December 18, 2016

The final smackdown of blahblah-Keynesianism

Comment on Brad DeLong on ‘(Early) Monday DeLong Smackdown Watch: Has Macroeconomics Gone Right?’


There is a lot of blahblah-Keynesianism that cannot easily be nailed down. But there is also a precious little piece of formalized Keynesianism that can be refuted. The straightforward refutation implodes the vast superstructure of blahblah-Keynesianism.

This is the exact point where macroeconomics has gone wrong: Keynes defined the formal core of the General Theory as follows “Income = value of output = consumption + investment. Saving = income − consumption. Therefore saving = investment.” (p. 63)

From this syllogism follows a series of Keynesian gadgets, prominently among them the multiplier and various IS-LM models.

The lethal fact of the matter is that the two-liner is defective because Keynes never came to grips with profit: “His Collected Writings show that he wrestled to solve the Profit Puzzle up till the semi-final versions of his GT but in the end he gave up and discarded the draft chapter dealing with it.” (Tómasson et al., 2010)

Keynes had NO idea of the foundational concepts of economics, viz. profit and income, and After-Keynesians never detected or rectified his foundational blunder.

To get out of failed Keynesianism requires nothing less than a full-blown paradigm shift to entirely new macrofoundations. In the following, a sketch of the consistent macroeconomic employment theory is given.#1

The elementary version of the objective-systemic-macroeconomic Employment Law for the investment economy (no government, no foreign trade) is shown on Wikimedia.

From this equation follows:
(i) An increase in the expenditure ratio ρE leads to higher employment (the Greek letter ρ stands for ratio). An expenditure ratio ρE greater than 1 indicates credit expansion, a ratio ρE less than 1 indicates credit contraction.
(ii) Increasing investment expenditures I exert a positive influence on employment, a slowdown in growth does the opposite.
(iii) An increase in the factor cost ratio ρF≡W/PR leads to higher employment.

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

Item (i) and (ii) cover Keynes’ well-known arguments about aggregate demand. The factor cost ratio ρF as defined in (iii) embodies the price mechanism which, however, does not work as standard economics assumes. As a matter of fact, overall employment INCREASES if the AVERAGE wage rate W INCREASES relative to average price P and productivity R. This implication is readily testable against standard economics.

The macroeconomic Employment Law is the one stone that kills the Keynesian multiplier, all IS-LM models, the stickiness argument, and the (bastard-) Phillips Curve including the Natural Rate Hypothesis.

Egmont Kakarot-Handtke

#1 For details see the working papers on SSRN  here  here  here  here  here

Related 'Macroeconomics ― dead since Keynes' and 'Macro for dummies'