April 19, 2016

It’s the price and profit mechanism, stupid!

Comment on Simon Wren-Lewis on ‘Its ideology, stupid’


You say: “What we should be talking about is why governments are not doing much more public investment.”

What the anti-austerity disputants have on their minds is good old Keynesian deficit spending. That is not wrong per se, but it is wrong for an economist. An economist should have realized after more than 80 years that Keynesian theory is defective. The fact of the matter is that (i) the multiplier arithmetic is fallacious, and (ii), that distributional effects are completely overlooked. Deficit spending is the very profit machine and more than anything else accounts for the observable unequal wealth-distribution.*

Could it be that it is not a question of ideology at all but that Schäuble has a better economic theory at the back of his mind than retarded economists?

To cut a longer formal derivation short (2015), the most elementary version of the macrofounded employment equation for the economy as whole 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.

Item (i) and (ii) is familiar stuff since Keynes. What is missing in the flawed Keynesian employment multiplier, though, is the ratio rhoF as defined with (iii). This variable embodies the price mechanism. It works such that overall employment increases if the average wage rate W increases relative to average price P and productivity R.

The correct employment equation shows that the price mechanism, i.e. the relationship of wage rate, price, and productivity, can be used to increase employment. Thus, there is, as a matter of principle, no need to increase private/public debt or of pushing investment. The crucial point is that standard price theory is provable false.

Correct economic theory opens new dimensions of economic policy. Or, put the other way round, right policy depends on true theory. Neither Keynesians nor Walrasians, though, have the true theory. In particular they lack a deeper understanding of how the price and the profit mechanism of the monetary economy works. This is what economists should be talking about before they make fools of themselves with inept economic policy blather.

Egmont Kakarot-Handtke

Kakarot-Handtke, E. (2015). Major Defects of the Market Economy. SSRN Working Paper Series, 2624350: 1–40. URL

* See the posts ‘Keynesianism as ultimate profit machine’ and ‘Deficit spending, helicopter money, and profit