April 21, 2017

Where MMT got macro wrong

Comment on Bill Mitchell on ‘MMT is what is, not what might be’

Blog-Reference and Blog-Reference

MMT consists of a political part and a theoretical part. The MMT developers “set out in the early 1990s to construct a better way of doing macroeconomics.” In the following, the exact point is located where MMT-macro went methodologically wrong. The political part of MMT is not addressed.

Methodology demands to start with the most elementary economic configuration. In the beginning, the economy consists only of the household and the business sector. No public sector, no foreign trade.

MMT is right: microfoundations is the wrong approach ― since 140+ years. The correct approach is macrofoundations.#1,#2 The elementary version of the objective, systemic, behavior-free, macrofounded employment equation is shown on Wikimedia.


From this equation follows:
(i) An increase of the expenditure ratio ρE leads to higher employment L (the Greek letter ρ stands for ratio). An expenditure ratio ρE greater than 1 indicates credit expansion, a ratio ρE less than 1 indicates credit contraction.
(ii) Increasing investment expenditures I exert a positive influence on employment.
(iii) An increase in the factor cost ratio ρF=W/PR leads to higher employment.

The complete employment equation contains in addition profit distribution, the public sector, and foreign trade.

Item (i) and (ii) cover the familiar arguments about aggregate demand. The factor cost ratio ρF as defined in (iii) embodies the price mechanism. The fact of the matter is that overall employment INCREASES if the AVERAGE wage rate W INCREASES relative to average price P and productivity R.

Total monetary profit for the economy as a whole is given with Qm=Yd+(I−Sm)+(G−T)+(X−M), which reduces to Qm=I−Sm for Yd, G, T, X, M = 0. The reduced macroeconomic profit equation says that the monetary profit of the business sector Qm is equal to the difference between investment expenditures of the business sector I and monetary saving of the household sector Sm (or dissaving −Sm as the case may be).

From the correct macrofoundations follows that the two statements of Bill Mitchell are provably false:
― “The obvious conclusion is that unemployment occurs when net government spending is too low to accommodate the need to pay taxes and the desire to net save.” Unemployment occurs when the expenditure ratio ρE or/and the factor cost ratio ρF is “too low”. Government spending/taxation can improve or worsen the situation.
― “Net government spending is required to meet the private desire to save.” False. Given investment expenditures I, the private desire to save Sm determines monetary profit Qm.

As a matter of principle, full employment can be achieved without private/public deficit spending, i.e. ρE=1, via the price mechanism by increasing ρF=W/PR.

In methodological terms, MMT messed macro up because it got the elementary accounting equations wrong.#3 Because the formal foundations are false the whole analytical superstructure of MMT-macro is false.

The economic policy proposals of MMT have NO sound scientific foundation, just like Post Keynesianism, New Keynesianism, DSGE, RBC, etcetera.

Egmont Kakarot-Handtke

#1 The macrofoundations approach starts with three SYSTEMIC axioms: (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 For the introduction of money see ‘Essentials of Constructive Heterodoxy: Money, Credit, Interest
#3 See ‘The Common Error of Common Sense: An Essential Rectification of the Accounting Approach


Related 'The final implosion of MMT' and 'How Keynes got macro wrong and Allais got it right' and 'Why Post Keynesianism Is Not Yet a Science' and 'True macrofoundations: the reset of economics'. For more details see cross-references MMT.

***
REPLY to MRW on Apr 22

The line of the argument is as follows. MMT is right: orthodox/mainstream economics is false. This is what already Keynes knew. In technical terms, the lethal error/mistake resides in the microfoundations. Keynes switched to macrofoundations but got it wrong.#1 MMT switched also to macrofoundations but got it also wrong.#2

The point is: when the foundations are false the whole analytical superstructure falls apart. The correct macrofoundations are given in the previous post.

From the correct foundations follow the correct systemic relationships for employment and total profit.

From the correct equations follows that there are basically two ways to arrive at full employment (i) deficit spending, (ii) to increase the wage rate faster than price and productivity, that is, to use the price mechanism.

Deficit spending has negative effects on the income distribution.#3 In the actual situation, the economic policy recommendation is therefore (ii). This is the best way to get out of unemployment, deflation, and stagnation.

To know how the monetary economy (i.e. the price and profit mechanism) works is the precondition for successful economic policy. The fact of the matter is that both microfounded mainstream and macrofounded MMT are provably false. Policy recommendations that lack sound scientific foundations are worthless or even counterproductive.

Incompetent economists WORSEN the situation. This holds for Walrasians, Keynesians, MMTers, Marxians, Austrians.

If this is too condensed, more details are to be found in the references. The economy is a complex system which does not fit in one short post.

#1 See ‘Keynes saw the problems but did not solve them
#2 See ‘The final implosion of MMT
#3 See ‘Austerity and the idiocy of political economists

***
REPLY to hog on Apr 22

You ask: “the flow from the government sector to the household sector, and why by your assumptions it can’t be greater than taxes.”

This flow is called transfers and it has been left out of the picture here.

You ask: “so your argument is what? that more money flows from the government sector to the business sector than to the household sector?”

The profit equation Qm=Yd+(I−Sm)+(G−T)+(X−M) reduces to Qm=G−T if Yd, I, Sm, X, M is set to zero and then it says: if government expenditure G is greater than taxes T, i.e. if there is a public sector deficit, then profit of the business sector as a whole is equal to the deficit. It holds Public Deficit = Private Profit. In the opposite case, if the government sector runs a surplus, i.e. if G is less than T, then the loss of the business sector is equal to the surplus of the government sector.

The growing profits of the US economy in the past decades and the increasing ratio of profits to wage income are the mirror image of public deficit spending = growth of public sector debt (plus growth of household sector debt).*

* See also ‘Austerity and the idiocy of political economists

***
REPLY to hog on Apr 22

You ask: “so how does arbitrarily setting various parameters of the profit equation to 0 somehow disprove it?”

The sole purpose of setting some variables initially to zero is to focus on the point at issue. The point at issue is here the relationship between public sector deficit/surplus and business sector profit/loss.

The other relationships have been dealt with elsewhere.

The rule of proper analysis is that one solves first the simple problems and then successively the more complex. As Morgenstern put it: “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.”

The crucial point is that MMTers do not even understand the most elementary case. Because of this, there is NO NEED AT ALL to tackle the general case with the other variables of the profit equation different from zero.

By the way, you can do the general analysis for yourself. It follows ALL almost by itself from the structural/systemic/macro axiom set, just like the whole of geometry follows from the Euclidean axioms.

***
REPLY to hog on Apr 23

Scientific standards are 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)

A theory must satisfy TWO criteria. Therefore, in order to refute a theory, it is SUFFICIENT to prove that it is either logically false or empirically false.

MMT-macro is logically defective. As a consequence, all economic policy conclusions drawn from it are scientifically worthless. While every moron is entitled to an opinion, economists are NOT. Economics is a science and from a scientist KNOWLEDGE is expected. Scientific knowledge, in turn, is well-defined by material/formal consistency.

The political sphere and the scientific sphere have to be kept strictly apart. The political sphere is for morons with an opinion, the scientific sphere is for scientists with knowledge.

MMT is soapbox economics because it does NOT satisfy the condition of logical consistency. It is therefore at best good for a sitcom.

The elementary case in economics is given with the pure consumption economy which consists of the household and the business sector. Neither Keynes, nor Post Keynesians, nor MMT got this simple case right. And the reason is that these so-called economists do not understand what profit is: “His Collected Writings show that he [Keynes] 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.)

So, Keynes did NOT understand the fundamental magnitude of economics. Worse, it is NOT the case that Keynesians or other so-called economists have realized or fixed the problem in the meantime. As the Palgrave Dictionary states: “A satisfactory theory of profits is still elusive.” (Desai, 2008)

MMTers, too, messed up macrofoundations.

The most elementary economic configuration yields for total monetary profit Qm=−Sm. This simple equation is lethal for Keynesianism, Post Keynesianism, New Keynesianism, IS-LM, MMT to name only the macrofounded approaches.

With the public sector added the equation becomes Qm=−Sm+(G−T). With investment added it becomes Qm=(I−Sm)+(G−T). With profit distribution added, it becomes Qm=Yd+(I−Sm)+(G−T). And so on, complexity increases in the course of analysis.

Advanced analysis is NOT needed, though, because it is pretty obvious that MMT messed already the elementary case up. Because of this, MMT economic policy guidance is the same brain-dead blather as Walrasianism, Keynesianism, Marxianism, Austrianism.

Note in passing that the complex profit equation is testable with the accuracy of two decimal places. This, of course, is the way to settle the whole matter.

***
REPLY to hog on Apr 23

You say: “While politics itself isn’t a science political theory however is.”

In order to give economic policy guidance economists need to know how the economy works: “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)

Economists do NOT have the true theory. After 200+ years they do not even know what profit is. This applies also to MMT. Political opinion is NOT needed, we have more than enough of this crap, but scientific knowledge is urgently needed.

The conclusions from the manifest failure of economists are: (i) to ban psychology, sociology, politics from economics and to leave it to sociology, psychology, political science,#2 (ii) to retire the whole bunch of incompetent scientists (Walrasians, Keynesians, Marxians, Austrians, MMTers, hog), and (iii), to focus on the question how the market system works.

#1 See ‘Ditch scientific incompetence!
#2 For details see cross-references Political economics

***
REPLY to Tom Hickey on Apr 23

You can research as many molehills as you like but with this method, you will never arrive at the correct theory of the universe. The same holds for economics. The simple reason is that conclusions drawn from properties and relationships that are true for a firm cannot be generalized for the economy as a whole. This is the well-known fallacy of composition.

Example: One firm can increase profit by lowering the wage rate but for the business sector as a whole this does not work.#1 Because of this, economic policy that is based on microeconomic partial analysis runs inevitably against the wall.

Bottom-up is how Orthodoxy proceeds under the label of microfoundations: “It is a touchstone of accepted economics that all explanations must run in terms of the actions and reactions of individuals.” (Arrow)

This molehill approach had been bound to fail already 140+ years ago. Keynes realized that microfounded economics 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 macrofoundations. This is why Keynesianism, too, is a failure.#2

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. Why? Because NO amount of microeconomic research will ever lead to the understanding of how the (world-) economy works.#3

The only thing that is methodologically correct with MMT is the move from microfoundations to macrofoundations. The subject matter of economics is an abstract entity called the (world-) economy and NOT the decisions that are taken in firms or before the yogurt shelf. Every junior consultant with some background in psychology and sociology and a statistics package on his laptop can do this kind of studies. That’s NOT economics.

The economist’s ambition goes beyond case studies: “The highest ambition an economist can entertain who believes in the scientific character of economics would be fulfilled as soon as he succeeded in constructing a simple model displaying all the essential features of the economic process by means of a reasonably small number of equations connecting a reasonably small number of variables.” (Schumpeter)

MMT failed at this task. MMT’s macrofoundations are provably false.

#1 See ‘Profit for Marxists
#2 See ‘The unfinished Keynes
#3 See ‘Macro for dummies

***
REPLY to Tom Hickey on Apr 23

You say: “Moreover, the notion that there is a scientific method that allows scientists to step outside of a worldview and see ‘with God’s eyes’ is just nonsense based on current scientific findings about how brains function.”

There is no need to invoke God’s eye, every person with a modicum of scientific instinct sees immediately that economics is a cargo cult science#1: “What is now taught as standard economic theory will eventually disappear, no trace of it will remain in the universities or boardrooms because it simply doesn’t work: were it engineering, the bridge would collapse.” (McCauley)

Generation after generation of dull economics students has accepted supply-demand-equilibrium as an explanation of how the market system works. No God is needed to realize that economists have NO idea of the fundamental concepts of their subject matter, it’s in the Palgrave Dictionary.

No brain research is necessary to figure out that economists’ brains contain just enough cells to philosophize about methodology and politics but not enough to understand how the economy works.

It is no good idea to invoke God in economic matters. If HE does realize what economists have produced so far (Walrasianism, Keynesianism, Marxianism, Austrianism, MMT, and silly excuses#2) he will make this heap of proto-scientific rubbish and methodological dilettantism disappear in a no-return black hole.

As far as MMT is concerned everybody can make it disappear in the wastebasket with a rather small quantity of logical thinking.

#1 Wikipedia
#2 See ‘Failed economics: The losers’ long list of lame excuses

***
MMT/historical

Bill Mitchell has been informed via Twitter that the final refutation of MMT took place on this blog.