April 4, 2016

As Napoleon said: don’t listen to economists

Comment on Robert Waldmann on ‘Brad DeLong Marks His Beliefs about "The Return of Depression Economics" to Market’

Blog-Reference and Blog-Reference on Apr 5

Before starting the discussion of several model variants you say: “I am going to be dumb (I am not playing dumb — I just worked through each step) and consider different less elegant models of aggregate supply.” (See intro)

The futility of the whole exercise derives from the fact that the models of Krugman and DeLong to which you refer are flawed since Keynes. Not to have realized this is indeed manifest dimwittedness of Paul, Brad, and Robert. No need to play dumb.

Keynes defined the formal foundations of the General Theory as follows: “Income = value of output = consumption + investment. Saving = income - consumption. Therefore saving = investment.” (1973, p. 63)

This elementary two-liner is conceptually and logically defective because Keynes never came to grips with profit and therefore “discarded the draft chapter dealing with it.” (Tómasson et al., 2010, p. 12).

The three main points of the correct approach are:
• All I=S/IS-LM models are false since Hicks (2011; 2014b). The refutation of Krugman is to be found here (2014a) and the refutation of DeLong is to be found in ‘It’s the price mechanism, stupid!
• The correct profit equation for the investment economy reads Qm=Yd+I-Sm (2014b, p. 8, eq. (18)). Legend: Qm monetary profit, Yd distributed profit, I investment expenditures, Sm monetary saving. Sm establishes the connection to the money/credit market.
• The correct employment equation/Phillips curve is given here (2012).

To cut the meticulous formal derivation short, the most elementary version of the correct employment equation for the economy as whole is shown here. From this equation follows:
(i) An increase of the expenditure ratio rhoE leads to higher employment L (the letter rho stands for ratio). An expenditure ratio rhoE>1 indicates credit expansion, a ratio rhoE<1 indicates credit contraction of the household sector.
(ii) Increasing investment expenditures I exert a positive influence on employment, a slowdown of growth does the opposite.
(iii) An increase of the factor cost ratio rhoF=W/PR leads to higher employment.

The complete employment equation is a bit longer and contains in addition profit distribution, public deficit spending, and import/export. The employment equation contains only measurable real and nominal variables (and NO expectations and other nonentities).

Item (i) and (ii) is familiar since Keynes. What is new is the ratio rhoF as defined in (iii). This variable embodies the price mechanism. It works such that overall employment INCREASES if the average wage rate W INCREASES relative to average price P and productivity R.

This translates into the recipe: if the central bank wants an inflation rate of, say, 2 percent and the actual productivity growth is, say, 1.5 percent then the AVERAGE wage rate must rise with 3.5 percent. The crucial point is that the price mechanism does NOT work as standard economics hallucinates.

The bottom line is that the models you use are defective, therefore your whole supply-demand-exercise falls flat. It is to be hoped that politicians remember Napoleon and do not take Paul, Brad, and Robert seriously.

“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)

Egmont Kakarot-Handtke


References
Kakarot-Handtke, E. (2011). Why Post Keynesianism is Not Yet a Science. SSRN Working Paper Series, 1966438: 1–20. URL
Kakarot-Handtke, E. (2012). Keynes’s Employment Function and the Gratuitous Phillips Curve Desaster. SSRN Working Paper Series, 2130421: 1–19. URL
Kakarot-Handtke, E. (2014a). Mr. Keynes, Prof. Krugman, IS-LM, and the End of Economics as We Know It. SSRN Working Paper Series, 2392856: 1–19. URL
Kakarot-Handtke, E. (2014b). The Three Fatal Mistakes of Yesterday Economics: Profit, I=S, Employment. SSRN Working Paper Series, 2489792: 1–13. URL
Keynes, J. M. (1973). The General Theory of Employment Interest and Money. London, Basingstoke: Macmillan.
Tómasson, G., and Bezemer, D. J. (2010). What is the Source of Profit and Interest? A Classical Conundrum Reconsidered. MPRA Paper, 20557: 1–34. URL
Viner, J. (1963). The Economist in History. American Economic Review, 53(2): pp. 1–22. URL

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COMMENT on anne on Apr 5

Krugman says: “The idea that inflation promises might go directly into prices is a hope, not a worry.”

Rising prices (relative to wages and productivity) INCREASE unemployment. Because of this, every policy that aims directly at price increases WORSENS the employment situation.

Krugman’s underlying model of the price mechanism is provable false. For details see the comment on Waldmann ‘As Napoleon said: don’t listen to economists’.

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COMMENT on Paul Krugman NYT on Apr 5

Paul Krugman argues: “The idea that inflation promises might go directly into prices is a hope, not a worry.”

Rising prices (relative to wages and productivity) INCREASE unemployment. Because of this, every policy that aims DIRECTLY at price increases WORSENS the overall situation.

Krugman’s underlying model of the price mechanism is provable false. The formal proof is not sloganizable and outsizes a succinct post. For more details and wonkish references see the comment on Waldmann ‘As Napoleon said: don’t listen to economists’.

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COMMENT on Paul Krugman NYT on Apr 6

The correct economic model yields this elementary employment equation.

In simple terms it says:
(i) An increase of the expenditure ratio leads to higher employment. An expenditure ratio >1 indicates credit expansion, a ratio <1 indicates credit contraction.
(ii) Increasing investment expenditures exert a positive influence on employment, a slowdown of growth does the opposite.
(iii) An increase of the factor cost ratio rhoF=W/PR leads to higher employment.

The factor cost ratio embodies the price mechanism. It works such that overall employment INCREASES if the average wage rate INCREASES relative to average price and productivity. The standard models of the price mechanism are PROVABLE false.

If Japan applies Krugman’s advice she commits economic Harakiri.

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COMMENT on Paul Krugman NYT on Apr 7

The problem is not at all located at the level of economic policy. Hence, it does not matter much what Paul Krugman, Greg Mankiw, Brad DeLong, Larry Summer, or Robert Waldmann proposes.

The problem is located at the level of economic theory. Because economists lack the true theory/model ALL proposals are hanging in midair. Without sound scientific foundations, what Paul and Greg and Brad and Larry and Robert say is not different from old Roman haruspicy, i.e. the reading of poultry entrails.