June 16, 2017

Economic bungee jumping without cord

Comment on Simon Wren-Lewis on ‘Raising the inflation target’

Blog-Reference and Blog-Reference on Jun 17

You say: “The argument for a higher inflation target is straightforward, once you understand two things. First the most effective and reliable monetary policy instrument is to influence the real interest rate in the economy, which is the nominal interest rate less expected inflation. Second nominal short term interest rates have a floor near zero (the Zero Lower Bound, or ZLB).”

The argument for a higher inflation target is NOT straightforward, once you understand two things. First interest theory is axiomatically false.#1 Because of this monetary policy never had sound scientific foundations. Second the same holds for fiscal policy.#2

Let us assume for a moment that, for whatever reasons, neither monetary nor fiscal policy is applicable. So, given investment expenditures of the business sector and the expenditure ratio of the household sector, the only alternative left is to directly influence the macroeconomic price mechanism.#3

The argument AGAINST higher inflation is that it REDUCES employment. Given the overall situation, the ONLY sensible policy is to increase the average wage rate, such that the rate of change of the wage rate is greater than the rate of change of productivity, because this increases employment. This is a SYSTEMIC necessity and has NOTHING to do with social policy. Employment is co-determined by the relationship between average wage rate, price and productivity. This relationship should automatically produce full employment but does not.

Standard employment theory is false.#4 The proposal to get the economy going by increasing price inflation is the direct result of the complete lack of understanding how the market economy works.

Egmont Kakarot-Handtke

#1 See ‘The Emergence of Profit and Interest in the Monetary Circuit
#2 See ‘Austerity and the utter scientific ignorance of economists
#3 For more details see ‘Think deeper
#4 For details of the bigger picture see cross-references Employment

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REPLY to Simon Wren-Lewis on Jun 19

You say: “For every borrower there is a saver.”

In this generality this is trivially true, nonetheless it is grossly misleading. To see this, let us take the pure consumption economy as the most elementary case as starting point (no investment, not government, no foreign trade). Wage income is denoted as Yw, consumption expenditures as C.#1

The sector balances (Sm≡Yw-C, Qm≡C-Yw) always add up to zero, i.e. Qm+Sm=0 or Qm=-Sm, that is, the business sector makes a monetary profit Qm which is equal to the household sector’s dissaving -Sm or a loss -Qm which is equal to monetary saving Sm. So, if the household sector dissaves it uno actu happens that the household sector becomes the borrower vis a vis the banking sector (including the central bank) and the business sector becomes the lender to the banking sector. When we cut the banking sector short the business sector becomes the ultimate lender to the household sector.

From this immediately follows that saving and investment is NEVER equal, neither ex ante nor ex post, and ALL Keynesian and Post Keynesian and New Keynesian and IS-LM models are provable false.#2

The same relationship holds when the private households are substituted by public households. Therefore, the period deficit of the public sector reappears one-to-one as profit of the business sector. When we cut the banking sector short the business sector becomes the ultimate lender to the public sector.

Needless to say that the business sector prefers the public sector as ultimate borrower. This explains the safe asset shortage if the monetary profits stem from private deficit spending.

The deficit spending of the private and public households together determine the overall profit of the business sector. This means that Keynesian deficit spending is the ultimate profit machine if the household sector’s budget is balanced. Increased private and public deficit spending in turn explains the falling labor share.#3

Whether public deficit spending helps employment depends on whether the average price increases or not. In any case, though, public deficit spending helps profit one-to-one. So, whoever wants the maximum employment effect from deficit spending has to see to it that the price increase is zero.#4

Now, you are in favor of expansive fiscal policy and propose to increase the inflation target. This is as counterproductive as can be. The combination of increasing public deficit spending and a rising price increases profit and leaves employment unaffected.

From the standpoint of the 1-percenters your policy mix is perfect. From the standpoint of the 99-percenters it is another instance of expert madness. The correct policy in the given situation is to put traditional=failed monetary and fiscal policy aside and to increase the average wage rate at ZERO inflation.

#1 For details see ‘First Lecture in New Economic Thinking
#2 For details see ‘Profit and the collective failure of economists
#3 See ‘Profit and distribution: a primer
#4 See ‘Unemployment is high because economics is false: period, full stop, end of story


Immediately following 'Attention: there are THREE types of inflation'