Concluding remarks

Since 2008 the most advanced capitalist countries have suffered financial instability and mass unemployment, often likened to the catastrophic Great Depression of the 1930s. Which economic theory can better explain the root causes of the crisis, the practical moves that can be designed and implemented by governments to contain the crisis and better guidance to prevent such crises in the future? The theory advanced by Kalecki and Keynes, emphasizing effective demand in the economy, or the mainstream theory that rests on supply-side factors in output and employment, fiscal austerity, and a quantity theory of money approach to prices? The latter theory has brought the misery of unemployment and instability. Full employment depends upon a return to the theory of Kalecki and Keynes.

Endogenous money

The capitalist economy is a money economy. But how is money created and destroyed? Is it exogenous, a limited resource like gold, or is it endogenous, emerging from processes of production and distribution? How is credit generated and what is the relationship between credit and savings? One form of endogeneity arises from bank balance sheets and the theory of the monetary circuit. This reveals the credit relations between households and firms. However, banks also need a central bank as a lender of last resort. In recent years, central banks have deployed quantitative easing to deal with economic recession. The other form of endogeneity arises from the “verticalist” and the “horizontalist” analyses of the market for base money, whose demand and supply is brought into equilibrium by the money rate of interest. Government bonds are used in portfolios as risk-free financial assets.

Profits and GDP in the basic model

In the basic model it is assumed that the economy is closed and there is no government. In this situation, with two sectors producing respectively investment and consumption goods, total output and employment are determined by investment through the Keynesian investment multiplier. This result obtains because the capitalist economy is demand-constrained. By contrast, the centrally planned socialist economies were supply-constrained. In the capitalist economy the multiplier process ensures that investment finances itself through providing exactly the same amount of saving as investment in any given period. However, the condition for the stability of this result is the rise in wages with labor productivity.

Surplus of consumer goods and how it can be turned into a profit

The capitalist economy is divided into social classes of workers and capitalists earning wages and profits. Production is undertaken in this economy in order to obtain profits. But the surplus of goods produced over and above the value of wages paid has to be sold in order for money profits to accrue to the owner of a capitalist enterprise. From this is derived the fundamental theory of profits showing how profits are determined by the expenditure of capitalists on investment and consumption. The problem of saving is that it prevents the realization of profits. This underlines the importance of securing an equality between intended saving and planned investment.

Macroeconomic concepts and analytical tools

The basic concepts of national income are explained, centered around the question of the measurement of the total output of heterogeneous goods in a capitalist economy, showing the effects of changes in the prices used to add up those goods. The capitalist economy consists of a private sector and a government sector. The balances between income and expenditure in these sectors are then linked to their supporting financial and non-financial balance sheets of assets and liabilities. The basic principles of stock-flow consistency between sectors of the economy are shown using sectoral balances.

GDP in an open economy model

This chapter deals with international trade in so far as it affects the course of macroeconomic processes. In a closed economy without the government sector, production is determined by private investment and the multiplier mechanism. The government’s activity may expand or contract the market if the government’s expenditure exceeds the demand-depressing effects of taxation so that the resulting budget deficit increases the market. If we incorporate the rest of the world (ROW) in this model, then ROW’s expenditures, resulting in exports, add to the domestic market, and ROW’s revenues, resulting in imports, reduce this market. Thus, if ROW’s expenditures and revenues are equal, then the domestic market volume remains unchanged. However, if ROW’s expenditures are higher than its revenues, then ROW’s deficit leads to an expansion of the domestic market through the foreign trade multiplier. As can be seen, there is a significant similarity between ROW’s deficit (the trade surplus of an individual country) and a budget deficit run by the government, but the macroeconomic roles of the government and ROW differ in some important aspects.

Prices and the distribution of national income

This chapter examines the role of the price system in macroeconomics and in the distribution of income between wages and profits. Prices are not naturally determined by supply and demand simultaneously. Instead, prices of raw materials tend to be demand-determined, while manufactured goods are set by the firms manufacturing them. The difference between them reflects the different degrees of monopoly or competition in their respective markets, so that the prices of finished goods are more likely to be set by their producers using a mark-up over labor costs.

Stylized features of economic growth after World War II

Following the World War II, the advanced capitalist world, in Europe and North America, has evolved through three stages of development. The 1950s and 1960s saw unprecedented economic growth rates that can only partially be explained by post-war recovery, but was principally the result of demand management and a redistributive approach to fiscal policy that kept employment high and tended to equalize incomes. However, in the second stage, economic development slowed down to varying degrees in different countries as policies of demand management and redistribution were abandoned in favor of the market liberalization especially in the labor market. This led to high unemployment, growing economic inequality, and economic stagnation, eventually giving rise to growing indebtedness, culminating in the financial crisis of 2008. The third stage began with the financial crisis in 2008. In Europe, governments were forced to abandon counter-cyclical policies in favor of fiscal and trade balance.

Economic growth and the growth of effective demand

With an adequately skilled workforce and a sufficient supply of raw materials and energy, it is investment that allows national income and employment to grow. However, this growth is only potential. If it is to materialize, then effective demand has to expand in step with production capacity. To analyze this growth it is necessary to distinguish between actual investment that creates productive capacity this year, and investment decisions that will result in productive capacity in the future. As investment takes place, additional demand raises output and employment. However, as productive capacity expands, it brings forward the moment when demand starts to lag behind the growth of capacity, and excess capacity starts to depress investment. This causes business cycles. In the long run technological change will affect the trend of growth through successive business cycles.

Income and GDP in the model with government

In the modern capitalist economy, the government fulfills three main economic functions. First, through fiscal policy, it influences employment, prices, and the GDP growth rate. With progressive taxation and welfare provision, the government can stabilize the economy through counter-cyclical policy. The government’s activity may expand or contract the market if the government’s expenditure exceeds the demand-depressing effects of taxation so that the resulting budget deficit increases the market. The controversy over the fiscal multiplier. Second, government supplements and corrects the market allocation of resources. A fiscal deficit provides a surplus for the private sector and is easier to organize than a rise in private-sector investment. Third, it can mitigate the degree of income disparities and assure a more socially just distribution by reallocating incomes spontaneously generated in the market economy. The government debt that results from fiscal deficits is really a system of income redistribution. However, the household distribution of income has become more unequal in recent years.