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Keynes on Inflation and Employment

Recently I’ve been reading “The General Theory of Employment, Interest, and Money” by John Maynard Keynes. There are few economists that really understand the way markets work, and human society functions. Classical economists, and monetary theorists, have built up an internally consistent logical framework for approaching the economy. However, this entire field of thought is wrong. Frankly, it does not matter if you THINK your understanding of the economy is correct, because it’s nice, elegant, and “logically” consistent. What matters is reality.

The economy is an emergent phenomenon. It does not arise out of any centrally planned office. It is haphazard and random. What the economy IS, is a measurement of how people choose to interact with each other. The economy represents relationships between people. Therefore, as it’s oft forgotten, the only thing that matters in the economy is people. The way people choose to interact. The way people re-act to news and events. The way people choose to structure their affairs. This is the only thing one should consider when attempting to understand the economy.

Relating this back to Keynes, in the general theory, Keynes begins by remarking on the postulates of employment laid out in classical economics. Classical economics states that workers should resist cuts in “real terms” but be unconcerned about cuts in “nominal terms”. However, this is not how people react. People are very very sensitive to changes in their nominal wages, and unless inflation is extremely high, will not really consider changes in real wages. Although, I’ve just started the General Theory, this initial salvo by Keynes against the classical theory, illustrates why I hold classical economics in such low regard.

The only real economic philosophy is Behavioral Economics. Understanding the psychology, neuro-biology, and sociological on-goings of the masses, is the only way to correctly understand the economy. In this vein, I see one true lineage of economic thought that begins with the mushy Adam Smith and his “Theory of Moral Sentiments” continuing with Keynes and his “General Theory” and finally Robert Shiller with “Irrational Exuberance”. This lineage more precisely understands the real economy, and the way reality actually works. Classical economists make books that sound nice. They seem elegant. But for all of their sophistication they fail miserably at understanding the way real people live their real lives.

Anyways, I’m not much of an economist, I just enjoy reading economic theory and understanding financial markets. The reason I mention Keynes and his general theory, is because of the novel insights he gives into how inflation should effect equities. With the understanding that at some level of inflation employees will not see raises, but there will be an increase in the price of goods, we should expect margins to increase. This is especially true where the primary input cost is labor. Thus, when you’re concerned your purchasing power is declining, keep your money in equities. Companies margins will increase, and therefore net income goes up, and if price-earnings remains the same, the asset price goes up! Thus, inflation is quite good for stocks, and should encourage you to purchase more when you see that CPI (consumer price index) going up!

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