June 17, 2015

Keenonomics, aggregate demand/change of debt, and some misleading critique

Blog-Reference

In a recent critique of Steve Keen's approach, Severin Reissl announces: “It is also shown that many weaknesses in Keen's argument stem from a lack of terminological clarity which originates in his interpretation of the works of Hyman Minsky.” (Reissl, 2015, Abstract)

This is true as I have shown with regard to Keen's definition of profit (2013) but Reissl argues from an unacceptable reference point, that is, from Stützel's version of balance mechanics. It has to be emphasized that balance mechanics is an indispensable tool of economic analysis; the crucial point is that Stützel got it not exactly right. For a start, a succinct summary of the different strands that treat the interconnection between the circular flow, the creation of credit/money, and balance mechanics is to be found in (Schmitt and Greppi, 1996).

Reissl summarizes Stützel's key methodological insight as follows.
“Partial statements are valid for groups, while global statements are valid for the aggregate economy. The application of a partial statement to the aggregate economy is very often only possible through the addition of highly restrictive assumptions; otherwise, it is an outright fallacy of composition.” (2015, p. 7)

In fact, the crippling methodological defect of the microeconomic approach is that partial truths are habitually but illegitimately generalized. Most conclusions of standard supply-demand-equilibrium analysis are false when generalized. Stützel was correct and far ahead of his time on this score.

The socially most deleterious fallacy of composition is what has become known as Ricardo's principle. “... profits would be high or low in proportion as wages were low or high.” (Ricardo, 1981, p. 110) This is true for a single firm but not for the economy as a whole. Hence it is not a great exaggeration to define the microfoundations Orthodoxy as the proto-science that confuses logic and fallacy of composition.

Reissl first correctly points out that it is important to distinguish between flows like consumption expenditures and income which affect net worth, on the one hand, and receipts and payments which affect the household/business sector's stocks of money, on the other hand.

But then, directly after eq. (6), the fatal blunder occurs: “Saving here denotes the difference between all additions and all reductions in net worth during a period. Investment (that is, by definition, a change in the quantity of tangible assets) is hence only a subcategory of saving for any subset of economic actors.”

This misleads Reissl in the course of the argument finally to: “These relations imply that, in a macroeconomic sense, investment is saving, but also that saving is investment.” (2015, p. 17)

And this, of course, is analytical rubbish but one that Reissl shares with the majority of economists. Keynes stated in his General Theory: “Income = value of output = consumption + investment. Saving = income - consumption. Therefore saving = investment.” (1973, p. 63)

Just like Reissl's balance mechanics, this elementary syllogism contains a fundamental conceptual error/mistake (2011) that invalidates all I=S-models without exception (see also the post E.K-H, 2015).

Where is the flaw in Reissl's critique of Keen? Reissl — just like Keen, Minsky, Keynes, Krugman, Wren-Lewis, Glasner, and the rest — got the pivotal distinction between income and profit wrong. So, welcome to the party: “... one of the most convoluted and muddled areas in economic theory: the theory of profit.” (Mirowski, 1986, p. 234)

The correct relationship between the key variables is given by Qre=I-S (2015, eq. (49)), that is, the business sector's investment expenditures are never equal to the household sector's saving and their difference is always equal to the business sector's retained profit. Balance mechanics cannot possibly yield a different result.

While Keen's approach is formally deficient, his assertion that there is a straightforward connection between aggregate demand and the change of the household sector's debt is absolutely correct for the pure consumption economy. For every economist, including Reissl, this is the firm ground in the conceptual morass. The First Law of balance mechanics says saving = loss and not saving = investment.

Not to have realized this in more than 200 years is the scientific opprobrium of economics.

Egmont Kakarot-Handtke


References
E.K-H (2015). Tricky business. Blog post. URL
Kakarot-Handtke, E. (2011). Why Post Keynesianism is Not Yet a Science. SSRN Working Paper Series, 1966438: 1–20. URL
Kakarot-Handtke, E. (2013). Debunking Squared. SSRN Working Paper Series, 2357902: 1–5. URL
Kakarot-Handtke, E. (2015). Essentials of Constructive Heterodoxy: Financial Markets. SSRN Working Paper Series, 2607032: 1–33. 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.
Mirowski, P. (1986). Mathematical Formalism and Economic Explanation. In P. Mirowski (Ed.), The Reconstruction of Economic Theory, pages 179–240. Boston, MA, Dordrecht, Lancaster: Kluwer-Nijhoff.
Reissl, S. (2015). The Return of Black Box Economics - a Critique of Keen on Effective Demand and Changes in Debt. IMK Working Paper, (149): 1–24. URL
Ricardo, D. (1981). On the Principles of Political Economy and Taxation. The Works and Correspondence of David Ricardo. Cambridge, New York, NY, etc.: Cambridge University Press. URL
Schmitt, B., and Greppi, S. (1996). The National Economy Studied as a Whole: Aspects of Circular Flow Analysis in the German Language. In G. Deleplace, and E. J. Nell (Eds.), Money in Motion, pages 341–364. Houndmills, Basingstoke, London: Macmillan.


Related 'Where advanced Heterodoxy — represented by Steve Keen — took the wrong turn' and 'Heterodoxy, too, is scientific junk'. For more on I≠S see cross-references