Profitability, Stimulus Policy, and Finance

Abstract

Both classical and Keynes’s theories of effective demand posit that capital accumulation is driven by the expected net rate of profit (i.e., by the difference between the expected rate of profit and the interest rate). In both schools, an increase in the interest rate will reduce the net rate of profit and hence the rate of growth. However, in the classical tradition, the expected rate of profit is linked to the actual rate of profit as in Soros’s theory of reflexivity, and the interest rate is tied to the profit rate, whereas in Keynes’s general theory, the expected rate of profit is left “hanging in the air” and the interest rate is tied to liquidity preference. Finally, both Keynes and at first also Kalecki ground their theories of effective demand in competition. In the classical framework, if a deficit-financed stimulus tightens the labor market to the point that real wages rise faster than productivity, the profit rate falls, and the stimulus can give way to a slowdown in growth. Then repeated stimuli can lead to stagnation with inflation (stagflation). And with inflation will come rising interest rates, which will further reduce the net rate of profit and slow down growth.