October 22, 2015

End of confusion (I)

Comment on David Glasner on ‘Keynes and Accounting Identities’


Hicks was the first to come up with a smart solution to the saving-investment conundrum: “What a tricky business this all is! In his Treatise on Money, Mr. Keynes told the world that savings and investment are only equal in conditions of equilibrium; that an excess of investment over saving means rising prices, and vice versa. In his General Theory, he told us that saving and investment are always equal, and that this is a mere identity or truism, without significance for the determination of prices. As far as I can make out, there are relevant and important senses in which all these statements are each of them right and each of them wrong.” (1939, p. 184)

Indeed, in economics, anything goes and at the end of every grand debate, the confusion is roughly the same as at the beginning; “Throughout the 1920s and 1930s the focus was increasingly on the role of the equality of saving and investment, but the semantic squabbles that dominated much of the debate (the distinctions between ‘ex-ante,’ and ‘ex-post,’ ‘planned’ and ‘realized’ saving and investment, the discussion of whether the equality of saving and investment was an identity or an equilibrium condition) reflected a deeper confusion.” (Blanchard, 2000, p. 1378)

The saving-equals-investment debate from Adam Smith onwards is a striking example of hereditary scientific incompetence.

Lest younger economists waste another eighty+ years in deeper confusion it should be mentioned that the whole issue has been settled: “Autrement dit l’investissement n’est pas égal à l’épargne spontanée, mais à l’épargne spontanée augmenté du revenue non distribué des entreprises ....” (Allais, 1993, p. 69) Or, summed up in a crisp formula (Wikimedia AXEC09c, for details see 2014; 2013):

This formally consistent accounting identity makes it clear that saving and investment never were and never will be equal and that the familiar story of the interest rate mechanism has never been more than clueless verbiage.

The formal foundations of Keynesianism are defective. For Keynesians, though, inconsistency is not a fatal flaw but the sign of an extraordinary mind: “It is well known that John Maynard was born anew every morning; for this reason, his colleagues at Bretton Woods commented that he was too intelligent to be consistent.” (Valentino, 1988, p. 239)

Any questions why Keynesians messed the whole IS thing up and, more generally, why economics is a failed science?

Egmont Kakarot-Handtke

Allais, M. (1993). Les Fondements Comptable de la Macro-Économie. Paris: Presses Universitaires de France, 2nd edition.
Blanchard, O. (2000). What Do We Know about Macroeconomics that Fisher and Wicksell Did Not? Quarterly Journal of Economics, 115(4): 1375–1409. URL
Hicks, J. R. (1939). Value and Capital. Oxford: Clarendon Press, 2nd edition.
Kakarot-Handtke, E. (2013). Settling the Theory of Saving. SSRN Working Paper Series, 2220651: 1–23. URL
Kakarot-Handtke, E. (2014). The Three Fatal Mistakes of Yesterday Economics: Profit, I=S, Employment. SSRN Working Paper Series, 2489792: 1–13. URL
Valentino, R. (1988). Discussion. In H. Hanusch (Ed.), Evolutionary Economics. Applications of Schumpeter’s Ideas, 238–249. Cambridge, New York, NY, etc.: Cambridge University Press.

Preceding Keynes and the logical brilliance of Bedlam.

For details of the big picture see cross-references I=S

ICYMI (comment on Anders of Oct 22)

The premise income=expenditure is false as I pointed out above (Oct 21) and the deeper reason is that the profit theory is false. For the rectification of Keynes's approach see the working paper The Three Fatal Mistakes of Yesterday Economics: Profit, I=S, Employment.

ICYMI (comment on Ramanan of Oct 22)

The mistake in your argument is that at first household saving is denoted with S and then, in an additional step, the sum of household saving and “Firm's saving” is also denoted with S. With this inadmissible double notation one arrives indeed at the familiar result. I have clarified this case in Section 17 of the working paper Keynes’s Missing Axioms.

ICYMI (comment on Anders of Oct 23)

Indeed, you ask the pivotal question: “I’m still unclear how you repudiate the basic “income=expenditure” identity. Within an accounting period, if aggregate income isn’t equal to expenditure, where does the surplus (deficit) go (come from)?”

The shortest possible and graphics-supported answer has been given in the 3-page working paper Debunking Squared.

The complete answer with the consistent inclusion of money has been derived in The Emergence of Profit and Interest in the Monetary Circuit.

In sum: Neither Classicals, nor Walrasians, nor Marshallians, nor Marxians, nor Keynesians, nor Institutionalists, 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 fail to capture the essence of the market economy.


ICYMI  (comment on Anders of Oct 23 on Oct 24)

The formally correct accounting relationship is given here.

Ignore for simplicity distributed/retained profit, i.e. Yd=0. Then the equation says: monetary profit Qm is equal to the difference between investment I and monetary saving Sm. All variables are measurable with a precision of two decimals and one will always find that the business sector’s investment expenditures are different from the household sector’s saving/dissaving in a period of a given length and that profit/loss for the business sector as a whole is different from zero.

Again, all I=S models are false and the proof is in the national accounts, see The Common Error of Common Sense: An Essential Rectification of the Accounting Approach.

Your statement ‘profit does not constitute a problem for standard economics’ is a bit strange, to say the least. The profit theory is false since Adam Smith and this methodological blunder disqualifies the whole of economics. The fact of the matter is that the representative economist cannot, after more than 200 years, tell the difference between profit and income. You will not find many examples in the history of science that are more embarrassing.


ICYMI (comment on djb of Oct 23 and Anders of Oct 23 on Oct 25)

You say: “Keynes understood profit was included in total income.”

This is true, of course, but my argument is that exactly at this point Keynes made the fatal conceptual blunder which consists of not coming to grips with the two fundamental economic concepts profit and income. To miss the crucial difference is just as unpardonable as a physicist confounding force and energy.

I perfectly agree with Anders up to this point: “Now, let’s make one business start to run a profit. This can happen from another agent running a deficit ...” This is a good example of begging the question. It is not demonstrated in detail how profit emerges from the monetary circuit but simply assumed with “let’s make one business start to run a profit ...” Note well, if one business starts to make a profit and the other makes a complementary loss, the profit of the business sector as a whole is still zero just as in the initial case. Obviously, this does not explain how the business sector has managed to make overall positive profits over several centuries.

Here is again the formally correct accounting relationship (Wikimedia AXEC09b):

For simplicity, distributed profit and investment are set to zero, i.e. Yd=0 and I=0. Then the equation says for the pure consumption economy: monetary profit for the business sector as a whole Qm is equal to dissaving; and monetary loss is equal to monetary saving Sm (under the condition of product-market-clearing, that is, no inventory investment/disinvestment).

Profit is a phenomenon that can only emerge in a monetary economy. As a matter of principle, real models cannot explain profit.

Summary It is incorrect to say that total income is the sum of wage income and profit, but it is correct to say that total income is the sum of wage income and distributed profit. This is the all-dominant conceptual difference. Its oversight makes that economic theory from Adam Smith to Keynes and up to the present will not even make a footnote in the history of scientific thought.


ICYMI (comment on djb of Oct 25 on Oct 26)

Confusion is the default state of the representative economist (2013). Obviously, you cannot get out of Keynes’s accounting mess by nonstop introducing new concepts like wealth, capital, the consumption function, etc. The solution lies exactly in the opposite direction.

“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.” (Morgenstern, 1941, p. 373)

In the most elementary case of the consumption economy, the accounting identity says (i) Qm≡−Sm.

After taking investment into account the accounting identity reads (ii) Qm≡I−Sm (for the full investment cycle see 2011).

And so it goes consistently on to ever-higher levels of complexity. Equations (i) and (ii) tell you that saving is never equal to investment. All equations are testable/refutable in principle. So there is absolutely no need for endless confused blather.

Kakarot-Handtke, E. (2011). Squaring the Investment Cycle. SSRN Working Paper Series, 1911796: 1–25. URL
Kakarot-Handtke, E. (2013). Confused Confusers: How to Stop Thinking Like an Economist and Start Thinking Like a Scientist. SSRN Working Paper Series, 2207598: 1–16. URL
Morgenstern, O. (1941). Professor Hicks on Value and Capital. Journal of Political Economy, 49(3): 361–393. URL