April 4, 2019

The canonical macroeconomic model

Comment on Noah Smith on ‘Examining an MMT model in detail’

Blog-Reference (Link) and Blog-Reference

Under the heading Formal Models vs. Guru-Based Theories Noah Smith demands: “These days, most economic theories are collections of mathematical models. If you want to know what the theory says, you can parse out the models and see for yourself. You don’t have to go ask Mike Woodford what New Keynesian theory says. You don’t have to go ask Ed Prescott what RBC theory says. You can go read a New Keynesian model or a Real Business Cycle model and figure it out on your own. MMT is different. There are many wordy explainers and videos that will explain some of the concepts behind MMT, or tell you some of MMT’s policy recommendations. But that’s different than having a formal model of the economy.” and “I want to be able to read a concrete, formal, well-specified model like the Tcherneva model above, and answer these questions myself.”

The problem with economics is this: microfoundations are false and because of this ALL microeconomic models are false. Supply-demand-equilibrium is proto-scientific garbage. However, macrofoundations are also false and because of this, ALL macroeconomic models are false since Keynes, including MMT. Proofs have been given elsewhere.

However, critique of Mainstream or MMT has run its course: “The moral of the story is simply this: it takes a new theory, and not just the destructive exposure of assumptions or the collection of new facts, to beat an old theory.” (Blaug)

From the overall failure of economics follows that a new theory has to be macrofounded but not Keynesian because Keynes messed things up. What is required is the Paradigm Shift from false microfoundations and false Keynesian macrofoundations to true macrofoundations.

So, let us forget methodological individualism and kick off the “concrete, formal, well-specified” macrofounded approach. The elementary production-consumption economy is defined with this set of macroeconomic axioms: (A0) The economy consists of the household and the business sector which, in turn, consists initially of one giant fully integrated firm. (A1) Yw=WL wage income Yw is equal to wage rate W times working hours. L, (A2) O=RL output O is equal to productivity R times working hours L, (A3) C=PX consumption expenditure C is equal to price P times quantity bought/sold X.

Under the conditions of market-clearing X=O and budget-balancing C=Yw in each period, the price as the dependent variable is given by P=W/R (1a). The price is determined by the wage rate W, which takes the role of the nominal numéraire, and the productivity R. The elementary production-consumption economy is shown on Wikimedia.#1

What is needed for a start is two things (i) a central bank which creates money on its balance sheet in the form of deposits, and (ii), a legal system which declares the central bank’s deposits as legal tender.

Deposit money is needed by the business sector to pay the workers who receive the wage income Yw per period. The need is only temporary because the business sector gets the money back if the workers fully spend their income, i.e. if C=Yw. Overdrafts are needed by the household sector for consumption expenditures if the households want to spend before they get their income.

For the case of a balanced budget C=Yw, the idealized transaction pattern of deposits/overdrafts of the household sector at the Central Bank over the course of one period is shown on Wikimedia.#2

The household sector’s deposits/overdrafts are zero at the beginning and end of the period. Money is continually created and destroyed during the period under consideration. There is NO such thing as a fixed quantity of money. The central bank plays an accommodative role and supports the autonomous market transactions between the household and the business sector. From this follows the average stock of transaction money as M=κYw, with κ determined by the transaction pattern.

If employment L is doubled, the average stock of transaction money M doubles. In a well-designed fiat money economy, growth is not hampered by a lack of the transaction medium. Money is endogenous and neutral.

The general price level P can be anchored by setting the wage rate W. In order to avoid both inflation and deflation, the rate of change of W has always to be equal to the rate of change of R. The Quantity Theory is dead because M is not a price determinant.

The macroeconomic Law of Supply and Demand (1a) implies W/P=R (1b), i.e. the real wage is always equal to the productivity no matter how the wage rate W is set.

Ramifications: (i) The State is needed for the institutional setup of the monetary order, (ii) the State is NOT needed for injecting money into the economy, (iii) what is needed is an accommodative Central Bank, (iv) neither the State nor the Central Bank interferes with the autonomous transactions of the household and business sector, (v) money is a generalized IOU, (vi) money is created and destroyed by the transactions between the household and the business sector, (vii) the value of money is given by W/P=R (1b), i.e. is equal to the productivity, (viii) the value of money does NOT depend on the (average) stock of money M, (ix) the functionality of monetary institutions and the value of money does NOT depend on the taxing power of the State.

The focus is here on the nominal/monetary balances. For the time being, real balances are excluded, i.e. it holds X=O. The condition of budget balancing, i.e. C=Yw, is now skipped. The monetary saving/dissaving of the household sector is defined as S≡Yw−C. The monetary profit/loss of the business sector is defined as Q≡C−Yw. Ergo Q≡−S.

The balances add up to zero. The mirror image of household sector saving S is business sector loss −Q. The mirror image of household sector dissaving (-S) is business sector profit Q. Q≡−S is the elementary version of the macroeconomic Profit Law.

Ramifications: (i) Because the mirror image of saving is loss Keynes’ I=S is false, (ii) ALL IS-LM models are false, (iii) Post Keynesianism in ALL variants is false.

Now, additional sectors can be introduced. The complete macroeconomic Profit Law is given by QYd+(I−S)+(G−T)+(X−M). #3, #4 In order to focus on the interactions between household, business, and government sector, it is here reduced to Q−S+(G−T). Legend: Q macroeconomic profit, S household sector saving, G government expenditures, T taxes, (G−T)>0 government deficit.

If the government’s budget is balanced, i.e. G=T, and if the households dissave then the business sector makes a profit, i.e. Q is positive.

If the government’s budget is balanced and the households save, i.e. S≡Yw−C>0, then the business sector makes a loss, i.e. Q is negative.

If the government’s budget deficit, i.e. (G−T)>0, is equal to the household sector’s saving, i.e. (G−T)=S, then macroeconomic profit Q is zero.

If the government’s deficit is greater than household sector saving, then the business sector makes a profit.

If the household sector’s saving is zero, i.e. S=0, and the government deficit is greater than zero, i.e. (G−T)>0, then it holds Q=(G−T), i.e. the business sector’s profit equals the government sector’s deficit. So, if the State deficit-spends in the elementary production-consumption economy it follows (i) a one-off price hike (NO inflation) under the condition of market clearing, (ii) Public Deficit = Private Profit. Bringing money into the economy by public deficit spending is NOT distributionally neutral, just the opposite: it is a free lunch for the Oligarchy.

MMT’s sectoral balances equation is false. Because of this, the whole analytical superstructure is false. MMT policy guidance has no sound scientific foundations and is harmful to the ninety-nine-percenters. MMT is refuted on all counts.

Any model that lacks true macrofoundations is scientifically worthless. Axioms (A0) to (A3) define the canonical macroeconomic model. The rest of microfounded and macrofounded economics goes down the scientific drain.

Egmont Kakarot-Handtke

#1 Wikimedia AXEC31 Elementary production-consumption economy
#2 Wikimedia AXEC98 Idealized transaction pattern
#3 The Profit Law yields the correct macroeconomic sectoral balances equation (I−S)+(G−T)+(X−M)−(Q−Yd)=0 which compares to the false MMT equation (I−S)+(G−T)+(X−M)=0. The equations are testable with the precision of two decimal places.
#4 Refuting MMT’s Macroeconomics Textbook

Related 'MMT vs Mainstream: examining proto-scientific garbage in detail' and 'The Law of Supply and Demand: Here It Is Finally' and 'How to Get Rid of Supply-Demand-Equilibrium' and 'The real trouble with Econ 101' and 'MMT sucks' and 'Where MMT got macroeconomics wrong' and 'Mr. Keynes, Prof. Krugman, IS-LM, and the End of Economics as We Know It' and 'Why Post Keynesianism Is Not Yet a Science' and 'MMT: A free lunch for the Oligarchy' and 'New Economic Thinking: The 10 crucial points' and 'Economics for Economists'. For details of the big picture see Paradigm Shift and for the full-spectrum refutation of MMT see cross-references MMT.

Wikimedia AXEC121i


LINKS on Pavlina Tcherneva’s ‘MMT, Models, Multidisciplinarity’ on Apr 8 and Blog-Reference

Pavlina Tcherneva’s model is NOT false because of some behavioral assumptions but because her macroeconomics is provably false. The model is built upon this defective accounting identity G+I=T+S. For details see

REPLY to André on Apr 9

You say: “To understand finance or economics, you need first to understand what currency is (a tax credit). It is a prerequisite. You can’t move one step without it.” and “Send an email to any of them (Bill Mitchell, Warren Mosler, Randall Wray, Stephanie Kelton, Scot Fullwiler, etc) and they will tell that ‘taxes drive money’ is the pillar and integral part of MMT. Also, everything you read in MMT is a direct or indirect consequence of ‘taxes drive money’, 

Take notice that the assertion that taxes drive money is false and has been refuted.


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