Wednesday, 4 May 2016

The Pigou effect.

Lars Syll backs the idea advocated by Keynes namely that falling wages and prices in a recession do not raise aggregate demand. Not quite right actually. Falling prices increase the REAL VALUE of money (and the national debt). I.e. those falling prices increase the value of private sector paper assets, which ought to induce the private sector to spend more, and hence alleviate unemployment.

That’s known as the “Pigou effect”, after the economist Arthur Pigou.

But against that, there's the "debt deflation" effect. That's the fact that falling prices increases the real value of debts. And since debtors presumably tend to be poor, and since their weekly spending is presumably more sensitive to their net worth than is the case with the better off, the overall effect of the debt deflation effect is probably deflationary. And that effect might or might not wipe out the Pigou effect. Hard to say.

Anyway, that's all very theoretical stuff: i.e. it's not of much relevance to the real world. That is, it's not realistic to rely on the Pigou effect to get us out of recessions.

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