February 3, 2015

Deflation: better take the correct formulas

Comment on merijnknibbe on 'Will the ECB push Europe over the deflation cliff?'


The simplified formula for the market-clearing price in the consumption good industry is given here.

Roughly, the formula says that the consumer price index Pc declines if (i) the average expenditure ratio falls, (ii) the wage rate W falls, (iii) the productivity R increases, and (iv) the employment in the investment good industry Li shrinks relative to the employment in the consumer goods industry Lc. The formula follows from (2014, Sec. 5).

The more differentiated and therefore better testable formula is given here.

The crucial message is that the nominal wage is the numéraire of the price system as Keynes argued in the GT. If at all, the quantity of money plays an indirect role via the expenditure ratio and the employment relation of the investment good and the consumption good industry.

The rule of thumb says: if wage increases for the business sector as a whole lag behind productivity increases deflation occurs (the rest of the formula kept constant).

Note that monetary profit Qm for the business sector as a whole is given here.

That is, total profit does not depend on the wage rate. Most economists do not know the correct profit formula (2014, Sec. 3).

Egmont Kakarot-Handtke

Kakarot-Handtke, E. (2014). The Three Fatal Mistakes of Yesterday Economics: Profit, I=S, Employment. SSRN Working Paper Series, 2489792: 1–13. URL