#Economics#Walrasianism, #Keynesianism, #Marxianism, #Austrianism etc. are axiomatically false & materially/formally inconsistent & ALL got #Profit wrong. Therefore, a #ParadigmShift is inevitable.
— E.K-H (@AXECorg) September 14, 2023
The Synthesis of Economic Law, Evolution, and Historyhttps://t.co/dHn56N7bbH
Showing posts with label Time. Show all posts
Showing posts with label Time. Show all posts
September 14, 2023
Occasional Xs: Clueless economists / Time & Evolution
June 13, 2018
Nick Rowe’s soap bubbling about money
Comment on Nick Rowe on ‘The Parable of the Fruit Trees’
Blog-Reference
“The apple producer produces apples. The banana producer produces bananas. The cherry producer produces cherries.” The economist produces proto-scientific garbage.
What is wrong with Nick Rowe’s depiction of the economy? The subject matter of economics is, as Keynes said, the ‘monetary theory of production’. This sets the frame for the theory of money. The fact that Nick Rowe clings to a long-defunct barter parable proves that he has no idea how the economy works.
As the correct analytical starting point, the elementary production-consumption economy is defined with this set of macroeconomic axioms: (A0) The objectively given and most elementary configuration of 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 is given by P=W/R (1). This is the most elementary form of the macroeconomic Law of Supply and Demand.
The price P is determined by the wage rate W, which takes the role of the nominal numéraire, and the productivity R. The quantity of money is NOT among the price determinants. This puts the commonplace Quantity Theory forever to rest.
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 sequence of deposits/overdrafts of the household sector at the central bank over the course of one period is shown on Wikimedia.#1
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 simply 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. In other words, the average stock of money M is determined by the autonomous transactions of the household and business sector and created out of nothing by the central bank. The economy NEVER runs out of money. There is NO such thing as “an excessive demand for one particular asset (the medium of exchange) relative to other assets.”
The transaction equation reads M=κPRL (2) in the case of budget balancing and market clearing. If employment L is doubled, the average stock of transaction money M doubles. If employment is halved, the average stock of transaction money M halves.
As long as the central bank finances the wage bill Yw=WL with money creation out of nothing, and with wage rate W and productivity R fixed, the price P does not move one iota according to (1). The average quantity of money M increases/decreases according to (2) but there is no inflation/deflation. Money is absolutely neutral. The creation of fiat money is the correct way of bringing money into the elementary production-consumption economy.
Egmont Kakarot-Handtke
#1 Wikimedia AXEC98 Idealized transaction pattern
Related 'The futile attempt to recycle Sraffa' and 'Money: from silly stories to the true theory' and 'Primary and Secondary Markets' and 'Exchange in the Monetary Economy' and 'Getting out of the economics swamp'.
Nick Rowe clarifies his parable: “It is not an excessive desire to accumulate assets that causes recessions; it is an excessive demand for one particular asset (the medium of exchange) relative to other assets. It’s about the composition of their portfolios of assets, not about the total size of that portfolio.”
The two lethal blunders of Nick Rowe are:
• to frame elementary economic activity as barter of stocks of goods a.k.a. assets,
• to frame money as an asset.
The elementary economy is about production and consumption. Input is a real flow = labor time per period, output is a real flow = apples/bananas/cherries per period, income is a nominal flow, and so on. Money is neither a stock, nor a flow. Money is not a thing, not a real asset. Money is information. The information is stored on a medium, e.g. magnetic data carrier, clay tablet, paper, coin, etcetera. As a matter of principle, money cannot be scarce, only the physical data carrier can become scarce.
Money starts as a medium of transaction as shown in the previous post and it supports ANY level of economic activity. Problems arise if the households do not balance their budget, i.e. do not fully spend their period income, that is, if consumption expenditures C are less than wage income Yw. In this case, the household sector’s deposits at the central bank increase, and money morphs from a pure transaction medium to a store of value.#1
Precisely at this point, money becomes an asset, more precisely a financial asset. All real assets (apples, bananas, cherries) are zero at the beginning of the period and at the end of the period. The household sector’s portfolio consists solely of deposits at the central bank. This is how the monetary economy works. Nobody barters apples for bananas.
In the elementary production-consumption economy, the household sector can increase its stock of money if C is less than Yw. This has some obvious consequences for the business sector.
Monetary profit for the economy as a whole is defined as Qm≡C−Yw and monetary saving as Sm≡Yw−C. It always holds Qm≡−Sm, in other words, the business sector’s surplus = profit equals the household sector’s deficit = dissaving. 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.
The simple fact of the matter is: as the household sector’s deposits at the central bank rise, so do the business sector’s overdrafts. The central bank’s balance sheet is always balanced. The business sector’s debt increases, that is, its deposits at the central bank = money become very, very scarce, and THIS causes a recession. The composition of output and changes in the composition of output (apples, bananas, cherries) are absolutely irrelevant.
Now, give Nick Rowe a banana, and send him back into the barter woods.
#1 Money and time
In the two preceding posts, it has been argued that Nick Rowe’s barter parable lacks the elementary features of the monetary economy. Barter models have always been false and will always be false because the economy constitutes itself through the interaction of real and nominal variables.#1
It has been argued that the composition of output and changes in the composition of output (apples, bananas, cherries) are irrelevant for the money transactions between the household- and the business sector and that they do not cause a recession. Only a reduction of total nominal demand causes a recession.
To see this, let us make a simple example. Imagine two firms, 1 and 2 for short. The wage rates in both firms are equal, so the total wage income is Yw=WL1+WL2 and total employment is L=L1+L2.
In the initial period, the respective prices are equal to unit wage costs, i.e. P1=W/R1 and P2=W/R2. Therefore, the profit in both firms is initially zero. The household sector spends total wage income on the two products, i.e. C=Yw, so there is neither saving nor dissaving.
The distribution of total consumption expenditures C=C1+C2 between the two products determines the production of the respective quantities and the respective labor inputs L1 and L2. It holds C=C1+C2=W(L1+L2)=WL=Yw.
So, if the household sector wants more of product 1 it spends more on it and less on product 2, such that C1 goes up and C2 goes down and C remains unchanged. Accordingly, the business sector employs more workers in firm 1 and less in firm 2, such that L1 goes up and L2 goes down and total employment L and total income Yw remain unchanged.
The relative price, i.e. the exchange relation between the two products remains unchanged, i.e. P1/P2=R2/R1.
So, changes in the preferences between the two products are mirrored in changes in the distribution of labor input between the two firms. This configuration can go on forever. Problems arise only if the household sector reduces total consumption expenditures C, such that saving Sm≡C−Yw is now greater zero. In this case, the business sector makes a loss and the economy goes into recession.
#1 The irreparable unreality of all ‘real’ models
The lethal flaw of The Parable of the Fruit Trees is the obsolete concept of direct barter. In the monetary economy, barter is indirect. In methodological terms, barter economists commit the Fallacy of Insufficient Abstraction.
In the monetary economy, agent 1 does not produce product 1 and barters directly with agent 2 who produces product 2.
In the monetary economy, agent 1 works in firm 1 which produces product 1 and gets the wage income Yw1 which is paid with a transfer of deposits at the central bank.
Analogous for agent 2.
Agent 1 then spends part of his income on product 2. Analogous for agent 2 who spends part of his income on product 1. This is how INDIRECT barter happens. By buying the other firm’s output, agent 1 barters “his” product with agent 2 and vice versa.
Indirect barter presupposes the existence of money which is used (i) to pay the wage bill, and (ii), to buy the products. Money is created and destroyed in the process. The cycle can be repeated ad infinitum. Transaction money is NOT a stock and NOT an asset. It is zero at the beginning and the end of the cycle.
Changes in preferences lead to changes in output and production and the allocation of labor between the two firms. Total spending and total employment and the relative prices do NOT change in the process. Production adapts quantitatively to preferences.
Put simply, if agents want more of product 1 and less of product 2 more labor input has to be allocated to firm 1 and less to firm 2. The change in the composition of output has NO effect on the monetary transactions. Total income and total consumption expenditures remain unaffected.
Only if the household sector saves, which gradually increases its “stock of money” = average amount of deposits at the central bank, problems arise in the elementary production-consumption economy. Changes in the composition of output do not, they only lead to a reallocation of labor input.
Needless to emphasize that normally the two processes, growth/shrinkage of total production/output/average stock of transaction money and change in the composition of output are mixed. Analytically, though, they have to be strictly kept apart.
You say: “There has to be money to start the transaction cycle. Money is needed for a purchase.”
Money is created in the act of transaction. Either the business sector creates an IOU and hands it over as wage payment to the household sector, or the central bank creates uno actu deposits for the wage receivers and corresponding overdrafts for the firms. The purchase of the output destroys money = deposits at the central bank. This is how fiat money works. The transactions themselves create/destroy money.
At the logical beginning of economic activity, there is neither a stock of goods nor of money. All physical stocks have to be produced and money is produced (or ‘created out of nothing’) by the central bank/banking system. The economic analysis starts at zero. And this holds also for the theory of money.
You say: “Simultaneous is a relative when money moves faster than fruit.”
The purpose of a parable is to make one point as clear as possible. For this purpose, the situation is radically simplified. Needless to emphasize that simplification and idealization are legitimate tools of analysis. However, as always, there is the possibility that the tool is misapplied and that the dilettantish scientific craftsman hits his thumb instead of the nail.
The problem with simplification/idealization is that it erroneously abstracts reality away instead of all the details that are indeed irrelevant for the question at issue. One of the most prominent examples of the Fallacy of Insufficient Abstraction is simultaneity. This is to eliminate time and this is sufficient to relegate any model/parable into the Dancing-Angels-On-A-Pinpoint category.
Nick Rowe’s Parable of the Fruit Trees, too, falls into this category. Its lethal defect is long known as the Hahn problem: “The Hahn problem reveals three things. First, a perfect barter GE solution always exists in any ‘monetary’ model erected on Walrasian GE microeconomic foundations. Second, inessential monetary features are easily attached to perfect barter microeconomic foundations but as easily removed, leaving the perfect barter solution intact. Third, attaching such inessential additions leads to logical error; the misuse of language that produces invalid conclusions.”*
Nick Rowe and Matthew Young have not gotten the point that in the monetary economy barter is indirect and that therefore the discussion of direct barter is pretty much a revival of the Dancing-Angels-On-A-Pinpoint disputations of the Middle Ages.
* Colin Rogers, Review of Political Economy
You say: “One problem we have translating your parable to the real world is that asset prices are generally highly flexible (and arguably asset markets can be much more easily cleared by price movements than goods and labour markets).”
Not at all! The real problem is that economists have after 200+ years still no clue how the price- and profit mechanism works.
To begin with, there are TWO fundamentally different types of markets.#1 In the elementary production-consumption economy one has the flows of labor input and product output (apples, bananas, cherries per period). The quantity produced is, for a start, equal to the quantity sold and consumed. So the stock of products is zero at the beginning and the end of the period. The primary markets (e.g. product, labor) deal with flows.
If part of the output is not consumed in the same period then there remains a stock of durable goods = real assets, e.g. houses. This is how the secondary markets come into existence.
The point is that the primary and secondary markets run on entirely different principles and that they can by no stretch of the scientific imagination be described with the barter parable nor with supply-demand-equilibrium. What Leijonhufvud has called the Totem-of-the-Micro has always been nincompoop-economics.
#1 Primary and Secondary Markets
Nick Rowe concludes: “If we see recessions as a cluster of symptoms, that usually (but not always) go together, it’s not obvious how we define a ‘recession’, and whether we define it in terms of symptoms or of causes. And what’s true by definition and what’s true/false as a statement of fact. Bit like defining different illnesses.”
There is science, and it is binary true/false with NOTHING in between. Truth is well-defined for 2300+ years by formal and material consistency. And there is the large swamp of cargo cult science where, as Keynes said, “nothing is clear and everything is possible.”
In the swamp, vagueness, indeterminacy, inconclusiveness, confusion dressed up as complexity, unresolved contradictions, storytelling, filibuster, gossip, finicky scholasticism (Popper), known/unknown unknowns, and the Humpty Dumpty Fallacy are the prevailing components of communication.#1, #2, #3
This, of course, has not gone unnoticed: “The currently prevailing pattern of economic theorizing exhibits the following three characteristics: (1) a syncopated style of argument fluctuating back and forth between literary and symbolic modes of expression, (2) naive translation, or the loose paraphrasing of formulae into sentences, and (3) loose verbal reasoning for certain aspects of theoretical argumentation where explicit symbolic formulation is lacking.” (Dennis, 1982)
From Nick Rowe’s Parable of the Fruit Trees nothing can be learned about how the price- and profit mechanism works. This does not matter, though, because the purpose of economics has never been to clarify matters and to advance science but to keep everything and everybody in the swamp of inconclusiveness.
Vagueness and inconclusiveness protect the scientifically incompetent and secure the status quo because:
• “... you cannot prove a vague theory wrong.” (Feynman)
• “With enough fog emitted, almost anything becomes possible.” (Mirowski)
One will not find one single scientist in the swamp.#4 The swamp has always been the habitat of parable-tellers and cargo cult scientists.
Egmont Kakarot-Handtke
#1 It is better to be precisely right than roughly wrong
#2 “This is a tough question to adjudicate on scientific grounds since the issue is largely definitional and, as Lewis Carroll pointed out, everyone is entitled to his own definitions.” (Blinder)
#3 “’When I use a word,’ Humpty Dumpty said in rather a scornful tone, ‘it means just what I choose it to mean — neither more nor less.’ ‘The question is,’ said Alice, ‘whether you can make words mean so many different things.’ ‘The question is,’ said Humpty Dumpty, ‘which is to be master — that’s all’.”
#4 Getting out of the economics swamp
Blog-Reference
“The apple producer produces apples. The banana producer produces bananas. The cherry producer produces cherries.” The economist produces proto-scientific garbage.
What is wrong with Nick Rowe’s depiction of the economy? The subject matter of economics is, as Keynes said, the ‘monetary theory of production’. This sets the frame for the theory of money. The fact that Nick Rowe clings to a long-defunct barter parable proves that he has no idea how the economy works.
As the correct analytical starting point, the elementary production-consumption economy is defined with this set of macroeconomic axioms: (A0) The objectively given and most elementary configuration of 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 is given by P=W/R (1). This is the most elementary form of the macroeconomic Law of Supply and Demand.
The price P is determined by the wage rate W, which takes the role of the nominal numéraire, and the productivity R. The quantity of money is NOT among the price determinants. This puts the commonplace Quantity Theory forever to rest.
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 sequence of deposits/overdrafts of the household sector at the central bank over the course of one period is shown on Wikimedia.#1
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 simply 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. In other words, the average stock of money M is determined by the autonomous transactions of the household and business sector and created out of nothing by the central bank. The economy NEVER runs out of money. There is NO such thing as “an excessive demand for one particular asset (the medium of exchange) relative to other assets.”
The transaction equation reads M=κPRL (2) in the case of budget balancing and market clearing. If employment L is doubled, the average stock of transaction money M doubles. If employment is halved, the average stock of transaction money M halves.
As long as the central bank finances the wage bill Yw=WL with money creation out of nothing, and with wage rate W and productivity R fixed, the price P does not move one iota according to (1). The average quantity of money M increases/decreases according to (2) but there is no inflation/deflation. Money is absolutely neutral. The creation of fiat money is the correct way of bringing money into the elementary production-consumption economy.
Egmont Kakarot-Handtke
#1 Wikimedia AXEC98 Idealized transaction pattern
Related 'The futile attempt to recycle Sraffa' and 'Money: from silly stories to the true theory' and 'Primary and Secondary Markets' and 'Exchange in the Monetary Economy' and 'Getting out of the economics swamp'.
***
REPLY to Nick Rowe on Jun 14Nick Rowe clarifies his parable: “It is not an excessive desire to accumulate assets that causes recessions; it is an excessive demand for one particular asset (the medium of exchange) relative to other assets. It’s about the composition of their portfolios of assets, not about the total size of that portfolio.”
The two lethal blunders of Nick Rowe are:
• to frame elementary economic activity as barter of stocks of goods a.k.a. assets,
• to frame money as an asset.
The elementary economy is about production and consumption. Input is a real flow = labor time per period, output is a real flow = apples/bananas/cherries per period, income is a nominal flow, and so on. Money is neither a stock, nor a flow. Money is not a thing, not a real asset. Money is information. The information is stored on a medium, e.g. magnetic data carrier, clay tablet, paper, coin, etcetera. As a matter of principle, money cannot be scarce, only the physical data carrier can become scarce.
Money starts as a medium of transaction as shown in the previous post and it supports ANY level of economic activity. Problems arise if the households do not balance their budget, i.e. do not fully spend their period income, that is, if consumption expenditures C are less than wage income Yw. In this case, the household sector’s deposits at the central bank increase, and money morphs from a pure transaction medium to a store of value.#1
Precisely at this point, money becomes an asset, more precisely a financial asset. All real assets (apples, bananas, cherries) are zero at the beginning of the period and at the end of the period. The household sector’s portfolio consists solely of deposits at the central bank. This is how the monetary economy works. Nobody barters apples for bananas.
In the elementary production-consumption economy, the household sector can increase its stock of money if C is less than Yw. This has some obvious consequences for the business sector.
Monetary profit for the economy as a whole is defined as Qm≡C−Yw and monetary saving as Sm≡Yw−C. It always holds Qm≡−Sm, in other words, the business sector’s surplus = profit equals the household sector’s deficit = dissaving. 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.
The simple fact of the matter is: as the household sector’s deposits at the central bank rise, so do the business sector’s overdrafts. The central bank’s balance sheet is always balanced. The business sector’s debt increases, that is, its deposits at the central bank = money become very, very scarce, and THIS causes a recession. The composition of output and changes in the composition of output (apples, bananas, cherries) are absolutely irrelevant.
Now, give Nick Rowe a banana, and send him back into the barter woods.
#1 Money and time
***
REPLY to Nick Rowe and other commentators on Jun 15In the two preceding posts, it has been argued that Nick Rowe’s barter parable lacks the elementary features of the monetary economy. Barter models have always been false and will always be false because the economy constitutes itself through the interaction of real and nominal variables.#1
It has been argued that the composition of output and changes in the composition of output (apples, bananas, cherries) are irrelevant for the money transactions between the household- and the business sector and that they do not cause a recession. Only a reduction of total nominal demand causes a recession.
To see this, let us make a simple example. Imagine two firms, 1 and 2 for short. The wage rates in both firms are equal, so the total wage income is Yw=WL1+WL2 and total employment is L=L1+L2.
In the initial period, the respective prices are equal to unit wage costs, i.e. P1=W/R1 and P2=W/R2. Therefore, the profit in both firms is initially zero. The household sector spends total wage income on the two products, i.e. C=Yw, so there is neither saving nor dissaving.
The distribution of total consumption expenditures C=C1+C2 between the two products determines the production of the respective quantities and the respective labor inputs L1 and L2. It holds C=C1+C2=W(L1+L2)=WL=Yw.
So, if the household sector wants more of product 1 it spends more on it and less on product 2, such that C1 goes up and C2 goes down and C remains unchanged. Accordingly, the business sector employs more workers in firm 1 and less in firm 2, such that L1 goes up and L2 goes down and total employment L and total income Yw remain unchanged.
The relative price, i.e. the exchange relation between the two products remains unchanged, i.e. P1/P2=R2/R1.
So, changes in the preferences between the two products are mirrored in changes in the distribution of labor input between the two firms. This configuration can go on forever. Problems arise only if the household sector reduces total consumption expenditures C, such that saving Sm≡C−Yw is now greater zero. In this case, the business sector makes a loss and the economy goes into recession.
#1 The irreparable unreality of all ‘real’ models
***
REPLY to Nick Rowe on Jun 16The lethal flaw of The Parable of the Fruit Trees is the obsolete concept of direct barter. In the monetary economy, barter is indirect. In methodological terms, barter economists commit the Fallacy of Insufficient Abstraction.
In the monetary economy, agent 1 does not produce product 1 and barters directly with agent 2 who produces product 2.
In the monetary economy, agent 1 works in firm 1 which produces product 1 and gets the wage income Yw1 which is paid with a transfer of deposits at the central bank.
Analogous for agent 2.
Agent 1 then spends part of his income on product 2. Analogous for agent 2 who spends part of his income on product 1. This is how INDIRECT barter happens. By buying the other firm’s output, agent 1 barters “his” product with agent 2 and vice versa.
Indirect barter presupposes the existence of money which is used (i) to pay the wage bill, and (ii), to buy the products. Money is created and destroyed in the process. The cycle can be repeated ad infinitum. Transaction money is NOT a stock and NOT an asset. It is zero at the beginning and the end of the cycle.
Changes in preferences lead to changes in output and production and the allocation of labor between the two firms. Total spending and total employment and the relative prices do NOT change in the process. Production adapts quantitatively to preferences.
Put simply, if agents want more of product 1 and less of product 2 more labor input has to be allocated to firm 1 and less to firm 2. The change in the composition of output has NO effect on the monetary transactions. Total income and total consumption expenditures remain unaffected.
Only if the household sector saves, which gradually increases its “stock of money” = average amount of deposits at the central bank, problems arise in the elementary production-consumption economy. Changes in the composition of output do not, they only lead to a reallocation of labor input.
Needless to emphasize that normally the two processes, growth/shrinkage of total production/output/average stock of transaction money and change in the composition of output are mixed. Analytically, though, they have to be strictly kept apart.
***
REPLY to Henry Rech on Jun 16You say: “There has to be money to start the transaction cycle. Money is needed for a purchase.”
Money is created in the act of transaction. Either the business sector creates an IOU and hands it over as wage payment to the household sector, or the central bank creates uno actu deposits for the wage receivers and corresponding overdrafts for the firms. The purchase of the output destroys money = deposits at the central bank. This is how fiat money works. The transactions themselves create/destroy money.
At the logical beginning of economic activity, there is neither a stock of goods nor of money. All physical stocks have to be produced and money is produced (or ‘created out of nothing’) by the central bank/banking system. The economic analysis starts at zero. And this holds also for the theory of money.
***
REPLY to Matthew Young on Jun 18You say: “Simultaneous is a relative when money moves faster than fruit.”
The purpose of a parable is to make one point as clear as possible. For this purpose, the situation is radically simplified. Needless to emphasize that simplification and idealization are legitimate tools of analysis. However, as always, there is the possibility that the tool is misapplied and that the dilettantish scientific craftsman hits his thumb instead of the nail.
The problem with simplification/idealization is that it erroneously abstracts reality away instead of all the details that are indeed irrelevant for the question at issue. One of the most prominent examples of the Fallacy of Insufficient Abstraction is simultaneity. This is to eliminate time and this is sufficient to relegate any model/parable into the Dancing-Angels-On-A-Pinpoint category.
Nick Rowe’s Parable of the Fruit Trees, too, falls into this category. Its lethal defect is long known as the Hahn problem: “The Hahn problem reveals three things. First, a perfect barter GE solution always exists in any ‘monetary’ model erected on Walrasian GE microeconomic foundations. Second, inessential monetary features are easily attached to perfect barter microeconomic foundations but as easily removed, leaving the perfect barter solution intact. Third, attaching such inessential additions leads to logical error; the misuse of language that produces invalid conclusions.”*
Nick Rowe and Matthew Young have not gotten the point that in the monetary economy barter is indirect and that therefore the discussion of direct barter is pretty much a revival of the Dancing-Angels-On-A-Pinpoint disputations of the Middle Ages.
* Colin Rogers, Review of Political Economy
***
REPLY to Nick Edmonds on Jun 19You say: “One problem we have translating your parable to the real world is that asset prices are generally highly flexible (and arguably asset markets can be much more easily cleared by price movements than goods and labour markets).”
Not at all! The real problem is that economists have after 200+ years still no clue how the price- and profit mechanism works.
To begin with, there are TWO fundamentally different types of markets.#1 In the elementary production-consumption economy one has the flows of labor input and product output (apples, bananas, cherries per period). The quantity produced is, for a start, equal to the quantity sold and consumed. So the stock of products is zero at the beginning and the end of the period. The primary markets (e.g. product, labor) deal with flows.
If part of the output is not consumed in the same period then there remains a stock of durable goods = real assets, e.g. houses. This is how the secondary markets come into existence.
The point is that the primary and secondary markets run on entirely different principles and that they can by no stretch of the scientific imagination be described with the barter parable nor with supply-demand-equilibrium. What Leijonhufvud has called the Totem-of-the-Micro has always been nincompoop-economics.
#1 Primary and Secondary Markets
***
REPLY to Nick Rowe on Jun 20Nick Rowe concludes: “If we see recessions as a cluster of symptoms, that usually (but not always) go together, it’s not obvious how we define a ‘recession’, and whether we define it in terms of symptoms or of causes. And what’s true by definition and what’s true/false as a statement of fact. Bit like defining different illnesses.”
There is science, and it is binary true/false with NOTHING in between. Truth is well-defined for 2300+ years by formal and material consistency. And there is the large swamp of cargo cult science where, as Keynes said, “nothing is clear and everything is possible.”
In the swamp, vagueness, indeterminacy, inconclusiveness, confusion dressed up as complexity, unresolved contradictions, storytelling, filibuster, gossip, finicky scholasticism (Popper), known/unknown unknowns, and the Humpty Dumpty Fallacy are the prevailing components of communication.#1, #2, #3
This, of course, has not gone unnoticed: “The currently prevailing pattern of economic theorizing exhibits the following three characteristics: (1) a syncopated style of argument fluctuating back and forth between literary and symbolic modes of expression, (2) naive translation, or the loose paraphrasing of formulae into sentences, and (3) loose verbal reasoning for certain aspects of theoretical argumentation where explicit symbolic formulation is lacking.” (Dennis, 1982)
From Nick Rowe’s Parable of the Fruit Trees nothing can be learned about how the price- and profit mechanism works. This does not matter, though, because the purpose of economics has never been to clarify matters and to advance science but to keep everything and everybody in the swamp of inconclusiveness.
Vagueness and inconclusiveness protect the scientifically incompetent and secure the status quo because:
• “... you cannot prove a vague theory wrong.” (Feynman)
• “With enough fog emitted, almost anything becomes possible.” (Mirowski)
One will not find one single scientist in the swamp.#4 The swamp has always been the habitat of parable-tellers and cargo cult scientists.
Egmont Kakarot-Handtke
#1 It is better to be precisely right than roughly wrong
#2 “This is a tough question to adjudicate on scientific grounds since the issue is largely definitional and, as Lewis Carroll pointed out, everyone is entitled to his own definitions.” (Blinder)
#3 “’When I use a word,’ Humpty Dumpty said in rather a scornful tone, ‘it means just what I choose it to mean — neither more nor less.’ ‘The question is,’ said Alice, ‘whether you can make words mean so many different things.’ ‘The question is,’ said Humpty Dumpty, ‘which is to be master — that’s all’.”
#4 Getting out of the economics swamp
November 20, 2015
Complementary time preferences and interest
Comment David Glasner on ‘Thinking about Interest and Irving Fisher’
Blog-Reference
The first rule of economic analysis says that all real models are fundamentally flawed because the economy constitutes itself through the interaction of real and nominal variables, and therefore the proper analytical framework is given by — what Keynes called — the ‘monetary theory of production’.
The most elementary economy is the production-consumption economy and it consists of the business and the household sector. For a start, the consolidated business sector produces and sells one consumption good.#1
First period: the business sector pays 100 monetary units (€, $ etc. *10exp) as wage income to the household sector and the household sector spends exactly this amount on the consumption good. There is no saving of the household sector. The business sector’s profit is zero and the price of the consumption good is equal to unit wage costs. This configuration reproduces itself without any change of the real variables labor input L, productivity R, and output O for an indefinite number of periods.
Second period: one household saves 10 units (S=10) and intends to spend it after 20 periods, i.e. in t+20. If this happens without any dissaving from another household the business sector makes a loss (Q=−10). The market-clearing price is, in this case, lower than constant unit wage costs.
Since we focus here on pure time preference we have to make sure that the consumption expenditures of the household sector as a whole do not change. Hence, we need a second household who wants to dissave 10 units (=take up a loan) in this period and to pay it back after 20 periods. What is needed, then, is two households with exactly complementary time preferences.
In real terms, the saver household buys and consumes 10/P real units of the consumption good less in period t and exactly the same quantity more in period t+20. The dissaver household is complementary in real terms. Together, the two households execute a perfectly synchronous nominal and real-time transfer without affecting the rest of the economy. All possible but distracting side effects have been excluded.
The real exchange over time presupposes complementary time preferences. Complementarity is what constitutes the market in the first place. If all households unanimously prefer real consumption now over real consumption in t+x there is no market for borrowing/lending, to begin with.
In order to focus on time preference alone risk is excluded. Then, the situation for the saver is this: he may hide the 10 monetary units for 20 periods under his mattress or lend it to the complementary household. On the other side, the dissaver/borrower household needs the 10 units now in order to carry out his plan.
Obviously, the decision of the saver to hand the money over to the borrower has nothing to do with time preference. The saver has to make a second decision between keeping the money under the mattress or lending it (risk-free) to the potential dissaver.
It is this asymmetry that gives rise to the phenomenon of interest and not time preference as such. Time preference relates to the act of saving but not to the act of lending. Both are disconnected in time. And this means that — in principle — Keynes’ liquidity preference is a better explanation for the emergence of consumer interest than Fisher’s time preference (2013). Consumer interest, in turn, is disconnected from the rate of interest which the business sector pays for financing capital investment. Because of this, there is no relationship at all between the households’ time preferences and the so-called marginal productivity of capital (2011).
Methodologically correct thinking leads inescapably to the conclusion that thinking about interest and Irving Fisher is a pointless exercise.
Egmont Kakarot-Handtke
References
Kakarot-Handtke, E. (2011). Squaring the Investment Cycle. SSRN Working Paper Series, 1911796: 1–25. URL
Kakarot-Handtke, E. (2013). Settling the Theory of Saving. SSRN Working Paper Series, 2220651: 1–23. URL
#1 The elementary interrelation of real and nominal variables in the elementary production-consumption economy is shown on Wikimedia AXEC31:
Immediately preceding How economic thinkers think they think about interest.
Blog-Reference
The first rule of economic analysis says that all real models are fundamentally flawed because the economy constitutes itself through the interaction of real and nominal variables, and therefore the proper analytical framework is given by — what Keynes called — the ‘monetary theory of production’.
The most elementary economy is the production-consumption economy and it consists of the business and the household sector. For a start, the consolidated business sector produces and sells one consumption good.#1
First period: the business sector pays 100 monetary units (€, $ etc. *10exp) as wage income to the household sector and the household sector spends exactly this amount on the consumption good. There is no saving of the household sector. The business sector’s profit is zero and the price of the consumption good is equal to unit wage costs. This configuration reproduces itself without any change of the real variables labor input L, productivity R, and output O for an indefinite number of periods.
Second period: one household saves 10 units (S=10) and intends to spend it after 20 periods, i.e. in t+20. If this happens without any dissaving from another household the business sector makes a loss (Q=−10). The market-clearing price is, in this case, lower than constant unit wage costs.
Since we focus here on pure time preference we have to make sure that the consumption expenditures of the household sector as a whole do not change. Hence, we need a second household who wants to dissave 10 units (=take up a loan) in this period and to pay it back after 20 periods. What is needed, then, is two households with exactly complementary time preferences.
In real terms, the saver household buys and consumes 10/P real units of the consumption good less in period t and exactly the same quantity more in period t+20. The dissaver household is complementary in real terms. Together, the two households execute a perfectly synchronous nominal and real-time transfer without affecting the rest of the economy. All possible but distracting side effects have been excluded.
The real exchange over time presupposes complementary time preferences. Complementarity is what constitutes the market in the first place. If all households unanimously prefer real consumption now over real consumption in t+x there is no market for borrowing/lending, to begin with.
In order to focus on time preference alone risk is excluded. Then, the situation for the saver is this: he may hide the 10 monetary units for 20 periods under his mattress or lend it to the complementary household. On the other side, the dissaver/borrower household needs the 10 units now in order to carry out his plan.
Obviously, the decision of the saver to hand the money over to the borrower has nothing to do with time preference. The saver has to make a second decision between keeping the money under the mattress or lending it (risk-free) to the potential dissaver.
It is this asymmetry that gives rise to the phenomenon of interest and not time preference as such. Time preference relates to the act of saving but not to the act of lending. Both are disconnected in time. And this means that — in principle — Keynes’ liquidity preference is a better explanation for the emergence of consumer interest than Fisher’s time preference (2013). Consumer interest, in turn, is disconnected from the rate of interest which the business sector pays for financing capital investment. Because of this, there is no relationship at all between the households’ time preferences and the so-called marginal productivity of capital (2011).
Methodologically correct thinking leads inescapably to the conclusion that thinking about interest and Irving Fisher is a pointless exercise.
Egmont Kakarot-Handtke
References
Kakarot-Handtke, E. (2011). Squaring the Investment Cycle. SSRN Working Paper Series, 1911796: 1–25. URL
Kakarot-Handtke, E. (2013). Settling the Theory of Saving. SSRN Working Paper Series, 2220651: 1–23. URL
#1 The elementary interrelation of real and nominal variables in the elementary production-consumption economy is shown on Wikimedia AXEC31:
Immediately preceding How economic thinkers think they think about interest.
November 9, 2015
The irreparable unreality of all ‘real’ models
Comment on David Glasner on ‘The Well-Defined, but Nearly Useless, Natural Rate of Interest’
Blog-Reference
Keynes had a great methodological insight: “In 1933, Keynes wrote a short contribution to a Festschrift for the German economist Arthur Spiethoff. He there attacked classical economists for not providing an adequate monetary theory. He then embarked upon the development of what he termed a monetary theory of production, a theory in which the interdependence of money and uncertainty, and their effects on economic behavior, could be properly investigated.” (Fontana, 2000, p. 40)
Keynes’ insight has been that the proper subject matter of economics is the monetary economy. Many economists have not got this point until today but still maintain that the ‘real’ economy is the real economy. It is definitively not.
And for one simple reason: the phenomenon of profit cannot appear at all in a ‘real’ economy (2011b). Because of this all ‘real’ models miss the essence of the market economy and are a priori worthless. This includes approaches like Ricardo, Sraffa, or RBC. This is Keynes’ lasting contribution to the advancement of theoretical economics: all ‘real’ models have to go out of the window because they are deeply and irreparably flawed.
The real-world economy manifests itself in the interaction of real and nominal variables. Because of this, the theory of saving, investment, and interest have to be developed within the framework of what Keynes called the ‘monetary theory of production’.
The real time travel, i.e. inventory accumulation/decumulation, is entirely disconnected from nominal time travel, i.e. saving/dissaving (2013). The same holds for capital accumulation/decumulation and saving/dissaving. And, most important of all, saving/dissaving is intimately connected with loss/profit. This connection is obviously important, yet it is entirely missing in the familiar theories of interest.
The crucial point is that the representative economist needs to understand what profit is (2011a). Because of this, the theory of interest is false by implication. The worst blunder consists of conceptualizing the natural rate as a real magnitude and in the futile attempt to derive interest from an apples-now-apples-later time preference model.
Egmont Kakarot-Handtke
References
Fontana, G. (2000). Post Keynesians and Circuitists on Money and Uncertainty: An Attempt at Generality. Journal of Post Keynesian Economics, 23(1): 27–48. URL
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). When Ricardo Saw Profit, He Called it Rent: On the Vice of Parochial Realism. SSRN Working Paper Series, 1932119: 1–19. URL
Kakarot-Handtke, E. (2013). Settling the Theory of Saving. SSRN Working Paper Series, 2220651: 1–23. URL
Related 'Debunking the natural rate of interest' and 'Are economists methodological retards?'.
Blog-Reference
Keynes had a great methodological insight: “In 1933, Keynes wrote a short contribution to a Festschrift for the German economist Arthur Spiethoff. He there attacked classical economists for not providing an adequate monetary theory. He then embarked upon the development of what he termed a monetary theory of production, a theory in which the interdependence of money and uncertainty, and their effects on economic behavior, could be properly investigated.” (Fontana, 2000, p. 40)
Keynes’ insight has been that the proper subject matter of economics is the monetary economy. Many economists have not got this point until today but still maintain that the ‘real’ economy is the real economy. It is definitively not.
And for one simple reason: the phenomenon of profit cannot appear at all in a ‘real’ economy (2011b). Because of this all ‘real’ models miss the essence of the market economy and are a priori worthless. This includes approaches like Ricardo, Sraffa, or RBC. This is Keynes’ lasting contribution to the advancement of theoretical economics: all ‘real’ models have to go out of the window because they are deeply and irreparably flawed.
The real-world economy manifests itself in the interaction of real and nominal variables. Because of this, the theory of saving, investment, and interest have to be developed within the framework of what Keynes called the ‘monetary theory of production’.
The real time travel, i.e. inventory accumulation/decumulation, is entirely disconnected from nominal time travel, i.e. saving/dissaving (2013). The same holds for capital accumulation/decumulation and saving/dissaving. And, most important of all, saving/dissaving is intimately connected with loss/profit. This connection is obviously important, yet it is entirely missing in the familiar theories of interest.
The crucial point is that the representative economist needs to understand what profit is (2011a). Because of this, the theory of interest is false by implication. The worst blunder consists of conceptualizing the natural rate as a real magnitude and in the futile attempt to derive interest from an apples-now-apples-later time preference model.
Egmont Kakarot-Handtke
References
Fontana, G. (2000). Post Keynesians and Circuitists on Money and Uncertainty: An Attempt at Generality. Journal of Post Keynesian Economics, 23(1): 27–48. URL
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). When Ricardo Saw Profit, He Called it Rent: On the Vice of Parochial Realism. SSRN Working Paper Series, 1932119: 1–19. URL
Kakarot-Handtke, E. (2013). Settling the Theory of Saving. SSRN Working Paper Series, 2220651: 1–23. URL
Related 'Debunking the natural rate of interest' and 'Are economists methodological retards?'.
September 3, 2015
Nominal and real time transfer
Comment on Hazel Henderson on ‘What Americans need: An ‘idiot-proof’ retirement system’
Blog-Reference
It is a bit tragic that the RWER blog moves ever closer towards Zerohedge. The one and only message of this popular blog is that all is a fraud, that the markets are rigged and manipulated by the FED, that the algos make their money by creating crashes on a regular basis, and so on. You can have as much empirical proof and juicy exposure as you like every day.
All this happens, no doubt, but we should calm down for a moment and ask ourselves whether economics has not degenerated into a criminal investigation, trickster hunt, swindle warning, wolf crying, and exchange of hot tips about safe havens and tax evasion.
When the question comes to the retirement system, thug-busting is the wrong approach. What is lacking is a sound theoretical underpinning of the effects of saving/dissaving over time.
The economic problem of the retirement system is that the real and nominal side of saving/dissaving is disconnected in time. That is to say that the problem lies on the macro level and not on the casino floor.
While I agree that stories about evil Flash Boys and other players on the stock market are more entertaining I strongly suggest that economists eventually come up with sound theoretical foundations for the construction of a viable retirement system. This means, first of all, to rethink the theory of saving/dissaving and the interconnection between saving/dissaving, increasing/shrinking debt, and loss/profit (2013).
As long as standard economics is idiotic, Americans will not get an idiot-proof retirement system.
Egmont Kakarot-Handtke
References
Kakarot-Handtke, E. (2013). Settling the Theory of Saving. SSRN Working Paper Series, 2220651: 1–23. URL
Blog-Reference
It is a bit tragic that the RWER blog moves ever closer towards Zerohedge. The one and only message of this popular blog is that all is a fraud, that the markets are rigged and manipulated by the FED, that the algos make their money by creating crashes on a regular basis, and so on. You can have as much empirical proof and juicy exposure as you like every day.
All this happens, no doubt, but we should calm down for a moment and ask ourselves whether economics has not degenerated into a criminal investigation, trickster hunt, swindle warning, wolf crying, and exchange of hot tips about safe havens and tax evasion.
When the question comes to the retirement system, thug-busting is the wrong approach. What is lacking is a sound theoretical underpinning of the effects of saving/dissaving over time.
The economic problem of the retirement system is that the real and nominal side of saving/dissaving is disconnected in time. That is to say that the problem lies on the macro level and not on the casino floor.
While I agree that stories about evil Flash Boys and other players on the stock market are more entertaining I strongly suggest that economists eventually come up with sound theoretical foundations for the construction of a viable retirement system. This means, first of all, to rethink the theory of saving/dissaving and the interconnection between saving/dissaving, increasing/shrinking debt, and loss/profit (2013).
As long as standard economics is idiotic, Americans will not get an idiot-proof retirement system.
Egmont Kakarot-Handtke
References
Kakarot-Handtke, E. (2013). Settling the Theory of Saving. SSRN Working Paper Series, 2220651: 1–23. URL
September 7, 2011
Geometrical exposition of structural axiomatic economics (II): qualitative and temporal aggregation {17}
Working paper at SSRN
Abstract Behavioral assumptions are not solid enough to be eligible as first principles of theoretical economics. Hence all endeavors to lay the formal foundation on a new site and at a deeper level actually need no further vindication. Part (I) of the structural axiomatic analysis submits three nonbehavioral axioms as groundwork and applies them to the simplest possible case of the pure consumption economy. The geometrical analysis makes the interrelations between income, profit, and employment under the conditions of market clearing and budget-balancing immediately evident. Part (II) applies the differentiated axiom set to the analysis of qualitative and temporal aggregation.
Abstract Behavioral assumptions are not solid enough to be eligible as first principles of theoretical economics. Hence all endeavors to lay the formal foundation on a new site and at a deeper level actually need no further vindication. Part (I) of the structural axiomatic analysis submits three nonbehavioral axioms as groundwork and applies them to the simplest possible case of the pure consumption economy. The geometrical analysis makes the interrelations between income, profit, and employment under the conditions of market clearing and budget-balancing immediately evident. Part (II) applies the differentiated axiom set to the analysis of qualitative and temporal aggregation.
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