We left off last week at the Bretton Woods, New Hampshire conference, where world leaders created a new global economic plan. The Bretton Woods Agreements, created in 1944, detailed plans for the World Bank and the IMF, two separate global financial institutions based on economic theories created by John Keynes and Harry White. The financial theory used as a basis for both agencies is commonly known as "Keynesian Economics."

I tried to find a simple explanation for Keynesian Economics for Cora's sake (at the cost of my own sanity). After browsing through about fifty articles and several online resources, I arrived at this description: Keynesian Economics is an economic theory based on the belief that government participation in marketplaces and monetary policies is the best method available to ensure economic growth and stability.

A person who supports Keynesian Economics believes government is responsible for smoothing out bumps in economic cycles. What we need to understand about this theory is these governments are expected to borrow money to level their volatile fluctuations. Therefore, Keynesian Economics is based on deficit spending.

Cora says, "What's wrong with that? You borrow money to pay for things."

Ok - I'll buy that. "But I'm not a government, and I don't borrow enough to build something- like a dam - on the premise that it MIGHT work." I hoped the enormity of a dam project opposed to the limits of my budget would illustrate the contrast between my petty individual affairs and a government's ideas for economic stability and growth.

"But, mom - you ARE a government. You're the ruler, and I'm your subject."

I never considered myself a monarch, but I let myself bask in that notion before we pursued further explanations about Keynesian policies. After a bit more exploration, I had to concede to Cora's statement. We've all fallen under the habitual spell of Keynesian Economics. We borrow in one currency, and we are expected to pay back our loans in the same currency plus interest. We can't borrow in American dollars and pay back with Japanese yen, because each currency is valued at different levels. This is exactly how the World Bank and the IMF operate, only on a larger scale.

According to Keynes, economic relationships exist between a country's overall (aggregate) demand and overall (aggregate) supply. The first step is to determine the difference between a country's potential for production and its actual level of production. This is similar to your child's grades. You know they're capable of "so much more," but there may be a vast difference between your hopes and the final score.

Once a country's capacity for actual output is determined, it's called a "full employment output." This is Keynes' description of maximum sustainable supply, based on variables needed to achieve this goal. Let's replace the word "country" with "company" to help explain this principle.

If a company makes weebobs, "full employment output" is that company's ability to produce weebobs, dependent on employment capacity, infrastructure, timing, quality, and these demands:

• Consumption Demands: How many weebobs could the company sell to the public? This demand would fluctuate, depending on consumer income.
• Government Demands: How many weebobs will the company sell to the government? Can the company interest the government in future projections (see investment demand)?
• Investment Demands: How many weebobs will the company buy for itself or sell to others? Think stocks, bonds, etc. to support company expenditures for expansion, based on future projections for sales.
• Export Demands: How many weebobs will be needed by countries unable to produce weebobs themselves?

In a perfect world, a company would make just enough weebobs to ensure profit (stimulating investment demands), pay taxes (stimulating government demands), pay employees (stimulating consumption demands), and create funds to market and export their weebobs (stimulating export demands). In this perfect world, each weebob is purchased with cash. Since any one of the purchasers may not have enough cash, they would borrow from a financial institution to pay for the weebobs.

Keynes explains how an economic downturn occurs within this scenario: It begins when investment demands slack off, creating an oversupply and a lack of income for the company. This problem can be resolved with increased government demand. Let's make the dollar figures small to keep this explanation simple: A drop in business confidence could reduce investment spending by $100, which would, in turn, reduce consumer spending by $100. This would equal a $200 total decrease in demand. If a government replaced investment demand with $100, this, in turn, would presumably increase consumer confidence and spending. Hopefully, the consumer demand would equal $100, so the company could resume "full employment output."

Keynes felt even wasteful government spending was better than no government spending during a recession. The government would borrow the spending money, because they couldn't raise money through taxation. Consumer spending falls when taxes are increased, so a tax increase would only backfire with another dip to be filled with government monies. When this debatable idea of "wasteful" spending is coupled with deficit spending, it's easy to see how this relationship spawns current anger and protests.

Another option to government spending is to cut taxes, increasing the likelihood taxpayers would spend more on consumption. However, taxes would be raised again when the economy returned to "full employment output." Higher taxes means consumers would decrease spending, and create another cycle of oversupply ready to be resolved by another bout of government deficit spending.

One fundamental problem with Keynesian Economics is the assurance of capable financial management. Ideally, this management would predict upcoming inflation and recession, and resolve these extremes before either one got out of hand. Another problem is the ability of any one government to repay loans. Yet another problem is a government's ability to attain a loan in the first place. Conflicts among various government monetary and trade policies are also on this list of problems. Next week we'll look more closely at some of these issues when we open the doors to the World Bank.

Until then,
Linda Goin