December 17, 2016

Macroeconomics ― dead since Keynes

Comment on Diane Coyle on ‘Rescuing macroeconomics?’

Blog-Reference and Blog-Reference on Dec 18 and Blog-Reference on Dec 18

Macroeconomics cannot be rescued ― and certainly not by Roger Farmer’s silly belief function ― because it is already defunct since 80 years. Farmer writes: “Macroeconomics has taken the wrong path. The error has nothing to do with classical versus New Keynesian approaches. It is a more fundamental error that pervades both.” This is probably the most enlightened sentence in Farmer’s new book.

The fact of the matter is, though, that Farmer does not spot the fundamental error in macro that pervades all of economics. In order to see this, one has to go back to Keynes.

Keynes realized that the classical microfoundations approach had led into a cul-de-sac and therefore switched to macrofoundations. This was ― in principle ― the right first step towards a paradigm shift, except for the fact that Keynes messed up his macrofoundations. This is why Keynesianism, too, is a failure.#1

The lesson from the history of economic thought is that theoretical economics has to proceed top-down, i.e. from macrofoundations down through intermediate levels (sectors, branches, firms, households) to the individual. What has to be recognized is the methodological insight that NO way leads from the understanding of microeconomic behavior to the understanding of how the monetary economy works. And this explains why the microfoundations approach has been doomed to failure from the very beginning.

What neither Orthodoxy nor Keynes ever understood was profit: “His Collected Writings show that he wrestled to solve the Profit Puzzle up till the semi-final versions of his GT but in the end he gave up and discarded the draft chapter dealing with it.” (Tómasson et al., 2010)

It is pretty obvious that an economist who cannot tell the difference between the fundamental economic magnitudes profit and income is a laughing stock. This applies to Walrasians and Keynesians of all colors. The profit theory is the “more fundamental error” that pervades both microeconomics and macroeconomics.

Rescuing macroeconomics in the correct understanding means a paradigm shift from false Walrasian microfoundations and false Keynesian macrofoundations to new macrofoundations. This, of course, is entirely beyond the horizon of Roger Farmer.

Egmont Kakarot-Handtke

#1 See ‘The unfinished Keynes’ and ‘How Keynes got macro wrong and Allais got it right
#2 See ‘Macro for dummies’ and ‘How the Intelligent Non-Economist Can Refute Every Economist Hands Down