September 17, 2016

Micro and macro inconsistency

Comment on Jo Michell on ‘Consistent modelling and inconsistent terminology’


“Research is, in fact, a continuous discussion of the consistency of theories: formal consistency insofar as the discussion relates to the logical cohesion of what is asserted in joint theories; material consistency insofar as the agreement of observations with theories is concerned.” (Klant, 1994, p. 31)

Economics is a failed science because Walrasianism, Keynesianism, Marxianism, Austrianism is provably inconsistent. This includes Godley’s and Lavoie’s approach. More precisely, Godley’s and Lavoie’s program ― the integrated approach to credit, money, income, production, and wealth ― is basically correct but at some point, an inconsistency slipped in and that happened exactly in Section 8.2, p. 262 (Godley et al., 2007).

The inconsistency relates to the definitions of profit (monetary, nonmonetary), distributed profit, retained profit, total income, and to the definition of total saving (monetary, nonmonetary). Roughly speaking, monetary profit results from objectively measurable market transactions, nonmonetary profit results from the highly subjective valuation of assets, and these are totally different things (2011b).

The problem of the accounting approach is twofold: (i) as a rule, economists do not understand the elementary mathematics that underlies accounting which leads to an inconsistent definition of total income and GDP (2012), (ii) the approach is axiomatically incomplete because it defines only the relationships of nominal variables.

All purely nominal models, as well as all purely real models, are false because the economy constitutes itself through the interaction of real AND nominal variables. Therefore, the methodologically correct framework is given by — what Keynes called — the ‘monetary theory of production’.

The overall failure of economics lies in the fact that economists argue from false premises/axioms, that is, Walrasianism in all shapes and forms (DSGE, RBC, AD/AS, etc.) argues from forever unacceptable microfoundations, and Keynesianism in all shapes and forms argues from false macrofoundations. To get out of failed economics requires nothing less than a Paradigm Shift from inconsistent to consistent foundations/axioms.

The correct macrofoundations are shown on Wikimedia AXEC137b.

Post/New/After-Keynesians have not realized until this very day that Keynes had messed up the formal foundations of the General Theory (1973, p. 63). The fatal flaw of Keynes’ and Godley’s/Lavoie’s approach is that the underlying profit theory is false (2011a). Clearly, if one gets the foundational concept of economics wrong all the rest of one’s theory is worthless. The present state of economics is that neither the microfounded Walrasians nor the macrofounded Keynesians have a formally and materially consistent theory of how the market economy works. Because of this, economic policy guidance has ― for more than 200 years ― zero scientific content. This applies also to the shop talk of Jo and Simon.

Egmont Kakarot-Handtke

Godley, W., and Lavoie, M. (2007). Monetary Economics. An Integrated Approach to Credit, Money, Income and Wealth. Houndmills, Basingstoke, New York: Palgrave Macmillan.
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). Primary and Secondary Markets. SSRN Working Paper Series, 1917012: 1–26. URL
Kakarot-Handtke, E. (2012). The Common Error of Common Sense: An Essential Rectification of the Accounting Approach. SSRN Working Paper Series, 2124415: 1–23. URL
Keynes, J. M. (1973). The General Theory of Employment Interest and Money. London, Basingstoke: Macmillan.
Klant, J. J. (1994). The Nature of Economic Thought. Aldershot, Brookfield: Edward Elgar.