August 8, 2017

How MMT got inflation wrong

Comment on Nick Johnson on ‘Modern Monetary Theory and inflation – Anwar Shaikh’s critique’

Blog-Reference and Blog-Reference

Nick Johnson compares Anwar Shaikh’s approach with the MMT approach. Scientifically, this is a futile exercise, just as comparing Superman with Spiderman because both are NONENTITIES.

MMT is an offshoot of Post Keynesianism. Anwar Shaikh works largely within the Classical/ Marxian tradition. However, the main approaches ― Walrasianism, Keynesianism, Marxianism, Austrianism ― are mutually contradictory, axiomatically false, materially/ formally inconsistent, and all got profit wrong. With the pluralism of provably false theories both orthodox and heterodox economics sits squarely at the proto-scientific level.

Clearly, when the pivotal concept profit is not properly understood the rest of the analytical superstructure falls apart and the whole is scientifically worthless. What the representative economist has to understand is that nothing less than a paradigm shift is required, that is, a move from obsolete Walrasian microfoundations and false Keynesian/ Marxian macrofoundations to entirely new macrofoundations.#1

In order to go back to the basics, the pure production consumption economy is for a start defined by three macro axioms (Yw=WL, O=RL, C=PX), two conditions (X=O, C=Yw) and two definitions (profit/loss Qm≡C−Yw, saving/dissaving Sm≡Yw−C).#2

It always holds Qm+Sm=0 or Qm=−Sm, in other words, the business sector’s deficit (surplus) equals the household sector’s surplus (deficit). Loss is the counterpart of saving and profit is the counterpart of dissaving. This is the most elementary form of the Profit Law. This law refutes the familiar profit theories. Note in particular that profit for the economy as a whole has nothing to do with capital or productivity or greed or power.

Money is needed by the business sector to pay the workers who receive the wage income Yper period. The workers spend C per period. Given the two conditions, the market clearing price is derived for a start as P=C/X=W/R. So, the price P is determined by the wage rate W, which has to be fixed as a numéraire, and the productivity R. From this follows the average stock of transaction money as M=κYw, with κ determined by the payment pattern. In other words, the quantity 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.

The transaction formula reads in the general case M=κ max(1, ρE) PX= κ (max(1, ρE) RL) P, with the ratio ρE defined as C/Yw, and this yields the commonplace correlation between quantity of money M and price P for a given employment/output level, except for the fact that M is the DEPENDENT variable.

The market clearing price is given in the general case with this price formula = Law of Supply and Demand:#3
An expenditure ratio ρE greater than 1 indicates credit expansion = dissaving, a ratio ρE less than 1 indicates credit contraction = saving. In the initial period ρE = 1, i.e. the household sector’s budget is balanced. The ratio ρE establishes the link between the product market and the money/capital market.

Now we have deficit spending, i.e. ρE greater 1, which yields a price hike. If deficit spending is repeated period after period the price remains on the elevated level but there is NO inflation. No matter how long the household sector’s debt increases, there is NO accelerated price increase.

The price formula makes it clear that inflation only occurs if the wage rate W increases in successive periods faster than productivity R. This can happen at ANY employment level. It is NOT a precondition that employment is close to the capacity limit. This is merely a false interpretation of the Phillips curve.

MMT claims that inflation/deflation can be managed via fiscal and monetary policy. This policy advice has no sound theoretical foundation.#4

The current deflationary trend is caused by the fact that (worldwide) wages lag behind productivity growth. To turn this trend around it does not matter much what happens on the money/bond/stock markets, what matters is that governments/central banks engineer a coordinated world wide increase of the average wage rate.

Policy guidance of both MMT and Anwar Shaikh is ineffective/misleading because for both approaches the macrofoundations and the concept of profit are ill-defined and methodologically forever unacceptable.

Egmont Kakarot-Handtke

#1 First Lecture in New Economic Thinking
#2 For the detailed description see ‘How the intelligent non-economist can refute every economist hands down
#3 Wikimedia Price formula = LAW OF SUPPLY AND DEMAND
#4 For the comprehensive overview and the point-by-point refutation of MMT see cross-references

Related 'Putting economic policy on scientific foundations' and 'Why Post Keynesianism Is Not Yet a Science' and 'The Profit Theory is False Since Adam Smith'