December 31, 2014

Deflation, saving, and employment

Comment on Asad Zaman on  'Why does aggregate demand collapse?'


Of course, you are right that deflation may become a problem. The crucial point is that the popular idea of the functioning of the price mechanism is mistaken. What is needed first is the correct price theory (2014) which delivers the correct Employment Law (2014b, p. 9, eq. (22)). Roughly speaking, if the product price (for the economy as a whole) falls faster than the wage rate the employment effect is positive under the condition that all other parameters remain unchanged. If the wage rate falls faster the employment effect is negative. On closer inspection, it turns out that there are two types of deflation. As you rightly pointed out, there are also secondary effects on the real value of debt but this is a separate issue. Resume: neoclassical economics got the price mechanism wrong.

Of course, Wolfgang Waldner is also right. If the relation between saving and income increases the employment effect is negative.

All these effects are captured by the Employment Law, see Wikimedia AXEC07 and (2014b, p. 9, eq. (22)).

Egmont Kakarot-Handtke

Kakarot-Handtke, E. (2014a). Economics for Economists. SSRN Working Paper Series, 2517242: 1–29. URL
Kakarot-Handtke, E. (2014b). The Three Fatal Mistakes of Yesterday Economics: Profit, I=S, Employment. SSRN Working Paper Series, 2489792: 1–13. URL