Sraffa and the Reconstruction of Economic Theory: Volume Two

Aggregate Demand, Policy Analysis and Growth

E. Levrero, A. Palumbo, A. Stirati, E. Levrero, A. Palumbo, A. Stirati

• Publisher: Palgrave Macmillan
• Year: 2013
• ISBN:
  9781137319166
• Topic: Economics
• Subtopic: Economic Theory
• Index: Economics

Written on the occasion of the 50th anniversary of the publication of Piero Sraffa's Production of Commodities by Means of Commodities, the papers selected and contained in Sraffa and the Reconstruction of Economic Theory account for the work completed around the two central aspects of his contribution to economic analysis, namely the criticism of the neoclassical (or marginalist) theory of value and distribution, and the reconstruction of economic theory along the lines of the Classical approach. Divided into three volumes, Sraffa and the Reconstruction of Economic Theory debates the most fruitful routes for advancement in this field and their implications for applied and policy analysis. This second volume focuses on the theory of output and growth as developed in the modern classical approach on the basis of the extension to the long run of the Keynesian principle of effective demand, and on the implications of the revival of the classical approach for policy analysis and for understanding the evolution of the international economic order in the last few decades.

Part I

Demand-Led Growth in the Classical Approach

1

Public Debt and Aggregate Demand: Some Unconventional Analytics

Roberto Ciccone

1.1 Introduction

This chapter explores some basic questions about the effects on the economic system of financing public expenditure by issuing debt. It develops within a theoretical framework differing from that which is currently predominant both in pure theory and in applications to specific problems such as those addressed here. In particular, the approach in this chapter rests on two basic and closely related premises.

The first is the ‘classical’ explanation of income distribution in terms of circumstances of a social and institutional character, and hence the rejection of the view of distribution as determined by the forces of demand and supply held by the dominant theory in its various formulations. The second is the application of the Keynesian principle of effective demand to the long-run or trend levels of total output, which are regarded here as dependent on the size of the aggregate demand ultimately determined independently of output in conditions of full employment (or ‘natural unemployment’). Aggregate demand therefore sets an upper limit on the levels of activity obtainable in the long run (and, needless to say, in the short run too), which would generally be insufficient to allow for the full employment of available resources.¹

The close relationship between the two premises stems from the natural compatibility of the classical theory of distribution with a determination of output levels into which the available quantity of labour and other resources do not enter as directly relevant circumstances. The analytical structure of classical theory, characterised by the absence of relations of a necessary character between the determination of distribution and the determination of output levels, makes it possible to study changes in variables such as the aggregates of output, consumption, investment, public expenditure and so on with no need to consider the effects that those changes may have on distribution and the price system. The analysis will therefore be carried out on the assumption of a given distribution of income and associated price configuration.

Within the theoretical framework outlined above, the work seeks to single out some basic relations and propositions concerning the effects of public deficits and public debt that might, if valid, serve as a foundation to address the issue under the conditions possibly set by specific contexts.

1.2 Public debt as additional private wealth

Let us start by defining some relations between the relevant magnitudes. In a closed economy the necessary equality between aggregate expenditure and aggregate output, i.e., between total savings and total investment, entails the identity

Sp = I + D

where Sp is private savings, I private investment and D public deficit.

In our theoretical framework, the level of income is determined by the level of aggregate demand, i.e., by the sum of private and public expenditure, which implies that that identity is satisfied, through changes in the level of income, by the adjustment of the flow of private savings to the sum of private investment and public deficit. An increase in public deficit ΔD caused by a given increase in public expenditure is therefore counterbalanced by an equal increase in the flow of private savings ΔSp. In other words, through the influence of public expenditure on aggregate demand and hence on the level of income, an increase in public deficit generates additional private savings, savings that would have not been formed in the absence of the increase in the deficit.

The flow of private savings is in turn equivalent to the addition to the stock of private sector wealth in the period, gross of capital depreciation:

ΔWp = Sp = I + D

where ΔWP stands for the gross variation in private wealth. Our point is that public deficits add to private investment by generating savings, and therefore wealth, in the hands of the private sector. As a result, the size of private wealth at any given time would be larger, the larger the sum of the public deficits built up in the past.

It should be evident how this conclusion relates to the view of total output as governed by aggregate demand independently of the availability of resources. In neoclassical theory, where the level of income is determined (apart from temporary deviations) by the supply of resources with consequent adjustment of aggregate demand, the size of private wealth is instead basically independent of the flows of public deficits. In that theoretical framework, the condition of full employment, or ‘natural’ unemployment, entails a corresponding level of income with the associated amount of savings. Private savings and the formation of private wealth are therefore set independently of the sum of public deficits and private investment, with a trade-off arising between the latter two ‘uses’ of private savings – unless it is maintained, as in the ‘Ricardian equivalence’ argument, that public deficits cause an increase in the share of savings out of full-employment income, thus displacing private consumption rather than private investment.²

We can say therefore that within the theoretical framework adopted here, no constraint is imposed on the size of public debt by the size of private wealth, since the latter increases to the same extent as the increase in public debt. Nor is any particular significance to be attached to a variation in the proportion of private wealth constituted by government debt, as an increase in that proportion, for example, would be no more than the arithmetical consequence of the fact that the stock of public bonds held by private agents has grown proportionally more than other types of assets constituting private wealth, such as real capital, and should not be mistaken for a negative influence on capital accumulation.

While public expenditure and deficits may play a role in raising the level of aggregate demand and income, no negative consequences need therefore arise for the economic system from the related accumulation of public debt as such. It is, however, precisely the capacity of public expenditure to produce relevant and lasting effects on aggregate demand that is questioned in mu...

Table of contents

• Cover
• Title
• Introduction
• Part I Demand-Led Growth in the Classical Approach
• Part II Understanding the International Economic Order
• Index