Obama has proposed a massive stimulus package to revive the American economy, only they have outlawed the use of the word “stimulus”. But let us take a good hard look at what this package, whatever they decide to calkl it, will entail.
There are three types of expenditure categories. Income may be used for consumption, for investment, and it can be wasted. Waste is defined as the destruction of goods value other than that planned by the person who earned the funds used. When a fire burns down a building, for example, that is waste, and when a government builds some project that few people find useful or desirable, that is also a waste, a destruction of the utility that could have been gained from alternative spending.
Investment is the creation of capital goods. Net investment is gross investment minus depreciation. In common language, people say they invest in land or in bonds, which can yield financial returns. But in economic terminology, only the creation of new capital goods is investment. When someone buys a bond or land, money simply changes hands, since no new land is created, and a bond is simply a debt.
These categories can now be put together as follows. First, the factors of land, labor, and capital goods are hired from households by firms, which create wealth in the three sectors, primary, manufacturing, and service. This wealth goes to their owners as factor payments by firms in the form of rent, wages, and capital yields, all of which constitute income. Governments obtain some of this income either from rent or from taxes. This income is spent in the three categories, consumption, investment, and waste.
There is also a money side, with the money supply a function of income, interest rates, and other variables, including monetary policy. In a classical model, the amount of money does not matter, since real output is determined independently of money; the price level will adjust to whatever the money supply is. In other models, especially of the Keynesian school, money does influence the real output. Both are right. In the short run, money can indeed influence output, but over the long run, inflation will simply increase prices, distorting relative prices in the process.
Ideas from Foldvary’s book “Science Of Economics”.