Blog-Reference
Thompson rejected the IS-LM model for various reasons but overlooked the lethal flaw, that is, the implicit equality/equilibrium of saving/investment. In this, he was by no means unique. From the utterances of the mouthpieces of the major economics sects, one can safely conclude that the representative economist has not gotten the point until this very day (2014; 2011).#1 Because the lethal flaw of IS-LM escaped Thompson he set out to repair non-existing or inconsequential defects.
The flaw of IS-LM and all its recent variants is that no such thing as an IS schedule exists because saving and investment are never equal. This is a testable proposition, so there is no need for further debate.
The corrections/improvements of Thompson are spurious because he methodologically falls back into pre-Keynesian darkness. Keynes realized that the neoclassical approach was fundamentally (=axiomatically) flawed. “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) And, by consequence “there is no remedy except to throw over the axiom of parallels and to work out a non-Euclidean geometry. Something similar is required to-day in economics.” (1973, p. 16)
What Keynes meant with ‘to throw over the axiom of parallels’ is now called a paradigm shift. Most economists erroneously think that it is enough to replace one model by another model or to replace a patently weird assumption, e.g. perfect wage/price flexibility, with something more ‘realistic’, e.g. sticky wages. Those marginal corrections are insufficient, a paradigm shift goes to the root.
Thompson’s attempt is misguided because the whole neoclassical approach is misguided because its axiomatic basis is forever unacceptable. The common denominator of all neoclassical models is given with these hardcore 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. (Weintraub, 1985, p. 147)
Or, as Krugman put it on his blog “most of what I and many others do is sorta-kinda neoclassical because it takes the maximization-and-equilibrium world as a starting point ...”. This is the root mistake.
What can be said with certainty is that the set of five neoclassical hardcore propositions has proven its worthlessness. More specifically, all sorta-kinda maximization-and-equilibrium models are “inherently unable to serve as analytical tools in macroeconomics” (See intro).
This includes Thompson’s approach. Note in particular that the distinction between stable and unstable equilibrium does not make the concept of equilibrium more acceptable — just as the distinction between female/male angels does not make the concept of angel more acceptable. Equilibrium is a nonentity. Because of this, HC5 has to be rejected. The same holds for HC2. And this means that all sorta-kinda maximization-and-equilibrium models have to be rejected. From wrong premises, nothing of any value ever follows: garbage in, garbage out.#2
We can agree with Thompson that Keynesian IS-LM models are unacceptable. We can agree with Keynes that all Walrasian models are unacceptable. This has the dire consequence that the policy proposals with regard to monetary and fiscal policy of both sects have no sound theoretical foundation. Where the true economic theory should reside there is a scientific black hole.
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. (2014). Mr. Keynes, Prof. Krugman, IS-LM, and the End of Economics as We Know It. SSRN Working Paper Series, 2392856: 1–19. 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.
Weintraub, E. R. (1985). Joan Robinson’s Critique of Equilibrium: An Appraisal. American Economic Review, Papers and Proceedings, 75(2): 146–149. URL
#1 I=S: Mark of the Incompetent
#2 The replacement of HC1/HC5 for the correct reformulation of macroeconomics is given here
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ICYMI (comment on elwailly of Nov 24 on Nov 25)
The correct employment theory states that — for the economy as a whole — the average wage rate must rise in order to prevent unemployment and deflation.
With the provably false standard employment theory economists bear the intellectual responsibility for the social devastation of unemployment. Since Keynes gave his diagnosis in ‘The Great Slump of 1930’ every economist could know that ‘what we economists have all learned, and many of us teach’ (Tobin) about the relationship between wage rate and employment for the economy as a whole is dead wrong.
For more details and references see the post ‘The key relationship between employment and wage rate’. For the big picture see ‘Profit and the collective failure of economists’