October 16, 2016

Macrofoundations, too, are defective

Comment on J. W. Mason and Lance Taylor on ‘Saving, investment and the natural rate’

Blog-Reference

J. W. Mason gives a summary of Lance Taylor’s recent paper* without realizing that Lance Taylor continues the tradition of messing up the saving-investment issue.

Lance Taylor asks: “Today’s New ‘Keynesians’ have tremendous intellectual firepower. The puzzle is why they revert to Wicksell on loanable funds and the natural rate while ignoring Keynes’s innovations.”*

Lance Taylor’s answer consists in a conspiracy hypothesis: “Wicksell and Keynes planted red herrings for future economists by concentrating on household saving and business investment.” Reality is much simpler, economists produce false theories because they are scientifically incompetent. The loanable funds theory is a case in point.

Roughly speaking, the loanable funds theory says that saving and investment are equalized by the interest rate mechanism, which is a variant of standard supply-demand-equilibrium. What economists have not realized until this day is that all three elements of the general market model (supply function, demand function, equilibrium) are NONENTITIES. This means that the Wicksellian model has already been dead in the cradle. However, as the saying goes: “The difficulty lies, not in the new ideas, but in escaping from the old ones …”. This applies to Walrasians AND Keynesians.

Keynes formulated the formal core of the General Theory as follows: “Income = value of output = consumption + investment. Saving = income - consumption. Therefore saving = investment.”

This elementary syllogism is conceptually and logically defective because Keynes never came to grips with profit (Tómasson et al., 2010).**

Let this sink in: Keynes had NO idea of the fundamental concepts of economics, that is, of profit and income. His error/mistake carried over to National Accounting.*** Therefore, it is NO surprise at all that loanable funds macro models do not fit the data.

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 profit equation gets a bit longer when government and foreign trade is included.

The difference between investment and saving I-Sm plus distributed profit Yd determines monetary profit Qm for the economy as a whole. Saving is NEVER equal to investment, neither ex ante nor ex post, and there is NO mechanism to equalize them, that is, NO such thing as supply-demand-equilibrium. The whole discussion about whether the Wicksellian interest rate mechanism or the Keynesian income mechanism establishes the equality/equilibrium of saving and investment is entirely vacuous. Because of this, the discussion about monetary and fiscal policy NEVER had a sound scientific foundation.

To conclude:
(i) All I=S/IS-LM models from Keynes/Hicks to the present are provable false.
(ii) The loanable funds/natural interest rate theory is provable false.
(iii) The classical and Keynesian profit theories are provable false.
(iv) The representative economist has not gotten (i) to (iii) since 80 years.**** This includes J. W. Mason and Lance Taylor.

Egmont Kakarot-Handtke

* See ‘The ‘Natural’ Interest Rate and Secular Stagnation: Loanable Funds Macro Models Don’t Fit the Data
** See post ‘How Keynes got macro wrong and Allais got it right
*** See paper ‘The Common Error of Common Sense: An Essential Rectification of the Accounting Approach
**** For more enlightment see cross-references

Related  'A new episode of one of the worst blunders of economics' and 'Loanable funds, lack of scientific firepower and abundance of political fartpower'