History delivers the questions but not the answers

Comment on Robert Locke on ‘The naiveté of science as the history of Ideas’

Blog-Reference

It is rather trivial that a scientific/mathematical proposition/law/discovery/theorem emerges in a specific social, historical, geographical, biographical context. But for the question of whether, for example, the Law of Universal Gravitation#1 is true or false these specifics are absolutely irrelevant.

What, then, is relevant?: “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)

Everything else, e.g. calendar time, religion, nationality, gender, etc., is a distraction from actual scientific problem solving and irrelevant for the assessment of the truth/falsity of a theory. Historians are occupied with the context of discovery, scientists are occupied with the context of justification, i.e. the logical and material consistency of a theory.

Science is about general and invariant features of reality (= invariances, see Nozick 2001 ), history/ evolution is about unique event configurations on the surface which never repeat themselves. This is known since Heraclitus and that is why Descartes said that history was not a science. Science abstracts from historical detail. No way leads from the history of falling apples to the universal Law of Falling Bodies. No way leads from the historical fact that Einstein wore no socks to the understanding of the Theory of Relativity.

Economics is about the underlying structural laws of the economic system. If you do not understand these (e.g. the macroeconomic Profit Law#2) you neither understand the present nor the past.

The current state of economics is this: economists got the premises/basic concepts/axioms of economic theory hopelessly wrong. Because of this, the whole theoretical superstructure that in turn informs economic policy is defective. What we actually have is folk psychology, folk sociology,#3 storytelling, political blather, senseless model bricolage, the history of money since the cowrie shell, and utter methodological confusion.

Egmont Kakarot-Handtke


#1 Wikipedia
#2 Wikimedia AXEC08

#3 How to get out of the Econ 101 PsySoc woods

***

REPLY to Robert Locke on Jun 4

You say: “ the pursuit of knowledge tempered by the subjectivity of the individual observer and by extension the political, economic, and social subjectivities specific to historical time and place.”

I agree. Just because of this economics has to leave all subjective/behavioral/human nature issues to psychology, sociology, history, politics, etc. and focus on the systemic aspect of the (world-) economy.

This is what the shift from subjective-behavioral microfoundations to objective-structural macrofoundations is all about. And this is the economic methodology of the 21st century.

False theory makes wrong policy: economics as loose cannon

Comment on Lars Syll on ‘NAIRU — a harmful fairy tale’

Blog-Reference

The NAIRU aberration goes back to the false interpretation of the Phillips Curve (2012). The correct curve is reproduced on Wikimedia AXEC36.

From the structural Phillips Curve, which is entirely FREE of rational expectation and natural rate nonsense, follows inter alia:
(i) An increase in the expenditure ratio ρ_E leads to higher employment L (the letter ρ stands for the ratio).
(ii) Increasing investment expenditures I exert a positive influence on employment, a slowdown of growth does the opposite.
(iii) An increase in the factor cost ratio ρ_F=W/PR leads to higher employment.

The complete structural Phillips Curve is a bit longer and contains, in addition, public deficit spending and import/export.

Items (i) and (ii) cover the familiar arguments about how aggregate demand affects employment. Item (iii) embodies the price mechanism. It works such that overall employment L INCREASES if the average wage rate W INCREASES relative to average price P and productivity R and vice versa. The structural Phillips Curve contains the original curve as a limiting case.

The structural Phillips Curve contains nothing but measurable variables and is readily testable. The NAIRU model is provably false and leads to wrong policy advice.#1

Egmont Kakarot-Handtke


References
Kakarot-Handtke, E. (2012). Keynes’ Employment Function and the Gratuitous Phillips Curve Disaster. SSRN Working Paper Series, 2130421: 1–19. URL

#1 What Keynes really meant but could not really prove

The mad flip-floppers

Comment on ‘Wren-Lewis/Mirowski/Syll on neoliberalism’

Blog-Reference

Since Adam Smith, economics consists of political and theoretical economics. It is, though, pretty obvious that the political sphere is ontologically different from the scientific sphere and because of this, it is of utmost importance to separate the two. Yet, it is an outstanding characteristic of the representative economist to persistently flip-flop between them.

This lack of focus guarantees all-round confusion but what is worse is that economic policy advice has no sound scientific foundation, to begin with: “In order to tell the politicians and practitioners something about causes and best means, the economist needs the true theory or else he has not much more to offer than educated common sense or his personal opinion.” (Stigum, 1991, p. 30)

It is a fact that economists do not have the true theory — Walrasianism, Keynesianism, Marxianism, Austrianism is provably false. Therefore, as a matter of principle, economic policy advice has no better scientific foundation than old Roman poultry entrails reading. Educated common sense and personal opinion, that is all that has been achieved in more than 200 years.

This point gets entirely lost in actual political discussions because the criterion for political economics is whether or not it fits an agenda and NOT whether the underlying theory is true or false. As soon as political economics dominates, the very task of the theoretical economist — to explain how the monetary economy works — is forgotten and the well-defined scientific standards of material and formal consistency are ignored.

Both, orthodox and heterodox economists have to be reminded of what science implies and why politics and science have to be strictly separated: “A scientific observer or reasoner, merely as such, is not an adviser for practice. His part is only to show that certain consequences follow from certain causes, and that to obtain certain ends, certain means are the most effectual. Whether the ends themselves are such as ought to be pursued, and if so, in what cases and to how great a length, it is no part of his business as a cultivator of science to decide, and science alone will never qualify him for the decision.” (Mill, 2006, p. 950)

The history of political economics can be summarized as a perpetual violation of scientific standards and as an abject failure. Not one of the political economists and agenda pushers from Smith, Ricardo, Marx to Keynes, Hayek, Friedman, Krugman or Varoufakis will in the final assessment be accepted as scientists.

Egmont Kakarot-Handtke


References
Mill, J. S. (2006). A System of Logic Ratiocinative and Inductive. Being a Connected View of the Principles of Evidence and the Methods of Scientific Investigation, volume 8 of Collected Works of John Stuart Mill. Indianapolis, Liberty Fund.
Stigum, B. P. (1991). Toward a Formal Science of Economics: The Axiomatic Method in Economics and Econometrics. Cambridge, MA: MIT Press.

For more details see cross-references Political Economics.

End of confusion (II)

Comment on Asad Zaman on ‘Economists confuse Greek method with science’

Blog-Reference

(i) You say: “Feynman agrees that if we have a complete valid body of knowledge, it may be possible to axiomatize it, but this is not true today.” False. Feynman makes the distinction between context of discovery where the axiomatic-deductive method plays NO role and the context of justification, where it plays a DECISIVE role. This is an ongoing mutually dependent process and NOT either/or—all/nothing. Newton famously axiomatized the Theory of Motion and did not wait until the body of physical knowledge was complete. The same holds a fortiori for the ancient Greeks and THIS was the ultimate reason why they got science off the ground.

(ii) Indeed, it can be very hard to distinguish between unobservables and nonentities. Gravity is a case in point, so are the ether, phlogiston, or quarks. But eventually, gravity could be expressed in a testable formula while phlogiston could not. Nowadays, all scientists agree that angels, Superman, and the Easter Bunny are nonentities. As far as economics is concerned we can agree that utility, constrained optimization, perfect foreknowledge, well-behaved production functions or supply-demand-equilibrium are nonentities like the Easter Bunny. Because the axiomatic foundations of Walrasianism contain several nonentities standard economics is storytelling and NOT science.

(iii) You say: “The distinction that I am trying to make here is between IDEOLOGY and SCIENCE. Economics is an ideology — there is a commitment to a methodological framework of rational and optimizing behavior, methodological individualism and some others which MUST BE MAINTAINED regardless of massive empirical evidence to the contrary.” False. The very essence of science is to ABANDON theories that are logically or empirically inconsistent. Therefore, the task of Heterodoxy is to REPLACE the already refuted Walrasian axiom set with the correct heterodox axiom set which contains exclusively objective concepts/entities and enables the derivation of testable propositions about how the economy works. Science is about PROOF and therefore the very opposite of ideology/belief/ wishful thinking/credibility/storytelling/hallucination. Political economics is scientifically worthless and this holds for Orthodoxy and Heterodoxy.

(iv) Boiled down to the essentials, what we have is this “most of what I and many others do is sorta-kinda neoclassical because it takes the maximization-and-equilibrium world as a starting point” (Krugman). Heterodoxy has to abandon this false starting point and reconstruct economic theory consistently from an entirely NEW starting point that does NOT contain maximization-and-equilibrium. This is called a Paradigm Shift and it consists of the move from microfoundations to macrofoundations.

(v) The problem of economics is twofold: (a) The scientific incompetence of Orthodoxy consists of sticking to the Walrasian axioms despite the fact that they are logically and empirically indefensible, and (b), the scientific incompetence of traditional Heterodoxy consists in “a failure of reason to find suitable alternatives” (Feyerabend).#1

Summary: Economics is a failed science and Asad Zaman neither identifies the ultimate cause correctly nor has he any idea how to get out of the mess.

Egmont Kakarot-Handtke


#1 Confused Confusers: How to Stop Thinking Like an Economist and Start Thinking Like a Scientist and Objective Principles of Economics.

Immediately preceding The consistent ancients and the confused moderns.

The tiny little problem with economics

Comment on Lars Syll on ‘The tiny little problem with Chicago economics’

Blog-Reference and Blog-Reference on Jun 2

The problem with economics is that BOTH orthodox and heterodox economists are scientifically incompetent. The proof is in the fact that they do not even get macroeconomic accounting right which is a rather elementary form of mathematics.

1. Locked-in for 80+ years
Lars Syll summarizes: “What Cochrane is reiterating here is nothing but Say’s law, basically saying that savings are equal to investments, and that if the state increases investments, then private investments have to come down (‘crowding out’). As an accounting identity there is, of course, nothing to say about the law, but as such it is also totally uninteresting from an economic point of view. As some of my Swedish forerunners — Gunnar Myrdal and Erik Lindahl — stressed more than 80 years ago, it’s really a question of ex-ante and ex-post adjustments.”

2. The logical blunder
(a) “Savings are equal to investments is an accounting identity,
(b) it’s really a question of ex-ante and ex-post adjustments.”
Both statements are provably false (2011a; 2011b; 2012).

3. How Keynes got I=S wrong
Keynes formulated the formal core of the General Theory as follows: “Income = value of output = consumption + investment. Saving = income − consumption. Therefore saving = investment.” (1973, p. 63)
This elementary syllogism is conceptually defective because Keynes NEVER came to grips with profit (Tómasson et al., 2010, p. 12).

4. Rectification
The Keynesian premises have to be replaced by the axiomatically correct macrofoundations. This is achieved as follows.
(A0) The objectively given and most elementary configuration of the (world-) economy consists of the household and the business sector which in turn consists initially of one giant fully integrated firm.
(A1) Yw=WL wage income Yw is equal to wage rate W times working hours. L,
(A2) O=RL output O is equal to productivity R times working hours L,
(A3) C=PX consumption expenditure C is equal to price P times quantity bought/sold X.

For the graphical representation of this ABSOLUTE formal MINIMUM see Wikimedia AXEC31:

(A1) to (A3) asserts: 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 (i) budget balancing, i.e. C=Yw, and (ii), market clearing, i.e. X=O.

Under the conditions (i)|(ii) the price is derived in each period as P=W/R, i.e. the market-clearing price is in the most elementary case equal to unit wage costs which vary over successive periods. This is the macroeconomic Law of Supply and Demand.

In the next period, the households save, i.e. condition (i) is now lifted. The result is shown on Wikimedia AXEC33:

Consumption expenditures C fall below Yw and with it the market-clearing price P. The product market is cleared due to (ii) and there is no such thing as inventory investment, i.e. I=0. 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. 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.

The sector balances always add up to zero, and THIS is the correct accounting identity. Saving and investment are NEVER equal, neither ex-ante nor ex-post.

5. Generalization
The correct profit equation for the investment economy reads Qm≡Yd+I−Sm. Legend Qm: monetary profit, Yd distributed profit, Sm monetary saving, I investment expenditures.

The DIFFERENCE between investment and saving I−Sm, which exists at EVERY moment on the time axis, plus distributed profit Yd determine monetary profit Qm, which is measurable with two decimal places at EVERY moment with an appropriate accounting system.

6. Conclusions
(i) Neither is investment determined by saving (= orthodox error) nor is saving determined by investment (= Keynesian error). Both variables vary independently and are NEVER equal, neither in accounting nor in reality, neither ex-ante nor ex-post because there is NO such thing as an equilibrium of I and S.
(ii) All I=S/IS-LM models from Keynes/Hicks to Krugman are provably false (2014).
(iii) The investment multiplier is formally defective since Keynes.
(iv) Both, orthodox and heterodox profit theories are false. This is the tiny little problem of economics since Adam Smith.
(v) The representative economist has NOT realized (i) to (iv) until this day because of elementary logical/mathematical/accounting incompetence. The Swedish school from Myrdal/Lindahl to Syll is no exception.

Egmont Kakarot-Handtke


References
Kakarot-Handtke, E. (2011a). Keynes’s Missing Axioms. SSRN Working Paper Series, 1841408: 1–33. URL
Kakarot-Handtke, E. (2011b). Why Post Keynesianism is Not Yet a Science. SSRN Working Paper Series, 1966438: 1–20. URL
Kakarot-Handtke, E. (2012). The Common Error of Common Sense: An Essential Rectification of the Accounting Approach. SSRN Working Paper Series, 2124415: 1–23. 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.  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

For more about the worst economic equation/equality/identity/equilibrium see cross-references Refutation of I=S.

For more about Myrdal see AXECquery.

Petitio principii — economists’ biggest methodological mistake

Comment on Lars Syll on ‘Ergodicity — the biggest mistake ever made in economics’

Blog-Reference

You summarize how ergodicity came to economics: “Samuelson said that we should accept the ergodic hypothesis because if a system is not ergodic you cannot treat it scientifically.” (See intro)

This is pretty much the same way how most other core concepts and foundational propositions came to economics as Mirowski has shown (1995).

And this eventually resulted in the neo-Walrasian axiom set with these core 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. By definition, the hard-core propositions are taken to be true and irrefutable by those who adhere to the program.” (Weintraub, 1985, p. 147)

Now it is obviously a methodological mistake to take equilibrium into the premises and then to establish and discuss the properties of general equilibrium. The same holds for ergodicity and most other foundational propositions. This mistake — known since antiquity as petitio principii* — is an age-old characteristic of incompetent scientists or savants: “These savants, as Galileo put it, first decided how the world should function in accordance with their preconceived principles. ... He openly criticized scientists and philosophers who accepted laws which conformed to their preconceived ideas as to how nature must behave. Nature did not first make men’s brains, he said, and then arrange the world so that it would be acceptable to human intellects.” (Kline, 1982, p. 48)

Now we can argue whether equilibrium, constrained optimization, rational expectations, ergodicity, well-behaved production functions, or any other NONENTITY is the worst petitio principii. But this itself is a methodological mistake: ‘someone has to say “stop, that’s enough”’ (See intro).

Any discussion about NONENTITIES falls into the how-many-angels-can-dance-on-a-pinpoint category and is merely a pastime of savants and other scientific dilettantes.

The right thing to do is to throw the neo-Walrasian axiom set and all its NONENTITIES and all textbooks from Samuelson to Rodrik without further ado out of the window and to move from microfoundations to macrofoundations. As Joan Robinson put it: “Scrap the lot and start again.” In technical terms, this is called Paradigm Shift.

Egmont Kakarot-Handtke


References
Kline, M. (1982). Mathematics. The Loss of Certainty. Oxford, New York: Oxford University Press.
Mirowski, P. (1995). More Heat than Light. Cambridge: Cambridge University Press.
Weintraub, E. R. (1985). Joan Robinson’s Critique of Equilibrium: An Appraisal. American Economic Review, Papers and Proceedings, 75(2): 146–149. URL

* Wikipedia "To beg a question means to assume the conclusion of an argument — a type of circular reasoning. This is an informal fallacy, in which an arguer includes the conclusion to be proven within a premise of the argument, often in an indirect way such that its presence within the premise is hidden or at least not easily apparent. The term "begging the question", as this is usually phrased, originated in the 16th century as a mistranslation of the Latin petitio principii, which actually translates as 'assuming the initial point'."

***

Wikimedia AXEC121i

The consistent ancients and the confused moderns

Comment on Asad Zaman and Ken Zimmerman on ‘Economists confuse Greek method with science’

Blog-Reference

Science is guided by the binary code true/false. True/false in turn has two dimensions: logical and material/empirical/factual. Economics claims since Adam Smith and Karl Marx to be a science, explicitly with “Bank of Sweden Prize in Economic Sciences in Memory of Alfred Nobel”. Yet, everybody who looks deeper into the matter (‘So we really ought to look into theories that don’t work, and science that isn’t science.’ Feynman) comes to the conclusion that economics has not risen above proto-scientific storytelling since Smith and Marx.

The rules of conduct of the scientific community demand that the actual state of economics is at all times unambiguously communicated to the general public. So, the first thing to do is to make it absolutely clear that economic policy advice of BOTH orthodox and heterodox economics has no better scientific foundation than old Roman poultry entrails reading.

By consequence, economic policy advice of Walrasianism, Keynesianism, Marxianism, Austrianism has to be taken without exception as scientifically worthless agenda pushing.

The second thing to do is to expel BOTH orthodox and heterodox economists from the sciences because of proven scientific incompetence over more than 200 years. The current pluralism of provable false or vacuous theories and the permanent ignorance and erosion of well-defined scientific standards (playing tennis with the net down, anything goes) is not acceptable.

The task of economists is to explain how the monetary economy works. This is NOT done by storytelling but in the form of a theory that satisfies the criteria of formal and material consistency.

What Asad Zaman calls the Greek method consists essentially in the distinction/ demarcation between doxa=opinion and episteme=knowledge=science, that is, “There cannot be both opinion and knowledge of the same thing at the same time.” and “When the premises are certain, true, and primary, and the conclusion formally follows from them, this is demonstration, and produces scientific knowledge of a thing.” (Aristotle, Posterior Analytics, Wikipedia)

In modern terminology: “The basic concepts and laws which are not logically further reducible constitute the indispensable and not rationally deducible part of the theory. It can scarcely be denied that the supreme goal of all theory is to make the irreducible basic elements as simple and as few as possible without having to surrender the adequate representation of a single datum of experience.” (Einstein, 1934)

The current state of economics is this: Orthodoxy got the premises/basic concepts/axioms badly wrong#1 and Heterodoxy has none at all. What we actually have is storytelling, political blather, senseless model bricolage, and utter methodological confusion.

The ancient Greeks had a better understanding of science than present-day orthodox/ heterodox economists and in any case than Asad Zaman and Ken Zimmerman.#2

Egmont Kakarot-Handtke


#1 “... most of what I and many others do is sorta-kinda neoclassical because it takes the maximization-and-equilibrium world as a starting point” (Krugman).
#2 When substandard thinkers dabble in science it is called economics

Immediately preceding Methodological wrong-way drivers.

***

REPLY to Asad Zaman on May 28

You say: “I insist that science is not axiomatic-deductive. ... A crucial requirement of science is GUESSING at invisible real structures based on observations.”

This is true for the creative solution of a scientific problem. It is a matter of indifference whether the eureka flashes while taking a bath (Archimedes), mounting a bus (Poincaré), dreaming (Kekulé), looking out of the window and imagining how gravity appears to a person falling from the rooftop (Einstein).

But science is a social activity and therefore the original inspiration has to be brought into a communicative form so that others can put the idea/result/conclusion in context and can reproduce it logically and factually on their own. This specific communicative form is called a theory. Methodology refers to the properties of a well-formulated theory and is NOT a prescription of how to solve a problem. There is no such thing as a prescription for scientific creativity.

So “guessing at invisible real structures” (context of discovery) is FULLY compatible with the axiomatic-deductive method (context of justification). As a matter of fact, axioms are themselves guesses, as every economist could know from J. S. Mill: “What are the propositions which may reasonably be received without proof? That there must be some such propositions all are agreed, since there cannot be an infinite series of proof, a chain suspended from nothing. But to determine what these propositions are, is the opus magnum of the more recondite mental philosophy.”

Or, as Feynman put the relationship between guessing and axiomatics: “It does not matter that moos and goos cannot appear in the guess. You can have as much junk in the guess as you like, provided that the consequences can be compared with experiment.” And: “Some day, when physics is complete and we know all the laws, we may be able to start with some axioms, and no doubt somebody will figure out a particular way of doing it so that everything else can be deduced.”

The decisive point is that Walrasian junk cannot be compared with experiments because its moos and goos are not ‘invisible real structures’ but NONENTITIES. Hence, standard economics is a story and not a theory, and economists are storytellers and not scientists.

Immediately following End of confusion.

Related 'Petitio principii — economists’ biggest methodological mistake' and 'When substandard thinkers dabble in science it is called economics' and 'Econ 101 — worse than useless'.

When substandard thinkers dabble in science it is called economics

Comment on Lars Syll on ‘Solow and Damon Runyon’s Law’

Blog-Reference

Tell an economist that economics is a failed science and he will come up with a barrage of excuses: “Economics is a strange sort of discipline. The booby traps I mentioned often make it sound as it is all just a matter of opinion. That is not so. Economics is not a Science with a capital S. It lacks the experimental method as a way of testing hypotheses. . . . There are always differences of opinion at the cutting edge of a science, . . . . But they last longer in economics . . . and there are reasons for that. As already mentioned, rival theories cannot be put to an experimental test. All there is to observe is history, and history does not conduct experiments: too many things are always happening at once. The inferences that can be made from history are always uncertain, always disputable, . . . You can’t even count on a long and undisturbed run of history, because the ‘laws’ of behavior change and evolve. Excuses, excuses. But the point is not to provide excuses.” (Solow, 1998, pp. x-xi)

So, there are no behavioral laws in economics? No, but there is a law that there is no law: “Unfortunately, however, economics is a social science. It is subject to Damon Runyon’s Law that nothing between human beings is more than three to one. To express the point more formally, much of what we observe cannot be treated as the realization of a stationary stochastic process without straining credulity.” (See intro)

This raises two questions: (i) Why are obviously false propositions like “agents individually optimize subject to constraints; agents have full relevant knowledge; observable outcomes ... must be discussed with reference to equilibrium states” given the status of axioms? (Weintraub, 1985, p. 147). And (ii), why do members of a “strange sort of discipline” insist on the term “Economic Sciences” in the title “Bank of Sweden Prize in Economic Sciences in Memory of Alfred Nobel”?

The ontological error of economics lies in this sentence: “Unfortunately, however, economics is a social science.” Not at all, economics is a systems science. Yet, most economists have not realized that economics is NOT a science of human nature/behavior/ action — not of individual behavior, not of social behavior, not of rational behavior, not of irrational behavior, not of sincerity, not of corruption. All these issues belong entirely to the realms of Psychology, Sociology, Anthropology, Political Science, History, Criminology, Philosophy, etcetera.

So let us replace Damon Runyon’s Law by the Ontological Impossibility Law: NO way leads from the explanation of individual/social human behavior to the explanation of how the monetary economy works. In other words, the microfoundations approach has already been dead in the cradle.

There is no such thing as a behavioral/social/historical law but there are systemic laws (2014). Economists are digging since Jevons/Walras/Menger in the wrong place. Neither Orthodoxy nor Heterodoxy has figured out until this day what profit is, that is, economists have no idea of the pivotal phenomenon of their subject matter since Adam Smith. Unfortunately, they have been too much occupied with making fools of themselves with folk psychology, folk sociology, and folk politics.

Egmont Kakarot-Handtke


References
Kakarot-Handtke, E. (2014). The Synthesis of Economic Law, Evolution, and History. SSRN Working Paper Series, 2500696: 1–22. URL
Solow, R. M. (1998). Foreword, volume William Breit and Roger L. Ranson: The Academic Scribblers. Princeton: Princeton University Press, 3rd edition.
Weintraub, E. R. (1985). Joan Robinson’s Critique of Equilibrium: An Appraisal. American Economic Review, Papers and Proceedings, 75(2): 146–149. URL

Related 'The consistent ancients and the confused moderns' and 'The stupidity of Heterodoxy is the life insurance of Orthodoxy'. For details of the big picture see cross-references Methodology.

***

COMMENT on The Arthurian on May 29

You say: “Because you cannot understand the present if you misunderstand the past.”

This assertion holds perhaps for politics but certainly not for science: “The next scheme, the new discovery, is going to be made in a completely different way. So history does not help much.” (Feynman)

Could it be that you have not yet grasped the difference between storytelling and theory? The history of falling apples is one thing and the Law of Falling Bodies is quite another thing.

Science is about general and invariant features of reality (= deep structure), history/ evolution is about unique event configurations on the surface that never repeat themselves. This is known since Heraclitus and “That is why Descartes said that history was not a science — because there were no general laws which could be applied to history.” (Berlin)

Economics is about the underlying structural laws of the economic system. If you do not understand these (e.g. the Profit Law) you neither understand the past nor the present.

Methodological wrong-way drivers

Comment on Asad Zaman on ‘Economists confuse Greek method with science’

Blog-Reference

The most ridiculous mistake of heterodox economists is that they take the claim of orthodox economists seriously that what they do is science. It is NOT. It is what Feynman called a cargo cult or look-alike science. Because of this, the methodological critique of Heterodoxy regularly runs into a vacuum. Here is the exact point where the discussion plunges into utter confusion.

(i) “As with any Lakatosian research program, the neo-Walrasian program is characterized by its hardcore, heuristics, and protective belts. Without asserting that the following characterization is definitive, I have argued that the program is organized around the following 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.”
(ii) “By definition, the hard-core propositions are taken to be true and irrefutable by those who adhere to the program. ‘Taken to be true’ means that the hard-core functions like axioms for a geometry, maintained for the duration of study of that geometry.” (Weintraub, 1985, p. 147)

The mistake is in part (ii), that is, in “taken to be true and irrefutable”. No genuine scientist makes the claim that his hardcore propositions, a.k.a. axioms are irrefutable. This is, or should be, well-known to every economist: “Whether an axiom is or is not valid can be ascertained either through direct experimentation or by verification through the result of observations, or, if such a thing is impossible, the correctness of the axiom can be judged through the indirect method of verifying the laws which proceed from the axiom by observation or experimentation. (If the axiom is deemed to be incorrect it must be modified or instead a correct axiom must be found.)” (Morishima, 1984, p. 53)

The claim that axioms are irrefutable is quite simply silly. Asad Zaman, however, does not get the point: “I am single-mindedly focused on one central idea here. What I call the Greek Method, is the Axiomatic-Deductive method. This method has no possibility of conflict with observations. This because axiom are certainties, and logical deductions from axioms are equally certain.”

The mistake is in “axioms are certainties”. Axioms are taken as TENTATIVE certainties for the duration of analysis and NOT as absolute or irrefutable certainties. Axioms are, as a matter of principle, open to scrutiny and revision. The best-known example is the critique of the axiom of parallels and the subsequent development of non-Euclidean geometries. Paradigm Shift means replacement of axiomatic foundations, either because they are false or more general axioms have been found.

Hence, Asad Zaman’s assertion that “This method has no possibility of conflict with observations” is patently false: “One of the most famous stories about Gauss depicts him measuring the angles of the great triangle formed by the mountain peaks of Hohenhagen, Inselberg, and Brocken for evidence that the geometry of space is non-Euclidean.” (Brown, 2011, p. 565)

Asad Zaman is so single-mindlessly focused on his methodological hallucination that he cannot see the elephant in the economics living room. All one has to do is to critically re-read section (i) above. What should become clear immediately is that HC2, HC4, and HC5 are not acceptable as axioms and therefore the whole set is unacceptable. The axiomatic foundation of standard economics is PROVABLY false. As a consequence, the whole logical superstructure from supply-demand-equilibrium onward is false.

The heterodox methodological idiocy consists of rejecting the axiomatic-deductive method instead of replacing the false Walrasian axiom set by correct heterodox axioms. To repeat ad nauseam that Orthodoxy is garbage is, while true, not a noteworthy scientific achievement. Both, orthodox AND heterodox economists are methodological wrong-way drivers.

Egmont Kakarot-Handtke


References
Brown, K. (2011). Reflections on Relativity. Raleigh: Lulu.com.
Morishima, M. (1984). The Good and Bad Use of Mathematics. In P. Wiles, and G. Routh (Eds.), Economics in Disarray, pp. 51–73. Oxford: Blackwell.
Weintraub, E. R. (1985). Joan Robinson’s Critique of Equilibrium: An Appraisal. American Economic Review, Papers and Proceedings, 75(2): 146–149. URL

Related 'Causa finita' and 'Axiomatics — the heterodox bugbear' and 'Over the cliff and 'The consistent ancients and the confused moderns'.

For details see Axiomatization: cross-references and Paradigm Shift: cross-references.

***

 

Wikimedia AXEC113f

Reading the correct Phillips Curve correctly

Comment on Tim Duy on ‘Fed Watch: Should The Fed Tolerate 5% Unemployment?’

Blog-Reference

You say: “My expectation [derived from the wage Phillips curve] is that when conditions are sufficiently tight to raise wage growth to the 4 percent range, they will also be sufficiently tight to raise inflation to the Fed’s target.”

You can substantiate your expectation by applying the correct (= non-behavioral) version of the Phillips Curve (2012) which is shown on Wikimedia AXEC36b:

From the structural Phillips Curve, which is entirely free of rational expectation and natural rate NONENTITIES, follows inter alia:
(i) An increase in the expenditure ratio ρ_E leads to higher employment L (the letter ρ stands for ratio).

(ii) Increasing investment expenditures I exert a positive influence on employment, a slowdown of growth does the opposite.
(iii) An increase in the factor cost ratio ρ_F≡W/PR leads to higher employment.

The complete structural Phillips Curve is a bit longer and contains, in addition, public deficit spending and import/export.

Item (i) and (ii) cover the familiar arguments about how effective demand affects employment. Item (iii) embodies the price mechanism. It works such that overall employment L INCREASES if the average wage rate W INCREASES relative to average price P and productivity R and vice versa. The structural Phillips Curve translates consistently into the Atlanta Fed’s chart titled ‘Unemployment and Wage Growth’.

From the theoretically well-founded structural Phillips Curve follows the policy recommendation that the Fed should actively encourage an increase of the (average) wage rate W and discourage an increase of the (average) price P. This increases overall employment without a negative effect on profit for the economy as a whole under the status quo condition for the rest of the variables.

Egmont Kakarot-Handtke


References
Kakarot-Handtke, E. (2012). Keynes’ Employment Function and the Gratuitous Phillips Curve Disaster. SSRN Working Paper Series, 2130421: 1–19. URL

Related 'NAIRU, wage-led growth, and Samuelson's Dyscalculia' and 'How Wicksell and the rest got inflation/deflation wrong' and 'Full employment, the Phillips Curve, and the end of Gaganomics' and 'Cross-references Employment/PhillipsCurve'.

For more about the Phillips Curve see AXECquery.

Could we, please, all focus on the key question of economics?

Comment on Paul Davidson on ‘Krugman and “what Keynes really meant”’

Blog-Reference

Keynes characterized the situation as follows: “Though we all started out in the same direction, we soon parted company into two main groups. What made the cleavage that thus divided us?” (See intro)

The key question that divides Orthodoxy and Heterodoxy is, in Keynes’ own words: “... is the existing economic system in any significant sense self-adjusting.”

You say “the key question is what causes changes in employment and output in a capitalist market-oriented economy?”

The answer to this question is in the elementary structural Employment Law which is given on  Wikimedia AXEC62:

From this equation follows:
(i) An increase in the expenditure ratio ρ_E leads to higher employment L (the letter ρ stands for the ratio).
(ii) Increasing investment expenditures I exert a positive influence on employment, a slowdown of growth does the opposite.
(iii) An increase in the factor cost ratio ρ_F≡W/PR leads to higher employment.

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

Items (i) and (ii) cover Keynes’ arguments about effective demand. So, the structural Employment Law contains your argument about the determinants of employment: “The answer is changes in the market demand for the products of industry.”

Can we put this undisputed stuff now aside? The critical point is that the original Keynesian multiplier 1/1-c is incomplete, to put it mildly (2012). What is missing is the ratio ρ_F as defined in (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 and vice versa.

Now, every half-witted supply-demand-equilibrium economist fancies that the remedy for excess supply in any market is a reduction in price. From whence the claim comes that wage reductions will — in principle — restore full employment. This is the essence of the self-adjustment claim. The strong version, though, is regularly wish-washed by admitting practical hindrances, delays, and imperfections.

The structural Employment Lawn says that wage reductions INCREASE unemployment which means that the market system is — in principle — self-destabilizing. The structural Employment Law is composed of measurable variables and is therefore readily testable. So, Keynes’ key question is unequivocally answerable.

What Post Keynesians have overlooked is that there are TWO ratios in the multiplier, the expenditure ratio ρ_E and the factor cost ratio ρ_F. For economic policy, this means: an increase in the expenditure ratio can be counteracted at any time by a decrease of the factor cost ratio, that is, by a falling average wage rate or by a rising average price. The hitherto missing variable explains why Keynesian demand policies are sometimes effective and sometimes ineffective.

This, though, is an implication of the key point. The key point is that the price mechanism does NOT stabilize the market system, neither in the short nor in the long run. This systemic feature cannot be cured by Keynesian demand management.

The correct answer to Keynes’ question “is the existing economic system in any significant sense self-adjusting?” is NO because (i) aggregate demand is not self-adjusting, and (ii), the structural interrelation between (average) wage rate, price, productivity, and employment moves the system farther away from full employment (2014).

Post Keynesians have to be reprobated for overlooking (ii) which proves that they have no idea about how (a) the price mechanism works, and (b), the profit mechanism works.

Egmont Kakarot-Handtke


References
Kakarot-Handtke, E. (2012). Keynes’ Employment Function and the Gratuitous Phillips Curve Disaster. SSRN Working Paper Series, 2130421: 1–19. URL
Kakarot-Handtke, E. (2014). The Truly General Theory of Employment: How Keynes Could Have Succeeded. SSRN Working Paper Series, 2406891: 1–25. URL

Related 'What Keynes really meant but could not really prove' and 'Proof of the inherent instability of the market economy'.

Still in the proto-scientific wood

Comment on Asad Zaman on ‘The emergence of science’

Blog-Reference

Heterodoxy once had a methodological edge over Orthodoxy. To see this one needs only compare Georgescu-Roegen with Zaman.

“Yet even Plato, Aristotle's teacher, had no idea of syllogism. He did talk of scientific propositions following from some basic truths, but a clear picture of the logical edifice of knowledge did not appear before Aristotle. And the important fact is that even Aristotle himself was inspired by some Elements of Geometry which existed in his time and have come down to us in highly polished form from the hands of Euclid.” (1966, p. 6)

“We are therefore justified in saying that with Euclid's Elements the causa materialis of geometry underwent a radical transformation; from a more or less amorphous aggregate of propositions it acquired an anatomic structure. Geometry itself emerged as a living organism with its own physiology and teleology, .... And this true mutation represents not only the most valuable contribution of the Greek civilization to human thought but also a momentous landmark in the evolution of mankind comparable only to the discovery of speech or writing.” (1966, p. 9)

Or compare Einstein with Zaman: “We honour ancient Greece as the cradle of western science. She for the first time created the intellectual miracle of a logical system, the assertions of which followed one from another with such rigor that not one of the demonstrated propositions admitted of the slightest doubt — Euclid’s geometry. This marvelous accomplishment of reason gave to the human spirit the confidence it needed for its future achievements. The man who was not enthralled in youth by this work was not born to be a scientific theorist. (1934, p. 164)

This obviously refers to Asad Zaman who maintains: “It was precisely overcoming this idea that led to the creation of modern science. Instead of going from axioms and logic to the study of observations, Scientific method goes in the opposite direction, from observations to theories.”

Obviously, it escaped Asad Zaman’s attention that the Greeks did not observe atoms but first developed the concept of atom by pure logical thinking which eventually led to the observation.

Obviously, it escaped Asad Zaman’s attention that science is ultimately the perfect SYNTHESIS of logic and experience: “Hilbert and Einstein again agree that geometry is a natural science based on real experiments and measurements. Thus, similarly to Einstein, Hilbert can assert: Geometry is nothing but a branch of physics; in no way whatsoever do geometrical truths differ essentially from physical truths nor are they of a different nature.” (Majer, 1995, p. 280)

The scientific method is well-defined: “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)

Logical consistency is secured by applying the axiomatic-deductive method and empirical consistency is secured by applying state-of-the-art testing.

Science was there before economics was there. Economists either conform to well-defined scientific standards or they are thrown out of science: they are in NO position to redefine scientific criteria. This holds for Orthodoxy AND Heterodoxy.

As Schumpeter put it: “We are not yet out of the wood; in fact, we are not yet in it.”

Egmont Kakarot-Handtke


References
Einstein, A. (1934). On the Method of Theoretical Physics. Philosophy of Science, 1(2): 163–169. URL
Georgescu-Roegen, N. (1966). Analytical Economics, chapter General Conclusions for the Economist, pages 92–129. Cambridge, MA: Harvard University Press.
Klant, J. J. (1994). The Nature of Economic Thought. Aldershot, Brookfield, VT: Edward Elgar.
Majer, U. (1995). Geometry, Intuition and Experience: From Kant to Husserl. Erkenntnis, 42(2): 261–285. URL

Cranks? What cranks? That’s economics!

Comment on Bradford DeLong on ‘Social Credit and "Neutral" Monetary Policies: A Rant on "Helicopter Money" and "Monetary Neutrality"’

Blog-Reference and Blog-Reference

You say: “Badly-intentioned or incompetent policymakers can mess up any system of macroeconomic regulation.” True enough.

But there is another alternative: macroeconomic regulation and policy advice of economists is not worth much, to begin with. So, ultimately it is incompetent economists and not politicians who mess up the economy.

“In order to tell the politicians and practitioners something about causes and best means, the economist needs the true theory or else he has not much more to offer than educated common sense or his personal opinion.” (Stigum, 1991, p. 30)

To this simple fact, policymakers and the general public wake up at the moment. As you observe: “And the answer, of course, is that by now centuries of painful experience have taught central bankers one thing: All advocates, wittingly or unwittingly, were simply selling snake oil.”

The irony of the matter is that it was not some soapbox agitators who were selling snake oil, it was the most respected members of the economics profession who traditionally tell central bankers how to conduct monetary policy. Economics, to be sure, is a honeypot for cranks but the most destructive effects are not brought about by borderline populists but by orthodox mainstream economists themselves.

The general point is that, as a rule, economic policy advice has no sound scientific foundations. Orthodoxy, that is Walrasianism with a grain of short-term Keynesian imperfections, is fundamentally defective.

All variants of Orthodoxy are built upon this set of foundational propositions, a.k.a. axioms: “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)

Methodologically, these premises are forever unacceptable but the representative economist swallows them hook line, and sinker for more than 150 years. Only scientific crackpots can do this. NOT ONE of the axioms holds water, but in the new form of DSGE models, HC1|HC5 underlay current monetary guidance. And this fully explains why over more than 150 years “Their advice was bad then. It is bad now.”

Economics is a failed science. The common fatal defect of Walrasianism, Keynesianism, Marxianism, and Austrianism is that the profit theory is false (Desai, 2008, p. 10). Mistakes/errors/blunders in the axiomatic foundations affect all parts of the logical superstructure. This means that the familiar theories of market coordination, the functioning of the price mechanism, distribution, employment, and money are false, too (2015).

Broadly speaking: economics, understood as the collective scientific knowledge of economists, should be able to tell with certainty how the economy works, what the critical functions are, and how institutions have to be designed in order to guarantee the proper functioning of subsystems and the integrated whole. Thus defined, there is no economics.

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”. Because these axiomatic foundations are provably false, most of what economists produce is proto-scientific garbage. To avoid further frustration, the first thing to do is to communicate clearly to the general public that no scientifically sound advice is ever to be expected from people who have not figured out since Adam Smith what profit is.

Egmont Kakarot-Handtke


References
Desai, M. (2008). Profit and Profit Theory. In S. N. Durlauf, and L. E. Blume (Eds.), The New Palgrave Dictionary of Economics Online, 1–11. Palgrave Macmillan, 2nd edition. URL
Kakarot-Handtke, E. (2015). Major Defects of the Market Economy. SSRN Working Paper Series, 2624350: 1–40. URL
Stigum, B. P. (1991). Toward a Formal Science of Economics: The Axiomatic Method in Economics and Econometrics. Cambridge: MIT Press.
Weintraub, E. R. (1985). Joan Robinson’s Critique of Equilibrium: An Appraisal. American Economic Review, Papers and Proceedings, 75(2): 146–149. URL

Related 'There are NO crank scientists in economics because economics is NOT a science' and 'Money, cranks, and morons' and 'Crisis, cranks, and scientists' and  'Your economics is refuted on all counts: here is the real thing'.

For more about cranks see AXECquery.

***

Wikimedia AXEC82

How Wicksell and the rest got inflation/deflation wrong

Comment on Stanley Fischer’s speech* on ‘(Money), Interest and Prices: Patinkin and Woodford’

Blog-Reference

Wicksell came after Jevons, Menger, and Walras, and stands in the long orthodox line which has actually morphed into DSGE. He has become famous for establishing the relationship between the rate of interest and the price level. His basic idea re-emerges in the actual contributions of Woodford and goes as follows.

“At any moment ... there is a certain level of the average rate of interest which is such that the general level of prices has no tendency to move either upwards or downwards. This we call the normal rate of interest. Its magnitude is determined by the current level of the natural capital rate, and rises and falls with it.” (See speech)

All variants of Orthodoxy are built upon this set of foundational propositions, a.k.a. axioms: “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)

Methodologically, these premises are forever unacceptable but the representative economist has swallowed them hook, line, and sinker for more than 150 years. NOT ONE of the axioms holds water. Today, the failure of the Walrasian program as embodied in HC1 to HC5 is indisputable. Strictly speaking, the microfoundations approach has already been dead in the cradle 150+ years ago.

Consequently, what has to be done is to fully replace HC1 to HC5. The Paradigm Shift from subjective-behavioral microfoundations to objective-structural macrofoundations is achieved as follows.
(A0) The objectively given and most elementary configuration of the (world-) economy consists of the household and the business sector which in turn consists initially of one giant fully integrated firm.
(A1) Y_w=WL wage income Y_w is equal to wage rate W times working hours. L,
(A2) O=RL output O is equal to productivity R times working hours L,
(A3) C=PX consumption expenditure C is equal to price P times quantity bought/sold X.

For the graphical representation of the ABSOLUTE STRUCTURAL MINIMUM see Wikimedia #1.

(A1) to (A3) asserts: At any given level of employment L, the wage income Y_w 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 ADDED preliminary conditions of (i) budget balancing, i.e. C=Y_w, and (ii), market clearing, i.e. X=O.

Under the conditions (i)|(ii) the price is derived in each period as P=W/R (1), i.e. the market-clearing price is in the most elementary case equal to unit wage costs. This is the most elementary form of the macroeconomic Law of Supply and Demand. It holds for the economy as a WHOLE.

The first point to notice is that the real wage W/P is invariably equal to the productivity R according to (1). The second point to notice is that monetary profit, i.e. Q_m≡C−Y_w in the most elementary case of the pure production-consumption economy is zero because of (i). For profit/loss to emerge this condition has to be lifted.

Note that the product market is cleared due to condition (ii), and it has been left open so far HOW this is done in practical detail. These details are not needed at the moment.

In a paraphrase of Wicksell, the summary is: ‘In any period there is, given an arbitrary change of (average) productivity R, a certain change of the (average) wage rate W which is such that the general level of prices P has no tendency to move either upwards or downwards.’

Inflation results if the rate of change of the wage rate is continuously above the rate of change in productivity. Deflation results in the opposite case. In the elementary production-consumption economy as given by (A1) to (A3) and the conditions (i)|(ii) inflation/deflation has nothing at all to do with the rate of interest. Transaction money is elastically provided by the Central Bank (2011), so the quantity of money plays a passive role.

For the investment economy, (A1) to (A3) has simply to be differentiated. The formula for the market-clearing price is then given on Wikimedia.#2.

Legend: P_c market-clearing price for the consumer goods industry, ρ_E expenditure ratio, W (average) wage rate, R_c productivity in the consumption good industry, L_i employment in the investment goods industry, L_c employment in the consumption good industry.

The purely structural formula says: if (under the condition of the usual negative elasticity) the rate of interest goes down and investment and with it L_i goes up, then P_c goes up. This is the Wicksell price effect of an interest rate change. However, if in the next period, the interest rate remains at the lower level, L_i remains on a higher level, that is, there is NO further price change and NO inflation.

Now, we combine the Wicksell effect, i.e. rate of interest down and L_i up, with wage rate W down. If the second effect is stronger, then P_c is DOWN, that is, the Wicksell effect is swamped. Hence, if the wage rate changes remain continually behind productivity growth one gets deflation. This is what can be observed at the moment.

Now, the problem is this: monetary policy, i.e. the stabilization of the value of money, depends on a strong and reliable Wicksell effect. The central bank can control the rate of interest but not the wage rate. Therefore, central bank policy is ineffective (i) at the zero lower bound, and (ii), if the wage rate/productivity effect swamps the Wicksell effect.

In the current situation, the Fed cannot achieve the 2 percent inflation objective. This has nothing at all to do with expectations or forward guidance or other Woodfordian psycho gimmicks. The one and only effective measure is to increase the average wage rate. And this is beyond the competence of any central bank.

Conclusion: The neo-Wicksellian/Woodfordian approach to macroeconomics is beside the point because it lacks the correct macrofoundations. With DSGE, the current monetary policy has no sound theoretical foundation.

Egmont Kakarot-Handtke


References
Kakarot-Handtke, E. (2011). Reconstructing the Quantity Theory (I). SSRN Working Paper Series, 1895268: 1–28. URL
Weintraub, E. R. (1985). Joan Robinson’s Critique of Equilibrium: An Appraisal. American Economic Review, Papers and Proceedings, 75(2): 146–149. URL

* Speech
#1 Wikimedia AXEC31
#2 Wikimedia AXEC41

What Keynes really meant but could not really prove

Comment Lars Syll on ‘Krugman and “what Keynes really meant”’

Blog-Reference and Blog-Reference

Keynes clearly saw that the economics of his time was just a matter of belief: “On the one side were those who believed that the existing economic system is in the long run self-adjusting, though with creaks and groans and jerks, ... Those on the other side of the gulf, however, rejected the idea that the existing economic system is, in any significant sense, self-adjusting.” (See intro)

Belief is the very opposite of science. Science is about knowledge. And scientific knowledge is clearly defined by material and formal consistency. What Keynes meant is that there are two beliefs about the economy and that neither side could prove their case. From this follows: “Thus, if the heretics on the other side of the gulf are to demolish the forces of nineteenth-century orthodoxy ... they must attack them in their citadel ... There is, I am convinced, a fatal flaw in that part of the orthodox reasoning that deals with the theory of what determines the level of effective demand and the volume of aggregate employment ...”

Neither Keynes nor the After-Keynesians, though, delivered anything that came close to scientific proof. All controversy remained on the level of opinion and belief. So let us now PROVE that the market economy is NOT self-adjusting as Orthodoxy claims.

Keynes formulated the formal core of the General Theory as follows: “Income = value of output = consumption + investment. Saving = income − consumption. Therefore saving = investment.” (1973, p. 63)

This formal core, a.k.a. axiom set, is false, just as the Walrasian axiom set, a.k.a. citadel is false. Consequently, what has to be done is to fully replace Keynes’ formal starting point. This is achieved as follows.
(A0) The objectively given and most elementary configuration of the (world-) economy consists of the household and the business sector which in turn consists initially of one giant fully integrated firm.
(A1) Y_w=WL wage income Y_w is equal to wage rate W times working hours. L,
(A2) O=RL output O is equal to productivity R times working hours L,
(A3) C=PX consumption expenditure C is equal to price P times quantity bought/sold X.

For the graphical representation of the ABSOLUTE formal MINIMUM see Wikimedia.#1.

(A1) to (A3) asserts: At any given level of employment L, the wage income Y_w 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 ADDED preliminary conditions of (i) budget balancing, i.e. C=Y_w, and (ii), market clearing, i.e. X=O.

Under the conditions (i)|(ii) the price is derived in each period as P=W/R (1), i.e. the market-clearing price is in the most elementary case equal to unit wage costs. This is the simplest form of the macroeconomic Law of Supply and Demand. It holds for the economy as a WHOLE.

The first point to notice is that the real wage W/P is invariably equal to the productivity R according to (1). So, for the economy as a whole, the marginal principle does NOT hold. This is the first blow to the citadel.

The second point to notice is that monetary profit, i.e. Q_m≡C−Y_w, in the most elementary case of the pure production-consumption economy is zero because of (i). For profit/loss to emerge this condition has to be lifted.

Note that the product market is cleared due to condition (ii), and it has been left open so far HOW this is done in practical detail. These details are not needed at the moment.

It is assumed now that actual employment L is below full employment L_f. There is no need to define L_f at this stage in greater detail.

Now, the orthodox behavioral assumption is added that the wage rate W falls as long as there is unemployment, i.e. as long as L−L_f is less than 0. What happens then? From (1) follows that the price falls and that the real wage is invariably equal to the productivity R. The profit of the business sector is again zero. Hence, wage reduction does NOT increase profit.

For the firm/business sector, there is no motive to move in any direction. All employment levels are INDIFFERENT with regard to profit. There is NO such thing as equilibrium/ disequilibrium. The wage reduction can be repeated for an arbitrary number of periods, the only result is deflation. The flexible fall of the wage rate cannot clear the labor market. This is the second blow for the citadel.

Up to this point, we have dealt with the pure production-consumption economy. Perhaps things change when the business sector is differentiated? So, in the next step, the investment economy has to be investigated.

To cut the meticulous formal derivation short (2012; 2014a; 2014b), the most elementary version of the macroeconomic Employment Law is shown on Wikimedia.#2.

From this equation follows:
(i) An increase in the expenditure ratio ρ_E leads to higher employment L (the letter ρ stands for ratio).
(ii) Increasing investment expenditures I exert a positive influence on employment, a slowdown in growth does the opposite.
(iii) An increase in the factor cost ratio ρ_F≡W/PR leads to higher employment.

The complete Employment Law is a bit longer and contains in addition profit distribution, public deficit spending, and import/export. Employment is now the dependent variable, the price is among the independent variables.

Item (i) and (ii) cover Keynes’ arguments about effective demand. What is missing in the Keynesian employment multiplier, though, is the ratio ρ_F as defined in (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 and vice versa.

This is the very OPPOSITE of what economics teaches. “We economists have all learned, and many of us teach, that the remedy for excess supply in any market is a reduction in price. If this is prevented by combinations in restraint of trade or by government regulations, then those impediments to competition should be removed. Applied to economy-wide unemployment, this doctrine places the blame on trade unions and governments, not on any failure of competitive markets.” (Tobin, 1997, p. 11)

The orthodox adaption rule for competitive markets DESTABILIZES the system. The system is NOT self-adjusting. This is the third and most lethal blow for the citadel. Note that all this is no longer a matter of belief and wish-wash but of proof. The macroeconomic Employment Law is formally consistent and because it consists of measurable variables its material consistency can be readily established through testing. This settles the matter once and for all according to the immutable scientific criteria of true/false.

Egmont Kakarot-Handtke


References
Kakarot-Handtke, E. (2012). Keynes’ Employment Function and the Gratuitous Phillips Curve Disaster. SSRN Working Paper Series, 2130421: 1–19. URL
Kakarot-Handtke, E. (2014a). The Three Fatal Mistakes of Yesterday Economics: Profit, I=S, Employment. SSRN Working Paper Series, 2489792: 1–13. URL
Kakarot-Handtke, E. (2014b). Towards Full Employment Through Applied Algebra and Counter-Intuitive Behavior. SSRN Working Paper Series, 2456184: 1–25. URL
Keynes, J. M. (1973). The General Theory of Employment Interest and Money. London, Basingstoke: Macmillan.
Tobin, J. (1997). An Overview of the General Theory. In G. C. Harcourt, and P. A. Riach (Eds.), The ’Second Edition’ of The General Theory, Vol. 2, 3–27. Oxon: Routledge.

#1 Wikimedia AXEC31
#2 Wikimedia AXEC62

For more about self-adjusting see AXECquery.

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REPLY to Paul Davidson 'Yes or No: Is the economy self-adjusting?' on May 23

Thank you for the reference to your INET article.#1 It covers the whole range of controversies between Keynes and what he called the citadel or Orthodoxy. The stated purpose of my post, though, is just the opposite, it is to focus exclusively on ONE point, the key point.

My understanding is the same as Keynes’: “We are ... at one of those uncommon junctures of human affairs where we can be saved by the solution of an intellectual problem, and in no other way.”#2

The only way the key question can be solved is by scientific proof. Proof has two dimensions: formal AND material consistency. Roughly speaking the procedure is as follows: (i) state your premises with utmost clarity, (ii) do NOT take outcomes into the premises (e.g. equilibrium = petitio principii), (iii) do NOT take nonentities into the premises (e.g. optimization, ergodicity, rational expectations), (iv) start with the MINIMUM of premises (= Occam’s razor), (v) derive the conclusions consistently from the premises, (vi) test the conclusions.

So, the key question is ‘Is the economy self-adjusting?’ and NOT how Keynes’ ideas have been perverted from Samuelson onward to Krugman. This is a legitimate question in itself, of course, but does not bear upon the key question which is about the working of the economy and NOT about the working of academic discourse.

What is needed are the objective determinants of employment/unemployment and NOT the accustomed silly second-guessing of human nature/behavior. The most elementary version of the Employment Law for the economy as a whole which satisfies the methodological requirements (i) to (v) is given with link #1 (2012).

This equation embodies the price mechanism and the interaction between TWO markets, the product, and the labor market. It works such that overall employment INCREASES if the average wage rate W INCREASES relative to average price P and productivity R and vice versa. This means that the orthodox rule, i.e. the remedy for excess supply is a reduction in price, does NOT apply to the labor market. This means in turn that Orthodoxy got the interaction of the two pivotal markets wrong. The Walrasian/Hayekian/Lucasian/ Krugmanian story of market coordination is provably false.

The structural instability is a feature, not a bug. So, the filibuster about flexibility/ stickiness or short run/long run is way beside the point.

All this follows from the correct Employment Law, which in turn follows from three elementary structural premises. After having established formal consistency the only thing that has to be done by Heterodoxy is to establish material consistency, that is, to empirically test the equation. To continue the discussion about what Keynes or Krugman meant or means is practical idiocy.

The market economy is NOT self-adjusting. Q.E.D.


References
Kakarot-Handtke, E. (2012). Keynes’ Employment Function and the Gratuitous Phillips Curve Disaster. SSRN Working Paper Series, 2130421: 1–19. URL

#1 Article
#2 See Keynes’ 1934 BBC radio address at EconoSpeak
#1 Wikimedia AXEC62

Immediately following Could we, please, all focus on the key question of economics?.

The worst economic equation

Comment on Matias Vernengo on 'The great economic equations'

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Economics abounds with logical/mathematical blunder. Keynes’ I=S is the worst error/ mistake measured by overall methodological fallout.

1. The argument
Keynes formulated the formal core of the General Theory as follows: “Income = value of output = consumption + investment. Saving = income − consumption. Therefore saving = investment.” (1973, p. 63)

This elementary syllogism is conceptually defective because Keynes never came to grips with profit (Tómasson et al., 2010, p. 12). This is fatal for an economist.

2. Rectification
The Keynesian premises have to be replaced by the correct macrofoundations. This is achieved as follows
(A0) The objectively given and most elementary configuration of the economy consists of the household and the business sector which in turn consists initially of one giant fully integrated firm.
(A1) Yw=WL wage income Yw is equal to wage rate W times working hours. L,
(A2) O=RL output O is equal to productivity R times working hours L,
(A3) C=PX consumption expenditure C is equal to price P times quantity bought/sold X.
For the graphical representation of this ABSOLUTE formal MINIMUM see Wikimedia AXEC31

(A1) to (A3) asserts: 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 (i) budget balancing, i.e. C=Yw, and (ii), market clearing, i.e. X=O.

Under the conditions (i)|(ii) the price is derived in each period as P=W/R, i.e. the market-clearing price is in the most elementary case equal to unit wage costs which vary over successive periods.

In the next period, the households save, i.e. condition (i) is now lifted. The result is shown here.

Consumption expenditures C fall below Yw and with it the market-clearing price P. The product market is cleared due to (ii) and there is no such thing as inventory investment, i.e. I=0. 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. 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. The sector balances always add up to zero, i.e. Qm+Sm=0.

Saving and investment are NEVER equal, neither ex-ante nor ex-post. Saving/dissaving is complementary to loss/profit.

The correct profit equation for the investment economy reads Qm≡Yd+I−Sm. Legend: Qm monetary profit, Yd distributed profit, Sm monetary saving, I investment expenditures.

3. Conclusion
(a) I=S is the worst economic equation. All I=S/IS-LM models from Keynes to Krugman are provably false (2014). (b) The multiplier is formally defective. (c) All microfounded profit theories are provably false. (d) The representative economist has NOT gotten (a) to (c) to this very day.

Egmont Kakarot-Handtke


References
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.  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 preceding The great economic equations.

For more details see cross-references Refutation of I=S.