November 10, 2019

Exploding the Household Fallacy

Comment on Charles Adams on ‘The household fallacy’*

Blog-Reference and Blog-Reference (Link) and Blog-Reference Nov 15

Charles Adams, a physics professor at the University of Durham, explains the Household Fallacy: “When the goverment spends, that spending is someones income and that someone pays some tax so the government immediately gets some of their money back. And then that someone spends most of their money which becomes other peoples income. And these other people also pay tax, so the government gets another fraction back. And these other people also spend which becomes the income of even more people who also give a fraction back to the goverment. And so on. If everyone spends then the government gets all its money back. Whereas when you or I spend we do not get anything back. That is a big difference. The only way the goverment can be in deficit is if the people decide to save. The goverment debt is simply the peoples savings. If at any point the people go out and spend their savings, then the goverment debt will be cleared.”

The first thing to notice is that in this story only the government sector and “people”, i.e. the household sector, appear but not the business sector. And, curiously, the word profit does not appear once. An economic story without profit is fishy, to begin with. However, having a bad smell in the nose and precisely locating its source are quite different things. So, one has to advance from storytelling to proper economic analysis.

For a start, one needs a description of the elementary production-consumption economy. This economy is constructed from scratch with the following set of macroeconomic axioms: (A0) The objectively given and most elementary configuration of the economy consists of the household sector 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. This is the macroeconomic Law of Supply and Demand. For the graphical representation of the analytical starting point see Wikimedia AXEC31.#1

In this elementary economy, the Central Bank finances the wage bill by creating fiat money out of nothing. The average stock of transaction money is given as M=κYw, with κ determined by the payment pattern.#2

So, the business sector spends money into the economy in the form of wage income Yw and gets it back in the form of consumption expenditures C. The stock of fiat money is zero at the beginning of the period under consideration and zero at the end. Money is created and destroyed by the autonomous transactions between the business and the household sector. There is NO government NO taxes and NO deficit spending.

It is pretty obvious that this elementary production-consumption economy can run for all eternity at any level of employment. Problems arise if the households do not spend exactly their income, i.e. do not balance their budget.

Dropping the condition C=Yw yields two balances: Saving/dissaving of the household sector S≡Yw−C and profit/loss of the business sector Q≡C−Yw. It always holds Q≡−S, in other words, the business sector’s surplus = profit equals the household sector’s deficit = dissaving and, vice versa, the business sector’s deficit = loss equals the household sector’s surplus = saving. This is the most elementary form of the macroeconomic Profit Law.

Now, if the households save the business sector makes a loss and if this continues for a while the economy breaks down. If the households dissave, i.e. run a deficit, the business sector makes a profit. The business sector’s deposits at the Central Bank (= money) grow in perfect lockstep with the household sector’s overdrafts (= debt). The deficit-spending of the households is financed by the Central Bank and it ends when the Central Bank puts a brake on further debt growth. In this case, C falls back to Yw and profit falls back to zero.

Conclusion: Capitalism depends on profit and profit depends on deficit spending, so Capitalism depends, in the most elementary case, on the growing debt of the household sector. It is NOT enough that “people” always fully spend their wage income, they have to spend more. So ultimately, Capitalism depends on a credit-creating banking system. However, here is the problem: either the households are not willing to go into debt or the banking system is not willing to give them much credit for an extended time span.

This is where the state comes to the rescue. With the state as an additional sector, the Profit Law reads Q≡−S+(G−T). So, if the private households balance their budget, i.e. S=0, and the public households balance their budget, i.e. G−T=0, the balance of the business sector (= profit) is zero. If the government sector taxes only a part of its expenditures back, i.e. T<G, then the business sector makes a profit, i.e. Q=G−T. The minimum condition for the survival of state-sponsored Capitalism is G−T>S.

Now, the crucial difference between private households and public households is that the growth of household sector debt is limited while the growth of public sector debt is virtually unlimited. Up to an ex-ante unknown amount, state debt is considered riskless because of the taxing power of the state.

So, the Household Fallacy does NOT come down to the economic miracle that “If everyone spends then the government gets all its money back.” No, the government runs a deficit, i.e. G−T>0, while the households spend what they get as wage income, i.e. C=Yw. The government does NOT get its spending back and this is why the public debt permanently increases ($22 trillion and counting).#3

The Household Fallacy consists of the idea that the public sector is, in the same way, debt-restricted as the individual household. MMT is absolutely right in pointing out that this is NOT the case. However, MMT is absolutely wrong in maintaining that government deficit-spending/money-creation is a good economic policy. As a general rule, is NOT. MMT policy creates the distribution of income and wealth that is now generally regarded as a grave danger to social stability. Economically, MMT policy amounts to the limitless issuance of counterfeit currency for the benefit of the Oligarchy.

The physics professor again gets economics badly wrong.#4 There is something rotten in UK academia.

Egmont Kakarot-Handtke

* Progressive Pulse
#1 Wikimedia AXEC31
#2 For details see Criminals and the monetary order
#3 Keynes, Lerner, MMT, Trump, Biden. and exploding profit
#4 MMT and the single most stupid physicist

Related 'The sectoral balances obfuscation: stupidity or corruption?' and 'The right and the wrong way to bring money into the economy' and 'Dear idiots, it is deficit spending that creates the distribution people complain about' and 'Dear idiots, government deficits do NOT fund private savings' and 'How counterfeiters save America with an extra profit and make WeThePeople pay for it' and 'MMT undermines democracy' and 'The MMT-Yawner: Government is not a household' and 'Swabian housewife vs Wall Street loan shark' and 'Why economists always seem to lose the fight against inequality' and 'Links on Austerity' and 'A beginner’s guide to MMT' and 'From the debt economy to the gift economy: how America is brainwashed to love budget deficits'.

Nov 14
Link missing