From Knowledge Problem:
Macroeconomics and I have never gotten along, and for years I couldn’t figure out why — I’ve just never understood much of the underlying logic, why the analyses start where they do and make the assumptions they do (the only exception to this is my undergrad class with William Hart at Miami when we worked through Malinvaud’s Theory of Unemployment Reconsidered). By nothing more than tenacity and stubbornness I managed to pass enough macro to be accepted into the economics guild.
This recession and the policy debates in it are clarifying some ideas that resolve my cognitive dissonance, the largest of which is the central role of consumption in Keynesian economics. This focus on consumption as the first step in the causal link that leads to underemployment in equilibrium seems to invert the causality of value creation embedded in all other economic models, which start with the production of compelling value propositions that attract customers. This shift in focus to consumption pivots on how Keynes’s model, and Keynesian models, treat Say’s Law. The Keynesian interpretation of, and rejection of, Say’s Law provides the justification for focusing on aggregate demand in general, and consumption in particular, as policy levers during business cycles.[editors note: Sir Paul told him no such thing]
In August Steve Horwitz wrote a clear analysis of the interpretations of Say’s Law, and it’s a good place to start. After quoting Say’s Treatise on Political Economy, he notes that:
… Say was making the claim that production is the source of demand. One’s ability to demand goods and services from others derives from the income produced by one’s own acts of production. Wealth is created by production not by consumption. My ability to demand food, clothing, and shelter derives from the productivity of my labor or my nonlabor assets. The higher (lower) that productivity, the higher (lower) is my power to demand.This is different from, and more nuanced than, the terse “supply creates its own demand” interpretation that Keynes placed on Say. It’s also not very different from Smith, Ricardo, or Mill in their articulations of the central role of productive activity in creating value, and hence economic growth....MORE