February 28, 2015

Replacing sand by granite

Comment on Lars Syll on ‘Macroeconomic foundations made of sand’

Blog-Reference

Newton told the storytellers of his day: “Those who take the foundations of their speculations from hypotheses, even if they then proceed most rigorously according to mechanical laws, are merely putting together a romance, elegant perhaps and charming, but nevertheless a romance.” (Roger Cotes, Preface to the 2nd edition of Principia, 1999, p. 386) With ‘hypotheses’ green cheese assumptions were meant.

Keynes told his fellow economists: “For if orthodox economics is at fault, the error is to be found not in the superstructure, which has been erected with great care for logical consistency, but in a lack of clearness and of generality in the premises.” (1973, p. xxi)

Hutchison aptly remarked some time ago: “... it is precisely the task of science to supersede crude common-sense notions by critical analysis, and further that it is the unsatisfactory state of the foundations beneath the common-sense surface which is the most serious and crippling deficiency of contemporary economic science, ...” (1960, p. 18)

Keen told us: “Even some of the most committed economists have conceded that, if economics is to become less of a religion and more of a science, then the foundations of economics should be torn down and replaced. However, if left to its own devices, there is little doubt that the profession of academic economics would continue to build an apparently grand edifice upon rotten foundations.” (2011, p. 35)

Actually, Frances Coppola tells us that the macroeconomic foundations are made of sand (see intro).

Well, now everybody got it! Let us see, then, what exactly are the foundations? Weintraub gave the following account.

“As with any Lakatosian research program, the neo-Walrasian program is characterized by its hard core, heuristics, and protective belts. Without asserting that the following characterization is definitive, I have argued that the program is organized around the following propositions: HC1 economic agents have preferences over outcomes; HC2 agents individually optimize subject to constraints; HC3 agent choice is manifest in interrelated markets; HC4 agents have full relevant knowledge; HC5 observable outcomes are coordinated, and must be discussed with reference to equilibrium states.
By definition, the hard-core propositions are taken to be true and irrefutable by those who adhere to the program. "Taken to be true" means that the hard-core functions like axioms for a geometry maintained for the duration of study of that geometry.” (1985, p. 147), see also (Arnsperger and Varoufakis, 2006) and (2013)

It cannot be said, as Keynes did, that there is a lack of clearness in the premises: “Like mathematics and physics, economics is proud of having an axiomatic foundation, and rightly so.” (Helbing, 2013, p. 4)

Formally, all is in perfect order. The orthodox paradigm is well articulated. Nevertheless, it has to be abandoned. The subjective behavioral foundations of Orthodoxy are unacceptable. No way leads from the neo-Walrasian hard core to the understanding of how the actual economy works: “Economics today is a discipline that must either die or undergo a paradigm shift ...” (Kaletsky, 2009, p. 156)

This is a critical juncture and one has to be very careful. From the fact that the behavioral axioms of Orthodoxy are forever beyond acceptability does not follow that axiomatization is inapplicable. It follows that subjective behavioral axioms have to be replaced by objective structural axioms (2014). That is what the ongoing paradigm shift is all about: sand is replaced by granite.

Egmont Kakarot-Handtke


References
Arnsperger, C., and Varoufakis, Y. (2006). What Is Neoclassical Economics? The Three Axioms Responsible for its Theoretical Oeuvre, Practical Irrelevance and, thus, Discursive Power. Paneconomicus, 1: 5–18.
Helbing, D. (2013). Economics 2.0: The Natural Step towards A Self-Regulating, Participatory Market Society. EconoPhysics Forum, pages 1–29. URL
Hutchison, T.W. (1960). The Significance and Basic Postulates of Economic Theory. New York, NY: Kelley.
Kakarot-Handtke, E. (2013). Confused Confusers: How to Stop Thinking Like an Economist and Start Thinking Like a Scientist. SSRN Working Paper Series, 2207598: 1–16. URL
Kakarot-Handtke, E. (2014). Economics for Economists. SSRN Working Paper Series, 2517242: 1–29. URL
Kaletsky, A. (2009). Goodbye, Homo Economicus. real-world economics review, 50: 151–156. URL
Keen, S. (2011). Debunking Economics. London, New York, NY: Zed Books, rev. edition.
Keynes, J. M. (1973). The General Theory of Employment Interest and Money. The Collected Writings of John Maynard Keynes Vol. VII. London, Basingstoke: Macmillan. (1936).
Newton, I. (1999). The Principia; Mathematical Principles of Natural Philosophy. Berkley, CA, Los Angeles, CA, London: University of California Press. (1687).
Weintraub, E. R. (1985). Joan Robinson’s Critique of Equilibrium: An Appraisal. American Economic Review, Papers and Proceedings, 75(2): 146–149. URL

Questions and answers about economics

Comment on Peter Radford on ‘I am a know-nothing’

Blog-Reference

First of all one has to distinguish between theoretical and political economics. The goal of political economics is to push an agenda, the goal of theoretical economics is to explain how the actual economy works. From the viewpoint of science political economics as a whole is a no-go. The first problem of economics is that many economists are not scientists but agenda pushers of one sort or another. This means that economics is exploited for other purposes.

Political economics is essentially moralizing and the explanation consists usually in a good-guy-bad-guy story. In political economics anything goes; in theoretical economics scientific standards are observed.

“Research is in fact a continuous discussion of the consistency of theories: formal consistency insofar as the discussion relates to the logical cohesion of what is asserted in joint theories; material consistency insofar as the agreement of observations with theories is concerned.” (Klant, 1994, p. 31)

Theoretical economics starts with ignorance and the attempt to clarify what the subject matter is and how to approach it. As a first approximation, we can agree here on the general characteristic that the economy is a complex system.

However, with the term system one usually associates a structure with components that are non-human. In order to stress the fact that humans are an essential component of the economy we could perhaps better say that the economy is a complex hybrid human/system entity.

The scientific method is straightforwardly applicable to the sys-half but not to the hum-half. While it is clear that the economy always has to be treated as an indivisible whole, for good methodological reasons the analysis has to start with the objective sys-half.

In gestalt-psychological terms the economic system is the foreground, individual behavior the background. Common sense wrongly insists that the hum-half must always be in the foreground. This fallacy compares to geo-centrism. The economic system has its own logic which is different from the behavioral logic of humans. The systemic logic is what Adam Smith called the invisible hand.

Whether the outcome of the human/system-interaction is good or bad is a political question that lies outside of theoretical economics. Theoretical economics explains how the actual economy works — no less, no more.

Since Veblen Heterodoxy has been mainly occupied with debunking the assumptions and claims of equilibrium theory. However, the fatal errors/mistakes of Orthodoxy do not lie so much in particular green cheese assumptions but in the complete failure to understand what the scientific method is all about.

Nonentities like equilibrium, rational expectation, constrained optimization, or utility maximization for that matter, are perfectly in line with the accepted methodology.

“It is a touchstone of accepted economics that all explanations must run in terms of the actions and reactions of individuals. Our behavior in judging economic research, in peer review of papers and research, and in promotions, includes the criterion that in principle the behavior we explain and the policies we propose are explicable in terms of individuals, not of other social categories.” (Arrow, 1994, p. 1); see also (Arnsperger and Varoufakis, 2006)

The fundamental methodological blunder resides in the idea that economics is about human behavior. Let us call this the social science delusion. The irony is that Heterodoxy is even more convinced that economics is essentially a social science. It differs from Orthodoxy only insofar as it claims that their behavioral assumptions are more realistic.

The fact of the matter is that economics is about the behavior of the economic system and not about the behavior of individuals. This, indeed, is the realm of psychology, sociology, anthropology, history, etcetera. To speculate about rational or irrational human behavior is not economic analysis at all (Hudík, 2011).

This means that the subject matter of economics has to be redefined. No way leads from the understanding of human behavior to the understanding of how the actual economy works. This fully explains why economics is a failed science.

You sum up:
“And I remain confused about the purpose of an economist — although I will check with Aristotle to clear that up.”

No need to check it. All answers are in Wikipedia and this is what Aristotle said about how to do science:
“When the premises are certain, true, and primary, and the conclusion formally follows from them, this is demonstration, and produces scientific knowledge of a thing.” (Resume of Aristotle's Posterior Analytics)

And from this follows for the economist's job description:
“A scientific observer or reasoner, merely as such, is not an adviser for practice. His part is only to show that certain consequences follow from certain causes, and that to obtain certain ends, certain means are the most effectual. Whether the ends themselves are such as ought to be pursued, and if so, in what cases and to how great a length, it is no part of his business as a cultivator of science to decide, and science alone will never qualify him for the decision.” (Mill, 2006, p. 950)

Certainly, this is not what the political economist thinks his true mission is. The problem with political economists, though, is not that agenda pushing is illegitimate. The problem is that the scientific claims are illegitimate. This, unfortunately, is what unites Orthodoxy and Heterodoxy. Both are talking scientific nonsense.

Egmont Kakarot-Handtke


References
Arnsperger, C., and Varoufakis, Y. (2006). What Is Neoclassical Economics? The Three Axioms Responsible for its Theoretical Oeuvre, Practical Irrelevance and, thus, Discursive Power. Paneconomicus, 1: 5–18.
Arrow, K. J. (1994). Methodological Individualism and Social Knowledge. American Economic Review, Papers and Proceedings, 84(2): 1–9. URL
Hudík, M. (2011). Why Economics is Not a Science of Behaviour. Journal of Economic Methodology, 18(2): 147–162.
Klant, J. J. (1994). The Nature of Economic Thought. Aldershot, Brookfield, VT: Edward Elgar.
Mill, J. S. (2006). A System of Logic Ratiocinative and Inductive. Being a Connected View of the Principles of Evidence and the Methods of Scientific Investigation, volume 8 of Collected Works of John Stuart Mill. Indianapolis, IN: Liberty Fund.

Essentials of Constructive Heterodoxy: money, credit, interest

Working paper at SSRN

Abstract  The goal of theoretical economics is to explain how the monetary economy works. The fatal methodological defect of Orthodoxy is that it is based on behavioral axioms. Yet, no specific behavioral assumption whatever can serve as a starting point for economic analysis. From this follows for Constructive Heterodoxy that the subjective axiomatic foundations have to be replaced. This amounts to a paradigm shift. Nobody can rest content with a pluralism of false theories. Based on a set of objective axioms all economic conceptions have to be reconstructed from scratch. In the following this is done for the theory of money.


For cross-references see here

Real wages: toward an explanation

Comment on ‘Falling real wages in the USA 2007—2014’

Blog-Reference

For the explanation of the real wage development a theoretical underpinning is needed. This is the correct formula to start with.

The average real wage depends on productivity R, the expenditure ratio (rhoE>1 means overall credit expansion), the relative size of the investment good industry Li/Lc, and the ratio of distributed profit Yd to wage income.

For the analytical details see (2014).

Egmont Kakarot-Handtke


References
Kakarot-Handtke, E. (2014). Economics for Economists. SSRN Working Paper Series, 2517242: 1–29. URL

February 26, 2015

United in the social science delusion

Comment on Lars Syll on ‘Microfoundations — contestable incoherence’

Blog-Reference

“Walras approached Poincaré for his approval. ... But Poincaré was devoutly committed to applied mathematics and did not fail to notice that utility is a nonmeasurable magnitude. ... He also wondered about the premises of Walras’s mathematics: It might be reasonable, as a first approximation, to regard men as completely self-interested, but the assumption of perfect foreknowledge ‘perhaps requires a certain reserve’.” (Porter, 1994, p. 154)

Rational expectations and the rest of neoclassical assumptions were never taken seriously by real scientists. The question is: Why has the representative economist not realized this in more than 100 years?

Lars Syll comes close to the right answer: “The fact that Lucas introduced rational expectations as a consistency axiom is not really an argument to why we should accept it as an acceptable assumption in a theory or model purporting to explain real macroeconomic processes.” (see intro)

Of course, rational expectation is an unacceptable behavioral assumption. However, the error/mistake of Orthodoxy does not lie in this particular green cheese assumption but in a complete failure to understand what the scientific method is all about.

Rational expectation, and constrained optimization, or utility maximization for that matter, are perfectly in line with the accepted methodology.

“It is a touchstone of accepted economics that all explanations must run in terms of the actions and reactions of individuals. Our behavior in judging economic research, in peer review of papers and research, and in promotions, includes the criterion that in principle the behavior we explain and the policies we propose are explicable in terms of individuals, not of other social categories.” (Arrow, 1994, p. 1); see also (Arnsperger and Varoufakis, 2006)

The fundamental methodological blunder resides in the idea that economics is about human behavior. Let us call this the social science delusion. The irony is that Heterodoxy is even more convinced that economics is essentially a social science. It differs from Orthodoxy only insofar as it claims that their behavioral assumptions are more ‘realistic’.

The fact of the matter is that economics is about the behavior of the economic system and not about the behavior of individuals. This, indeed, is the realm of psychology, sociology, anthropology etcetera. To speculate about rational or irrational human behavior is not economic analysis at all (Hudík, 2011).

This means that the subject matter of economics has to be redefined. The fault of Orthodoxy is not so much that it introduces rational expectation as a behavioral axiom, the methodological blunder is that there is no such thing as a behavioral axiom.

No way leads from the understanding of human behavior to the understanding of how the actual economy works. This fully explains why economics is a failed science.

Because there is no such thing as a behavioral axiom, Lars Syll is right: “And that ought to be rather embarrassing for those ilks of macroeconomists to whom axiomatics and deductivity is the hallmark of science tout court.”

Lars Syll is completely wrong, though, in concluding that axiomatics and deductivity have to be abandoned as ‘horseshit’. See here.

From the fact that the behavioral axioms of Orthodoxy are forever beyond acceptability does not follow that axiomatization is wrong. It follows that subjective behavioral axioms have to be replaced by objective structural axioms.

To find the correct axioms is the prime task of economics since J. S. Mill: “What are the propositions which may reasonably be received without proof? That there must be some such propositions all are agreed, since there cannot be an infinite series of proof, a chain suspended from nothing. But to determine what these propositions are, is the opus magnum of the more recondite mental philosophy.” (Mill, 2006, p. 746)

Neither Orthodoxy nor Heterodoxy has achieved the opus magnum.

Egmont Kakarot-Handtke


References
Arnsperger, C., and Varoufakis, Y. (2006). What Is Neoclassical Economics? The Three Axioms Responsible for its Theoretical Oeuvre, Practical Irrelevance and, thus, Discursive Power. Paneconomicus, 1: 5–18.
Arrow, K. J. (1994). Methodological Individualism and Social Knowledge. American Economic Review, Papers and Proceedings, 84(2): 1–9. URL
Hudík, M. (2011). Why Economics is Not a Science of Behaviour. Journal of Economic Methodology, 18(2): 147–162.
Mill, J. S. (2006). Principles of Political Economy With Some of Their Applications to Social Philosophy, volume 3, Books III-V of Collected Works of John Stuart Mill. Indianapolis, IN: Liberty Fund. URL
Porter, T. M. (1994). Rigor and Practicality: Rival Ideals of Quantification in Nineteenth-Century Economics. In P. Mirowski (Ed.), Natural Images in Economic Thought, pages 128–170. Cambridge: Cambridge University Press.

February 22, 2015

Heterodoxy, too, is still in the wood

Comment on 'Money and Say’s law: on the macroeconomic models of Kalecki, Keen, and Marx'

Blog-Reference

José Tapia sets out to clarify the interrelations between aggregate income, aggregate demand, money, credit, profit, and Say's Law in Kalecki's, Keen's, and Marx's respective approaches. This is an absolute theoretical necessity because Heterodoxy cannot claim that Orthodoxy is false and then present a motley of heterodox approaches that do not fit together or are even contradictory. Heterodoxy has to prove its superiority.

It is remarkable that, for example, the profit theories of the Top 20 heterodox economists (link below) are quite different. Clearly, they cannot all be correct at the same time. As a matter of fact, they are all false. This has been demonstrated in a formally rigorous way for Marx (2014a), Keynes (2011b), Kalecki (2011a), and Keen (2013).

And this is why not only the orthodox but also the heterodox stories about the functioning of the market system are false (2014b). For the correct heterodox version of Say's Law see (2015b).

The general relationship between monetary profit Qm, distributed profit Yd, investment I and saving Sm is given with this formula.

It is easy to see that Minsky, too, is contained in this equation as a limiting case for Yd=0 and S=0. To recall “For Minsky, the notion that profits equals investment was ‘a profound insight into how a capitalist economy works’.” (Tapia, 2015, p. 110)

For the formally correct interrelation between aggregate demand and money see (2015a).

The general relationship between employment, aggregate demand and changes of money/credit is given with this formula.

This equation contains Keen's relationship between changes of employment and changes of debt.

José Tapia has shown how major heterodox economists have treated the relationships between aggregate income, aggregate demand, money, credit, profit, and Say's Law in their idiosyncratic approaches. What is lacking is a consistent synthesis, so he leaves Heterodoxy in the wood.

In marked contrast, the structural axiomatic approach puts the essential building blocks in a formally rigorous way together. This is the prerequisite for a successful paradigm shift.

Given the failure of Orthodoxy, there cannot be the slightest doubt that a paradigm shift is overdue.

Egmont Kakarot-Handtke


References
Kakarot-Handtke, E. (2011a). What is Wrong With Heterodox Economics? Kalecki’s Profit Theory as an Example. SSRN Working Paper Series, 1845803: 1–9. URL
Kakarot-Handtke, E. (2011b). Why Post Keynesianism is Not Yet a Science. SSRN Working Paper Series, 1966438: 1–15. URL
Kakarot-Handtke, E. (2013). Debunking Squared. SSRN Working Paper Series, 2357902: 1–5. URL
Kakarot-Handtke, E. (2014a). Profit for Marxists. SSRN Working Paper Series, 2414301: 1–25. URL
Kakarot-Handtke, E. (2014b). The Three Fatal Mistakes of Yesterday Economics: Profit, I=S, Employment. SSRN Working Paper Series, 2489792: 1–13. URL
Kakarot-Handtke, E. (2015a). Essentials of Constructive Heterodoxy: Aggregate Demand. SSRN Working Paper Series, 2564590: 1–23. URL
Kakarot-Handtke, E. (2015b). Essentials of Constructive Heterodoxy: Say’s Law. SSRN Working Paper Series, 2556434: 1–10. URL
Tapia, J. A. (2015). Money and Say’s law: On the Macroeconomic Models of Kalecki, Keen, and Marx. real-world economics review, (70): 110–120. URL

Link to Top 20 Heterodox Economics Books here.

February 21, 2015

The real limit of Heterodoxy

Comment on Lars Syll on 'The real limit of public debt'

Blog-Reference

David Graeber makes the crucial point that money and credit are two sides of the same coin. What follows from this? In rough terms, it follows that the Quantity Theory, which is complementary to General Equilibrium theory, is wrong. And from this, it turn follows that Heterodoxy should come up as soon as possible with a new Theory of Money.

That the Bank of England shares Graeber's insight is a good sign. On the other hand, does this eliminate the need for a better Theory of Money, nay, for an entirely new paradigm, that is, for rethinking economics from the ground up? Certainly not.

Time for everybody to switch to the constructive mode (for a start see 2011).

Egmont Kakarot-Handtke


References
Kakarot-Handtke, E. (2011). Reconstructing the Quantity Theory (I). SSRN Working
Paper Series, 1895268: 1–26. URL

February 20, 2015

Educating economists? Yes, but where is the scientific stuff?

Comment on Simon Wren-Lewis on 'Greece and educating economists'

Blog-Reference

First of all one has to distinguish between theoretical and political economics. The goal of political economics is to push an agenda, the goal of theoretical economics is to explain how the actual economy works. From the viewpoint of science political economics as a whole is a no-go. The first problem of economics is that many economists are not scientists but agenda pushers of one sort or another.

The theoretical economist who understands his scientific mission and knows that J. S. Mill was not only a great economist but one of the greatest methodologists (Popper, 1980, p. 19) simply keeps out of politics.

“A scientific observer or reasoner, merely as such, is not an adviser for practice. His part is only to show that certain consequences follow from certain causes, and that to obtain certain ends, certain means are the most effectual. Whether the ends themselves are such as ought to be pursued, and if so, in what cases and to how great a length, it is no part of his business as a cultivator of science to decide, and science alone will never qualify him for the decision.” (Mill, 2006, p. 950)

But should economists not bring in their expertise? This seems to be a question that has only one answer.

“To be able to say intelligent stuff about what is going on at the moment (which you would hope an economics education would enable you to do), you need to know quite a lot of economic theory. A lot of macro of course, but quite a bit of finance, and also at least some game theory.” (see intro)

And here the problem begins because economists do not understand how the economy works.

“In order to tell the politicians and practitioners something about causes and best means, the economist needs the true theory or else he has not much more to offer than educated common sense or his personal opinion.” (Stigum, 1991, p. 30)

Economists lack the true theory. And they are only dimly aware of this. Here is a simple self-test.

You apply one of these items
• supply-demand-equilibrium,
• general equilibrium,
• marginal utility,
• well-behaved production functions,
• total income = value of output,
• total income = wages + profits,
• I=S,
• behavioral axioms?
Then you are out of science because of unnoticed material or formal inconsistency.

Make no mistake, economists have a lot of interesting things to tell, but the informative description of various economic institutions and phenomena, unsubstantiated modeling, psychologism, biologism, physicalism, sheer mathematical toolism, plain observationism, myopic empiricism, historicism, exegesis, rhetoric, or metaphor do not make a consistent and empirically valid theory. Storytelling is not science.

What, then, is the state of theoretical economics?

Neither orthodox nor heterodox economists understand the two most important phenomena in the economic universe: profit and income (2014). This is like pre-Newtonian physics before the elementary concepts force and mass were properly defined and clearly understood.

As professionals, economists cannot be compared to doctors, they are more like the barber surgeons of the Middle Ages.

Because economists fail to capture the essence of the market economy they have not much to offer in the way of a scientifically founded advice. This is publicly known since Napoleon and there has been no real progress since then.

“Late in life, moreover, he [Napoleon] claimed that he had always believed that if an empire were made of granite the ideas of economists, if listened to, would suffice to reduce it to dust.” (Viner, 1963, p. 1)

Early in his academic life Greece's new Finance Minister Varoufakis, too, has said a lot of intelligent stuff about the practical irrelevance of neoclassical economics in particular (Arnsperger and Varoufakis, 2006).

Egmont Kakarot-Handtke


References
Arnsperger, C., and Varoufakis, Y. (2006). What Is Neoclassical Economics? The Three Axioms Responsible for its Theoretical Oeuvre, Practical Irrelevance and, thus, Discursive Power. Paneconomicus, 1: 5–18.
Kakarot-Handtke, E. (2014). The Three Fatal Mistakes of Yesterday Economics: Profit, I=S, Employment. SSRN Working Paper Series, 2489792: 1–13. URL
Mill, J. S. (2006). A System of Logic Ratiocinative and Inductive. Being a Connected View of the Principles of Evidence and the Methods of Scientific Investigation, olume 8 of Collected Works of John Stuart Mill. Indianapolis, IN: Liberty Fund.
Popper, K. R. (1980). The Logic of Scientific Discovery. London, Melbourne, Sydney: Hutchison, 10th edition.
Stigum, B. P. (1991). Toward a Formal Science of Economics: The Axiomatic Method in Economics and Econometrics. Cambridge, MA: MIT Press.
Viner, J. (1963). The Economist in History. American Economic Review, 53(2): pp. 1–22. URL

February 19, 2015

How to solve almost any problem

Comment on 'Lucas’ bridge and the Ricardian equivalence fairy-tale'

Blog-Reference

In the preceding discussion (see links below) the important methodological point has been made that there are two fundamentally different systemic configurations:
(1) the pure production-consumption economy,
(2) the investment economy.

Historically, Ricardo made his argument in the context of (1), however, the discussion oscillates between these two entirely different configurations. This is inadmissible because it makes a real difference whether the economy produces non-durable consumption goods, 'apples' in Nick Rowe's terminology, or infrastructures like dikes and bridges.

We stay in the following in the pure production-consumption economy (1) which has been explicitly defined in the preceding post 'Nobody understands debt'; see here.

This is the benchmark scenario: the government taxes the wage income [100] in period t [X=20]. Households reduce consumption expenditures in perfect lockstep [from 100 to 80]. Gov fully spends income tax [20], that is, total consumption expenditures remain unchanged [20+80] and the market clearing price remains constant. Both, private and public households fully consume their respective shares of output. There is no real transfer of goods between periods, i.e., no investment goods.

Now, Wren-Lewis's argument runs as follows:
“If you spend X at time t ..., aggregate demand increases by X at time t. If you raise taxes by X at time t, consumers will smooth this effect over time so their spending at time t will fall by much less than X. Put the two together and aggregate demand rises.”

Yes! Let household consumption fall from 100 to 90 instead from 100 to 80, then total consumption expenditure is 110=90+20. Aggregate demand indeed rises. In the case of perfect flexibility, the market clearing price rises accordingly and the business sector now makes a profit of 10=110-100.

The households spend 90 but their net income is 80, hence their overdrafts at the central bank increase. Aggregate demand rises because of the deficit spending of the households. This may lead to employment effects in the sequel but has nothing to do with taxation as such or Ricardian equivalence. Whether private or public households run a deficit makes no difference for aggregate demand or the multiplier effect.

If both private and public households stick to strict budget balancing, taxation and public spending have no effect at all.

So, the whole argument shifts to the question of whether households reduce their consumption expenditures in step with taxation or not. Lucas says yes, Wren-Lewis says no, neither knows for sure. To recall, the original question was whether taxation or credit financing of public spending amounts ultimately to the same.

The fuss about Ricardo's equivalence it's not so much a problem of ideology but of the economists' proto-scientific habit of storytelling.

“Keynes always believed that ‘a little clear thinking’ or ’more lucidity’ could solve almost any problem.” (Moggridge)

Egmont Kakarot-Handtke


Preceding posts:
Multiplying confusion
Nobody understands debt – including the shrinks
The true nature of economists’ confusion
Better precisely right than roughly wrong


For the correct employment multiplier see here.

February 18, 2015

Multiplying confusion

Comment on 'Abba Lerner on Functional Finance and Ricardian equivalence'

Blog-Reference

To beginn with, there are two fundamentally different configurations:
(1) the pure consumption economy,
(2) the investment economy.

And there are three scenarios:
(a) income tax = gov spending in period t,
(b) no tax; but household saving=gov spending; H deposits=Gov overdrafts,
(c) no tax, no saving; but business profit=gov spending; B deposits=Gov overdrafts.

These are six different configurations. Ricardian equivalence refers to configurations (1a) and (1b).

The national debt payoff causes losses and depression in configuration (1c) but not in (1a) and (1b). Note that we conveniently start with full employment. Otherwise, the additional discrimination between full employment (F) and unemployment (U) has to be introduced. This then makes in total 12 configurations.

Functional finance refers to (2aU), (2bU) and (2cU).

In the discussion, the twelve configurations are constantly played out against each other. With no useful result, of course.

Lerner's approach suffers from the same error/mistake as Keynes's approach. Both do not correctly discriminate between profit and income and therefore apply I=S, which is the worst fallacy of all. For details see (2014; 2015).

Egmont Kakarot-Handtke


References
Kakarot-Handtke, E. (2014). The Three Fatal Mistakes of Yesterday Economics: Profit, I=S, Employment. SSRN Working Paper Series, 2489792: 1–13. URL
Kakarot-Handtke, E. (2015). Essentials of Constructive Heterodoxy: Aggregate Demand. SSRN Working Paper Series, 2564590: 1–23. URL


See also the preceding post.

Nobody understands debt — including the shrinks

Comment on Lars Syll on 'Debt myths debunked'

Blog-Reference

The burden-of-debt problem has never been solved but only kicked around in a circle because both orthodox and heterodox economists are ignorant of an elementary methodological principle.

“There can be no doubt whatsoever that a problem which has not yet been solved in all its aspects under its simplest conditions will be still more difficult to tackle if other, ‘more realistic’ assumptions are being made.” (Morgenstern, 1941, p. 373)

What, then, are the simplest conditions? In the following the intro and mainly Nick Rowe's posts are used as references; see the links below.

In order to simplify and to secure common premises ...
• ... take the world economy for a start. This rules out foreign debt.

• Take Samuelson's awkward infinity out. The process consists of three phases: (i) taking up credit, (ii) holding the debt, and (iii) repayment. For a start, each phase consists of one period only. This keeps generations and bequests out for a while.

• For the beginning, the pure consumption economy has to be considered as a limiting case. There is no investment, no real capital stock, no disinvestment.

• The economy starts with full employment and zero profit. There is only wage income. Productivity and output remain constant. At first, there is no growth.

• Money, credit, and bonds have to be consistently integrated. Stocks and flows have to be kept properly apart. The banking system is represented by the central bank.

• In order to exclude distributional effects all agents get the same wage income, save/dissave the same amount, and pay the same income tax.

• In the initial period the household sector's budget is balanced, that is, consumption expenditures are equal to wage income; and the product market is cleared, that is, the quantity bought is equal to the quantity produced at the market clearing price.

• The government needs part of the current output in period t. The need is legitimate and undisputed.

Benchmark scenario: The government taxes the wage income in period t. Households reduce consumption expenditures in step. Gov fully spends income tax, that is, total consumption expenditures remain unchanged and the market clearing price remains constant. Both, private and public households fully consume their respective shares of output. There is no real transfer of goods between periods.

First scenario: No income tax. Households reduce consumption expenditures. Through saving the household sector's current deposits at the central bank increase. Gov takes up overdrafts at the central bank. Both sides of the central bank's balance sheet are equal. Gov spends overdrafts. Total consumption expenditures and market clearing price remain unchanged.

In period t+1 the private households buy government bonds with their current deposits. The central bank's balance sheet shrinks again to zero. Each household gets the same interest income and pays the same income tax, that is, net income remains unchanged and is fully spent. The consumption good output remains constant, the market is cleared. The households in effect pay interest to themselves. The public budget is balanced, no matter how high or low the interest rate is.

In period t+2 the households spend their unchanged wage income and pay the income tax through dissaving. Gov fully repays the debt.

In real terms there is absolutely no difference between the two scenarios. The private households get the same quantity of consumption good output in each period.

The individual household is subjectively wealthier in period t+1 and keeps its wealth in the form of interest bearing bonds. Taken private and public households together, ‘our’ total wealth, though, does not increase. Psychologically, however, private households become the ‘prudent’ savers/lenders, public households become the ‘reckless’ borrowers. The problem of creditworthiness emerges. Both, lenders and borrowers become sleepless.

What happens in the most elementary case is a deferred payment of income tax. This should make the households happy, but it does not. The deferment is forgotten and future payment becomes a burden. Finally — the ultimate horror — the households' wealth is taxed away.

In real terms there is perfect equivalence between immediate and deferred taxation. Psychologically, both modes are worlds apart. It's all in the heads.

Now it is possible to consider variants. First of all, of course, the distributional effects from the heterogeneity of agents. Second, public investment instead of consumption. Third, permanent revolving or full monetization of debt and zero interest. Tax evasion, corruption, etcetera.

For the second scenario with no income tax and no reduction of the private households' consumption expenditures, which is psychologically even more challenging, see (2015, Sec. 8.4).

Egmont Kakarot-Handtke


References
Kakarot-Handtke, E. (2015). Essentials of Constructive Heterodoxy: Aggregate Demand. SSRN Working Paper Series, 2564590: 1–23. URL
Morgenstern, O. (1941). Professor Hicks on Value and Capital. Journal of Political Economy, 49(3): 361–393. URL


Links hereherehere, and here.

February 15, 2015

The true nature of economists' confusion

Comment on 'The true nature of public debt'

Blog-Reference

Ricardo spoke about war financing in a monetary economy. Merijnknibbe talks about financing dikes. The Neoclassicals have not realized that utility is a nonentity and  let the representative agent, another nonentity, optimize real consumption over time. Pontus declares that consumption does not, by accounting, depend on either debt or taxes. No accountant worth his salt would ever make such a claim.

Lerner famously said 'we' pay interest on public debt to 'ourselves'. But 'we' consist of savers and non-savers. And while income tax and interest payments are indeed equal there occurs a redistribution of income from non-savers to savers that never ends if debt is revolved. This crucial distinction and this real effect is semantically vaporized with 'we' and ‘ourselves’.

The true nature of confusion and mystification is that economists subscribe to the 'anything goes' methodology and are more famous for never ending wish-wash than for logical consequence.

For the formally correct refutation of Ricardian equivalence see the Section “The question of equivalence: three scenarios” in (2015).

Egmont Kakarot-Handtke


References
Kakarot-Handtke, E. (2015). Essentials of Constructive Heterodoxy: Aggregate Demand. SSRN Working Paper Series, 2564590: 1–22. URL

February 13, 2015

Better precisely right than roughly wrong

Comment on 'Public debt and Keynes’ paradox of thrift'

Blog-Reference

Allais characterized the phenomenon Keynes as follows:
“L’intuition de Keynes lui a fait sentir où se trouvaient les difficultés, mais son insuffisance logique ne lui a pas permis de résoudre les problèmes que son intuition lui avait fait entrevoir.” (1993, p. 70)

In other words:
“Keynes's intuition led him directly to the crucial difficulties but his logical shortcomings prevented the solution of the problems he encountered.” (rough translation)

Keynes felt that there was something wrong with the classical theory of saving. But in the General Theory he ended up with the equality/identity of saving and investment:
“Income = value of output = consumption + investment. Saving = income - consumption. Therefore saving = investment.” (1973, p. 63)

Unfortunately, this apparently simple syllogism is false. Loosely speaking there is something wrong with profit, which is missing in the syllogism. The correct relationship is given with this formula.

The formula points the way to the consistent theory of aggregate demand, public debt, and debt deflation (see 2015).

The paradox of Keynesianism is that Keynes has never been recognized as the real great benefactor of the market economy.

In the pure consumption economy, the stabilization of aggregate demand directly benefits the business sector through loss prevention and indirectly stabilizes employment at the given level. Taken the process as a whole, the compensatory actions of the public households save the life of the business sector and redistribute income from non-savers to savers, that is, to those who have triggered the chain reaction of problems in the first place. The whole process is a bit more complex, but not essentially different, in the general case of an investment economy. Saving not only reduces aggregate demand but is the exact complementary of loss. The theory of saving is false because the profit theory is false.

Egmont Kakarot-Handtke


References
Allais, M. (1993). Les Fondements Comptable de la Macro-Économie. Paris: Presses Universitaires de France, 2nd edition.
Kakarot-Handtke, E. (2015). Essentials of Constructive Heterodoxy: Aggregate Demand. SSRN Working Paper Series, 2564590: 1–22. URL
Keynes, J. M. (1973). The General Theory of Employment Interest and Money. The Collected Writings of John Maynard Keynes Vol. VII. London, Basingstoke: Macmillan.

Essentials of Constructive Heterodoxy: aggregate demand

Working paper at SSRN

Abstract  Heterodoxy has left not one stone unturned and has unraveled a plethora of errors/mistakes/contradictions of Orthodoxy. The outcome of this prolonged critical and self-critical process is that there is actually no acceptable and accepted theoretical economics. The need of a paradigm shift is irrefutable. There is less need of further debunking exercises. For Constructive Heterodoxy follows that the subjective axiomatic foundation of Orthodoxy has to be replaced. All economic conceptions have to be consistently reconstructed. What comes to mind first are phenomena like market, profit, money, employment or aggregate demand. The latter is dealt with in the present paper.

February 11, 2015

What does a market really look like?

Comment on  'Finding equilibrium'

Blog-Reference

Equilibrium is a nonentity. For theoretical economics follows that the familiar supply-demand-equilibrium depiction of the textbooks has to be replaced. This presupposes an entirely new approach because equilibrium is an indispensable element of the orthodox research program.

“Thus it is an organizing feature of any theory in the program that there must be a well-defined idea of equilibrium present; that equilibrium notion is to be intrinsic to any model or theory that exists in the protective belts.” (Weintraub, 1985, p. 148)

In order to replace Orthodoxy, the correct market theory has to be developed. This is the make-or-break challenge for Heterodoxy (2015).

Egmont Kakarot-Handtke


References
Kakarot-Handtke, E. (2015). Essentials of Constructive Heterodoxy: The Market. SSRN Working Paper Series, 2547098: 1–10. URL
Weintraub, E. R. (1985). Joan Robinson’s Critique of Equilibrium: An Appraisal. American Economic Review, Papers and Proceedings, 75(2): 146–149. URL


For the correct depiction of the product market see here.

February 8, 2015

From false to true

Comment on 'Finding equilibrium'

Blog-Reference

All one needs to know about market theory is known:
“There is little or nothing in existing micro- or macroeconomics texts that is of value for understanding real markets. Economists have not understood how to model markets mathematically in an empirically correct way.” (McCauley, 2006, p. 16)

For Heterodoxy follows that the defunct theory of market interaction has to be replaced by the correct approach. For a start see (2015).

Egmont Kakarot-Handtke


References
Kakarot-Handtke, E. (2015). Essentials of Constructive Heterodoxy: The Market. SSRN Working Paper Series, 2547098: 1–10. URL
McCauley, J. L. (2006). Response to "Worrying Trends in Econophysics". EconoPhysics Forum, 0601001: 1–26. URL

February 7, 2015

Who rides the debt-tiger cannot dismount

Comment on 'The Hayekization of modern society'

Blog-Reference

Wolfgang Streeck gives a summary of the development of private/public debt, tax revenues/public spending and employment in the major economies over the last 50 years and then turns to the actual transition from expansion to consolidation of public debt. This is the empirical part and it deserves the highest praise.

The part of interpretation consists of second-guessing the agents' motives, aims, constraints, and means of coercion, that is, essentially of psychology and sociology. We learn what we knew already, viz. that the relationship between borrower and lender is asymmetric in good times and turns nasty when the economy underperforms. The game can only go on for another round as long as credit-worthiness is maintained. All this is pretty obvious.

However, the psychological/sociological/political account, which is plausible indeed, masks the lack of an underlying economic theory. We know from Adam Smith that it is one thing what the individual agents think and want and do; and quite another thing how the economy as a whole behaves.

The bridge from the small picture to the big picture is established by theoretical economics. And, to make a long analysis (2014b; 2012b; 2012a; 2014a) short, the correct theoretical approach yields this testable formula.

It says roughly: unemployment goes down when the (world) economy grows (=I=investment up), when the (average) expenditure ratio rhoE increases, and when the (average) factor cost ratio rhoF increases, and up in the opposite case. The definitions of the ratios are given here.

An expenditure ratio rhoE>1 says that private/public debt increases. That means that the transition from credit expansion to consolidation, i.e. to rhoE=1, increases unemployment (if the rest of the variables is kept constant). Worse, if overall credit is redeemed, i.e. rhoE<1, the economy breaks down. As the Chinese proverb says 'Who rides a tiger cannot dismount.'

What can be done to counter, or at least postpone, this outcome? The formula says that the (average) factor cost ratio rhoF should increase. The ratio is defined as W/PR. That is, under the condition of price stability the (average) wage rate W should rise faster than productivity R. Since the factor cost ratio is formally connected to the profit ratio this means in other words, that the (average) profit ratio (not absolute profit for the economy as a whole) should be lowered.

Note well, that wage cutting — the classical economists' cure all recipe — worsens the situation (all other variables in the formula kept constant). That throughout history economists have been a menace to their fellow citizens is publicly known at least since Napoleon:
“Late in life, moreover, he [Napoleon] claimed that he had always believed that if an empire were made of granite the ideas of economists, if listened to, would suffice to reduce it to dust.” (Viner, 1963, p. 1)

In theoretical economics a paradigm shift is overdue.

Egmont Kakarot-Handtke


References
Kakarot-Handtke, E. (2012a). General Formal Foundations of the Virtuous Deficit-Profit Symmetry and the Vicious Debt Deflation. SSRN Working Paper Series, 2115185: 1–30. URL
Kakarot-Handtke, E. (2012b). Keynes’s Employment Function and the Gratuitous Phillips Curve Disaster. SSRN Working Paper Series, 2130421: 1–19. URL
Kakarot-Handtke, E. (2014a). Mathematical Proof of the Breakdown of Capitalism. SSRN Working Paper Series, 2375578: 1–21. URL
Kakarot-Handtke, E. (2014b). The Three Fatal Mistakes of Yesterday Economics: Profit, I=S, Employment. SSRN Working Paper Series, 2489792: 1–13. URL
Viner, J. (1963). The Economist in History. American Economic Review, 53(2): pp. 1–22. URL

February 5, 2015

Forget equilibrium

Comment on Lars Syll on 'Finding equilibrium'

Blog-Reference

It is a rather old problem with these savants:
“These savants, as Galileo put it, first decided how the world should function in accordance with their preconceived principles. ... He openly criticized scientist and philosophers who accepted laws which conformed to their preconceived ideas as to how nature must behave.” (Kline, 1982, p. 48)

Equilibrium, or by implication disequilibrium, is a nonentity. However, it is a fact — not only in the realm of science — that people have a strong proclivity to occupy themselves with nonentities. As J. S. Mill put it:
"Mankind in all ages have had a strong propensity to conclude that wherever there is a name, there must be a distinguishable separate entity corresponding to the name; ..." (2006, p. 756)

The inexcusable methodological blunder with equilibrium is this:
“... you shouldn't find the fixed equilibria first and then see if an economy converges to it; rather, the convergence process will itself constitute the equilibrium, if any exist.” (Mirowski, 1989, p. 459)

In brief, it is inadmissible to put assumptions like equilibrium, decreasing returns, perfect competition etcetera into the premises (2014). This mistake is known since antiquity as petitio principii and J. S. Mill, the founder of economic methodology, dealt with it at length in his System of Logic.

Equilibrium economists have not solved anything.

“It is utopian, as a matter of economics, because in effect it simply assumes from the outset a perfect solution to the very problem that an economic system is supposed to solve.” (Nelson, 2006, p. 62)

Therefore, the title of the book is, to begin with, misleading. Economists have not found equilibrium but simply put it into the hat. Economic methodologists who overlook this constructive defect, and there are many, are not up to their task.

What follows from all this?

Students of economics can gain a wealth of time by immediately stopping to read an article or a book as soon as the concept of equilibrium is introduced. Even better, with immediate effect journals do no longer accept papers that apply equilibrium.

Identifying nonentities is one of the defining activities of science. The discussions among physicists became enormously productive just by no longer applying concepts like perpetual motion machine or epicycle because these refer to nonentities. It is perfectly analogous with equilibrium.

The representative economist does not understand what Aristotle already understood.

“When the premises are certain, true, and primary, and the conclusion formally follows from them, this is demonstration, and produces scientific knowledge of a thing.” (Resume of Posterior Analytics)

Equilibrium is neither a certain, true nor primary premise. To cling any longer to equilibrium is self-disqualifying.

Egmont Kakarot-Handtke


References
Kakarot-Handtke, E. (2014). Objective Principles of Economics. SSRN Working Paper Series, 2418851: 1–19. URL
Kline, M. (1982). Mathematics. The Loss of Certainty. Oxford, New York, NY: Oxford University Press.
Mill, J. S. (2006). A System of Logic Ratiocinative and Inductive. Being a Connected View of the Principles of Evidence and the Methods of Scientific Investigation, volume 8 of Collected Works of John Stuart Mill. Indianapolis, IN: Liberty Fund.
Mirowski, P. (1989). The Rise and Fall of the Concept of Equilibrium in Economic Analysis. Louvain Economic Review, 55(4): 447–468. URL
Nelson, R. H. (2006). Economics as Religion: From Samuelson to Chicago and Beyond. Pennsylvania, PA: Pennsylvania State University Press.

February 3, 2015

Economists — sloppy, stupid, or scientifically incompetent?

Comment on 'Greg Mankiw on loanable funds — so wrong, so wrong'

Blog-Reference and parallel Blog-Reference

"The loanable funds theory is in many regards nothing but an approach where the ruling rate of interest in society is — pure and simple — conceived as nothing else than the price of loans or credit, determined by supply and demand — as Bertil Ohlin put it — ‘in the same way as the price of eggs and strawberries on a village market.'” (See intro)

Economists think they have explained something when they paint a supply-demand-equilibrium cross or what Leijonhufvud called the totem of the micro. However, already Schumpeter found it necessary to diffuse doubts about the scientific content of the whole exercise.

“The primitive apparatus of the theory of supply and demand is scientific. But the scientific achievement is so modest, and common sense and scientific knowledge are logically such close neighbors in this case, that any assertion about the precise point at which the one turned into the other must of necessity remain arbitrary.” (Schumpeter, 1994, p. 9)

As a matter of fact, the ‘primitive apparatus of the theory of supply and demand’ is a thoroughly faulty construct.

“There is little or nothing in existing micro- or macroeconomics texts that is of value for understanding real markets. Economists have not understood how to model markets mathematically in an empirically correct way.” (McCauley, 2006, p. 16), see also (2014a; 2015)

Because the generic supply-demand-equilibrium apparatus has to be rejected, the specific loanable funds application also goes out of the window. Keynes was right in this respect (See intro and 2014b).

However, Keynes got it also wrong. The formal core of the General Theory is given with:
“Income = value of output = consumption + investment. Saving = income - consumption. Therefore saving = investment.” (Keynes, 1973, p. 63)

This is rather elementary mathematics and pure conceptual sloppiness. Keynesians and the rest of the profession simply cannot tell the fundamental difference between income and profit (2011). As can be seen from the intro, Kalecki too got it wrong.

“It should be emphasized that the equality between savings and investment … will be valid under all circumstances.”

As a matter of fact, the equality is invalid under all circumstances. The correct relationship is given with this equation.

It says: the business sector's monetary profit Qm is equal to distributed profit Yd plus investment expenditure I minus the household sector's monetary saving Sm (2014c, Sec. 3). Alternatively: The business sector's retained profit Qm-Yd is equal to the difference between investment and saving. Seen from the business sector as a whole, with retained profit investment ‘finances itself.’ What has to be clearly seen, though, is that the firm with retained profit is normally not the same firm that finances investment. This establishes a direct or indirect financing relationship within the business sector. This is something quite different from financing relationships between the business and the household sector.

The representative economist has always argued that this is all a matter of definition and everybody is free to define whatever seems convenient. This ‘anything goes’ methodology fully explains the failure of economics. The representative economist has always been a scientific write-off.

Egmont Kakarot-Handtke


References
Kakarot-Handtke, E. (2011). Why Post Keynesianism is Not Yet a Science. SSRN Working Paper Series, 1966438: 1–15. URL
Kakarot-Handtke, E. (2014a). Economics for Economists. SSRN Working Paper Series, 2517242: 1–29. URL
Kakarot-Handtke, E. (2014b). Loanable Funds vs. Endogenous Money: Krugman is Wrong, Keen is Right. SSRN Working Paper Series, 2389341: 1–17. URL
Kakarot-Handtke, E. (2014c). The Three Fatal Mistakes of Yesterday Economics: Profit, I=S, Employment. SSRN Working Paper Series, 2489792: 1–13. URL
Kakarot-Handtke, E. (2015). Essentials of Constructive Heterodoxy: The Market. SSRN Working Paper Series, 2547098: 1–10. URL
Keynes, J. M. (1973). The General Theory of Employment Interest and Money. The Collected Writings of John Maynard Keynes Vol. VII. London, Basingstoke: Macmillan. (1936).
McCauley, J. L. (2006). Response to "Worrying Trends in Econophysics". EconoPhysics Forum, 0601001: 1–26. URL
Schumpeter, J. A. (1994). History of Economic Analysis. New York, NY: Oxford University Press.

For details of the big picture see cross-references Refutation of I=S

Deflation: better take the correct formulas

Comment on 'Will the ECB push Europe over the deflation cliff?'

Blog-Reference

The simplified formula for the market clearing price in the consumption good industry is given here.

Roughly, the formula says that the consumer price index Pc declines if (i) the average expenditure ratio falls, (ii) the wage rate W falls, (iii) the productivity R increases and (iv) the employment in the investment good industry Li shrinks relative to the employment in the consumption goods industry Lc. The formula follows from (2014, Sec. 5).

The more differentiated and therefore better testable formula is given here.

The crucial message is that the nominal wage is the numéraire of the price system as Keynes argued in the GT. If at all, the quantity of money plays an indirect role via the expenditure ratio and the employment relation of the investment good and the consumption good industry.

The rule of thumb says: if wage increases for the business sector as a whole lag behind productivity increases deflation occurs (the rest of the formula kept constant).

Note that monetary profit Qm for the business sector as a whole is given here.

That is, total profit does not depend on the wage rate. Most economists do not know the correct profit formula (2014, Sec. 3).

Egmont Kakarot-Handtke


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