April 15, 2016

Econ 101 or How to train morons

Comment on Brad DeLong on ‘We Are so S---ed. Econ 1-Level Edition’


“The highest ambition an economist can entertain who believes in the scientific character of economics would be fulfilled as soon as he succeeded in constructing a simple model displaying all the essential features of the economic process by means of a reasonably small number of equations connecting a reasonably small number of variables.” (Schumpeter, 1946, p. 3)

Standard economics never got close to this ‘simple model’. Roughly speaking, the two main approaches, the Walrasian and the Keynesian, are both defective, that is, they cannot explain how the monetary economy works (2015). The ultimate reason is that standard economics is not built upon a set of acceptable foundational premises a.k.a. axioms.

Brad DeLong starts his model with: (i) Y is real GDP, (ii) μ = 1/(1-cy) is the Keynesian multiplier. Both concepts are provable false (2011), so the model breaks already down after the first two steps. This, though, is a matter of indifference because generation after generation of Econ 101 students has swallowed every supply-demand-equilibrium-crap with gusto.

What does the correct ‘simple model’ look like? Generally speaking, it is based upon a set of axioms that do NOT contain any Walrasian or Keynesian propositions. The replacement of foundational premises amounts to a paradigm shift.

The correct employment equation for the investment economy is given here. From this equation follows:
(i) An increase of the expenditure ratio rhoE leads to higher employment L (the letter rho stands for ratio). An expenditure ratio rhoE>1 indicates credit expansion, a ratio rhoE<1 indicates credit contraction of the household sector.
(ii) Increasing investment expenditures I exert a positive influence on employment, a slowdown of growth does the opposite.
(iii) An increase of the factor cost ratio rhoF=W/PR leads to higher employment.

The complete employment equation is a bit longer and contains in addition profit distribution, public deficit spending, and import/export.

What remains to be done, is to establish how the expenditure ratio depends on the deposit rate rhoE=f(Jl) and how investment depends on the lending rate I=f(Ja). These two functions inserted give the GENERAL relationship between employment, prices, and the TWO interest rates. Under the zero profit condition there is a fix relationship between the two rates. The central bank, though, is in principle free to set any configuration of Ja and Jl. A very interesting limiting case is Jl=0, i.e. the zero lower bound.

This ‘simple model’ fully replaces Brad DeLong’s flawed Econ 101 construct.

Wicksell’s natural-rate mechanism implies the equalization of saving and investment (Blaug, 1998, p. 621). It can be proved that this equality/equilibrium NEVER occurs, neither ex ante nor ex post.* And this in turn means that the concept of the natural rate has been fallacious from the start. Brad DeLong has not gotten the point and his students will not get it either. This is how moronomics works since more than 200 years.

Egmont Kakarot-Handtke

Blaug, M. (1998). Economic Theory in Retrospect. Cambridge: Cambridge University Press, 5th edition.
Kakarot-Handtke, E. (2011). Keynes’s Missing Axioms. SSRN Working Paper Series, 1841408: 1–33. URL
Kakarot-Handtke, E. (2015). Major Defects of the Market Economy. SSRN Working Paper Series, 2624350: 1–40. URL
Schumpeter, J. A. (1946). The Decade of the Twenties. American Economic Review, 36(2): 1–10. URL

* See the post ‘Accounting basics

Immediately following 'If You Meet the Storyteller on the Road, Kill Him'.