October 14, 2016

Loanable funds, lack of scientific firepower and abundance of political fartpower

Comment on Lance Taylor and Lars Syll on ‘Loanable funds theory is inconsistent with data’


Lance Taylor asks: “Today’s New ‘Keynesians’ have tremendous intellectual firepower. The puzzle is why they revert to Wicksell on loanable funds and the natural rate while ignoring Keynes’s innovations.” (See intro)

Lance Taylor’s answer consists in a conspiracy hypothesis: “Wicksell and Keynes planted red herrings for future economists by concentrating on household saving and business investment.”

Reality is much simpler, economists produce false theories because they are scientifically incompetent. It is of utmost importance to realize that economics consists of political economics (= agenda pushing) and theoretical economics (= science). Political economics has captured theoretical economics and has not produced anything of scientific value in the last 200 years. The loanable funds theory is a case in point.

Roughly speaking, the loanable funds theory says that saving and investment are equalized by the interest rate mechanism, which is a variant of standard supply-demand-equilibrium. What economists have not realized to this day is that all three elements of the general market model (supply function, demand function, equilibrium) are nonentities. Keynesians are no exception. As the saying goes: “The difficulty lies, not in the new ideas, but in escaping from the old ones …”

Keynes formulated the formal core of the General Theory as follows: “Income = value of output = consumption + investment. Saving = income - consumption. Therefore saving = investment.” (1973, p. 63)

This elementary syllogism is conceptually and logically defective because Keynes never came to grips with profit (Tómasson et al., 2010, p. 12).#1

The correct profit equation for the investment economy reads: Qm=Yd+I-Sm. Legend Qm: monetary profit, Yd: distributed profit, Sm: monetary saving, I: investment expenditures. All variables are measurable with the precision of two decimal places.

The difference between investment and saving I-Sm plus distributed profit Yd determines monetary profit Qm for the economy as a whole. Saving is NEVER equal to investment, neither ex ante nor ex post, and there is NO mechanism to equalize them, that is, NO such thing as supply-demand-equilibrium. The whole discussion about whether the Wicksellian interest rate mechanism or the Keynesian income mechanism establishes the equality/equilibrium of saving and investment is entirely vacuous. The discussion about monetary and fiscal policy NEVER had a sound scientific foundation ― it has always been political hot air.

To conclude:
(i) All I=S/IS-LM models from Keynes/Hicks to the present are provable false (2014b).
(ii) The loanable funds theory is provable false (2014a).
(iii) The classical and Keynesian profit theories are provable false (2014c).
(iv) The representative economist has not gotten (i) to (iii) to this day because of an absolute lack of intellectual firepower. This, though, has never been a serious disadvantage in the political arena.

Egmont Kakarot-Handtke

Kakarot-Handtke, E. (2014a). Loanable Funds vs. Endogenous Money: Krugman is Wrong, Keen is Right. SSRN Working Paper Series, 2389341: 1–17. URL
Kakarot-Handtke, E. (2014b). Mr. Keynes, Prof. Krugman, IS-LM, and the End of Economics as We Know It. SSRN Working Paper Series, 2392856: 1–19. URL
Kakarot-Handtke, E. (2014c). The Profit Theory is False Since Adam Smith. What About the True Distribution Theory? SSRN Working Paper Series, 2511741: 1–23. URL
Keynes, J. M. (1973). The General Theory of Employment Interest and Money. London, Basingstoke: Macmillan.
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

#1 How Keynes got macro wrong and Allais got it right