A Chaotic Business Cycle

Figure 1: A Chaotic Attractor in Kaldor's Model of the Business Cycle

I might as well post another interim result from my analyses of formalizations of Kaldor's business cycle model. (Today, Noah Smith also posts about chaotic dynamics.) Figure 1 is based on Figure 3 in a 2006 paper from Orlando Gomes. Table 1 shows the parameter values for the model used to generate this figure. For these parameters, Kaldor's model has one attractor, and that attractor is chaotic. The figure shows 1,000,000 (presumably non-transient) points on a single orbit. Although maybe not apparent from the figure, the orbit rotates around the origin in a clockwise direction.

Table 1: Values of Model Parameters

Parameter	Value
Speed of adjustment (α)	12
Depreciation rate (δ)	0.2
Propensity to Save (σ)	0.13
Expected level of output (μ)	200
Cost to adjust capital stock (γ)	0.6

In this model, for these parameters, every business cycle looks somewhat different from the previous one. Yet the model is deterministic. Variations among business cycles, in this model, are not coming from a source of random shocks. Furthermore, the figure shows a fractal structure across business cycles that may not be apparent to agents in the model living through five or ten cycles.

In Figure 1, I've also shown the model's fixed points and indicated their stability. The stability of fixed points in a dynamical system can be analyzed by looking at the eigenvalues of a linear approximation to the system at each fixed point (Figure 2). Methods exist to determine the stability of a fixed point without actually calculating eigenvalues. But the calculation of eigenvalues and eigenvectors is needed to numerically determine the location of the stable and unstable sets at interesting fixed points (albeit I do not show such sets in Figure 1).

Figure 2: Eigenvalues and Stability

References

• Andronov, A. A., E. A. Leontovich, I. I. Gordon, and A. G. Maier (1971). Theory of Bifurcations of Dynamic Systems On a Plane (Translated from Russian), National Aeronautics and Space Administration.
• Gomes, Orlando (2006). "Routes to Chaos in Macroeconomic Theory", Journal of Economic Studies, V. 33, N. 6: 437-468.
• Kuznetsov, Y. A. (1998). Elements of Applied Bifurcation Theory, Second edition. Springer-Verlag.

When Did Scientific Political Economy Start?

Johnathan Schlefer writes, "There is no invisible hand". He bases his claim on empirical observation and the Sonnenschein-Mantel-Debreu results and other investigations into the stability of general equilibrium. Some find amusing the ignorance and stupidity in the comments.

He also brings up Adam Smith's failure to support propertarian dogma. Gavin Kennedy mostly endorses Schlefer's view of Smith.

Which brings me to my question. Suppose you accept the distinction between scientific political economy and vulgar political economy. Some see both types of political economy in Adam Smith. He contains both esoteric and exoteric elements. But who would you say was the first writer on scientific political economy? I think you can find scientific elements in Quesnay. After all the study of schemes of expanded reproduction builds on Quesnay's Tableau. Maybe William Petty is the answer to my question. Or maybe one should go back all the way to Aristotle.

Speculation On Why Monetary Cranks Exist

I think many people, without too much thought, naturally intuit:

• The system under which they live works fairly well.
• Somehow, they are being exploited.

The first idea might come partly from modifying your ideas to fit your constraints. You aren't likely to drastically change the world, so you might as well accept it as it is. Another source of the first idea is the ruling ideas of society, which as the man said, are the ideas of the ruling class. Maybe the second idea comes partly from how your success isn't as much as that of others around you.

I suggest a third element, other than the above two contradictory ideas, contributes to the formation of monetary cranks. That is a surprising revelation about some details about how some institution that you interact with every day actually works. What do you mean that banks don't have money for my deposit immediately on hand? Doesn't this paper, accepted as money, represent a quantity of gold that the government is obligated to pay out? People naturally look for a concrete foundation for their practices and are left in the air when it isn't to be found.

I suggest some combine some such mishmash of ideas to conclude that the system can be set right if one particular thing is changed. And something about money is often taken to be the thing to be changed. Others might look at rent on land. I find it suggestive that Henry George's popularity is almost contemporary with closing of the American frontier.

For purposes of this discussion, I deliberately do not identify which ideas are crankish, whether it be advocacy for stamped money, social credit, or a belief that interest rates reflect the interaction of supply and demand for loanable funds. Nor, of course, does labeling an idea with an insult show why it is wrong, if it is.

Thomas Palley's Book On The Little Depression

Figure 1: A Figure Illustrating Data From A Table In Palley (2012)

I have been reading Thomas Palley's new book, From Financial Crisis to Stagnation: The Destruction of Shared Prosperity and the Role of Economics. He argues that the ongoing crisis is not just a downturn in the business cycle, but the manifestation of the exhaustion of the neoliberal paradigm for economic growth¹. Palley points to underlying structural contradictions, such as the role of consumer debt in the United States of providing the mass-based aggregate demand for consumption no longer sustainable when the overwhelming majority of workers do not participate in income gains from improving productivity. The expanded power of the less-regulated financial sector fits nicely into this thesis. Palley also discusses flaws in how the United States has come to fit into the global economy.

How academic economists have forwarded flawed ideas in support of these unsustainable structures is another major theme of this book. Both the freshwater (also known as Chicago school) and saltwater (also known as MIT school) economists are neoliberals. Palley, as is typical of Post Keynesians, opposes the views of saltwater economists, who agree with freshwater economists that, if it were not for failures of competition, externalities, information asymmetries, and sticky and rigid prices, the economy would generally perform well. The disagreement, on the level of analysis, is on the empirical importance of such imperfections². Both erroneously think that economics can be separated from politics. Palley names his contrasting, third view as "Structural Keynesianism".

Palley does not describe the ideas of economists as driving economic policy in the United States. Rather, the market capture of academic economics provides a challenging obstacle for enlightenment. Palley approvingly quotes³ both Keynes' final paragraph in the General Theory and Karl Marx from the The German Ideology, "The ideas of the ruling class are in every epoch the ruling ideas..."

I have yet to finish this book, but I still have some criticisms. I wish Palley had included more graphs in this book. It seems to me that some of his charts in Chapter 4 could more usefully be graphs. What figures he has are usually decompositions of ideas, like Ishikawa diagrams in another format. In his discussions, Palley drops some nuances⁴ from his text that are explained earlier. Having skipped from Chapter 2 to Chapter 11, I can see some redundancies. Also, I wish Palley had referenced more heterodox economists.

Finally, I want to note José Antonio Ocampo's cover blurb:

"This is an outstanding book: clear, concise, and comprehensive. It shows that the economic crisis is the result of economic policies derived from flawed ideas and flawed ideologies. Read it and recommend it to your friends. It provides a map to overcome the Great Stagnation and to return to shared prosperity."

Ocampo has been in the news lately; Brazil just nominated him for president of the World Bank.

Footnotes

1. Palley dates the start of this growth model with the Reagan era. I would rather point to Nixon's abolishing of the Bretton Woods' system. I suppose one could say the last half-decade of the 1970s was a transitional period.
2. Palley notes Post Keynesian agreements with saltwater economists on short run policy.
3. Antonio Gramsci does not appear in the index.
4. Such as the distinction between textbook (or bastard) Keynesianism and structural Keynesianism.

A Nonergodic Model of the Business Cycle

Figure 1: A Fractal in the Phase Diagram for One Specification of Parameters in the Kaldor Model1

1.0 Introduction

I thought I would try to combine an ability for computers to draw fractals with an economic model that suggests practical conclusions. In this post, I merely duplicate some results in the literature. In a deterministic ergodic process, as I understand it, all trajectories pass through every state in whatever attractor may exist. Hence, the Kaldor model, like some dynamical systems arising in mathematics, is non-ergodic.

2.0 The Model

In 1940, Nicholas Kaldor proposed a model of the business cycle. It can be expressed by four equations². National ouput evolves from the previous period as a response to aggregate demand:

Y_t+1 = Y_t + α(I_t - S_t),

where Y_t is the value of output in year t, I_t is intended investment, and S_t is intended saving. The parameter α represents the speed of adjustment to excess aggregate demand. The evolution of the value of the capital stock depends on investment and depreciation:

K_t+1 = I_t + (1 - δ)K_t,

where δ is the depreciation rate of capital stock. Intended saving is directly proportional to output:

S_t = σY_t,

where σ is the (average and marginal) propensity to save. An investment function³ is the final equation specifying the model:

I_t = σμ + γ(σμ/δ - K_t) + Tan^-1(Y_t - μ),

where μ is the expected level of output, and γ represents the costs of adjusting the capital stock. Along with some restrictions on the values of parameters, the model is now fully specified. The arc tangent function provides a s-shaped non-linear term, such that entrepreneurs increase investment when output exceeds their expectations⁴.

I find it convenient to define new variables normalized around a stationary state:

k_t = K_t - σμ/δ

y_t = Y_t - μ

The model, expressed in terms of normalized capital stocks and normalized output, is:

k_{t + 1} = Tan^-1(y_t) + (1 - δ - γ)k_t

y_{t + 1} = (1 - ασ)y_t + αTan^-1(y_t) - αγk_t

Note that the following is a solution:

For all time t, y_t = k_t = 0.

3.0 Some Results

The above version of the Kaldor model is a discrete-time dynamical system, defined by a map from the two-dimensional real plane (k, y) to the same space. Four⁵ parameters are used to define the map. Questions for the mathematician revolve around describing how the phase portrait for the system varies qualitatively with variations in the parameters. Complex and chaotic behavior can arise in the Kaldor model with appropriate choices of parameter values.

For a small enough speed of adjustment and large enough propensity to save, the dynamics is boring. All trajectories converge to the origin.

As the propensity to save decreases, the system goes through a pitchfork bifurcation, so-called because the bifurcation diagram looks like a pitchfork. The origin loses its stability, and two symmetric fixed points appear. For a small enough speed of adjustment, at least, the two symmetric fixed points exhibit local asymptotic stability. The location of these new fixed points must be found numerically. A fortiori, the computer must be used as an aid to perform a local stability analysis of these points, based on the eigenvalues of the Jacobian matrix.

As the speed of adjustment increases, the boundary between the basins of attraction becomes more complex. Figure 1 shows a case where they are entangled in a fractal-like structure, and the outer perimeter of the colored area is repelling. The limit cycle shown is a short distance outside this repelling boundary.

I have by no means exhausted the dynamics of the Kaldor model. Consider a region in which the origin is the only fixed point, and it is asymptotically stable. As the speed of adjustment increases, the system undergoes a Neimark-Sacker bifurcation, which, I gather, is the discrete-time analog to a Hopf bifurcation. Cycles exist in which the cycle is not a fixed point on the Poincaré return map, but winds around many times before repeating. And if I want my application to explore all these dynamics, I have quite a bit of programming to do. I am curious if I will be able to plot a bifurcation diagram, given that the behavior at the limit depends on the initial value.

4.0 Observations

For the parameter values illustrated in the figures, trajectories have three possible destinations:

• A stable equilibrium with lots of capital and high output.
• Another stable equilibrium with less capital and less output.
• A business cycle.

Furthermore, the boundary between the basins of attraction for the stable limit points is fractal-like. These properties suggest that a random shock to the system can redirect trajectories to a very different final destination.

Although not illustrated above, the model exhibits structural instability. A perturbation of the model parameters can result in different observable behavior, of greater or less complexity.

One general way of conceptualizing business cycles is to see them as the response of a damped linear system to exogenous shocks. Their height and depth depends on the characteristics of the external impulses driving the system. The Kaldor model suggests another possibility. In this model, the properties and extent of business cycles are endogenously determined. Shocks can drive the system from one trajectory to another, but the range of possible behaviors is determined from within the system. It is my impression that the former way of understanding business cycles is dominant among mainstream macroeconomists, while the latter is closer to describing actually existing capitalist economies.

Footnotes

1. Figure 1 is drawn with the parameter values specified in Figure 2(c) in Agliari et al (2007).
2. Kaldor uses a nonlinear savings function and merely specifies the form of the investment function.
3. The specification of investment independent of saving is an essential characteristic of Keynesian models.
4. In this model, expectations are held constant.
5. Notice the expected level of output does not appear in the two equations giving the normalized model.

Selected References

• A. Agliari, R. Dieci, and L. Gardini (2007). Homoclinic Tangles in a Kaldor-like Business Cycle Model. Journal of Economic Behavior & Organization. Vol. 62: 324-347.
• W. W. Chang and D. J. Smyth (1971). The Existence and Persistence of Cycles in a Non-linear Model: Kaldor's 1940 Model Rexamined. Review of Economic Studies. Vol. 38, No. 1: 37-44.
• Richard M. Goodwin (1951). The Nonlinear Accelerator and the Persistence of Business Cycles. Econometrica. Vol. 19, No. 1: 1-17.
• Nicholas Kaldor (1940). A Model of the Trade Cycle. Economic Journal. Vol. 50, No. 197: 78-92.
• Yuri A. Kuznetsov (1998). Elements of Applied Bifurcation Theory, 2nd edition.

The Wise On Roke

Ursula Le Guin sets her Earthsea trilogy on an imaginary world containing many islands¹. Nine mages run a world-famous school for wizards on Roke.

ROKE is now also an acronym, for the Review of Keynesian Economics. It sounds like it prmises to be an interesting journal.

Footnotes

1. Strangely enough, six books now comprise the Earthsea trilogy.

Elsewhere

• Matías Vernengo provides an introduction to the capital controversy. He concludes, like others, including myself, that the neoclassical theory of supply and demand cannot explain factor incomes in a capitalist economy.
• Philip Pilkington interviews Yanis Varoufakis, concentrating on Varoufakis' views on the errors in mainstream economics and the sociology of economics. Update: The second part of the interview is here.
• Dan Little reviews The End of Value-Free Economics, a book edited by Vivian Walsh and Hilary Putnam. I have only skimmed the Putnam book that the essays in this book are responding to. I have read Putnam's Reason, Truth and History, which makes the case, drawing on the later Wittgenstein, that facts and values cannot be disentangled in science. And Gram and Walsh's Classical and Neoclassical Theories of General Equilibrium: Historical Origins and Mathematical Structure is a very good textbook introduction to the Sraffian revolution.
• Open Democracy is hosting a series called "Uneconomics". Hey, one of the articles is by Philip Mirowski. Hat tip: Rod Hill and Tony Myatt.

How To Defend Capitalism

"It is possible to defend our economic system on the ground that, patched up with Keynesian correctives, it is, as he put it, the 'best in sight'. Or at any rate that it is not too bad, and change is painful. In short, that our system is the best system that we have got.

Or it is possible to take the tough-minded line that Schumpeter derived from Marx. The system is cruel, unjust, turbulent, but it does deliver the goods, and, damn it all, it's the goods that you want.

Or, conceding its defects, to defend it on political grounds - that democracy as we know it could not have grown up under any other system and cannot survive without it.

What is not possible, at this time of day, is to defend it, in the neo-classical style, as a delicate self-regulating mechanism, that has only to be left to itself to produce the greatest satisfaction for all.

But none of the alternative defences really sounds very well. Nowadays, to support the status quo, the best course is just to leave all these awkward questions alone." -- Joan Robinson, Economic Philosophy: An Essay on the Progress of Economic Thought (1962): p. 140.

These days, economists are not trained to competently address these questions. For one thing, economists would have to read both history and philosophy as part of their academic work.

The defenses Robinson offers for capitalism do not say any particular embodiment of capitalism does not require a lot of patching up.

I think Robinson's position that markets cannot be regarded as a "delicate self-regulating mechanism" has become even stronger in the last half-century. For my purposes, never mind looking out your door at our current situation. Consider what we now know about economic theory. My point is not merely that economists have no proof of the stability of a (unique?) equilibrium in models of markets. My point is that what we know about the question suggests that markets, in such models, are not likely to approach equilibrium. I am thinking of, for instance:

• the Sonnenschein-Mantel-Debreu theorem.
• Franklin Fisher's demonstration that one should impose the assumption of "no favorable surprise" to ensure an approach to general equilibrium.
• Fabio Petri's explanation that the Arrow-Debreu model cannot allow production to occur along the approach to equilibrium (since production will change part of the data defining the equilibria, namely the initial endowments).

Apparently, the situation is no better from the perspective of game theory.

I think that this perspective on equilibrium leads one to disbelieve that capitalism can be made self-regulating by establishing or restoring competitive forces that do not seem to be operative today. In short, Mark Thoma is simply wrong.

David Ruccio and "Larry, the Barefoot Bum" also have comments about Mark Thoma's editorial. I've previously noted that Marxist exploitation is compatible with perfect competition and every factor receiving the full value of their marginal product. I've also previously expressed my opinion that Marxist exploitation is not about describing an injustice when capitalism is viewed under the aspect of eternity.

References

• Franklin M. Fisher (1983). Disequilibrium Foundations of Equilibrium Economics, Cambridge University Press.
• Franklin M. Fisher (1989) "Games economists play: A noncooperative view", RAND Journal of Economics. V. 20, N. 1 (Spring) [To read].
• Fabio Petri (2004). General Equilibrium, Capital and Macroeconomics: A Key to Recent Controversies in Equilibrium Theory, Edward Elgar.
• Joan Robinson (1962). Economic Philosophy: An Essay on the Progress of Economic Thought.

The Economic Consequences Of Mr. Draghi

This post is somewhat on current events, and about topics I'm even less expert in than usual. I suggest that a certain historical analogy might be useful for understanding certain aspects of the Greek crisis¹. Not that I'm willing to propose a solution. I look to, for example, Yanis Varoufakis for more informed takes on the Euro².

John Maynard Keynes, in 1925, wrote a pamphlet, "The Economic Consequences of Mr. Churchill". Keynes' title is a suggestion of his previous best-seller, The Economic Consequences of the Peace, another work in which Keynes foresaw the dire consequence of then current events. In the case of Churchill, Sir Winton was then serving as Chancellor of the Exchequer.

Britain had gone off the gold standard during World War I. Churchill oversaw the restoration of the gold standard, with the Treasury insisting on establishing the foreign exchange value of the pound sterling to its pre-war parity in gold. Apparently, according to Keynes, the market value was about 10% below that at the time. The foreign exchange rate of a currency combines with the general price level to determine the standard of living in terms of foreign goods. If the British wanted to maintain their then-current standard of living, and Churchill insisted on the pre-war parity, then prices and costs, including wages, must drop 10%. And this process of deflation could be expected to be resisted. In fact, widespread unemployment and general labor unrest were some of the economic consequences of Mr. Churchill. I think you can see some of these consequences in the 1926 general strike in Great Britain.

Churchill refused to acknowledge the necessity of devaluing the pound. In the case of Greece, they do not have control over the value of their currency, as long as they remain on the Euro. So they cannot devalue their currency. But, as in the case of the British population in the 1920s, they are being asked for the functional equivalent - that is, for a general reduction of prices and wages throughout the country. Maybe the consequences in Greece will resemble the consequences in Britain in the 1920s. I don't see how this is likely to increase the odds of Greece fully paying back their external debts.

Footnotes:

1. I think of this post as, perhaps, an illustration of the usefulness of studying economic history and the history of economics. Even if you conclude that my suggested analogy is too facile, you might accept that discussing it is a useful point of departure.
2. D-Squared also has a view on the topic, given certain constraints.

Playing With Fractals

Figure 1: An Enlargement Of A Piece Of The Mandelbrot Set

A number of years ago, I loaned Heinz-Otto Peitgen and Peter H. Richter's 1986 book, The Beauty of Fractals: Images of Complex Dynamical Systems to a relative. This is a coffee-table book that, apparently, was issued as a companion piece to a digital art exhibition. This book was returned to me at Christmas.

So, for fun, I've been writing a fractal-drawing program. I'm not sure what the point of this is, besides reviewing certain aspects of Java programming. I don't plan on distributing my program, even if I did include some help capabilities, icons for various windows, and such like. I deliberately have not looked at any programs that may be out there on Windows, Icon, Mouse, Pointer (WIMP) platforms. I eventually did look at a free app for a touch interface. This app cued me to think about assigning colors on a logarithmic scale, with lighter shades being near the Mandelbrot set boundary.

In software development, a difficulty is often how to define what you want to do. And one can always think of additional capabilities. In my case, at some point I included capabilities to save and load the current state, to print the current canvas, and to provide user-control over the number of iterations and various colorings. I struggled with how to define coloring algorithms. I'm curious about how one might implement Sigel discs, that is, regions of convergence for limit points and cycles within a Julia set. A history capability would also be nice.

Anyways, I haven't been reading all that much economics while taking this excursion into recreational mathematics.

Figure 1: A Julia Set

Some Stupid Stuff From David Levine

Suppose you can get people to refer to some theory or principle that you advocate as "Motherhood and Apple Pie". A rather stupid way to argue against opponents is to rely on the mere label. So one can argue against a strawperson - one can say that one's opponents are against motherhood and apple pie. Economists happen to have this nonsensical rhetoric strategy readily available, given some of the names of their models. For example, if one were a fool or a knave, one could say that opponents of Dynamic Stochastic General Equilibrium models all preferred static, deterministic, partial equilibrium models - obviously not as good a thing.

David K. Levine insults the reader's intelligence in this way. He has an article, "Why Economists Are Right: Rational Expectations and the Uncertainty Principle in Economics" (part I, part II) in the Huffington Post. He focuses on the label "Rational Expectations:

"In simple language what rational expectations means is 'if people believe this forecast it will be true.' By contrast if a theory is not one of rational expectations it means 'if people believe this forecast it will not be true.' Obviously such a theory has limited usefulness. Or put differently: if there is a correct theory, eventually most people will believe it, so it must necessarily be rational expectations. Any other theory has the property that people must forever disbelieve the theory regardless of overwhelming evidence -- for as soon as the theory is believed it is wrong.

So does the crisis prove that rational expectations and rational behavior are bad assumptions for formulating economic policy? Perhaps we should turn to behavioral models of irrationality in understanding how to deal with the housing market crash or the Greek economic crisis? Such an alternative would have us build on foundations of sand. It would have us create economic policies and institutions with the property that as soon as they were properly understood they would cease to function." -- David K. Levine

I know of nobody who advocates constructing models based on irrational expectations. On the other hand, I can easily imagine a model in which diverse agents might have different theories of the world and rely on different heuristics. Maybe the agents in such a model might not converge on a single model for the world. (Levine does mention issues of convergence, in a wholly inadequate way, in Part II of his article. Even if one accepted his emotionally-charged story, economists still lack any general argument for convergence to a rational expectations equilibrium.) One might construct such a model of short term interest rates. The equilibrium interest rate at any moment of time would be a balance of bullish and bearish forces.

These are hardly unknown ideas in economics. I am drawing directly on Chapter 12 of Keynes' General Theory of Employment, Interest, and Money. G. L. S. Shackle called this a restless equilibrium. Paul Davidson wrote about human decision-making in an environment characterized by processes, of which some are non-ergodic. Nowadays, one might experiment with implementing agent-based models in computer simulations. I could even cite Brad DeLong, Andre Shleifer, Larry Summers, and Robert Waldmann's work on noise traders. Economists in these sort of traditions are well aware of the impact of economic theory on the behavior of economic agents. They even explain why agents might find it rewarding to knowingly persist in behavior based on assumptions that prices will continue deviating from fundamentals, if the idea of a fundamental price is even coherent. Some somewhere have even talked about "performativity".

In short, Levine has completely failed to grapple with the economics literature at all. He is merely misrepresenting the state of play to a popular audience.

So far, I have not mentioned Levine's rationalization of why economists cannot predict crashes and depressions (or even identify bubbles?). Now, clearly some economists did forecast our current hard times. Steve Keen is probably one of the most well-known. But I'll turn to another incident. On 10 July, K. Bastiaensen, P. Cauwels, D. Sornette, R. Woodard, and W.-X. Zhou predicted a crash of the Shanghai Composite index. They stated the crash, with certain confidence estimates, would come between 17 to 27 July 2009. The China Shanghai composite index was around 3,400 during the week of 27 July. And it was around 2,860 during the week of 31 August, a decline of 16%. According to Levine, these successful predictions are just a matter of those with secret methods sometimes being lucky:

"If I say every year 'there will be a crisis this year' eventually I will be right. If 100 people each pick a different year then one of them is bound to be right. A reliable method of predicting a crisis must be a rule that anyone (or at least anyone with the requisite technical expertise) can apply and reach the same correct conclusion as anyone else using the same method."

I am not totally unsympathetic to the above view. But notice that according to the theory of rational expectations, people with divergent theories, models, and heuristics do not exist. On Levine's view, how can he account for the existence of such a range of predictions? How is it that the agents in the model are possessed of superhuman powers not available to mere mortal economists looking on?

Selected References

• K. Bastiaensen, P. Cauwels, D. Sornette, R. Woodard, and W.-X. Zhou (10 July 2009). "The Chinese Equity Bubble: Ready to Burst".
• Paul Davidson (1983-1984). "Rational Expectations: A Fallacious Foundation for studying Crucial Decision Making Processes". Journal of Post Keynesian Economics, V. 5.

On The Lack Of Persuasiveness Of Austrian-School Economists

Mattheus von Guttenberg exemplifies what I think are defects in many fanboys of Austrian school economics. Among these defects is an uncritical acceptance of Ludwig von Mises' characterization of his own theories. And another defect is uncritical acceptance, likewise, of what Mises, or even worse, Murray Rothbard, had to say about the mainstream economics of their day. And a third defect is to apply these characterizations to mainstream economics of our day, while remaining quite ignorant of relevant trends in contemporary economics. Without more widespread correction of such defects, advocates of the Austrian school should not be able to persuade many economists, both orthodox and heterodox, of the worth of their views.

For this post, I focus on the theory of choice.

Here are examples of arguably a weak understanding of both the Austrian school and of mainstream economic theory:

"...we're not rejecting cardinal utility functions because it's hip and counter-culture. There's a distinct reason utility functions are impossible and unrealistic, and that's because utility cannot be known or measured... The degree to which we draw swooping utility functions overlaying cost curves is a unacceptable practice borrowed from coordinate geometry. Utility, again - is ordinal, it is intrinsically subjective, and it cannot be made known by other people." -- Mattheus von Guttenberg

"The concept of diminishing marginal utility is implicit in the logic of action, the Austrians just draw it to the fore." -- Mattheus von Guttenberg

The claim that utility reaches an interval-level measurement scale is a conclusion formally drawn from the Von Neumann and Morgenstern axioms (which can be considered independently of game theory). Most introductory economic textbooks claim that utility only reaches an ordinal-level measurement scale, anyways. The introductory textbooks have a different set of axioms, where choice among a set of goods with specified probability is not formally modeled. And they assert that the utility obtained is not interpersonally comparable. Mattheus' objections are not addressed to any views prominent in mainstream economic teaching for at least half a century. And to assert that diminishing marginal utility is consistent with utility reaching only an ordinal-level scale requires an argument. (I'm actually intrigued by J. Huston McCulloch's 1977 attempt to make such an argument, the one example of which I know in the last quarter of the last century.)

Mises incorrectly asserted that much of his theory could be deduced from a single postulate.

"The only axiom is 'man acts' and we draw the entire body of economic science spanning a thousand pages." -- Mattheus von Guttenberg

"...I have always been interested in rewriting [Human Action] 'as a set of numbered axioms, postulates, and syllogistic inferences using, say, Russell's Principia.' I believe it can be done." -- Mattheus von Guttenberg

I think such a rewriting, as it starts from the above informally stated premise, would be unconvincing.

Furthermore, the current state of decision theory suggests that analyses other than Mises' approach, are consistent with this axiom. The Austrian school approach is roughly akin to Samuelson's revealed preference theory. (One important difference is that Austrian advocates have some silly things to say about the impossibility of indifference.) Anyways, the idea is that an acting human, when presented with two lists of goods, decides between them. But social choice theory, as developed by, say, Amartya Sen in the late 1960s and early 1970s, has shown how to dispense with the formalization of choice as a binary relation as a primitive notion. Instead, one can start with a choice function, that is, a mapping from each menu that an agent might be presented with to a set of best choices for that menu. The derivation of a complete and transitive binary preference relation from a choice function requires additional structure on how menu choices relate across menus. And why the imposition of those additional requirements follows from human action needs to be argued. For example, why are not increasingly prevalent models, at least in research literature, of divided selves consistent with human action?

Update (3 July 2014): The blog free radical has a blog post pointing out Austrian confusions about mainstream teaching on ordinal utility.

Elsewhere

• The Non-Equilibrium Social Science community and newsletter.
• Mike Beggs, in Jacobin Magazine, on Occupy Economics.
• Robert Johnson, in Time, on Economists: A Profession at Sea.
• Yanis Varoufakis has been building on his paper, "The Dance of the Meta-Axioms: On the Dynamic Mechanism by which the Inescapable Theoretical Failures of Neoclassical Economics Reinforce Its Dominance".
• Noah Smith has a couple of posts that I find hard not to read as implying that mainstream economists are trained into, at best, ignorance.

Nell's Diagram Of A Capitalist Economy

Figure 1: Nell's Diagram

Over at Naked Keynesian, Matías Vernengo explains some aspects of how he teaches the surplus approach. Vernengo presents a diagram created by Garegnani. Garegnani's diagram shows the logical relations among the endogenous variables and the givens in the Classical theory of value.

I thought I would take this opportunity to present the (complementary?) diagram above. Nell's diagram shows flows among three foci: production, markets, and the social classes comprising the population of an idealized capitalist economy.

Nell represents industrial production with an icon in the lower right of his diagram. The arrows connecting the factories in a circle suggest the production of commodities by means of commodities. Sraffa's book expresses this viewpoint in rigorous theory, and Leontief applied it empirically. Gross industrial output consists of a heterogeneous odd-lot of commodities. This output is divided into:

• The replacement of the existing means of production (represented by the previously mentioned arrows within the icon for industry)
• The surplus (represented by the arrow labeled "Net social product").

The net social product presents itself as an immense accumulation of commodities. It is further decomposed into:

• Necessities, consumed by the workers and the Unemployed
• Luxuries, consumed by the owners (i.e., capitalists)
• New capital goods, channeled back into industrial production from the markets on which industrial firms sell them.

Each component of the net social product also consists of a heterogeneous collection of commodities.

The diagram also shows money flows. The diagram illustrates the simplifying assumption that workers consume all their income. And the diagram also abstracts from the existence of government and of foreign trade. (All of these abstractions are removed in more advanced political economy, for example, in Kalecki's work.) Anyway one can identify a couple of accounting identities under these assumptions:

Total Receipts = Worker Consumption + Capitalist Consumption + Investment

Total Receipts = Wages + Profits

I like the clarity with which monetary flows and commodity flows are distinguished in this approach. It is not the case that capitalists own blast furnaces sitting in their backyard, which they then loan to firms. Mainstream economists are deliberately and consistently obfuscating on this issue, from introductory teaching to beyond. Perhaps there's a reason for this widespread confusion:

"From the point of view of Political Economy, however, the most important fact is that while wages are paid for work, and one can (and in some circumstances should) think of the wage bill, equal here to Worker Consumption, as reproducing the power to work, profits are not paid for anything at all. The flow of profit income is not an exchange in any sense. The Samuelson [circular flow] diagram...is fundamentally misleading; there is no 'flow' from 'household supply' to the factor market for capital. The only flow is the flow of profit income in the other direction. And this, of course, leads straight to that hoary but substantial claim that the payment of wages is not an exchange either, or at any rate, not a fair one. For Wages plus Profits adds up to the Net Income Product; yet profits are not paid for anything, while wages are paid for work. Hence the work of labor (using the tools, equipment, etc., replacement and depreciation of which is already counted in) has produced the entire product. Is labor not therefore exploited? Does it not deserve the whole product?" -- Edward Nell

References

• Edward Nell (1972). "The Revival of Political Economy"

Economists Working To Increase The Pain And Misery Of Billions

"Over the last three decades, economists played an important role in creating the conditions of the 2008 crisis (and dozens of smaller financial crises that came before it since the early 1980s, such as the 1982 Third World debt crisis, the 1995 Mexican peso crisis, the 1997 Asian crisis and the 1998 Russian crisis) by providing theoretical justifications for financial deregulation and the unrestrained pursuit of short-term profits. More broadly, they advanced theories that justified the policies that have led to slower growth, higher inequality, heightened job insecurity and more frequently financial crises that have dogged the world in the last three decades... On top of that, they pushed for policies that weakened the prospects for long-term development in developing countries... In the rich countries, these economists encouraged people to overestimate the power of new technologies..., made people's lives more and more unstable..., made them ignore the loss of national control over the economy..., and rendered them complacent about de-industrialization... Moreover, they supplied arguments that insist that all these economic outcomes that many people find objectionable in this world - such as rising inequality..., sky-high executive salaries... or extreme poverty in poor countries... - are really inevitable, given (selfish and rational) human nature and the need to reward people according to their productive contributions.

In other words, economics has been worse than irrelevant. Economics, as it has been practised in the last three decades, has been positively harmful for most people." -- Ha-Joon Chang, 23 Things They Don't Tell You About Capitalism. Bloomsbury Press (2011).

On "Lady Rosa De Luxembourg"

Figure 1: Statue on top of Obelisk

During the last week of 2011, I saw an exhibition of Sanja Ivekovíc's work at the Museum of Modern Art (MOMA). This show, Sweet Violence, continues through March.

The centerpiece of the exhibition is Ivekovíc's Lady Rosa of Luxembourg. This work mocks a statue, Gëlle Fra (Golden Lady), in Luxembourg. As I understand it, the original commemorates partisans active during World War II. The base of Ivekovíc's obelisk combines the phrases "La Résistance", "La Justice", "La Liberté", "L’Indépendence"; "Kitsch", "Kultur", "Kapital", "Kunst"; and "Whore", "Bitch", "Madonna", "Virgin". Three words, one from each of the three groups, is repeated on each of the four sides.

As far as I can see, this work, despite its title, does not have much to do with Rosa Luxemburg. It is more a matter of épater la bourgeoisie. I think Luxemburg's friend and colleague Clara Zetkin was more of a feminist; Luxemburg focused more on class. I don't know how Luxemburg looked while giving speeches. I know she walked with a limp as a result of a childhood disease. One leg was longer than the other. So I doubt she stood like the statue.

And I didn't overhear any museum visitors discussing such questions as:

• Do Marx's models of simple and expanded reproduction require an outside source of demand for capitalists to make the depicted investment decisions?
• Does Marx's depiction in volume 2 of Capital of smoothly reproducing capitalist economies contradict his account in volumes 1 and 3 of the breakdown of capitalism?

Occupy the American Economic Association@Chicago

Today's events consist of:

• 12:00 - 3:00 - People's Economic Conference Roosevelt University (430 S. Michigan, 3rd Floor)
• 4:30 - Mock Awards Ceremony (Michigan and Wacker)

If I were there, would I be able to explain reswitching and capital-reversing?

"Perverse" Price Wicksell Effects Swamping "Normal" Real Wicksell Effects

1.0 Introduction

Capital-reversing can arise in a couple of ways without reswitching. This post steps through a case in which positive price Wicksell effects can dominate negative real Wicksell effects. Around each switch point, firms choose to adopt a more capital-intensive technique of production for slightly lower interest rates. So real Wicksell effects agree, in this example, with the incoherent and outdated intuition of applied neoclassical economics. Nevertheless, due to the re-evaluation of a given set of capital goods at different interest rates, one can find a pair of points such that cost-minimizing firms adopt a more capital-intensive technique, from the given technology, at the higher interest rate. And this pair of points can span at least one switch point. Basically, I created a simple example to replicate graphs like those in Appendix D in Lazzarini (2011).

A case of a positive price Wicksell and negative real Wicksell effect is one case in my suggested taxonomy of Wicksell effects. Burmeister provides one possible neoclassical response to this sort of example. Burmeister advocated the use of David Champernowne’s (unobservable) chain-index measure of capital.

2.0 The Technology

Consider a very simple economy in which a single consumption good, corn, is produced. Entrepreneurs know of the two processes for producing corn shown in the last two columns of Table 1. One corn-producing process produces corn from inputs of labor time and steel. The other corn-producing process uses inputs of labor time and tin. The entrepreneurs know of two other processes, also shown in Table 1. Additional steel can be produced from inputs of labor time and steel. Similarly, labor time and tin can produce more tin.

Table 1: The CRS Technology

Inputs	Steel Industry	Tin Industry	Corn Industry
Labor	1 Person-Year	1 Person-Yr	1 Person-Yr	2 Person-Yrs
Steel	1/2 Ton	0 Ton	1/4 Ton	0 Ton
Tin	0 Kg.	9/20 Kg.	0 Kg.	1/3 Kg.
Output:	1 Ton Steel	1 Kg. Tin	1 Bushel Corn	1 Bushel Corn

All processes exhibit Constant Returns to Scale (CRS). Each process requires a year to complete. Their outputs become available at the end of the year, and they totally use up their inputs of capital goods over the course of the year.

3.0 Quantity Flows

Two techniques are available for producing a bushel of corn as net output.

The first technique, to be called the steel technique, operates the first process to produce 1/2 ton steel and the first corn-producing process to produce one bushel corn. 1/4 ton of the output of the steel-producing process replaces the steel-capital used up in producing steel. The other 1/4 ton output from the steel-producing process replaces the 1/4 ton steel used up in producing corn. In effect, 1 1/2 person-years labor are used in the steel technique for each bushel corn producing in a self-sustaining way.

In the tin technique, 20/33 kilograms tin are produced with the tin-producing process, and one bushel corn is produced with the second corn-producing process. 2 20/33 person-years labor are used in the tin technique for each bushel of corn in the economy’s net output.

Note that the production of corn with the steel system provides more consumption per worker-year than is provided with the tin system. Under the false and exploded neoclassical theory, one would expect the steel system to require more capital per worker. One would also expect it to be adopted at a low interest rate, since the low interest would be signaling a relative lack of scarcity of capital.

4.0 Price Equations

Next, I consider constant prices consistent with the adoption of each technique. Firms will not adopt a technique unless the interest rate (also known as the rate of profits) is earned for each process in use in a technique. For definitiveness, I assume that wages are paid at the end of the year out of output and that a bushel corn is the numeraire.

4.1 Steel Technique

Given these assumptions, the following system of two equations must hold when the steel technique is in use:

(1/2)p_s(1 + r) + w = p_s

(1/4)p_s(1 + r) + w = 1

where p_s is the price of a ton of steel, w is the wage, and r is the interest rate.

Above is a system of two equations in three variables. This system has one degree of freedom. Two variables can be found as functions of the one remaining variable. For example, the wage and the price of steel can be expressed as (rational) functions of the rate of profits. And that price of steel can be used to find the value of capital. The resulting capital-output ratio is:

v_s(r) = 2/(3 - r)

where v_s is the ratio of the value of capital to the value of output in the steel technique.

4.2 Tin Technique

The following system of two equations must hold when the tin technique is in use:

(9/20)p_t(1 + r) + w = p_t

(1/3)p_t(1 + r) + 2 w = 1

where p_t is the price of a kilogram of tin.

The ratio of the value of capital to the value of output in the tin technique, v_t, expressed as a function of the interest rate, is:

v_t(r) = 200/(473 - 187 r)

5.0 Choice of Technique

The trade off between the wage and the rate of profits, for a given technique, is the wage curve for that technique. Figure 1 shows the wage curves for the two techniques, as well as the wage frontier formed as an outer envelope of the wage curves for all the techniques that comprise the technology. Given the interest rate, the cost-minimizing firm adopts the technique whose wage curve is on the frontier at that point. At the switch point, two techniques are simultaneously cost minimizing.

Figure 1: The Wage-Rate of Profits Frontier

The wage curve for a given technique expresses the wage as a function of the rate of profits. The rate of profits at which the switch point occurs is found by equating the wage for two techniques. In the numerical example analyzed in this post, the following quadratic equation arises:

(41/240)(1 + r)² - (13/15)(1 + r) + 1 = 0

The switch point occurs at a rate of profits of approximately 77.46%.

6.0 Conclusion

The above analysis has shown for the example:

• Which technique is cost-minimizing at any given interest rate up to a maximum.
• The ratio of the value of capital to output for each technique for each interest rate.

Thus, as shown in Figure 2, one can find the capital-output ratio for the cost-minimizing technique for each economically feasible interest rate. The price Wicksell effect exhibits the revaluation of given capital goods at different interest rates, while the real Wicksell effect results from the adoption of different capital goods at a given interest rate. Both effects are illustrated in Figure 2.

Figure 2: The Rate of Profits Versus Capital-Intensity

This example has shown that capital-reversing can exist around a switch point even in the absence of reswitching.

References

• Edwin Burmeiser (1980). Capital Theory and Dynamics, Cambridge University Press.
• Andrés Lazzarini (2011). Revisiting the Cambridge Capital Theory Controversies: A Historical and Analytical Study, Pavia University Press.

Pecan Pie

9 inch pie	8 inch pie
3 large eggs	2
2/3 cup sugar	1/2 cup
1/3 teaspoon salt	1/4 teaspoon
1/3 cup butter, melted	1/4 cup
1 cup maple syrup	3/4 cup
1 cup chopped pecans	3/4 cup

Add ingredients in order, stirring thoroughly after each ingredient. Pour into pastry-lined pie pan. Bake at 375 degrees for 40-50 minutes, until set and pastry is nicely browned. Cool. Serve cold or slightly warm.

Elsewhere

• Dan Berrett, in The Chronicle of Higher Education, reports that "Economists push for a broader range of viewpoints". The Institute for New Economic Thinking, Econ4, a couple of professors at the University of Massachusetts at Amherst, and Stephen Marglin are all mentioned.
• Daron Acemoglu recommends five books¹ on inequality in the distribution of income or wealth. Is he basically confused about the logic of the theory of marginal productivity?
• Bryan Caplan parades his ignorance of Keynes on wages. According to Caplan, "nominal wage rigidity is the driving force of the Keynesian model" and if employment increases, wages must fall. But:
• Keynes explicitly argues, in chapter 19 of the General Theory that his analysis applies if money wages are flexible.
• At the time of the publication of the General Theory, Keynes had "always regarded decreasing physical returns in the short period as one of the very few incontrovertible propositions in our miserable subject". So he believed then that less unemployment would be associated with lessened real wages. He changed his mind² in responding to empirical evidence from John T. Dunlop and Laurie Tarshis. Empirical evidence for reverse L-shaped cost curves in industry has held up since then.

Footnotes

1. My list includes, at least:

• James K. Galbraith (1998). Created Unequal: The Crisis in American Pay. Free Press.
• Stephen A. Marglin (1984). Growth, Distribution, and Prices. Harvard University Press

2. References (which I know of from the secondary literature):

• John T. Dunlop (1938). "The Movement of Real and Money Wage Rates", Economic Journal. v. 48 (Sept.): 413-434.
• J. M. Keynes (1939). "Relative Movements of Real Wages and Output", Economic Journal, v. 49 (March): 34-51.
• Lorie Tarshis (1939). "Changes in Real and Money Wages", Economic Journal, v. 49 (March): 150-154.

A Serendipitous Juxtaposition

Tuesday, Peter Dorman, at Econospeak, considers why reactionaries in the United States are not embarrassed when caught at their constant lying. He says the contemporary right-wingers' pride in lying is ultimately derived from Leo Strauss. According to Dorman, Strauss taught:

"The cartoon version of Strauss, which is broadly correct, goes like this: The great philosophers of the past, each in their way, were led by the force of logic and experience to a dangerous insight, that no social or cultural arrangement can substitute for the necessity of virtue, and that only a small minority of individuals are truly virtuous... Those who perceive this truth must write deceptively, since the unworthy masses, if they sense that they are being judged unworthy, will persecute the truth-teller. Strauss provided readings of the canonical texts that claimed to show they functioned on two levels, as decoys for the average reader and secret wisdom for the initiate." -- Peter Dorman

And on Monday, Dani Rodrik, at Project Syndicate notes the difference between discourse among elite economists and what they tell introductory students and the general public:

"As the late great international economist Carlos Diaz-Alejandro once put it, 'by now any bright graduate student, by choosing his assumption...carefully, can produce a consistent model yielding just about any policy recommendation he favored at the start.' And that was in the 1970's! An apprentice economist no longer needs to be particularly bright to produce unorthodox policy conclusions.

Nevertheless, economists get stuck with the charge of being narrowly ideological, because they are their own worst enemy when it comes to applying their theories to the real world. Instead of communicating the full panoply of perspectives that their discipline offers, they display excessive confidence in particular remedies - often those that best accord with their own personal ideologies...

...In my book The Globalization Paradox, I contemplate the following thought experiment. Let a journalist call an economics professor for his view on whether free trade with country X or Y is a good idea. We can be fairly certain that the economist, like the vast majority of the profession, will be enthusiastic in his support of free trade.

Now let the reporter go undercover as a student in the professor’s advanced graduate seminar on international trade theory. Let him pose the same question: Is free trade good? I doubt that the answer will come as quickly and be as succinct this time around. In fact, the professor is likely to be stymied by the question. 'What do you mean by "good?"' he will ask. 'And good for whom?'

The professor would then launch into a long and tortured exegesis that will ultimately culminate in a heavily hedged statement: 'So if the long list of conditions I have just described are satisfied, and assuming we can tax the beneficiaries to compensate the losers, freer trade has the potential to increase everyone's well-being.' If he were in an expansive mood, the professor might add that the effect of free trade on an economy’s growth rate is not clear, either, and depends on an altogether different set of requirements.

A direct, unqualified assertion about the benefits of free trade has now been transformed into a statement adorned by all kinds of ifs and buts. Oddly, the knowledge that the professor willingly imparts with great pride to his advanced students is deemed to be inappropriate (or dangerous) for the general public." -- Dani Rodrik

This bifurcated discourse in economics creates a problem for critics. They can point out that most introductory mainstream teaching and applied policy advice of mainstream economists is self-contradictory and theoretically and empirically unfounded. Defenders of orthodox economists can then accuse the critics of attacking a strawperson. The failure to take their own advanced teaching seriously leads orthodox economists to disappear as a target, in some sense. Maybe the question is one of professional ethics.

On Hayek's Lack Of Impact On Macroeconomics

I'm agreeing with, for example, Brad DeLong, Paul Krugman, and David Warsh. I'm disagreeing with, for example, Peter Klein, Mario Rizzo, Alex Tabarrok, and Steven Horwitz. I suppose I'm also disagreeing with Nicholas Wapshott. Refutations of Austrian Business Cycle Theory (ABCT) are relevant today because of confusions propagated in popular literature.

Keynes argued with many while writing the General Theory. Why not say Keynes versus Dennis Robertson is "the clash that defined modern economics"? I think one could argue that Hayek influenced mainstream macroeconomics through J. R. Hick's exposition of temporary equilibrium in Value and Capital, but this seems a quite attenuated influence.

Keynesians can accept that Hayek had the better of the early 1930s debate with Keynes over Keynes's Treatise on Money. The Treatise is not the General Theory. But Sraffa and Kaldor embarrassed Hayek in his attempt to develop the ABCT. I think the two most important errors in the ABCT are:

• The natural rate of interest is undefined in intertemporal General Equilibria (also known as, more or less, "plan coordination").
• No simple relation exists between the optimal allocation of resources among orders of goods and interest rates.

In short, both Hayek's monetary theory and his capital theory are incorrect.

Qualitative stories about the embodiment in capital goods of misaligned plans are, perhaps, the best one can get from Hayek's capital theory. Ludwig Lachmann and Peter Lewin are my favorite Austrian-school economists to read on this point. (Did Lachmann have any enduring effect on mainstream economics?) But it is hard to quantitatively estimate the effects of such misalignments, and I don't find convincing that recovering from these misalignments are the source of the largest worldwide business cycles that we have seen. Anyways, I prefer Joan Robinson on capital theory in disequilibrium.

The importance one should assign the clash between Hayek and Keynes in the history of macroeconomics seems to me to depend crucially on the impact of Hayek on mainstream views of Keynes' General Theory. But Hayek had no such impact. Hayek tried to address the General Theory in his Pure Theory of Capital. But Hayek's book was ignored at the time and is generally considered a failure. About the only thing else Hayek had to say about Keynes's General Theory occurred in interviews and other transient popular pieces. So, whatever you may think about the worth of Hayek's writings, where can you locate their impact?

Walras's Law Is False

1.0 Introduction

I have asserted that the distribution of income is determined by political power, not by intertemporal utility-maximization. Interest rates are not the result of individual decisions trading off consumption at future dates against consumption now.

Is it not a consequence of this view that Walras's law does not apply to capitalist economies?

2.0 On the Derivation of Walras's Law

Walras's law states that the sum of excess demand across all goods is zero:

p z(p) = p₁z₁(p) + p₂z₂(p) + ... + p_nz_n(p) = 0

The excess demand for the jth good is the difference between the demand and supply of that good at the set of prices at which these functions are being evaluated:

z_j(p) = d_j(p₁, p₂, ..., p_n) - s_j(p₁, p₂, ..., p_n)

And supply and demand functions for each market are found by summing over the supplies and demands for all individuals. But individual supply and demand functions are derived from the theory of utility-maximization, given the initial distribution of the endowments of all goods.

3.0 Macroeconomic Reasoning With Walras's Law

Don Patinkin considered an economy in which n - 1 commodities and "money" are traded.

"For the amount of excess demand for money equals the aggregate value of the amounts of excess supplies of commodities." -- Don Patinkin, Money, Interest, and Prices (2nd edition, Harper and Row, 1965)

I believe Patinkin's approach can be seen as building on J. R. Hicks's Value and Capital (2nd edition, Oxford University Press, 1946). Hicks included demands for both money and other securities in his General Equilibrium approach.

One can argue that the world economy is currently in a disequilibrium; both labor and produced commodities are in excess supply. Thus, by Walras's law, there must be an excess demand for money. And it is the job of monetary authorities, such as the United States's Federal Reserve, to meet that demand, by flooding the market with money while this disequilibrium exists. At least, this is the argument of prominent mainstream "Keynesians", such as Brad DeLong and Paul Krugman (suggestions for links to their blogs here are welcome).

4.0 Conclusion

Keynes's emphasis on fundamental uncertainty is arguably incompatible with the explanation of the demand for money by intertemporal utility-maximizing in a model of General Equilibrium. Thus, the above justification of "Keynesian" monetary policy, based on Walras's law, does not harmonize with Keynes's theory.

Krugman Wrong, Robinson Correct

In last Friday's column in the New York Times, Paul Krugman writes:

"After all, in an idealized market economy each worker would be paid exactly what he or she contributes to the economy by choosing to work, no more and no less. And this would be equally true for workers making $30,000 a year and executives making $30 million a year." -- Paul Krugman

Elsewhere, Rod Hill and Tony Myatt quote Joan Robinson:

"There is the problem of the relative levels of different types of earned income. Here we have the famous marginal productivity theory... The real wage of each type of labour is supposed to measure its marginal product to society. The salary of a professor of economics measures his contribution to society and the wage of a garbage collector measures his contribution. Of course this is a very comforting doctrine for professors of economics but I fear that once more the argument is circular. There is not any measure of marginal products except the wages themselves. In short, we have not got a theory of distribution. We have nothing to say on the subject which above all others occupies the minds of the people whom economics is supposed to enlighten." -- Joan Robinson

I like to refute the existence of the so-called marginal productivity theory of distribution with reswitching examples. In such examples, at least two vastly different distributions of income between wages and profits are associated with a single technique. Presumably in Krugman's morality play, the owner of each factor of production would be making the same "contribution" to the economy, whichever income distribution happened to prevail. Furthermore, it can be the case that a higher wage results in more labor being hired by cost-minimizing competitive firms. A similar point can be made with models with heterogeous labor.

I welcome Krugman's support for (some) good policies - including in the referenced newspaper column, despite his archaic knowledge of economics.

Mark Blaug (1927 - 2011)

Was any historian of economics more prominent throughout the last half century? As I understand it, David Ricardo was an early area of concentration for Blaug, even influencing him in naming his son. It's been decades since I read Blaug's 1958 book on Ricardo, and I recall it hardly at all. As you can see, he wrote it just after Sraffa had provided a trove of new materials and scholarship on Ricardo, but before the novelty of Sraffa's interpretation was widely apparent. Blaug's work spans changes in standards in history, including the development of more contextualized, thick, postmodern histories.

The first edition of Blaug's Economic Theory in Retrospect was published in 1962, and later editions came out in 1968, 1978, 1985, and 1997. I can comment on the fourth edition. I particularly like the suggested readings at the end of each chapter, which, as far I can see, provide tasteful selections of competing interpretations. And I appreciate the reading guides to various classic books. The fourth edition guides are to Smith's The Wealth of Nations, Ricardo's Principles, J. S. Mill's Principles, Marx's Capital, Marshall's Principles, Wicksteed's Common Sense of Political Economy, Wicksell's Lectures. I find the book too Whiggish for my tastes, and I have differences with Blaug throughout. Nevertheless, I can say Blaug seems equally at home in writing about any economist in the period from before Smith to after Keynes.

Blaug has been quarreling with Sraffians for decades. Consequently, I have previously had something to say about his work. The current issue of the History of Political Economy contains a posthumous article by Garegnani and an article by Kurz and Salvadori, both counter-attacking Blaug's most recent attack on Sraffians. A demand for empirical demonstrations of Sraffa effects is a defense of neoclassical economics I have never found plausible. The Cambridge critique is a logical demonstration of the incoherence of neoclassical theory. I think this defense on the basis of supposed empiricism was introduced by C. E. Ferguson, but Blaug may have been the most consistent advocate of this point of view.

Blaug has also been a critic of trends in mainstream economics, especially the effects of the formalist revolution, which he dates to the 1950s. I found particularly surprising a recent article praising Henry George.

I have nothing to say about the economics of art and the economics of education, apparently two fields in which Blaug had a lot to say.

References

• Mark Blaug (1958). Ricardian Economics: A Historical Study, Yale University Press.
• Mark Blaug (1975). The Cambridge Revolution: Success or Failure? A Critical Analysis of Cambridge Theories of Value and Distribution, Institute of Economic Affairs.
• Mark Blaug (1985). Economic Theory in Retrospect, Fourth edition, Cambridge University Press. [This is the version I have most convenient. I believe there is a fifth edition.]
• Mark Blaug (1987). "Classical Economics", in The New Palgrave (ed. by J. Eatwell, M. Milgate, and P. Newman), Macmillan.
• Mark Blaug (1998). Economics Through the Looking Glass: The Distorted Perspective of the New Palgrave Dictionary of Economics, Institute of Economic Affairs.
• Mark Blaug (1997). "Ugly Currents in Modern Economics", Policy Options (September): pp. 3-8.
• Mark Blaug (1998). "The State of Modern Economics: Disturbing Currents in Modern Economics", Challenge (May-June).
• Mark Blaug (1999). "Misunderstanding Classical Economics: The Sraffian Interpretation of the Surplus Approach", History of Political Economy, V. 31, n. 2: pp. 213-236.
• Mark Blaug (2000). "Henry George: Rebel with a Cause", European Journal History of Economic Thought, V. 7, n. 2 (Summer): pp. 270-288.
• Mark Blaug (2001). "No History of Ideas, Please, We're Economists", Journal of Economic Perspectives, V. 15, n. 1 (Winter): pp. 145-164.
• Mark Blaug (2002). "Kurz and Salvadori on the Sraffian Interpretation of the Surplus Approach", History of Political Economy, V. 34, n. 1: pp. 237-247.
• Mark Blaug (2003). "Rational vs. Historical Reconstruction - A Counter-note on Signorino's Note on Blaug", European Journal of History of Political Economy, V. 10, n. 4 (Winter): pp. 607-608.
• Mark Blaug (2003). "The Formalist Revolution of The 1950s", Journal of History of Economic Thought, V. 25, n. 2: pp. 145-156.
• Mark Blaug (2009). "The Trade-Off between Rigor and Relevance: Sraffian Economics as a Case in Point", History of Political Economy, V. 41, n. 2: pp. 219-247.
• Pierangelo Garegnani (2002). "Misunderstanding Classical Economics? A Reply to Blaug", History of Political Economy, V. 34, n. 1 (Spring): pp. 241-254.
• Pierangelo Garegnani (2011). "On Blaug Ten Years Later", History of Political Economy, V. 43, n. 3: pp. 591-605.
• Heinz D. Kurz and Neri Salvadori (2002). "Mark Blaug on the 'Sraffian Interpretation of the Surplus Approach'", History of Political Economy, V. 34, n. 1 (Spring): pp. 225-236.
• Heinz D. Kurz and Neri Salvadori (2011). "In Favor of Rigor and Relevance: A Reply to Mark Blaug", History of Political Economy, V. 43, n. 3: pp. 607-616.
• Carlo Panico (2002). "Misunderstanding the Sraffian Reading of the Classical Theory of Value and Distribution: A Note", in Competing Economic Theories: Essays on Memory of Giovanni Caravale (ed. by Nisticò and D. Tosato), Routledge.

Two Updates

A couple of weeks ago, I mentioned the Harvard students walkout on Mankiw's introductory economics class. Gabriel Bayard and Rachel Sandalow-Ash, apparently two Harvard undergrads, had an article in the Harvard Crimson a couple of tuesdays ago. This article has better points than the "Open Letter to Greg Mankiw" closer to the date of the walkout. Daniel MacDonald has other links.

Last October, I briefly surveyed some experimental evidence, including a paper by Romer and Romer, demonstrating the existence of the Keynesian multiplier. Christina Romer has a more comprehensive presentation of the evidence. (Hat tip: Paul Krugman.)

Keynes Versus Hayek On The Radio

Yesterday, National Public Radio concluded a three part series. Each day surveyed a thinker have shaped the past and may shape the future. I'll ignore the first part, since it was about a deluded non-philosopher. Tuesday, NPR covered Friedrich Hayek. Yesterday, they discussed John Maynard Keynes.

"He's Mixin' Up The Truth With Something Funny, I Start To See"

I consider the following propositions to be well-established:

1. Adam Smith did not use the phrase "The invisible hand" to refer to the optimality properties of a static general equilibrium supposedly brought about by the workings of competitive markets.
2. Thomas Carlyle did not coin the phrase "The dismal science" to refer to Thomas Malthus's anti-utopian theory of population. According to that theory, human population responds endogenously to increased prosperity, thereby making impossible any rapidly established, long-lasting general rise in per capita income beyond the custom and habits of mankind.
3. John Maynard Keynes, in The General Theory of Employment, Interest, and Money, did not explain widespread and persistent unemployment by sticky, rigid, or slowly adjusting money wages and prices - a pre-Keynesian theory that, in fact, he opposed.

Many economists, I claim, teach the opposite of these propositions. Here, for example, is Tyler Cowen falsely characterizing Keynes' theory (at least, if "Keynesian" is supposed to refer to that theory):

"You can even give this all a Keynesian take... Since 1997-2000, there is downward pressure on lots of wages, but morale matters and labor market incumbents retain a favored position. Though some wages fall, employers resist that downward pressure, and pass along a lot of the burden of adjustment to new job seekers. Even if that original downward pressure on wages is smallish, new job seekers have to make big adjustments in their career plans, majors, ambitions, etc. to get through the door at all. They didn't." -- Tyler Cowen

It seems to be a quixotic and never-ending task to oppose demonstrably false statements about economics, often made by economists. Gavin Kennedy illustrates such a quest in defense of my first proposition.

Sausage With Pepper And Onions

Note to myself: I liked this recipe. Next time, consider making it with only two peppers. On the other hand, despite the leftover sauce, having a slightly different pepper taste with each bite is neat. Maybe I'll look for other recipes at that site.

(The sides in this case are mashed sweet potatoes and a cut-up Granny Smith apple with a little bit of sugar sprinkled and mixed in. I like a mixture of cut-up apples and pears, too.)

Elsewhere

• Arjo Klamer has a blog, mainly in dutch. In one post in English, he argues that the award of the Nobel to Sargent and Sims symbolizes the failure of economics.
• The U.S. Solidarity Economy Network (SEN) looks like an interesting site to explore. They attempt "to connect a diverse array of individuals, organizations, businesses and projects in the shared work of building and strengthening regional, national and international movements for a solidarity economy."
• A group anti-Mankiw blog has been created to respond to the bushwa Mankiw posts on his blog. (Hat tip to Daniel MacDonald, who has quite a bit to say about walking out on Mankiw's class and the incoherence of his textbook.)
• Corey Robin has a blog. His book, The Reactionary Mind: Conservatism from Edmund Burke to Sarah Palin, argues that what unites conservatives is reacting against attempts of oppressed groups (slaves vs. masters, workers vs. capitalists, women vs. men) to assert agency. The reaction is important - conservatives are often modernizers and derisive of the abilities of the ruling classes that they are attempting to defend. His book is analytical, not mocking, and not arguing for what is to be done.

Walkout On Mankiw's Blather

Apparently, some Harvard students are planning on an organized walkout on Mankiw's introductory economics class today. This action is planned in solidarity with the Occupy Wall Street movement.

Stephen Marglin is one Harvard economist I respect. I find the Harvard Crimson has been, with difficulty*, scanning back issues. Apparently, they rewrote the same article about Marglin every few years for a while there: 1975, 1980, 1982, 2009. Here's a 2009 article about his controversial introductory economics class.

Update: CNN and the Crimson report on the results. An open letter to Greg Mankiw, from one of the organizers, explains the action. Some Harvard student has a response at the same site.

* Substituting "Mary" for "Marx" is probably a scanning error.