October 9, 2016

The very serious blunders of very serious people

Comment on Simon Wren-Lewis on ‘Very Serious People and the deficit’


There is the surface level of economic policy and there is the underlying level of economic theory. The problem of economics is that there is a total DISCONNECT of the two levels, in other words, economic policy proposals have no sound scientific foundation.

“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)

Economists have no true theory but different opinions about the respective roles of monetary and fiscal policy. What is fateful in the current situation is that economists lack the true employment theory since more than 200 years.

To make a comprehensive analysis short (2012; 2015), the basic version of the objective structural employment equation is shown on Wikimedia. From this equation follows:
(i) An increase of the expenditure ratio rhoE leads to higher employment (the letter rho stands for ratio). An expenditure ratio rhoE greater than 1 indicates credit expansion, a ratio rhoE less than 1 indicates credit contraction.
(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 AND testable employment equation is a bit longer and contains in addition profit distribution, public deficit spending, and import/export.

Items (i) and (ii) cover Keynes’s arguments about the role of aggregate demand, which have been commonsensically right but formally defective. More precisely, Keynes’s multiplier is provably false (2012). The factor cost ratio rhoF as defined in (iii) embodies the price mechanism which works very different from what the representative economist hallucinates. As a matter of fact, overall employment (in the world economy or a closed national economy) INCREASES if the average wage rate W INCREASES relative to average price P and productivity R.

So, in simple terms, full employment (in any definition) can be achieved by increasing overall demand (expenditure ratio, investment expenditures etc.) or by INCREASING the average wage rate or by a combination of the two.

Now, economists have always argued that the wage rate must and will fall as long as there is unemployment and that one can rely upon that the price mechanism ― if unhindered ― clears the market. This depiction of the labor market price mechanism is simply a fallacy of composition. For the economy as a WHOLE holds the exact OPPOSITE. In other words, the market economy is fundamentally unstable. There is NO such thing as an equilibrium or a NAIRU.

The whole discussion about monetary and fiscal policy and the deficit suffers from the provable fact that the underlying theory/model of people who cannot be taken seriously is materially/formally inconsistent. In the current situation, the best policy is to forget both monetary and fiscal policy and to increase the (average) wage rate faster than productivity and price.

Egmont Kakarot-Handtke

Kakarot-Handtke, E. (2012). Keynes’s Employment Function and the Gratuitous Phillips Curve Disaster. SSRN Working Paper Series, 2130421: 1–19. URL
Kakarot-Handtke, E. (2015). Essentials of Constructive Heterodoxy: Employment. SSRN Working Paper Series, 2576867: 1–11. URL
Stigum, B. P. (1991). Toward a Formal Science of Economics: The Axiomatic Method in Economics and Econometrics. Cambridge, MA: MIT Press.