Saturday, May 28, 2011

Deflation and Neo-Classical Economics

I came across these very enlightening videos on the economy by Steve Keen, blogger at, that articulate the case for why I have believed that the economy will be facing deflation, not inflation. Watch for your benefit, they can be found right here.

I was aware of many of the things he talked about, such as contracting private sector debt being counteracted by an exponential increase in public sector debt. What I found interesting - and i'm embarrassed for not having thought of this earlier - is that aggregate demand is not determined just by income, but by the change in debt as well. This is why I am so confident that the worst of the recession is not over, given that private sector debt is still at astronomical levels. Once the government stops offsetting the contracting private sector debt, and it will have to eventually, then overall debt levels will decrease, shifting the aggregate demand curve way inward.

Because the neo-classical economists don't take into account the change in debt, they are blind to the upcoming crash (and as someone who had a neo-classical economics professor, I can see exactly how they are blindsided). Why they are so sound in other areas like free-markets and the inefficacy of government intervention but don't take this into account is beyond me. It may be because subscribing to a school of thought that originated in the late 1700's, early 1800's, they are unaccustomed to our modern debt-based fractional reserve system, but I don't know for sure. At any rate, the *neo* prefix to their name should have fixed that problem.

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