December 27, 2015

Deficit spending, helicopter money, and profit

Comment on ‘Randall Wray attacks “debt-free-money cranks” based on sloppy arguments’


There are two fundamentally different types of profit/loss: monetary and nonmonetary. The latter stems from the change of value of assets. The former emerges in the sphere of production. It is common knowledge that the familiar profit theories are defective. As the Palgrave Dictionary sums up “A satisfactory theory of profits is still elusive.” (Desai, 2008, p. 10)

To this day, neither the Walrasian, nor the Keynesian, nor the Marxian, nor the Austrian sect can tell the difference between income and profit. This is not exactly a noteworthy scientific achievement of the economics profession.

Keynes had no correct profit theory, and Post Keynesianism never realized that deficit spending is the source of monetary profits (2011). So, by fighting unemployment, Keynesians in actuality became the benefactors of business.

How does the Invisible Hand perform this feat? To answer this question the methodologically correct approach is to take the simplest economic configuration as analytical point of departure.

The pure consumption economy is defined for one period by three rather straightforward equations. (i) Yw=WL wage income Yw is equal to wage rate W times working hours L, (ii) O=RL output O is equal to productivity R times working hours L, (iii) C=PX consumption expenditure C is equal to price P times quantity bought/sold X. For the graphical representation see here.

At any given level of employment L, the wage income Yw that is generated in the consolidated business sector follows by multiplication with the wage rate W. On the real side, output O follows by multiplication with the productivity R. Finally, the price P follows as the dependent variable under the conditions of budget balancing, i.e. C=Yw and market clearing, i.e. X=O. Note that the ray in the southeastern quadrant is not a linear production function; the ray tracks any underlying production function. Note also that the wage rate W is an average if the individual wage rates are different among the employees, which is normally the case. These details are of no consequence for the question on hand.

Under the conditions of market clearing and budget balancing in each period the price is given by P=W/R, i.e. the market clearing price is always equal to unit wage costs. All changes in the system are reflected by the market clearing price. Things are different, of course, if the price is not the dependent variable.

In the next period, the households save. The result is shown here. Consumption expenditure C falls below Yw and with it the market clearing price P. With perfect price flexibility there are no unsold quantities and no change of inventory. The product market is always cleared and there is no such thing as an inventory investment. Monetary saving of the household sector is given by Sm=Yw-C.

The business sector makes a monetary loss which is equal to the household sector’s saving, i.e. Qm=-Sm. Therefore, loss is the exact counterpart of saving; by consequence, profit is the exact counterpart of dissaving, that is, of the growth of household sector’s debt. This is the most elementary form of the Profit Law. It follows directly from the profit definition Qm=C-Ym and the definition of household sector saving Sm=Yw-C. The sector balances always add up to zero, i.e. Qm+Sm=0.

With dissaving/deficit-spending the debt of the household sector increases in each period. For simplicity debt takes here the form of current overdrafts at the central bank, which stands for the banking industry. As a mirror image, monetary profit increases the current deposits of the business sector. The stocks of overdrafts and deposits are equal at any point in time.

Helicopter money is deficit spending without a simultaneous increase of households sector debt. To balance the accounts, the central bank enters a debt claim against itself in the books. This ‘drop of money from the sky’ in no way alters the fact that the additional household sector spending increases the profit of the business sector as a whole by exactly the same amount. Ultimately, the business sector is the beneficiary of all forms of deficit spending of the private or public households. Whether the household sector’s debt increases or is taken over by the central bank is a matter of indifference for the business sector.

The Profit Law for the more complex investment economy reads Qm=Yd+I-Sm (2014, p. 8, eq. (18)). Legend: Qm monetary profit, Yd distributed profit, Sm monetary saving, I investment expenditure. Deficit spending of the household sector means that Sm has a negative sign, hence the effect on profit is positive -(-Sm).

With the correct profit theory we arrive at the result that ‘QE for the people’ directly leads to an increase of the volume of financial wealth of the business sector. If employment L and productivity R remain unchanged output remains unchanged and the real situation of the household sector as a whole does not change at all through the issuance of helicopter money. If employment increases the situation of the household sector improves but total profit of the business sector remains unchanged because it is always equal to the amount of deficit spending and independent of employment, productivity, or the wage rate.

Independently of the original intention to benefit the ‘workers’, both Keynesian deficit spending and helicopter money ultimately benefit the ‘capitalists’. In the course of time this leads to an extremely unequal distribution of financial wealth. This is what everybody can observe.

Egmont Kakarot-Handtke

Desai, M. (2008). Profit and Profit Theory. In S. N. Durlauf, and L. E. Blume (Eds.), The New Palgrave Dictionary of Economics Online, pages 1–11. Palgrave Macmillan, 2nd edition. URL
Kakarot-Handtke, E. (2011). Why Post Keynesianism is Not Yet a Science. SSRN Working Paper Series, 1966438: 1–20. URL
Kakarot-Handtke, E. (2014). The Three Fatal Mistakes of Yesterday Economics: Profit, I=S, Employment. SSRN Working Paper Series, 2489792: 1–13. URL

Related 'Keynesianism as ultimate profit machine' and 'Profit and the collective failure of economists'.

Immediately preceding post 'Money and debt in six elementary steps'.