July 13, 2017

Macro for dummies (II)

Comment on Peter Cooper on ‘Short & Simple 7 ― A Fundamental National Accounting Identity’

Blog-Reference

The heteconomist Peter Cooper maintains: “Since every act of spending results in income for somebody else, total spending for the economy as a whole equals total income. This is true by definition and is a basic building block in macroeconomics.”

Both, orthodox and heterodox economists subscribe to this statement as the self-evident rock-bottom truth of all of economics. Too bad that this statement is materially/logically false.

The foundational error/mistake/blunder consists in the methodological fact that the two most important magnitudes of economics — profit and income — are ill-defined.#1 In order to see this one has to go back to the MOST ELEMENTARY configuration, that is, the pure production-consumption economy which consists of the household and the business sector.#2

In this elementary economy, three configurations are logically possible: (i) consumption expenditures are equal to wage income C=Yw, (ii) C is less than Yw, (iii) C is greater than Yw.

In case (i) the monetary saving of the household sector Sm≡Yw−C is zero and the monetary profit of the business sector Qm≡C−Yw, too, is zero. The product market is cleared, i.e. X=O.
In case (ii) monetary saving Sm is positive and the business sector makes a loss, i.e. Qm is negative.
In case (iii) monetary saving Sm is negative, i.e. the household sector dissaves, and the business sector makes a profit, i.e. Qm is positive.

It always holds Qm+Sm=0 or Qm=−Sm, in other words, at the heart of the monetary circuit is an identity: the business sector’s deficit (surplus) equals the household sector’s surplus (deficit). Put bluntly, loss is the counterpart of saving and profit is the counterpart of dissaving. This is the most elementary form of the macroeconomic Profit Law. It follows directly from the profit definition Qm≡C−Yw and the definition of household sector saving Sm≡Yw−C.

Loss or profit are NOT income. Only distributed profit is income. The profit theory is false since Adam Smith.#3

Economists are too stupid for the elementary mathematics of accounting.#4 The statement total income equals total spending is simply false because of the all-important phenomenon of credit. Equipped with credit the household sector can spend MORE than its period income (= dissaving in accounting terms) or in the opposite case LESS (= saving).

Egmont Kakarot-Handtke

#1 For details see ‘How the Intelligent Non-Economist Can Refute Every Economist Hands Down’ and ‘Keynes’s Missing Axioms’ Sec. 14-18
#2 The elementary production-consumption economy is given by three macro axioms: (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. For a start holds X=O.
#3 See ‘Essentials of Constructive Heterodoxy: Profit’ and cross-references Profit
#4 See ‘The Common Error of Common Sense: An Essential Rectification of the Accounting Approach


Related 'Macro for dummies (I)' and 'A crash course in macro accounting' and 'Settling the Theory of Saving' and 'Profit theory in less than 5 minutes' and 'Economists: scientists or political clowns?' and 'You are fired!'

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REPLY to SDB on Jul 14

You say: “It’s logically impossible for any spending to not ‘go somewhere’ and result in income somewhere else.”

This is the usual vague blather.

The pure production-consumption economy is for a start defined by three macro axioms (Yw=WL, O=RL, C=PX), two conditions (X=O, C=Yw) and two definitions (Qm≡C−Yw, Sm≡Yw−C). No vagueness here.

The condition C=Yw says that consumption expenditures C are initially equal to wage income Yw. Or in the words of Peter Cooper: total spending is equal to total income.

Now it is logically and practically possible that consumption expenditures C are LESS than wage income Yw, i.e., total spending is NOT equal to total income.

What happens in the two sectors follows from the definitions. For the business sector, it holds Qm≡C-Yw. Clearly, Qm bears here a negative sign (C less than Yw), which means the business sector makes a loss.

It is pretty obvious that the firm’s loss is something quite different from income. Wage income is a flow from the business sector to the household sector. Loss is the DIFFERENCE of two flows. Methodologically, it is NOT admissible to use the same term for entirely different phenomena. So it is inadmissible to speak of loss as a type of income. This blunder is called category mistake.

With ‘loss income’ this is clear because it sounds already weird. But it is also inadmissible to speak of ‘profit income’ because profit, too, is the difference of flows, i.e. C−Yw, and not a flow like wage income Yw. Wage income and profit are NOT two different forms of income.

So the blunder of the representative economist consists in confusing a balance with a flow.

The parallel to wage income is distributed profit income or dividend. Needless to emphasize that the representative economist cannot tell the difference between profit and distributed profit either.

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TAKE-AWAY for non-economists on Jul 14

The fact that the simple statement ‘Total spending equals total income’ is still commonplace in economics has far-reaching implications.

(i) In 200+ years economists have NOT figured out that the statement is false. This is a straight metric of scientific incompetence.

(ii) Since 200+ years the two fundamental economic concepts ― profit and income ― are ill-defined. By consequence, all theories/models that contain these concepts are false. In other words, the whole analytical superstructure of economics is false.

(iii) This applies to the four main approaches Walrasianism, Keynesianism, Marxianism, Austrianism. Economics, therefore, is nothing but the mutually accepted pluralism of provably false theories.#1 Economics lacks the true theory.

(iv) This applies also to National Accounting#2 which is lethal because National Accounting is pivotal for empirical testing. The correct FUNDAMENTAL IDENTITY of National Accounting is NOT spending = income but Qm+Sm=0 or Qm=−Sm, in other words, the business sector’s deficit (= loss) equals the household sector’s surplus (= saving) and vice versa, i.e. profit = dissaving.

(v) The claim that economics is a science is false and amounts to a misguidance of the general public and the government bodies that are responsible for economic policy.#3

#1 For more details see
How Keynes got macro wrong and Allais got it right
Tricky business
Where MMT got macro wrong
Heterodoxy, too, is scientific junk
#2 See ‘The Common Error of Common Sense: An Essential Rectification of the Accounting Approach
#3 See ‘Economics is not a science, not a religion, but proto-scientific rubbish

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REPLY to SDB on Jul 14

(i) You say: “As best I can tell EKH is confusing a simple barter model for the real world.” The confusion is obviously on your side: (i) the title of this thread explicitly talks about National Accounting, (ii) National Accounting is about NOMINAL magnitudes, NOT real magnitudes, (iii) from all magnitudes that appear in the formal description of the pure production-consumption economy FOUR reappear in National Accounting, viz. C, Yw, Qm, Sm.#1

(ii) The pure production-consumption economy is NOT a barter model but the simplest possible instantiation of what Keynes called the ‘monetary theory of production’.#2

(iii) You say “profit is simply a mark-up over cost”. This microeconomic definition translates for the consolidated business sector into the MACRO equation Qm≡C−Yw.

(iv) You say “Perhaps one might ask where the money comes from to pay for the profits above costs?” Indeed, this question has been asked and already answered: “In order that profit comes into existence for the first time in the pure production-consumption economy the household sector must run a deficit at least in one period. This presupposes the existence of a credit creating entity.”#3

Fact is that you are ill-informed and way behind the curve. Your best is simply not good enough.

#1 The pure production-consumption economy is for a start defined by three macro axioms (Yw=WL, O=RL, C=PX), two conditions (X=O, C=Yw) and two definitions (Qm≡C−Yw, Sm≡Yw−C).
#2 See ‘The irreparable unreality of all ‘real’ models
#3 See ‘Essentials of Constructive Heterodoxy: Profit’ p. 7

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REPLY to Magpie on Jul 15

You say: “To paraphrase: So the blunder of Egmont Kakarot-Handtke consists in confusing a balance with a flow.”

You are simply ill-informed. There are two balances of flows: X−O the difference between quantity X sold and quantity produced O per period. This balance changes the inventory = real stock. The other balance is C−Yw, i.e. the difference between consumption expenditure C and wage income Yw. This balance changes the stock of money. The stock increases in the case of saving, i.e. C−Yw greater zero, and decreases it in the opposite case of dissaving.

Mathematically it holds: the business sector’s stock of products and the household sector’s stock of money is determined by the sales ratio (X/O) and the expenditure ratio (C/Yw). So the relation of stocks (numerical integrals) and ratios (numerical derivatives) is well defined for the case of discrete flow variables.#1

Your gloating [Considering that Michal Kalecki is credited with the witticism that economics is the science of confusing stocks with flows, one can conclude that Egmont Kakarot-Handtke truly is a practitioner of scientific economics. :-)] is premature.

For my take on Kalecki see the cross-references.#2

#1 See ‘Primary and Secondary Markets’ Section 2 (Residuals and the emergence of stocks)
#2 Cross-references Kalecki

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REPLY to Tom Hickey on Jul 15

You say: “In scientific modeling, which economic purports to do, fundamental assumptions are stated and key terms define in terms of the model being constructed. … Economists adopt different assumptions and define key terms differently.”

And here you have it: the muddled heads of economics define what they please without taking care whether the definitions fit consistently together. In economics, Humpty Dumpty calls the shots: “’When I use a word,’ Humpty Dumpty said in rather a scornful tone, ‘it means just what I choose it to mean — neither more nor less.’ ‘The question is,’ said Alice, ‘whether you can make words mean so many different things.’ ‘The question is,’ said Humpty Dumpty, ‘which is to be master — that’s all’.”

And this is why economics is since 200+ years not more than confused blather. Not even the foundational concepts profit and income are properly defined. This is like medieval physics before the concept of energy was defined and understood. The representative economist does not understand what profit is and has never realized that the statement ‘total spending for the economy as a whole equals total income’ is abysmal logical crap.

Science proceeds differently. The foundational concepts including the dimensions of the magnitudes are consistently defined: “The most basic rule of dimensional analysis is that of dimensional homogeneity.”#1

The tried and tested means to establish coherent talk and dimensional homogeneity is since 2000+ years axiomatization: “The often heard rule that concepts are to be defined before they are used in a discussion is much too simple-minded pre-Hilbertian. The only way to arrive at coherent languages is to set up axiomatic systems implicitly defining the basic concepts.” (Schmiechen)

And here you have it: The pure production-consumption economy is for a start clearly defined by three macro axioms (Yw=WL, O=RL, C=PX), two conditions (X=O, C=Yw) and two definitions (Qm≡C−Yw, Sm≡Yw−C).#2

The axioms and definitions can be reduced to one equation, the First Economic Law#3, which is dimensionless and satisfies the Buckingham π theorem.#4

You say: “Profit is a weasel word”. Did it ever appear to you that this is the most damning characterization of economics? The first thing scientists do is to eliminate weasel words. Economists have not achieved this in the past 200+ years. They are simply too stupid for consistent scientific modeling.

#1 Wikipedia Dimensional analysis
#2 For the complete verbal and graphics supported description of the pure production-consumption economy see ‘How the intelligent non-economist can refute every economist hands down
#3 Wikimedia First Economic Law
#4 Wikipedia Buckingham π theorem

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REPLY to Magpie on Jul 15

You say: “Answer this extremely simple question.”
(i) Loss is the DIFFERENCE of two flows.
(ii) If loss, as you clearly wrote above, is not a flow, then what on earth is it? (A stock? … If it’s not a flow then it must be a stock.)

Wage income Yw is a flow from the business to the household sector. Consumption expenditure C is a flow from the household to the business sector. Loss is the difference of these two flows Qm≡C−Yw if C is less than Yw. Loss diminishes the stock of money of the business sector.

So we have the flow, the difference of flows and the change of stock. Loss is so to speak the first derivative of the stock of money. Or, vice versa, the stock of money of the business sector is the numerical integral of loss/profit.

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REPLY to SDB on Jul 16

(i) You say: “… after accumulation of savings is widespread, then profit of the business sector/dissaving of the household sector can occur without a change in the stock of money. Yes? It’s a shift if deposit balances from the household to the business sector, with no change in the stock of money.”

No. In the simplest case money consists of the debit side of the central bank’s balance sheet. If the household sector dissaves profit of the business sector goes up and BOTH sides of the central bank’s balance sheet get longer by the SAME amount. Money has been dealt with elsewhere at length.

(ii) You say: “I still don’t understand your problem with the notion that total spending = total income.”

Start with total spending C = total wage income Yw. In the next period the household sector takes up credit from the central bank and total spending C is greater than wage income Yw. So the statement total spending = total wage income is obviously not generally true.

What happens is that the profit of the business is now Qm≡C−Yw. But profit (or loss as the case may be) is NOT income so the statement total spending = total wage income changes for the GENERAL CASE to total spending C is numerically equal to total wage income Yw plus/minus profit/loss Qm (to recall Yw is a flow, Qm is a balance).*

From the accountant’s perspective only Qm≡C−Yw is the 100 percent correct statement, i.e. if spending C is equal to wage income Yw profit is zero, otherwise, there is a profit or loss. Everything else is layman’s babble.

* See also the Figure 5 in ‘Keynes’s Missing Axioms’ p. 25

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REPLY to Magpie on Jul 16

You say: “If flows are like first derivatives, so to speak, as you say, then one should expect of them that they can be added and subtracted: first derivatives, I'm sure you know (don’t you?) are additive.”

First of all, I do NOT say ‘flows are like first derivatives’. Time to learn reading!

In economics, we are in the world of discrete variables. And because there are no underlying continuous and differentiable functions we speak in analogies. So the stock of money of the business sector is the numerical integral = sum of discrete period values of profit/loss. Profit/loss, i.e. the change of the stock of money, in turn, is a difference of flows. The change of stock is ANALOGOUS to the first derivative (see the graphic in the working paper Primary and Secondary Markets.)

I do NOT say ‘flows are like first derivatives’ I say ‘the difference of flows is like the first derivative’.

Needless to emphasize that the formalism of calculus does NOT one-to-one apply to discrete period variables. This does not matter at all because the analogy holds.

So we have the flow, the difference of flows = the change of stock, and the stock, that is, we have perfect stock-flow consistency for discrete variables.

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REPLY to SDB on Jul 16

You ask: “Why is profit not income for the business sector?”

To say profit is income for the business sector is like saying a whale is a fish. It is simply scientifically incorrect.

If you subscribe to anything-goes and freedom of speech and the human right of ignorance you can say profit is income of the business sector if you subscribe to scientific principles (material/formal consistency, dimensional homogeneity) you cannot. To lump income (= flow) and profit (= difference of flows = accounting balance) together is a category mistake.

The fact that the representative economist cannot until this very day tell the difference between profit and income is the proof of utter scientific incompetence since 200+ years.*

* See also ‘Economists: scientists or political clowns?

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REPLY to SDB on Jul 16

(1) I have translated the argument into accounting. It is self-explanatory:

(a) National accounts, two sectors, initial period C=Yw, consumption expenditures = wage income
(b) National accounts, dissaving C > Yw, consumption expenditures greater than wage income, profit Qm = dissaving −Sm
(c) National accounts, saving C < Yw, consumption expenditures less than wage income, loss −Qm = saving Sm

(2) You ask “So do you prefer the edit: total spending = total revenue? (instead of total spending = total income).”

Absolutely. From the perspective of the household sector, C is total spending, from the perspective of the business sector C is total revenue. The accounts make it clear that this is ALWAYS the case because it is two views of the same thing.

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REPLY to wilwon32 on Jul 17

(i) You are right, the definitions of terms can easily degenerate into wordplay and give rise to misinterpretation. For example:
• TRUE Total spending (of the household sector) is total revenue (of the business sector).
• FALSE Total spending for the economy as a whole equals total income.
• FALSE Income = value of output.

It is the second statement which has become known as the fundamental accounting identity. This is the exact point where the whole of macro went wrong.

(ii) Most famous example: Keynes

This is the piece of evidence from the General Theory: “Income = value of output = consumption + investment. Saving = income − consumption. Therefore saving = investment.” (p. 63)

This two-liner is conceptually and logically defective because Keynes did not come to grips with 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.)

Because profit is ill-defined the whole theoretical superstructure of Keynesianism is false. This includes MMT.*

(iii) All language problems are eliminated by turning to mathematical formalism and/or graphical representation.

(a) National accounts, pure production-consumption economy, two sectors, initial period C=Yw, consumption expenditures = wage income.
(b) National accounts, dissaving C > Yw, consumption expenditures greater than wage income, profit Qm = dissaving −Sm (with Qm≡C−Yw, Sm≡Yw−C, Qm+Sm=0 or Qm=−Sm).
(c) National accounts, saving C < Yw, consumption expenditures less than wage income, loss −Qm = saving Sm.

The balances Qm and Sm change and redistribute the stock of money in the economy and are the interface to the theory of money. The accounts establish the logical connection between flows, the difference of flows = the change of stock, and the stock of money.

(iv) From the accounting graphics, it is immediately obvious that Keynes’s foundational identity “Income = value of output” is false.

This seemingly commonsensical identity is the biggest methodological blunder in all of economics because it led to the treatment of profit as income of capital.

Because the profit theory is false since Adam Smith ― “... one of the most convoluted and muddled areas in economic theory: the theory of profit” (Mirowski) ― economics became the failed science that it is today.

(v) The scientific incompetence of the representative economist is documented by the fact that he cannot tell the difference between profit and income until this very day. Economists have NO idea of the foundational concepts of their subject matter.

* Where MMT got macro wrong

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NOTE on Short & Simple 8 on Jul 17

The concept of GDP with GDP = Total Output = Total Income is essentially the same as the age-old ‘Income = value of output’ error/mistake. See: ‘The Common Error of Common Sense: An Essential Rectification of the Accounting Approach’ and ‘You are fired!

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NOTE on Short & Simple 9 on Jul 21

Peter Cooper writes: “We understand that, as a rule, total spending must equal total income.”

This is NOT the case as can be gleaned from the most elementary cases of National Accounting.
(a) Two sectors, initial period C=Yw, consumption expenditures = wage income
(b) Saving C < Yw, consumption expenditures less than wage income, loss −Qm = saving Sm
(c) Dissaving C > Yw, consumption expenditures greater than wage income, profit Qm = dissaving −Sm

Dissaving/saving = change of household sector’s debt means that wage income (total income) and consumption expenditures (total spending) is NEVER equal for the economy as a whole. Peter Cooper is fired because of the lack of elementary logical faculties.*

* You are fired!
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NOTE on Short & Simple 10 on Jul 24

Peter Cooper writes in Short & Simple 10: “We have also noted (in parts 5 and 9) that a household or business can spend independently of current income. They can do this either by drawing down past savings or through borrowing.”#1

Peter Cooper wrote in Short & Simple 9: “We understand that, as a rule, total spending must equal total income.”#2

There are two things that Peter Cooper does not understand
(i) National Accounting, which determines the relationship between flows (wage income, consumption expenditures) and balances = differences of flows (saving/dissaving of the household sector, loss/profit of the business sector)
(ii) The relationship between the flows and balances of National Accounting and the changes of the stock of money/credit at the central bank.

This prevents any understanding of how money is created and destroyed in a monetary economy. Accordingly, he claims that money comes into the world by deficit spending of government.

In order that money comes into the world, the government is NOT needed as a deficit spender but only as an institution builder. What is needed is, roughly speaking, a central bank that issues transaction money in parallel with expanding/contracting wage income.#3

#1 Link to source
#2 Link to source
#3 For details see ‘Essentials of Constructive Heterodoxy: Money, Credit, Interest


Immediately following 'How money emerges out of nothing ― the functional account'