April 11, 2016

No ground to lose

Comment on Brad DeLong on ‘Yes, in Some — Many — Ways Our Macro Debate has Lost Intellectual Ground since the 1930s. Why Do You Ask?’


The point of interest is not so much economic policy debate or who said what. The core issue is that all of what is said in macro has no sound foundation. Because economists lack the true theory all arguments/proposals are hanging in midair. So, what Wren-Lewis, Friedman, Viner, Knight etcetera ever uttered about monetary/fiscal policy is not different from old Roman haruspicy, i.e. the reading of poultry entrails.

This starts with Keynesian macro. Keynes defined the formal foundations of the General Theory as follows: “Income = value of output = consumption + investment. Saving = income − consumption. Therefore saving = investment.” (1973, p. 63)

This two-liner is conceptually and logically defective because Keynes never came to grips with profit and therefore “discarded the draft chapter dealing with it.” (Tómasson et al., 2010, p. 12).

As a result, all I=S/IS-LM models are false since Hicks (2011; 2014). Among many others, Krugman, Wren-Lewis, DeLong did not get the point to this day. Ignorance, though, is obviously no hindrance to busily dole out economic policy advice.

Let us leave this intellectual vale of tears behind and throw a glimpse into the true theory. The most elementary version of the correct Employment Law for the economy as a whole is shown on Wikimedia AXEC62:
From this equation follows
(i) An increase of the expenditure ratio ρE leads to higher employment L (the letter ρ stands for ratio). An expenditure ratio ρE>1 indicates credit expansion, a ratio ρE<1 indicates credit contraction of the household sector.
(ii) Increasing investment expenditures I exert a positive influence on employment, a slowdown of growth does the opposite.
(iii) An increase of the factor cost ratio ρF≡W/PR leads to higher employment.

The complete Employment Law is a bit longer and contains in addition profit distribution, public deficit spending, and import/export.

Item (i) and (ii) is familiar stuff since the 1930s. What is new is the ratio ρF as defined in (iii). This variable embodies the price mechanism. Curiously enough, economists were so occupied with sticky prices that they did not spend much thought on how the price mechanism could be used to get out of unemployment and deflation. Thus, items (i) and (ii) were most of the time in the foreground.

As (iii) shows, the price mechanism works such that overall employment INCREASES if the average wage rate W INCREASES relative to average price P and productivity R. There is no policy instrument available to achieve this.

The crucial point to note is that the price mechanism does NOT work as standard economics hallucinates. So economists are groping in the dark with regard to the two most important features of the economy: (1) the profit mechanism, and (2), the price mechanism. The macro debate has not lost ground since the 1930s because it never had any.

“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, 1991, p. 30)

What has been offered by Keynes, Friedman, and all the rest up to Wren-Lewis is an interpretation of poultry entrails.

Egmont Kakarot-Handtke

Kakarot-Handtke, E. (2011). Why Post Keynesianism is Not Yet a Science. SSRN Working Paper Series, 1966438: 1–20. URL
Kakarot-Handtke, E. (2014). The Three Fatal Mistakes of Yesterday Economics: Profit, I=S, Employment. SSRN Working Paper Series, 2489792: 1–13. URL
Keynes, J. M. (1973). The General Theory of Employment Interest and Money.  London, Basingstoke: Macmillan.
Stigum, B. P. (1991). Toward a Formal Science of Economics: The Axiomatic Method in Economics and Econometrics. Cambridge: MIT Press.
Tómasson, G., and Bezemer, D. J. (2010). What is the Source of Profit and Interest? A Classical Conundrum Reconsidered. MPRA Paper, 20557: 1–34. URL

Immediately following  From microfoundations to macrofoundations.