Demand Management in the Age of Global Finance

From the preface to a new policy brief by Amit Bhaduri:

In our era of global finance, the theory of aggregate demand management is alive and unwell. In this policy brief, Bhaduri describes what he regards as a prevalent contemporary approach to demand management. Detached from its Keynesian roots, this “vulgar” version of demand management theory is being used to justify policies that stand in stark contrast to those prescribed by the original Keynesian model. Rising asset prices and private-debt-fueled consumption play the starring roles, while fiscal policy retreats into the background. …

While some might insist that the age of global finance leaves little room for the idea of demand management, Bhaduri contends that the theory survives, but that it does so in a form that is nearly unrecognizable from the original. This contemporary model of demand management receives its inspiration from the presuppositions of neoclassical economics, and its policy emphasis is often the very opposite of the old Keynesian model. … To support demand, the “vulgar,” or “Great Moderation,” model hinges on the interplay between expectations of ever-rising asset prices and a consumption boom driven by private debt.

Bhaduri cautions, however, that a model centered on private credit creation is prone to instability. More and more financial investment is needed to produce greater returns and boost asset prices, continually shifting the composition of investment from the real to the financial and creating the conditions for a delinking of finance from output and employment. When the paths of the financial and real sectors of the economy diverge, when incomes stagnate while debt and asset prices continue to rise, this creates the conditions for a financial crisis.

Read the brief here.