February 10, 2017

Windmill economics

Comment on Lars Syll on ‘Why governments should run deficits’

Blog-Reference and Blog-Reference

Lars Syll provides a mixture of political and economic arguments in favor of deficit spending. These arguments are based on his perception of how the monetary system works. Unfortunately, Lars Syll knows only one thing for sure, i.e. that Orthodoxy is false, but has not yet arrived at a valid heterodox economics. Because of this, all his policy proposals lack sound scientific foundations.

With regard to employment policy, he wholeheartedly propagates Keynesian deficit spending without realizing that Keynesianism is theoretically defective and deficit spending has some distributional secondary effects that are not compatible with his own normative ideas of the Good Society.

As with Don Quixote, good intentions paired with incompetence produce tragic results.

For details see:
― Macroeconomics ― dead since Keynes
― Unemployment is high because economics is false: period, full stop, end of story
― Rethinking deficit spending.

Egmont Kakarot-Handtke
***
REPLY to Ralph Musgrave on Feb 11

You say: “Egmont Kakarot-Handtke central point seems to be that Keynes did not understand profit. Given that every convenience store owner understands what profit is, it is totally absurd to claim Keynes didn’t understand it.”

The idea that ‘every convenience store owner understands what profit is’ is itself of utmost absurdity for anyone who has grasped what science is all about. This is what J. S. Mill, the great methodologist among the founding fathers, had to say about commonsensers in general: “People fancied they saw the sun rise and set, the stars revolve in circles round the pole. We now know that they saw no such thing; what they really saw was a set of appearances, equally reconcileable with the theory they held and with a totally different one. It seems strange that such an instance as this, ... , should not have opened the eyes of the bigots of common sense, and inspired them with a more modest distrust of the competency of mere ignorance to judge the conclusions of cultivated thought.”

So much for the understanding of convenience store owners.

What most people who call themselves economists do not understand is that the very characteristic of science is that it goes BEYOND common sense: “... it is precisely the task of science to supersede crude common-sense notions by critical analysis, and further that it is the unsatisfactory state of the foundations beneath the common-sense surface which is the most serious and crippling deficiency of contemporary economic science.” (Hutchison)

The ‘most serious and crippling deficiency of contemporary economic science’ is that the representative economist has NO idea of the pivotal economic concept of profit. Keynes was no exception: “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.)

Scientifically, Keynes never rose above the level of a convenience store owner.

Every economist can know from the Palgrave Dictionary that the profit theory is false (Desai, 2008). Or, as Mirowski put it, “... one of the most convoluted and muddled areas in economic theory: the theory of profit.” In other words: the confused confusers of economics have NO idea what the pivot of their subject matter is. In still other words, because this bunch of scientific deplorables#1 does not know how the profit mechanism works it does not know how the market economy works. Economics is proto-scientific rubbish and this goes from Adam Smith to Keynes and beyond.

After- and Post-Keynesians and MMTers have not spotted Keynes’s foundational blunder until this very day.#2,#3 The scientific incompetence of economists ― Walrasians, Keynesians, Marxians, Austrians ― is beyond absurd.

#1 See ‘How the intelligent non-economist can refute every economist hands down'
#2 See ‘How Keynes got macro wrong and Allais got it right
#3 See ‘Going beyond Wicksell, Keynes and MMT

***
REPLY to Bob Roddis on Feb 13

Your question of February 11 has to be put into a macroeconomic context or what Keynes called the ‘monetary theory of production’ and it has to be answered in GENERAL terms, that is, without the technicalities of the US banking system. In other words, the whole banking system is reduced to the central bank which has only deposits on the liability side of its balance sheet and overdrafts on the asset side. The deposits are money and they are created uno actu with overdrafts, that is, deposits = overdrafts or central bank liabilities = central bank assets.

The most elementary configuration constitutes the analytical starting point: “There can be no doubt whatsoever that a problem which has not yet been solved in all its aspects under its simplest conditions will be still more difficult to tackle if other, ‘more realistic’ assumptions are being made.” (Morgenstern)

Scenario_0#1: The economy starts with employment L. There is only wage income Yw = 100 monetary units [e.g. billion $]. Productivity R and output O remain constant. Consumption expenditures C are equal to wage income, i.e. C = Yw. By consequence, profit of the business sector is zero. Wage payments to the household sector consist of deposits (= overdrafts of the business sector). Through consumption expenditures, the household sector’s deposits are again reduced to zero. The stock of money = deposits is zero at the beginning and at the end of the period.#2 During the period money is created and destroyed through the autonomous transactions (wage payments and consumption expenditures) of the business and the household sector.

In the initial scenario, the household sector’s budget is balanced, i.e. C=Yw, and the product market is cleared, that is, the quantity bought X is equal to the quantity produced O, i.e, X=O,  at the market clearing price P (see chart).

Scenario_1: The government needs part of the current output in period 1. The need is legitimate and undisputed, e.g. war. The government taxes the wage income in period 1. Disposable income is reduced by 10 units from 100 to 90. Households reduce consumption expenditures in step from 100 to 90. Government fully spends the income tax of 10 units, that is, total consumption expenditures C remain unchanged and the market clearing price P remains constant. Both, private and public households fully consume their respective shares of output O. There is no real transfer of goods between periods. The war is fully paid for by taxes in period 1. In the following periods income tax is again zero and everything else is like in the initial scenario.

Scenario_2: NO income tax. Households reduce consumption expenditures C voluntarily from 100 to 90 in period 1. Through saving of 10 units the household sector’s current deposits at the central bank increase. At the same time, government spends 10 units and takes up overdrafts at the central bank. Both sides of the central bank’s balance sheet are equal. Households’ deposits = government’s overdrafts. Total consumption expenditures C and market clearing price P remain unchanged.

No changes happen in period 2, 3, 4. The households keep the deposits and the government keeps the overdrafts. Interest payments are left out of the picture.

In period 5 the government is supposed to pay back the overdrafts. The wage income of 100 is taxed with 10 units. Disposable income is reduced to 90. The government uses the 10 units of income tax to reduce its overdrafts to zero. At the same time, the household sector dissaves 10 units, i.e. reduces its deposits to zero. Consumption expenditures C are then equal to disposable income 90 plus dissaving 10 = 100. The balance sheet of the central bank at the end of period 5 is again zero as in the initial period. Deposits = money and overdrafts are ‘destroyed’, the creation of period 1 is fully reversed.

What happens in scenario_2 in comparison to scenario_1 is that the taxation for the war is shifted from period 1 to period 5. In real terms there is NO difference at all. Real consumption of the household sector is in both cases reduced in period 1. In other words, the taxes are paid in period 5 with the saving of 10 units in period 1. That’s all.

Nothing changes in real terms when the government issues bonds with a volume of 10 units in period 2. The household sector’s deposits are reduced to zero and so are the government's overdrafts. The central bank’s balance sheet reduces to zero. The household sector holds bonds instead of deposits and the government switches overdrafts into bond liabilities. The central bank is out as an intermediary and there is a DIRECT creditor-debtor relationship between the household and the government sector in the form of bonds or similar types of government securities.

In period 4 the whole securitisation transaction is exactly reversed. The government sector takes up 10 units overdrafts and redeems the bonds. Accordingly, the household sector’s stock of bonds is reduced from 10 to zero and the deposits go up from zero to 10.

In period 5 the households are taxed, they dissave and the government fully repays the overdrafts. In period 6 everything is again as it was in the initial period.

In real terms, the securitization over period 2, 3, 4 makes absolutely no difference. Only the form of assets and liabilities changes. The household sector holds bonds instead of deposits.

Now it is assumed that the central bank buys the bonds in period 4 from the household sector. So the household sector’s stock of bonds goes down to zero and deposits go up to 10. The central bank has now 10 units of bonds on the asset side instead of government overdrafts. The credit relationship between central bank and government takes now the form of bonds.

If the government taxes the households in period 5 it can redeem the bonds which are held by the central bank. Everything else is as in the previous scenario.

If, on the other hand, the central bank keeps the bonds and the government does not tax the households the repayment of the war debt is simply postponed indefinitely. The household sector keeps its saving of period 1 in the form of deposits = money instead of bonds. The households can buy and sell bonds from and to the central bank and thereby change their liquidity. The sum of bonds and deposits is always 10.

The situation only changes if the households dissave. In this case, consumption expenditures increase from 100 to 110 and deposits reduce to zero. Because output remains unchanged the market clearing price P rises and the business sector now makes a profit of 10 units, i.e. equal to dissaving. Accordingly, the business sector’s deposits go up while those of the household sector go down by the same amount. The balance sheet of the central bank does not change, only the owners of the deposits change.

In the next period consumption expenditures and the market clearing price fall back to their previous level.

As long as the government does not tax the households everything remains unchanged for an indefinite time. The trouble comes when the net income falls due to taxation from 100 to 90 and consumption expenditures fall also to 90 because now there is no dissaving. In this case, the market clearing price falls and the business sector makes a loss of 10 units which reduces its deposits to zero.

Now the government is in the possession of 10 units of deposits from taxation which can be used to redeem the bonds. After this action, the stock of money and bonds is again zero.

Again, in real terms, NOTHING has changed. The households have paid for the war in terms of output in period 1. Everything else is basically a deferment of taxes. The central bank can extend the deferment in principle until eternity by buying the government securities and keeping them on the asset side.

#1 (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.
#2 The idealized transaction pattern looks like this. The wage rate and the market clearing price in period 2 is doubled. All real magnitudes remain unchanged.

***
REPLY to Bob Roddis, continued on Feb 13

Scenario_3: NO income tax and NO saving of the household sector in period 1. Households do NOT reduce consumption expenditures C = 100 and accordingly their deposits are zero at the beginning and the end of period 1. Government takes up overdrafts at the central bank and spends these 10 units IN ADDITION to the households, so total consumption expenditures are now 110. Since output remains unchanged the market clearing price now rises and the business sector makes a profit of 10 which is equal to the government’s budget deficit. At the central bank, the business sector’s deposits are 10 and government overdrafts are also 10 at the end of period 1. The redistribution of current output O between the household and the government sector does not happen via the income tax or saving but via the market clearing price.

In real terms, there is again NO difference between the scenarios. The difference compared to scenario_2 is that the business sector now has 10 units deposits instead of the household sector because the households do not save and the business sector makes a profit of 10 units. Business sector’s deposits = money = government’s overdrafts.

In the next period, the market clearing price falls back to the initial level. The business sector can hold its deposits indefinitely and the government can keep its overdrafts indefinitely. Alternatively, the government sector can sell bonds to the business sector which takes the central bank out of the loop and establishes a DIRECT credit relationship between business sector and government. Deposits = money reduce again to zero.

As long as the government does not tax the households everything remains unchanged for an indefinite time. The trouble comes when the net income falls due to taxation from 100 to 90 and consumption expenditures fall also to 90 because now there is no dissaving. In this case, the market clearing price falls and the business sector makes a loss of 10 units which reduces its deposits to zero. The one-period ‘inflation’ of period 1 is reversed by a one-period ‘deflation’ in period 5.

The government is now in the possession of 10 units of deposits from taxation which can be used to redeem the bonds. After this action, the stock of money and bonds is again zero. Everything is then again as in the initial period.

In scenario_1 the households pay income tax in period 1 and NO credit relationships ensue. In scenario_2 the tax payment is deferred via saving in period 1 and dissaving in period 5. In scenario_3 we have instead of the saving/dissaving of the household sector profit in period 1 and loss in period 5. Over all periods profit and loss cancel out. In scenario_2 profit is zero over all periods.

In REAL terms there is absolutely NO difference between the scenarios. The significant difference is between the saving/dissaving scenario and the profit/loss scenario. Because MMT lacks the proper macrofoundations (see footnote #1 above) these folks NEVER got this ALL-DECISIVE difference. It is pretty obvious that the problem of scenario_3 lies in its DISTRIBUTIONAL effect. This scenario in effect PRODUCES the overall profit of the business sector. In other words, Keynesian deficit spending is the biggest pro-one-percenter profit booster ever. How this is compatible with the Keynesian rhetoric for a more equal income distribution remains forever a mystery.

Keynesians and MMTers simply do NOT understand what profit is and how the profit mechanism works. This is disqualifying for an economist, isn’t it?