And how do we reach that equilibrium? Through changes in Output/Income brought about by firms’ responses to unplanned changes in their inventory. Aggregate Expenditure can certainly deviate from total Income/Output in a given period. For example, a sudden rise in autonomous expenditure, which results in inventory (production from prior periods) depletion.

It seems like the issue here stems from the treatment of AE = Y as an identity rather than an equilibrium criterion.

]]>JKH, The nonsense results from treating expenditure and income as identical, which means that the theory collapses to the 45-degree line. The behavioral function says that expenditure is a function of itself, so you nothing by which to explain how expenditure (consumption) varies. A solution is just specified arbitrarily. Keynes obviously didn’t understand it, and Hawtrey, Robertson, and Haberler and others all pointed it out to him, but he seems to have had a blind spot on that point.

]]>“So the only reasonable way to interpret the equality between investment and saving, so that you can derive a solution to the simple Keynesian model is to treat E and Y as distinct variables that may differ, but will always be equal when the economy is in equilibrium.”

I disagree.

I think it’s just an algebraic solution as to where the economy will end up based on where investment will END UP plus the multiplier effect. The economy is always on the 45 degree line, but the cross changes where it is. All points on the cross other than the intersection are essentially meaningless, because the graph only includes the assumed end game for investment. You would need a continuous movie of investment iteration to see all of the end points in sequence.

That doesn’t require treating E and Y as distinct.

]]>I actually don’t see this.

The Keynesian theory is about path adjustment toward something defined as “equilibrium” according to some sort of behavioral function.

Actual saving and actual investment must be equal at every moment along that path.

I’d be extremely surprised to find that somebody can show Keynes didn’t understand this.

The problem lies in the use of the word “equilibrium” as the anchor point for some notion of equivalence between saving and investment. It is an anchor point for the end of the path that is determined by the behavioral function. That is all.

]]>Scott, I really don’t think that the point is that he doesn’t like the definitions, but that the definitions lead to incoherent or mistaken interpretations of what the model is saying. If you define E and Y to be identical, then it is not easy to formulate a theory of how to solve the model for a unique equilibrium value of income and expenditure. How do you solve the equation x = y for a unique value of x if you define x to be identical to y? If x and y are identical they are equal for all values of x. Similarly, the insistence that savings and investment are identical leads to an interpretation of how the simple income-expenditure model behaves out of equilibrium that is clearly inconsistent with the behavior of the model when you introduce a lag and get a period by period adjustment taking the model from the old equilibrium to a new equilibrium. This is a simple textbook version of the adjustment to a parameter change, and it requires no distinction between ex ante and ex post.

I think that, depending on the context, economists might consider a situation with E not equal to Y as a disequilibrium, even though they might also regard a situation with actual Y not equaling the natural rate of Y as a disequilibrium of another sort. The latter might be considered as a condition of full equilibrium and the former a condition for short-period, or even a temporary, equilibrium.

I was not disagreeing with your conclusion that consumption tends to be more stable than GDP; I was just raising an issue with the reasoning that used to arrive at the conclusion.

]]>Nat, Sorry I missed your oomment when I responded earlier. I have no problem with E = Y as an equilibrium condition, whether we call E “demand” or “expenditure” and Y “supply” or “income.” The problem arises when you define them to be identical.

]]>