August 8, 2015

The Humpty Dumpty methodology

Comment on Nick Rowe on ‘On defining "recession"’


With regard to definitions the representative economist easily takes side with Humpty Dumpty. "’When I use a word,’ Humpty Dumpty said in rather a scornful tone, ‘it means just what I choose it to mean — neither more nor less.’ ‘The question is,’ said Alice, ‘whether you can make words mean so many different things.’ ‘The question is,’ said Humpty Dumpty, ‘which is to be master — that's all’.” (Carroll, Through the Looking-Glass)

That is not how science works. The freedom or arbitrariness of definition is a methodological illusion. It applies only to the first definition. Subsequently, one has to make sure that every new definition is consistent with the preceding ones. Overall consistency cannot be achieved in the economist's cavalier fashion: “The only way to arrive at coherent languages is to set up axiomatic systems implicitly defining the basic concepts.” (Schmiechen, 2009, p. 344)

The fact of the matter is that economists got the fundamental concepts income and profit wrong. Keynes is a case in point. 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 it should not be too hard to get it right. Actually, the fault in Keynes's two-liner is in the premise income = value of output. This equality holds only in the limiting case of zero profit in both the consumption and investment good industry. Profit does not appear in Keynes's elementary formalism. That is, he in effect talks about capitalism without profit. The simple reason for this analytical blunder is that Keynes never got the profit theory right. This sad fate is shared by the representative economist (2014) — among many others by Nick Rowe.

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 (2014, Sec. 3). Alternatively: The business sector's retained profit Qm-Yd is equal to the difference between investment and saving.

In short, household sector saving is never equal to business sector investment, that is, all I=S models including IS-LM are false.*

From this follows in turn that Nick Rowe's blog post of 2011** is logically defective as well as the recent posts on the Origin of Specious blog.***

The problem here as everywhere is the false definition of profit which in turn leads to a false definition of income which in turn leads to a false definition of saving. All mistakes together produce a closed and stable framework of self-delusion. Post-Keynesians are trapped in this logical fallacy since more than 70 years.

Egmont Kakarot-Handtke

Kakarot-Handtke, E. (2014). 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. The Collected Writings of John Maynard Keynes Vol. VII. London, Basingstoke: Macmillan.
Schmiechen, M. (2009). Newton’s Principia and Related ‘Principles’ Revisited, volume 1. Norderstedt: Books on Demand, 2nd edition. URL

* See also the cross-references
** here
*** here