Blog-Reference and parallel Blog-Reference
"The loanable funds theory is in many regards nothing but an approach where the ruling rate of interest in society is — pure and simple — conceived as nothing else than the price of loans or credit, determined by supply and demand — as Bertil Ohlin put it — ‘in the same way as the price of eggs and strawberries on a village market.'” (See intro)
Economists think they have explained something when they paint a supply-demand-equilibrium cross or what Leijonhufvud called the Totem of the Micro. However, already Schumpeter found it necessary to diffuse doubts about the scientific content of the whole exercise: “The primitive apparatus of the theory of supply and demand is scientific. But the scientific achievement is so modest, and common sense and scientific knowledge are logically such close neighbors in this case, that any assertion about the precise point at which the one turned into the other must of necessity remain arbitrary.” (Schumpeter, 1994, p. 9)
As a matter of fact, the ‘primitive apparatus of the theory of supply and demand’ is a thoroughly faulty construct: “There is little or nothing in existing micro- or macroeconomics texts that is of value for understanding real markets. Economists have not understood how to model markets mathematically in an empirically correct way.” (McCauley, 2006, p. 16), see also (2014a; 2015)
Because the generic supply-demand-equilibrium apparatus has to be rejected, the specific loanable funds application also goes out of the window. Keynes was right in this respect (see intro and 2014b).
However, Keynes got it also wrong. The formal core of the General Theory is given with:
“Income = value of output = consumption + investment. Saving = income − consumption. Therefore saving = investment.” (Keynes, 1973, p. 63)
This is rather elementary mathematics and pure conceptual sloppiness. Keynesians and the rest of the profession simply cannot tell the fundamental difference between income and profit (2011). As can be seen from the intro, Kalecki too got it wrong: “It should be emphasized that the equality between savings and investment … will be valid under all circumstances.”
As a matter of fact, the IS-equality is invalid under all circumstances. The correct relationship for the 2-sector economy is given with the equation on Wikimedia AXEC09
It says: the business sector's monetary profit Qm is equal to distributed profit Yd plus investment expenditure I minus the household sector's monetary saving Sm (2014c, Sec. 3). Alternatively: The business sector's retained profit Qm−Yd is equal to the difference between investment and saving. Seen from the business sector as a whole, with retained profit investment ‘finances itself.’ What has to be clearly seen, though, is that the firm with retained profit is normally not the same firm that finances investment. This establishes a direct or indirect financing relationship within the business sector. This is something quite different from financing relationships between the business and the household sector.
The representative economist has always argued that this is all a matter of definition and everybody is free to define whatever seems convenient. This anything-goes mentality fully explains the failure of economics. The representative economist has always been a scientific write-off.
Kakarot-Handtke, E. (2011). Why Post Keynesianism is Not Yet a Science. SSRN Working Paper Series, 1966438: 1–15. URL
Kakarot-Handtke, E. (2014a). Economics for Economists. SSRN Working Paper Series, 2517242: 1–29. URL
Kakarot-Handtke, E. (2014b). Loanable Funds vs. Endogenous Money: Krugman is Wrong, Keen is Right. SSRN Working Paper Series, 2389341: 1–17. URL
Kakarot-Handtke, E. (2014c). The Three Fatal Mistakes of Yesterday Economics: Profit, I=S, Employment. SSRN Working Paper Series, 2489792: 1–13. URL
Kakarot-Handtke, E. (2015). Essentials of Constructive Heterodoxy: The Market. SSRN Working Paper Series, 2547098: 1–10. URL
Keynes, J. M. (1973). The General Theory of Employment Interest and Money. The Collected Writings of John Maynard Keynes Vol. VII. London, Basingstoke: Macmillan. (1936).
McCauley, J. L. (2006). Response to "Worrying Trends in Econophysics". EconoPhysics Forum, 0601001: 1–26. URL
Schumpeter, J. A. (1994). History of Economic Analysis. New York: Oxford University Press.
For details of the big picture see cross-references Refutation of I=S