November 1, 2015

Humpty Dumpty is back again

Comment on Henry Oct 31 on ‘Keynes on the Theory of Interest’

Blog-Reference

“Research is in fact a continuous discussion of the consistency of theories: formal consistency insofar as the discussion relates to the logical cohesion of what is asserted in joint theories; material consistency insofar as the agreement of observations with theories is concerned.” (Klant, 1994, p. 31)

So, science is about formal and material consistency. Economists fail on both counts since Adam Smith and for this reason economics is not a science. It is as simple as that.

What has the outer appearance of a science is in fact a proto-science until this very day. This includes Orthodoxy and Heterodoxy and Keynesianism in particular. With regard to consistency Keynesians have conveniently defined their own methodological rules. “For Keynes as for Post Keynesians the guiding motto is ‘it is better to be roughly right than precisely wrong!’” (Davidson, 1984, p. 574)

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)

Keynes got the fundamental concepts income and profit wrong. The formal core of the General Theory is given with: “Income = value of output = consumption + investment. Saving = income - consumption. Therefore saving = investment.” (1973, p. 63)

This is rather elementary mathematics and it should not be too hard to get it right. Actually, Keynes got it provable wrong; and neither Keynesians, nor Post-Keynesians, nor New Keynesians, nor the Anti-Keynesians ever spotted the logical blunder.

The correct relationship is given here. 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 provable false. And this in turn means that all theories of interest which are predicated on the equalization/equilibrium of investment and saving are false. All attempts to filibuster this fact away are self-defeating.

Is is pretty obvious that Henry goes straight off into a parallel universe with what Keynes rightly condemned as ‘method of blind manipulation’ (1973, p. 297).

As mentioned above, there is no such thing as freedom or arbitrariness of definition. This freedom is restricted by the requirement of consistency. The fault in Henry's argument lies in the redundant on-top definitions of total income and total saving which yield: I = St. What Henry does not notice is that St is different from S, so the intended proof of I=S fails. This has already been demonstrated in Section 17 of ‘Keynes’s Missing Axioms

There is no hope that the Keynesian Humpty Dumpties will ever understand what formal consistency is all about. After all, they did not get it the last 80 years.

Egmont Kakarot-Handtke


References
Davidson, P. (1984). Reviving Keynes’s Revolution. Journal of Post Keynesian Economics, 6(4): 561–575. URL
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.
Klant, J. J. (1994). The Nature of Economic Thought. Aldershot, Brookfield, VT: Edward Elgar.
Schmiechen, M. (2009). Newton’s Principia and Related ‘Principles’ Revisited, volume 1. Norderstedt: Books on Demand, 2nd edition. URL

Immediately preceding posts 'Accounting basics'

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ICYMI (comment on FedUp of Nov 1 on Nov 2)

Imagine that, starting at zero, the national accountant records every single transaction between the business sector and the household sector in the investment economy. At any arbitrary point in time he may close the books and draw the balances. What the balances show is with mathematical certainty Q=Yd+I-S. Let us simplify matters with Yd=0, then the accountant ends up with Q=I-S. Accounting is the natural measurement instrument in economics and the underlying math is indeed elementary. The sad fact is that the representative economist does not even understand the principles of accounting.

With closing the books and arriving at Q=I-S the accountant’s job is done. Like a physicist he has taken a correct measurement with the accuracy of two decimal places. Every time he makes his measurement, i.e. entirely independent of the period length, he verifies the formula.

Enters the representative economist in his full smartness and says. Let’s play with the symbols and make a new definition, that is, let total saving ß be the sum of household sector saving S and profit Q which we rename as business sector's saving, so ß=S+Q. Note in passing that renaming profit as saving is semantic idiotism, hence the concept of total saving is a nonentity.

But now, look what we get: I=ß, i.e. total saving is invariably equal to investment. Yes, but look carefully, this is different from I=S. What this formal shell game amounts to is a substitution of ß and S and an unnoticed verbal equalization of saving and total saving.

Every accountant who carries out the economist’s redundant add-on book entry is either fired for incompetency or jailed for cooking the books.


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ICYMI (comment on JKH of Nov 2)

In Keynes's derivation of I=S neither profit nor retained profit appears (Keynes, 1973, p. 63).

Now, you assert “Saving by firms amounts to their retained profit.” This add-on definition is nowhere to be found in the General Theory. The simple reason is that Keynes never understood what profit is: “His Collected Writings show that he wrestled to solve the Profit Puzzle up till the semi-final versions of his GT but in the end he gave up and discarded the draft chapter dealing with it.” (Tómasson and Bezemer, 2010, pp. 12-13, 16)

Because Keynes never came clear with either profit, distributed profit or retained profit — not to speak of those who came after him — one will not find a correct definition of these concepts in all of Keynesianism. Yet, one can find the consistent definitions in Allais or in my paper ‘Keynes's Missing Axioms’.

The final result of correct accounting is invariably Qre=I-S. Your definitions are (i) a superfluous add-on (ii) formally illegitimate (iii) a semantic shell game that proves, if anything, a complete lack of understanding of the mechanisms of profit generation and distribution.

Keynesianism has been formally deficient from the very beginning. Because the multiplier and IS-LM relies on Keynes's profitless I=S all Keynesian policy advice has been nothing more until this very day than reading tea leaves and telling the silly exante/expost story. Monetary policy that relies on the familiar interest mechanism has no theoretically sound foundation.

The equality/equilibrium of saving and investment has been academically declared dead with Allais’s publication of 1993. In the history of science I=S will — if mentioned at all — forever stand out as a monument of scientific incompetence.


References
Keynes, J. M. (1973). The General Theory of Employment Interest and Money. The Collected Writings of John Maynard Keynes Vol. VII. 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

Immediately following post 'Down and out'