, on the other hand, either output or prices or both fall.

Demand is good, and business downturns can be 'cured' by raising demand.  What's true for the individual firm and worker, it is concluded, must therefore be true for the economy as a whole.

It is no small irony that that conclusion results from the commission of the fallacy of composition.

Second, Keynesianism naturally appeals to politicians who then naturally talk as if it is valid.

Third, Keynesianism — and, more generally, all macroeconomics done using aggregates such as (Y=C+I+nX+G) — lends itself rather readily to empirical analysis.  It's relatively easy to get data on aggregate demand, international-trade flows, and government spending.

Whether these data mean much, or even what they mean to the extent that they have meaning, are open questions – as are questions about the significance or meaning of any observed or measured regularities between these aggregates.

The ability to write letters on a board in the form of an equation, to give those letters names that seem to correspond to some imaginable economic things, and to assemble quantitative data on those things, is not necessarily good science.

For reasons explained in the link below, and simply because I very much doubt that, say, Europe's secularly high rates of unemployment could be reduced by raising aggregate demand, I doubt that Keynesianism is good science.

I encourage all of you who haven't read Hayek's 1974 Nobel Prize lecture — "The Pretense of Knowledge" — to do so now.  It's free.  It's wise.  It's vital.


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