AXEC: New Foundations of Economics: On the saying “We owe the debt to ourselves”

November 6, 2017

On the saying “We owe the debt to ourselves”

Own post, no external Blog-Reference

The best-known meme of Functional Finance and MMT with regard to internal public debt is “We owe it to ourselves” which is to say that there is nothing at all to worry about.

The growth of public debt is usually discussed within the Walrasian or the Keynesian framework. The problem is that both the microfoundations approach and the macrofoundations approach are axiomatically false. Methodologically it holds: if the axioms are inconsistent the whole analytical superstructure falls apart. Because of this, it is necessary to shift to the correct macrofoundations and to rethink the whole issue of public deficits/debt.#1

As the correct analytical starting point, the elementary production-consumption economy is defined with this set of macro 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) Y_w=WL wage income Y_w 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.

Under the conditions of market-clearing X=O and budget-balancing C=Y_w, the price is given by P=C/X=W/R, i.e. the market-clearing price is in the initial period equal to unit wage costs. This is the most elementary form of the macroeconomic Law of Supply and Demand. For the graphical representation see Figure 1.#2

Monetary profit for the economy as a whole is defined as Q_m≡C−Y_w and monetary saving as S_m≡Y_w−C. It holds Q_m≡−S_m, in other words, the business sector’s surplus = profit (deficit = loss) equals the household sector’s deficit = dissaving (surplus = saving). This is the most elementary form of the macroeconomic Profit Law. Under the condition of budget balancing, total monetary profit is zero.

There are three alternatives of how to redistribute output between the household and the government sector: (i) taxation, (ii) public deficit spending and compensatory household sector saving, (iii) public deficit spending with newly created money.

(i) The government needs, for some legitimate reason, a part of the output in period 1 and decides to tax the wage income receivers. Wage income is unchanged Y_w1=Y_w and disposable income is then Y_w1−T₁. The consumption expenditures of the household sector fall by the same amount under the condition of budget balancing, i.e. C_h1=Y_w1−T₁. Taken together, total expenditures of the household and government sector remain unchanged, i.e. C_h1+C_g1=C. The government sector’s budget is balanced, i.e. C_g1=T₁. Accordingly, one has these three sectoral balances.

Q_m1≡C_h1+C_g1−Y_w monetary profit/loss, business sector,
S_m1≡Y_w−T₁−C_h1 monetary saving/dissaving, household sector,
B_m1≡T₁−C_g1    surplus/deficit, government sector,
----------------------
Q_m1+S_m1+B_m1=0 with Q_m1=0, S_m1=0, B_m1=0.

The market-clearing price remains unchanged, i.e. P₁=P=W/R. The real share of the household sector is O_h1=C_h1/P₁ and of the government sector O_g1=C_g1/P₁ with O_h1+O_g1=O₁=O.

Thus, the transfer of a share of current output from the household to the government sector is completed. In the following periods, government taxation and spending are again zero. Everything is as it was in the initial period.

(ii) The government needs again a part of the current output but does not tax the wage income receivers. Instead, a group A of the households saves, thus that household sector saving S_m1≡Y_w1−C_h1 is exactly equal to government spending, i.e. S_m1=C_g1. Total expenditures remain unchanged, i.e. C₁=C_h1+C_g1=C. The real shares of output are exactly equal to the taxation variant (i). The balances now look as follows.

Q_m1≡C_h1+C_g1−Y_w monetary profit,
S_m1≡Y_w−C_h1 monetary saving,
B_m1≡−C_g1     government sector deficit,
---------------------
Q_m1+S_m1+B_m1=0 with Q_m1=0, S_m1>0, B_m1<0.

The public debt (= stock) has been zero and is at the end of the first period equal to the deficit C_g1. It may accumulate in subsequent periods or not. The household sector’s savings (= stock) have been zero and are at the end of the first period equal to S_m1. Both amounts are exactly equal and it is assumed that the government debt is fully consolidated by selling bonds to group A of the households = savers = creditors.

All households are taxed beginning with period 2, thus that the total of lump-sum individual tax is equal to the total of interest payments that go to the creditor households A. As a result, the disposable income of the creditor households increases and that of the complementary group B decreases. So, for the duration of the debt, an income redistribution takes place. It is NOT the case that “we” pay interest to “ourselves” but group A + B = “we” pay to group A = creditor households. The net income increase of group A is interest minus lump-sum tax of group A. Compared to the taxation case (i) group A is better off and group B is worse off depending on the interest rate and the duration of the debt.

Eventually, the public debt is redeemed. All households A+B are taxed in period t and the sum goes to the creditor households A. The tax in period t, i.e. T_t, is equal to the public debt C_g1. The households spend their current income, i.e. Ct=Y_wt, the lump-sum tax is paid by dissaving. The balances now look as follows.

Q_mt≡C_ht−Y_w monetary profit, C_ht=Y_w,
S_mt≡Y_w−T_t−C_ht monetary dissaving, S_mt=−T_t,
B_mt≡T_t    government budget surplus,
------------------
Q_mt+S_mt+B_mt=0 with Q_mt=0, S_mt<0, B_mt>0.

At the end of period t, the public debt is again zero. The household sector as a whole ends up with total savings of zero which are composed of deposits of group A and overdrafts of group B. The public debt becomes in part private debt = overdrafts at the central bank after the completion of the whole cycle. Group A can pay the tax out of savings and is left with deposits at the central bank. Group B is left with overdrafts of an equal amount.

So, public deficit spending plus compensatory household sector saving amounts to a deferred tax for the household sector as a whole. Instead of paying the tax in period 1, the household sector pays in period t. For the duration of the tax deferment, a redistribution of income from all taxpayers A+B to creditor households A takes place. The statement “We owe the debt to ourselves” is misleading. “We”, i.e. A+B, owe the debt to A. Compared to taxation (i) deficit spending (ii) makes group B worse off. In addition, group B is left with private debt at the end of the process.

Only if all households A+B save the same amount and are taxed the same amount the whole process is distributionally neutral.

(iii) The government again runs a budget deficit. Now, the households do not save but spend the whole period income C_h1=Y_w1=Y_w. Government spending is given with C_g1 and taxes T₁ is zero. Total expenditures are now C₁=C_h1+C_g1 and this yields a price hike: P₁=C₁/X=(C_h1+C_g1)/X=P+C_g1/X with market-clearing X=O.

The redistribution of output between the household sector and the government sector, that is, the REAL taxation, is now realized via the price mechanism and becomes thereby invisible. If deficit spending is exactly repeated period after period the price remains at the elevated level, otherwise, it falls back to the initial level. The balances now look as follows.

Q_m1≡C_h1+C_g1−Y_w monetary profit, C_h1=Y_w, Q_m1=C_g1,
S_m1≡Y_w−C_h1 monetary saving,
B_m1≡−C_g1 government budget deficit,
---------------------
Q_m1+S_m1+B_m1=0 with Q_m1>0, S_m1=0, B_m1<0.

The amount C_g1 = government budget deficit comes from the central bank, i.e. is created out of nothing. The two sides of the central bank’s balance sheet, overdrafts, and deposits, rise by the same amount. The newly created money ends in the ‘cash box’ of the business sector, i.e. government sector’s overdrafts = business sector’s deposits. It is assumed that the government consolidates its overdrafts by selling bonds to the business sector. So overdrafts and deposits at the central bank vanish completely.

The household sector is then taxed with a lump-sum tax and the interest payments go to the business sector for the duration of the public debt. There is no redistribution of income between different groups within the household sector. The creditor is now the business sector.#3

Eventually, the public debt is redeemed. All households are taxed in period t and the total of the lump-sum tax, T_t=C_g1, goes to the business sector. The tax reduces current spending C_ht<Y_w. This causes the market-clearing price to fall. The balances now look as follows.

Q_mt≡C_ht−Y_w monetary loss, C_ht<Y_w,
S_mt≡Y_w−T_t−C_ht monetary saving, T_t+C_ht=Y_w, S_mt=0,
B_mt≡T_t government budget surplus,
-------------------
Q_mt+S_mt+B_mt=0 with Q_mt<0, S_mt=0, B_mt>0.

Monetary loss for the economy as a whole is now given by Q_mt=C_ht−Y_w=−T_t. The loss in period t is exactly equal to the profit of period 1. Deficit spending again amounts to a tax deferment for the household sector. The difference to variant (ii) is that the tax is not paid by dissaving but by saving in period t which causes the loss of the business sector. Eventually, the real taxation, i.e. the output transfer of period 1, is trailed in the nominal sphere. The household sector gains NOTHING by this delay. Just the opposite, the balanced budget case is the most advantageous for the household sector. Alternative (iii), i.e. budget deficit with money printing, is the most advantageous for the business sector. This is the version that is promoted by MMT and the other deficit spenders.#4

To argue in favor of deficit spending with the slogan “We owe the debt to ourselves” is either a testimonial of utter scientific incompetence or deliberate political deception of the general public.

Egmont Kakarot-Handtke

#1 10 steps to leave cargo cult economics behind for good
#2 Wikimedia AXEC31 Elementary production-consumption economy

#3 Gov-Deficits do NOT cause inflation
#4 Keynesianism as ultimate profit machine

Related 'Settling the Theory of Saving' and 'Meet the MMT smart arses' and 'No MMT illusions! YOU are going to pay for it' and 'How to pay for the war and to be bamboozled by economists' and 'Stephanie Kelton sells children into debt slavery'. For details of the big picture see cross-references Profit/Distribution.

***

Wikimedia AXEC168

Knowledge only — no opinion

Science does not explain everything, but non-science explains nothing.

Neither orthodox nor heterodox economics satisfies the scientific criteria of material and formal consistency.

Economists cannot explain how the economy works. The Profit Theory is false since Adam Smith. There is much opinion and little knowledge.

Opinion is the realm of political economics, knowledge is the realm of theoretical economics.

Political economics is scientifically worthless.

Theoretical economics is built upon clearly stated premises, i.e., upon a set of axioms.

Orthodoxy got the axiomatic foundations wrong and Heterodoxy has none at all.

Economics is a failed science. Economists are incompetent scientists.

Profit

Neither Classicals, nor Walrasians, nor Marshallians, nor Marxians, nor Keynesians, nor Institutionialists, nor Monetary Economists, nor MMTers, nor Austrians, nor Sraffaians, nor Evolutionists, nor Game theorists, nor EconoPhysicists, nor RBCers, nor New Keynesians, nor New Classicals ever came to grips with profit. Hence, they all fail to capture the essence of the market economy.

Because of this, economists have nothing to offer in the way of a scientifically founded economic policy guidance.

The hybrid science

As a first approximation, one can agree on the general characteristic that the economy is a complex system.

However, with the term system one usually associates a structure with components that are non-human. In order to stress the obvious fact that humans are an essential component of the economic system the market economy should be characterized more precisely as a complex hybrid human/system entity.

The scientific method is straightforwardly applicable to the sys-component but not to the hum-component. While it is clear that the economy always has to be treated as an indivisible whole, for good methodological reasons the analysis has to start with the objective system-component.

In gestalt-psychological terms the economic system is the foreground, individual behavior the background. Common sense wrongly insists that the hum-component must always be in the foreground. This fallacy compares to geo-centrism. The economic system has its own logic which is different from the behavioral logic of humans. The systemic logic is what Adam Smith called the Invisible Hand.

There are systemic laws but no behavioral laws. Systemic laws have the same methodological status as physical laws.

Neither Orthodoxy nor Heterodoxy can tell what the systemic laws of the actual monetary economy are.

Whether the outcome of the human/system-interaction is good or bad is a politcal question that lies outside of theoretical economics. Theoretical economics explains how the actual economy works - no less, no more.

Narrative vs.Theory

Psychological, sociological or behavioral assumptionism cannot yield anything other than a gossip model of the world. Second-guessing the agents is not economic analysis.

Science deals exclusively with propositions that can in principle be decided by objective means. The rest is opinion, faith, phantasy, motive speculation, allegation, hallucination, myth, paranoia, ink-blot association, psychology, philosophy, in one word: storytelling.

Storytelling is the original mode of communication in the social realm — except science.

Political economics is storytelling and, by default, the natural habitat of confused confusers. Walrasianism, Keynesianism, Marxianism, Austrianism are social narratives and not scientifically valid representations of reality.

"The truth is, most persons, not excepting professional economists, are satisfied with very hazy notions." (Fisher)

In marked contrast, theoretical economics lives up to the standards of material and formal consistency. A scientific theory is the best mental representation of reality that is humanly possible.

Theory starts with a set of objective and consistent axioms.

Paradigm Shift

"The problem is not just to say that something might be wrong, but to replace it by something — and that is not so easy." (Feynman)

"As will become evident, there is more agreement on the defects of orthodox theory than there is on what theory is to replace it: but all agreed that the point of the criticism is to clear the ground for construction." (Nell)

"The moral of the story is simply this: it takes a new theory, and not just the destructive exposure of assumptions or the collection of new facts, to beat an old theory." (Blaug)

"Is it not a fact, which stares at us from the histories of all sciences, that it is much more difficult for the human mind to forge the most elementary conceptual schemes than it is to elaborate the most complicated superstructure when those elements are well in hand?" (Schumpeter)

"The task of producing knowledge against the grain requires imagination." (Mirowski)

"A new idea is extremely difficult to think of. It takes a fantastic imagination." (Feynman)

"The scientific imagination dreams of explanations and laws." (Peirce)

"It is brilliance of imagination which makes the glory of science." (Evans)

"... we know little more now about ‘how the economy works,’ ... than we knew in 1790, after Adam Smith completed the last revision of The Wealth of Nations." (Clower)

Selftest and to watch for

You apply one of these items

• supply-demand-equilibrium,

• general equilibrium,

• marginal utility,

• well-behaved production functions,

• total income = value of output,

• total income = wages + profits,

• I=S,

• wage rate down - employment up,

• behavioral axioms?

Then you are out of science because of unnoticed material or formal inconsistency.

Every economist who uses the concept of equilibrium is scientifically incompetent because she/he failed to notice that equilibrium is an economic nonentity.

Practically this means: as soon as the word equilibrium appears in an economic text it can be thrown into the waste basket. The same holds for all other nonentities.

The vast majority of economists deals mainly with nonentities. This is why Walrasianism, Keynesianism, Marxianism, Austrianism is scientifically worthless.

Since Adam Smith, economic policy guidance has no sound scientific foundations.

To be replaced (1)

The core premises of Orthodoxy are uncertain and false and this fully explains the failure of the research program.

“As with any Lakatosian research program, the neo-Walrasian program is characterized by its hard core, heuristics, and protective belts. Without asserting that the following characterization is definitive, I have argued that the program is organized around the following propositions: HC1 economic agents have preferences over outcomes; HC2 agents individually optimize subject to constraints; HC3 agent choice is manifest in interrelated markets; HC4 agents have full relevant knowledge; HC5 observable outcomes are coordinated, and must be discussed with reference to equilibrium states.” (Weintraub)

The inescapable Paradigm Shift consists of the move from this obsolete hard core to the superior set of structural axioms.

To be replaced (2)

The fundamental equations of macroeconomics have been formulated by Keynes in two lines.

"Income = value of output = consumption + investment. Saving = income - consumption. Therefore saving = investment."

This elementary syllogism is demonstrably false. The demonstration consists in the proof that Keynes could not solve the Profit Puzzle. Neither did Post-Neo-New-Keynesians.

In the most general terms, the economics Paradigm Shift consists in switching from the behavior-centric bottom-up approach to the structure-centric top-down approach. This is comparable to the Copernican turn from geo-centrism to helio-centrism.

Consensus

Economics is a science without scientists. Because they are ignorant of the elementary difference between profit and income, the present generation of economists has not made and cannot make a significant contribution to the discussion about how the actual economy works.

Every orthodox or heterodox economist can convince himself/herself that their profit theory is defective.

Every non-economist can — by applying elementary logic — convince himself that conventional profit theories are false. See 'How the intelligent non-economist can refute every economist hands down'.

Because the profit theory is false the whole of conventional economic theory has to be rejected.

"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)

No scientist will ever accept Walrasianism, Keynesianism, Marxianism, or Austrianism. These approaches are logically and/or empirically refuted. This is the actual methodological state-of-art. Walrasians, Keynesians, Marxians, or Austrians are still at the proto-scientific stage. These approaches cannot be improved, only abandoned.

Economists are a public nuisance because they have an opinion on everything but knowledge of nothing.

About me

“Bottom line is that your profit law is just a definition you made up nobody else agrees with, nobody. You are all alone with your precious tautology.” Barkley Rosser

“In any event, your entire theory is based on you doing macro accounting in wacky fashion that nobody agrees with.” Brian Romanchuk

"Your stuff is at least original: it's quite cool after a couple of decades at this to see a fresh Economics. But real promises are not advanced: they were around for millennia until the Greeks obscured them with Metaphysics." Chris Cook

"No mate, they're you-blockers. You have all the personality traits of a crank, and the rest of them have tired of you. You could be 100% right, and you'd still die as your only follower." Steve Keen

"What you are doing fills is all with joy, your constructive critique is most welcome!"

Achim Truger,

German Council of Economic Experts,

in a failed attempt to be ironic

"200+ years of thought and yet you are the only one who gets it—or even understands your argument. Thank god we have you, pseudonymous Twitter user. Otherwise no one would know."

William Luther

Assistant Professor of Economics

in a failed attempt to be funny

"Egmonts profit law is the perfect equation that demonstrates this in action. Put the equation into a spreadsheet and then add government spending and watch how it flows into profits. Enter in some debt (-Sm) and watch too how that flows into profits. It can't go anywhere else."

Dean

About the rest of economics

Walrasianism, Keynesianism, Marxianism, Austrianism, MMT, Pluralism are mutually contradictory, axiomatically false, materially/ formally inconsistent. Economics is a failed science.

“There are three classes of people: those who see. Those who see when they are shown. Those who do not see.” Leonardo da Vinci

In economics, the overwhelming majority belongs to Class III. This explains why economics is after 200+ years still at the proto-scientific level.

The obvious task for every economist is to advance from cargo cult science and political agenda-pushing to science. This is absolutely beyond the means of Class III people.

For 200+ years now, economists are not scientists but agenda pushers, useful idiots, clowns in the political Circus Maximus.

Nopopop

This blog does not add to any popular/un- popular opinion.

This blog does not hand out advice about how to avoid taxes, to get rich on the stock market, to be successful in business, to increase the wealth of nations, to run an economy, to maximize welfare, to prevent national/global bankruptcy, to improve the institutional setup of society, to get out of national/global depression, nor about how to save humankind or any subgroup thereof.

This blog is about the true theory of the actual monetary economy.

"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)

Focus

Science is of primary interest and importance. Scientists are of secondary interest.

With regard to science, most people lose focus easily because of a natural preference for anecdotes and gossip over facts or subjectivity over objectivity.

Hence, Schumpeter once considered it necessary to remind his habitually disoriented fellow economists: “Remember: occasionally, it may be an interesting question to ask why a man says what he says; but whatever the answer, it does not tell us anything about whether what he says is true or false.”

Science is about true/false and nothing else.

Disclaimer

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Caution: Do not expect a corroboration of your political view. Neither a refutation. Political economics has been scientifically worthless since Adam Smith. Politics has to be separated from economics because it is categorically different from science. The best science can do and has always done is to prove beyond reasonable doubt that you have been objectively wrong or ignorant until now. Science goes beyond the naive common sense of today and becomes the sophisticated common sense of tomorrow.

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Outlook

To recall, while political economics is storytelling, theoretical economics adheres to scientific standards.

The first task of theoretical economics is to get the axiomatic foundations right. This is what J. S. Mill called the opus magnum. Neither Orthodoxy nor Heterodoxy came up with a reasonable solution to this day. This explains the secular stagnation of economics.

There is no serious alternative to structural axiomatic economics. This is not a matter of opinion but of proof. The sole criteria are material and formal consistency.

All of economics has to be reconstructed from the ground up.

Major economic policy implication

The price mechanism does not work as standard economics hypothesizes. The axiom-based Employment Law states that overall employment increases if the average wage rate increases relative to average price and productivity. This gives one the lever to improve the employment situation all over the world and to fend off deflation without rising debt and without artificial capacity growth. To increase the average price relative to the average wage rate and productivity increases unemployment.

Right policy depends on true theory.

“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)

Lacking the true theory, economists promote for more than 200 years opinion instead of knowledge.