December 31, 2014

From theory collapse to economic collapse

Comment on  'Why does aggregate demand collapse?'


The litmus test for every economist is whether he takes the Walrasian approach seriously. Since the days when Keynes saw more clearly than his fellow economists that the 'classical' axioms had been refuted once and for all by the Great Depression this is self-disqualifying. There is no way back before Keynes.

However, Keynesianism has to be developed further. It is not such a good idea to cling to the General Theory. Keynes started the overdue paradigm shift but he did not finalize it in a formally acceptable manner (2011).

You ask two important questions, first about aggregate demand, second about the price mechanism. Both are, of course, interrelated but the crucial point is that the popular idea of the functioning of the price mechanism is mistaken. Loosely speaking: it is the profit mechanism that is decisive, not the price mechanism. Even if the adaptation of the product price and the wage rate for the business sector as a whole is perfectly flexible, this cannot turn the losses that result from insufficient aggregate demand into profit. Therefore, the price mechanism cannot prevent the self-dissolution of the economy.

Hence it is the familiar story of supply-demand-equilibrium that has to be replaced by the correct price theory (2014). The correct employment equation contains both aggregate demand and the interplay of the price mechanism (2014, p. 9, eq. (22)).

It is proverbial that the representative economist does not know how the economy works. Neither orthodox nor heterodox economists understand the two most important phenomena in the economic universe: profit and income. Because of this economists have nothing to offer in the way of a scientifically founded advice.

“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)

Not to forget, before you tell students about the economy you need the true theory.

Egmont Kakarot-Handtke

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). The Three Fatal Mistakes of Yesterday Economics:
Profit, I=S, Employment. SSRN Working Paper Series, 2489792: 1–13. URL
Stigum, B. P. (1991). Toward a Formal Science of Economics: The Axiomatic
Method in Economics and Econometrics. Cambridge, MA: MIT Press.