Thursday, February 14, 2019

Brian Romanchuk — Functional Finance Versus New Keynesian Economics, Krugman Edition

Paul Krugman has piled onto the "MMT explained by non-MMTers" bandwagon, with a critique of Functional Finance. Functional Finance is largely associated with the Old Keynesian Abba Lerner, and is one of the key intellectual roots of Modern Monetary Theory (MMT). In my view, the most interesting part of the article is that it contradicts the commonly made assertion that there is very little new in MMT (which Krugman hints at in the article as well). In presenting his summary of Functional Finance, Krugman obviously has theoretical blinders on, and the objective of MMTers is to point out the existence of those blinders.…
The fundamental problem with the New Keynesian approach of Paul Krugman, Brad DeLong, Simon Wren-Lewis, etc., is that the model is fundamentally neoclassical rather than Keynesian., only departing somewhat in assumptions but not methodology. This methodology falls into the class formal (mathematical) rather than empirically based and it ignores the role of institutions and operations. As a result, it is either utopian or fitted.

For example, "full employment" in the neoclassical model is defined down to fit the assumptions about "natural rates" that are theoretical constructs and are not observables. The proof is in the pudding and the data reveals that the model only fits special cases, and it doesn't fit the non-trivial aspects of the issue, namely the turning points in the financial and business cycles.

As a result conventional economists missed the most momentous financial and economic event of contemporary times, the global financial crisis, because it was beyond the scope and scale of the model, explained as an "exogenous shock." Other models, in particular the Godley stock-flow consistent model based on accounting that MMT economist did, because such occurrences are within the scope and scale of the model.

Moreover, the remedies for the subsequent recession when the financial crisis went viral and spilled over into the global economy proposed by conventional economists failed. The country that dealt with the crisis successfully used the fiscal approach recommended by MMT economists. That country was China.

MMT economists were all trained in conventional economist in their academic studies and teach it along with other approaches in their classes. They have provided nuanced critics of other systems in their writings by showing the differences between MMT and these approaches, which conventional economists seem not to be aware of. Keynes and other of his followers have also, notably in the Cambridge capital debates in which Piero Sraffa and Joan Robinson defeated Paul Samuelson and Robert Solow, although the inadequacies of the model were not addressed subsequently. In fact, the "Keynesianism" of the New Keynesian synthesis developed and popularized by Samuelson is based on John Hicks' misreading of Keynes, and so the IS-LM model that Paul Krugman loves to cite is not true to Keynes.

The charge that there is nothing new in MMT, or that "we knew that already," are clearly false, as MMT economists have pointed out. So is the charge that the monetarism of the New Keynesian approach is superior to the fiscal approach of MMT. Finally, New Keynesians define down "full employment" to fit the NAIRU model based on dubious assumptions, resulting in a buffer stock of unemployed that involves million of people throughout the cycle.The MMT approach includes actual full employment (less transitional) by using a buffer stock of employed in which the government-set wage provided a price anchor by denominating the hourly wage for unskilled labor in the currency as the government's unit of account.

Bond Economics
Functional Finance Versus New Keynesian Economics, Krugman Edition
Brian Romanchuk


Brad DeLong follows Krugman, although he had aleady offered this criticism some time ago. As the MMT economists point out, this confuses Abba Lerner's approach to functional finance with the MMT approach to it. Similarly, the MMT approach to the JG is not the same as Hyman Minsky's.


AXEC / E.K-H said...

Krugman vs MMT ― like the blind talking about colors
Comment on Brian Romanchuk on ‘Functional Finance Versus New Keynesian Economics, Krugman Edition’*

The characteristic of economic debates is to talk about everything except the point at issue.

Krugman starts the talk show with: “Well, it looks as if policy debates over the next couple of years will be at least somewhat affected by the doctrine of Modern Monetary Theory, …” Then he realizes that he is not up-to-date but this does not matter because: “The good news is that MMT seems to be pretty much the same thing as Abba Lerner’s ‘functional finance’ doctrine from 1943.” And off he goes parroting the worn-out stuff about inflation and crowding-out with the finale: “The bottom line is that while functional finance has a lot going for it, it’s not the kind of axiomatically true doctrine that Lerner ― and, I think, modern MMTers ― imagined it to be.”

No word about that MMT is just proto-scientific garbage. And, of course, no state-of-art refutation of the MMT approach, no proof of material/formal inconsistency.

Brian Romanchuk’s answer remains on the same low level and consists of pointing out that Krugman himself clings to a rather crappy approach: “The fundamental problem with the New Keynesian approach of Paul Krugman, Brad DeLong, Simon Wren-Lewis, etc., is that the model is fundamentally neoclassical rather than Keynesian., only departing somewhat in assumptions but not methodology. This methodology falls into the class formal (mathematical) rather than empirically based and it ignores the role of institutions and operations.”

Both parties are spot on in their critique of the other approach. The irony is that both approaches share a common blunder. Krugman refers via the IS-LM model back to Keynes and MMT via the sectoral balances equation, i.e. via (I−S)+(G−T)+(X−M)=0 which boils down to I=S when the public sector and the foreign sector are taken out of the picture for a moment.

The common blunder can be exactly located in the GT: “Income = value of output = consumption + investment. Saving = income − consumption. Therefore saving = investment.” (p. 63)

“His Collected Writings show that he wrestled to solve the Profit Puzzle up till the semi-final versions of his GT but in the end he gave up and discarded the draft chapter dealing with it.” (Tómasson et al.)

Keynes, like his academic colleagues, NEVER understood what profit is and thus ended with I=S ― one of the greatest blunders in the history of modern science. Neither New Keynesians nor MMTers, though, have realized anything for 80+ years.#1 Both are too stupid for the elementary mathematics that underlies macroeconomics.

The correct macroeconomic relations are given by Q=−S for the elementary production-consumption economy and Q=I−S for the elementary investment economy with Q business sector’s monetary profit, S household sector’s monetary saving, business sector’s I investment expenditures. From this follows that all I=S/IS-LM models and their derivatives are scientifically worthless.#2

Both New Keynesianism and MMT are provably false.#3 By consequence, the economic policy arguments of both sides have NO scientifically valid foundations. What Krugman advertises as wonkish is just the usual brain-dead blather of failed/fake scientists.

Egmont Kakarot-Handtke

* NYT, Paul Krugman, What’s Wrong With Functional Finance? (Wonkish)

#1 Mr. Keynes, Prof. Krugman, IS-LM, and the End of Economics as We Know It

#2 For details see cross-references Refutation of I=S

#3 See cross-references Keynesianism
and cross-references MMT

Noah Way said...

AXEC does not guarantee the accuracy, completeness or quality of the information provided.

AXEC / E.K-H said...


Brian Romanchuk

You say: “The cost of goods sold is itself complicated, since it depends on the valuation of inventory. … Depreciation is also based on the historical cost of capital. In summary, way more complex than the junk you blather on about.”

The alleged complexity is merely a projection of your own confusion.

(i) Total macroeconomic profit Q is composed of monetary profit Qm and nonmonetary profit Qn.

(ii) Nonmonetary profit Qn is the sum of all positive/negative changes of valuation including depreciation.

(iii) Qn has been dealt with elsewhere and is taken out of the picture for a moment.

(iv) Monetary profit Qm for the one-fully-integrated-macroeconomic firm is defined as Qm≡C−Yw. In your words: Qm is “sales revenue” C minus “cost of goods sold” Yw in the most elementary production-consumption economy with market clearing, i.e. X=O. Changes of inventory, i.e. X≠O, have been dealt with elsewhere.

(v) The investment economy has been dealt with elsewhere.

(vi) Monetary saving of the household sector is defined as Sm≡Yw−C. Total saving S is the sum of monetary Sm and nonmonetary saving Sn. The latter has been dealt with elsewhere.

(vii) Monetary profit Qm and monetary saving Sm are measurable with the precision of two decimal places. There is NOT the slightest ambiguity here. Qm and Sm are as real as cash in the box or as money in the bank.

(viii) From this follows: the macroeconomic Profit Law for the most elementary case of a production-consumption economy reads Qm+Sm=0 or Qm=−Sm. This is the irreducible hardcore of the macroeconomic Profit Law.

For the more complex cases see the overview on Wikimedia.#1 From this overview follows that the MMT sectoral balances equation is provably false.

That you have not realized anything to this day disqualifies you as a mathematician and economist.

Egmont Kakarot-Handtke

#1 Wikimedia, Profit Law

Noah Way said...

Don't feed the troll.