Hanging in the air

Comment on Lars Syll on 'IS-LM is bad economics no matter what Krugman says'

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There seems to be consensus that it is alone IS-LM that concerns us here.

The main point is rather simple: the General Theory (GT) is a loose composition of formal and verbal arguments. The problem is that most of Keynes's verbal arguments cannot be derived from the foundational formalism. This is not to say that the verbal arguments are factually wrong, it means that, in the best case, they are hanging in the air. This does not diminish the value of the GT as a piece of political opinion making but certainly as a piece of theoretical economics.

In the GT the original formalism and the original interpretation (oK) do not match. In addition, the formalism is indefensible with regard to the treatment of income and profit. With IS-LM Hicks provided a second interpretation (H). The (oK)-interpretation and the (H)-interpretation do not match either. What is more, we have a new interpretation but the foundational formalism is still defective. That is, the (H)-interpretation is also hanging in the air.

Krugman has been reprimanded for not admitting that interpretations (oK) and (H) are incompatible. The salient point is, instead, that Krugman and Hicks before him have not realized that, to begin with, Keynes's formal foundations are indefensible with regard to the treatment of income and profit. This is the oversight that counts from the viewpoint of theory building.

In sum: Keynes, Hicks, and Krugman provide different interpretations of the same flawed formalism. In order to advance economics from a talk-show to a science, all three interpretations have to be rejected on purely formal grounds.

Flawed logic

Comment on Lars Syll on 'IS-LM is bad economics no matter what Krugman says'

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Lars Syll and Paul Davidson argue (a) that IS-LM is bad economics and (b) that it has not much in common with Keynes' economic reasoning in the General Theory.

I agree with both points. My question is a more fundamental one. Does this clarification make the General Theory look much better?

Let me resume the point that I have made at length in: Why Post Keynesianism is Not Yet a Science, Economic Analysis and Policy, March 2013, pp. 95-106. There is no need to lose many words about equilibrium, ergodicity, or the finance motive because Keynes' formalism is logically defective. This is sufficient to refute it and with it all illegitimate IS-LM derivatives.

Hence, we have to go one step further: it is not so simple that IS-LM is bad economics and Keynes is good economics; both are bad economics and for the same reason.

Keynes' profit theory is false. The correct relation reads Qret≡I−S, i.e., retained profit is equal to the difference between the business sector's investment and the household sector's saving. Since retained profit for the economy as a whole is always different from zero, we have empirical proof that investment and saving are, as a corollary, never equal. The ex-ante/ex-post argument can be shown to be logically defective. Because the IS schedule of IS-LM is formally unacceptable, the whole argumentation built upon it is vacuous. Free association, interpreting IS-LM, or reading tea leaves is scientifically on the same level. What unites Keynes, Hicks, and Krugman, as well as their critics, is the same logical flaw in the formal foundations.

Egmont Kakarot-Handtke


Related 'How Keynes got macro wrong and Allais got it right'.

Crisis and Methodology: Some Heterodox Misunderstandings {31b}

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Abstract  Whether justified by the concrete circumstances or not, an economic crisis is, by simple association, taken as an implicit refutation of the invisible hand vision and the underlying theory. The fundamental heterodox critique locates the source of apparent theoretical difficulties at the level of methodology. Although acceptable in principle, this belief involves some actual misunderstandings with regard to the respective roles of deterministic laws and deductive reasoning. In order to clarify these, the present paper revisits some key episodes in the history of economic methodology.

Why Post Keynesianism is not yet a science {23b}

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Abstract  In a programmatic article Alfred Eichner explained, from a Post Keynesian perspective, why neoclassical economics is not yet a science. This was some time ago and one would expect that Post Keynesianism, with a heightened awareness of scientific standards, has done much better than alternative approaches in the meantime. There is wide agreement that this is not the case. Explanations, though, differ widely. The present – strictly formal – inquiry identifies an elementary logical flaw. This strengthens the argument that the Post Keynesian motto ‘it is better to be roughly right than precisely wrong!’ is methodologically indefensible.

The calculating auctioneer, enlightened wage setters, and the fingers of the Invisible Hand {40}

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Abstract  The formal foundations of theoretical economics must be nonbehavioral and epitomize the interdependence of real and nominal variables that constitutes the monetary economy. This is a cogent conclusion from the persistent collapse of behavioral and real models. Conceptual rigor demands, first, to take objective-structural axioms as a formal point of departure and, secondly, to clarify the interrelations of the fundamental concepts of income and profit. The present paper reconstructs the characteristic properties of a Walrasian economy in structural axiomatic terms, generalizes them, and explores the consequences for our understanding of the working of the economy we happen to live in.

Walras's Law of Markets as special case of the General Period Core Theorem {39}

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Abstract  From the set of the first three structural axioms follows the Period Core Theorem. It asserts that the product of the key ratios, which characterize the firm, the market outcome, and the income distribution, is always equal to unity. The theorem contains only unit-free variables, is testable in principle, and involves no behavioral assumptions. The differentiated Period Core Theorem applies to an arbitrary number of firms. Therefrom Walras's Law can be derived without recourse to demand and supply functions or the notion of equilibrium. It is shown that the familiar interpretation is methodologically illegitimate.

For the complete set of foundational equations — structural axioms and behavioral propensity function — see AXEC61.

Settling the theory of saving {38}

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Working paper at ARCHIVE

Abstract  There is no way around it: each theory rests on a tiny set of foundational propositions. Standard economics rests on behavioral axioms. After a long intellectual detour, it should be clear by now that behavioral axioms are the wrong formal departure point. Being beyond repair, they have to be replaced by objective structural axioms. This paper deals with saving and its relation to investment and profit. It starts with the fact that there is no such thing as a 'real' economy. Hence economic phenomena are only explicable as the outcome of the interaction of real and nominal variables.