Government spending hurts Aggregate demand

Warning: I ripped this out of a facebook post I made with no formatting effort to clean it up. In reality I should really make it a video with a whiteboard, and I will endeavor to do that in the future.

I doubt that the government can really drive up aggregate demand.

I don’t like the spherical cow approach that Keynes takes but I’ll assume that it is correct and we can look at his models.

Here are some Keynesian variables
AD=Aggregate Demand
C=Consumption
I=Investment
G=Government Spending
NX = Net Export
Here is the Keynesian equation
AD=C+I+G+NX
Now I’m going to do some equating of my own
lets use
P=Production
A net export equation would be
NX=P-C-G
I include G because government spending is consumption too
Productivity is a function of investment
P=f(I)
This function would have some element of something I’ll call “fertility” corruption and theft lower fertility, new technology and appropriate infrastructure increase fertility
So now I want to look at what G is made up of.
B=Bonds
T=Taxes
Simply enough
G=B+T
Where does that Bond money come from? Well bonds are essentially a form of investment, a contractual form with limited upsides and lower risk that equity but a form of investment
Lets add that somehow to the I picture
Ii=Intent to Invest
Ia=Actual Investment in the private sector
Ii=Ia+B
Ia=Ii-B
Our new Keynesian formula will look something like this now
AD=C+Ia+G+NX
Now lets give taxes the same treatment
W=Wealth
People either invest their wealth or they consume it (and yes putting your wealth in a bank counts as investment, because the bank loans that money out and invests it for you)
W=C+I-T
Since government spending is transferring rather than creating wealth (at least in the short term) W can be held as a constant. When T increases C and I fall
Now lets work this all back into our Keynesian Model
AD=C+Ii-T-B+G+NX
AD=C+Ii-T-B+G+P-C-G
AD=C+Ii-T-B+(T+B)+f(Ia)-C-(T+B)
AD=C+Ii-T-B+f(Ii-B)
AD=C+Ii-G+f(Ii-B)

Would you look at that, government spending wraps back around to hurt aggregate demand rather than boost it

Keynes was counting the benefits but not the costs of his plan, classic bad accounting.

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About opcnup

Emerson White is a biology student working on post grad while doing private research on the side.
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