November 9, 2015

The irreparable unreality of all ‘real’ models

Comment on David Glasner on ‘The Well-Defined, but Nearly Useless, Natural Rate of Interest’


Keynes had a great methodological insight: “In 1933, Keynes wrote a short contribution to a Festschrift for the German economist Arthur Spiethoff. He there attacked classical economists for not providing an adequate monetary theory. He then embarked upon the development of what he termed a monetary theory of production, a theory in which the interdependence of money and uncertainty, and their effects on economic behavior, could be properly investigated.” (Fontana, 2000, p. 40)

Keynes’ insight has been that the proper subject matter of economics is the monetary economy. Many economists have not got this point until today but still maintain that the ‘real’ economy is the real economy. It is definitively not.

And for one simple reason: the phenomenon of profit cannot appear at all in a ‘real’ economy (2011b). Because of this all ‘real’ models miss the essence of the market economy and are a priori worthless. This includes approaches like Ricardo, Sraffa, or RBC. This is Keynes’ lasting contribution to the advancement of theoretical economics: all ‘real’ models have to go out of the window because they are deeply and irreparably flawed.

The real-world economy manifests itself in the interaction of real and nominal variables. Because of this, the theory of saving, investment, and interest have to be developed within the framework of what Keynes called the ‘monetary theory of production’.

The real time travel, i.e. inventory accumulation/decumulation, is entirely disconnected from nominal time travel, i.e. saving/dissaving (2013). The same holds for capital accumulation/decumulation and saving/dissaving. And, most important of all, saving/dissaving is intimately connected with loss/profit. This connection is obviously important, yet it is entirely missing in the familiar theories of interest.

The crucial point is that the representative economist needs to understand what profit is (2011a). Because of this, the theory of interest is false by implication. The worst blunder consists of conceptualizing the natural rate as a real magnitude and in the futile attempt to derive interest from an apples-now-apples-later time preference model.

Egmont Kakarot-Handtke

Fontana, G. (2000). Post Keynesians and Circuitists on Money and Uncertainty: An Attempt at Generality. Journal of Post Keynesian Economics, 23(1): 27–48. URL
Kakarot-Handtke, E. (2011a). The Emergence of Profit and Interest in the Monetary
Circuit. SSRN Working Paper Series, 1973952: 1–22. URL
Kakarot-Handtke, E. (2011b). When Ricardo Saw Profit, He Called it Rent: On the Vice of Parochial Realism. SSRN Working Paper Series, 1932119: 1–19. URL
Kakarot-Handtke, E. (2013). Settling the Theory of Saving. SSRN Working Paper Series, 2220651: 1–23. URL

Related 'Debunking the natural rate of interest' and 'Are economists methodological retards?'.