The great IS-LM obfuscation
from Lars Syll
Thirty years ago – as a young research stipendiate in the U.S. – yours truly had the great pleasure and privelege of having Hyman Minsky as teacher. He was a great inspiration at the time. He still is.
The concepts which it is usual to ignore or deemphasize in interpreting Keynes – the cyclical perspective, the relations between investment and finance, and uncertainty, are the keys to an understanding of the full significance of his contribution …
The glib assumption made by Professor Hicks in his exposition of Keynes’s contribution that there is a simple, negatively sloped function, reflecting the productivity of increments to the stock of capital, that relates investment to the interest rate is a caricature of Keynes’s theory of investment … which relates the pace of investment not only to prospective yields but also to ongoing financial behavior …
The conclusion to our argument is that the missing step in the standard Keynesian theory was the explicit consideration of capitalist finace within a cyclical and speculative context. Once captalist finance is introduced and the development of cash flows … during the various states of the economy is esplicitly examied, then the full power of the revolutionary insights and the alterntive frame of analysis that Keynes developed becomes evident …
The greatness of The General Theory was that Keynes visualized [the imperfections of the monetary-financial system] as systematic rather than accidental or perhaps incidental attributes of capitalism … Only a theory that was explicitly cyclical and overtly financial was capable of being useful …
As all students of economics know, time is limited. Given that, there has to be better ways to optimize its utilization than spending hours and hours working through or constructing irrelevant economic models. I rather recommend my students to allocate some time to study great forerunners like Keynes and Minsky, helping them to construct better, real and relevant economic models – models that really help us to explain and understand reality.
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Real-World Economics Review Blog 
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Empirical Reality based standards for model building theories
The great “Obfuscation” is that “poverty” is crisis itself, and that bubbles deny the existence of corporate power to circumvent social and economic externalities or create favorable market circumstances that target profits over pain , or dismiss the social costs that corporations bent solely on maximizing profits and gain routinely disregard as extraneous circumstances…and frankly none of their business.
Minsky grounds a Keynesian focus of working class context into Austrian business cycles, and that takes it beyond the basic business model of society. Unfortunately he inevitably sees or (neglects to see) “culture” as a result of those social elite forces determined by markets of exclusivity and narrow interests and a full spectrum economic crisis theory of poverty was never conceived or even perceived as systemic failure.
The trouble with Minsky’s analysis is that the business-financial cycle is endogeneous — which means the future is already predetermined — and therefore Minsky assumes the ergodic hypothesis. His uncertainty is an epistemic concept –if he had any concept of uncertainty at all.
Hyman, who was a personal friend, refused to be associated with the Post Keynesian economic nomenclature. He was against Sidney Weintraub and I starting the Journal of Post Keynesian Economics and tried to talk us out of starting it..He believed he was more an Old Keynesian– in the mold of Bob Solow, but with a financial story on top.
Professor Davidson,
Would it be possible for you to explain how to integrate fundamental uncertainty into economic models?
@amoghsahu: Isn’t it more clear and coherent to say the “uncertainty of fundamentals?”
Paul, I’m having real difficulties following your argumentation here. Minsky’s whole work is one big plaidoyer for incorporating Keynes’ insights on genuine uncertainty and the disequilibrating forces it together with finance creates in an economy. How you reconcile that with a rather unsubstantiated allegation of Minsky assuming ergodicity is hard to imagine.
I think it’s interesting how these debates shift around over time. The lines of conflict in macro are quite different than they were 30 years ago. Then, it made perfect sense for people like Minsky or Leijonhufvud to point out all the important things left out of IS-LM and the income-expenditure version of Keynesianism. But in the intervening time, the profession has completely rejected IS-LM and income-expenditure approaches, but for very different reasons than Minsky, Leijonhufvud etc. wanted them to.
Today, Minsky’s John Maynard Keynes reads in some ways like a defense of the stuff it was intended to criticize, because Minsky was much closer to the mainstream Keynesians of his time than either is to modern macro, and because in making the case against the simple income-expenditure approach, he has to first make the case for it, in a way that nobody would bother doing now. (It’s a bit like Darkness at Noon that way.)
Today the problem is certainly not IS-LM, which nobody believes and is rapidly disappearing even from undergraduate textbooks. If anything we could use a lot more of it, and similar simple aggregate models. It seems to me that from where we are now, it would be considerable progress to get back to the kind of economics Minsky was reacting against.
“If anything we could use a lot more of it, and similar simple aggregate models.”
The structural problems in our current economy are largely obscured using aggregate data. Your own study on household debt dynamics is a good example of one that fails to examine what is going on at a disaggregated level. Recent studies have shown that leverage of the top 5% of the income distribution remained stable over the period examined in your paper , while leverage increased dramatically for the bottom 95%. By definition , that means the “debt dynamics” you describe for the aggregate would not be accurate for these two groups if examined separately. This has consequences for understanding the current sluggish demand situation as it relates to things like income inequality , propensity to consume , etc.
I’m not sure why this matters? It is simply not the case, as a factual matter, that the aggregate expenditure-income ratios rose during the 1980s, but the aggregate debt-income ratio did rise, by about 20 points. I think this is an interesting fact. It is true that leverage did not rise much at the very top of the income distribution. It also did not rise in the bottom half of the distribution. Rising debt-income ratios were mainly seen in the 60th-80th percentiles or so. But so what? It remains true that most of the rise in debt-income ratios is explained by higher interest rates and lower inflation, not by higher expenditure relative to income, whether due to inequality or any other reason.
On the broader question, of course aggregate data misses lots of stuff. Any disaggregated story you can actually tell, also misses lots of stuff. That’s the nature of social science, we have to radically simplify a complex reality in order to say anything. I think IS-LM is both more useful for the sort of questions folks around here are interested in, and closer to the spirit of Minsky’s work, than the DSGE and similar models of intertemporal optimization that dominate macro today. Fighting Hicks was important in 1975; given the guys we’re dealing with now, he’s an ally.
I mean, it IS the case, not it is not the case.
Ah crap sorry no, I had it right the first time.
:-[
On the economics of the 99%:
The 99% might argue that, in the objective reality of their “real-world economics,” the capitalist elite collusively mandate behind closed doors that the government adopt public policies in which the operation of the marketplace is primarily beneficial to corporate special interests; which “public policy,” in being mandated by invested interests of the private sector, collusively through allied organizations and institutions working behind the scenes, is typically – and quite knowingly to these special interests – adverse to the general interest, i.e. adverse to the public good. Isn’t it now time that economics entertain models that explain and understand the adverse reality experience by the 99%.
That is the “obfuscation” of instituionalized patent ecocentric medicine. The 99% are essentially not part of the narrative of model building based upon “bubbles” and not the spectrum of context and content of substance. Essentially and virtually the Formalists’ theroetical tracking sees the finance as foundation to reality itself, and the reality of the underbelly is the virtual equivalent to “collateral damages” expected and anticipated in a “growth” economy of scope and scale expansions.
Yes it is time that economics explains the adverse reality experience by the 99% But neo-classical economics had no such concerns, nor do the economists blogging here. If they look at the reality experience of the 99%, by the time they force the “facts” through the “strainer” of economics, they disappear It’s a game economists play among themselves, without relevance to human experience and public utility.
Warm compliments to you Robert! I wonder truthfully if Minsky & managerialism isn’t a Doctoral dissertation waiting to be written? Or a serious book for that matter?
Regards:
Bruce
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http://en.wikipedia.org/wiki/Cosmopolis_%28film%29
Cosmopolis Poster.jpg
Cosmopolis is a 2012 Canadian drama film written, produced, and directed by David Cronenberg and starring Robert Pattinson. It is based on the novel of the same name by Don DeLillo. Cosmopolis is Don DeLillo’s thirteenth novel. It was published by Scribner on April 14, 2003.http://en.wikipedia.org/wiki/Cosmopolis_%28novel%29
Cosmopolis (the movie) is a somewhat surreal characterization of how the scope and scale of finance has become an electronic fantasy separated from reality and yet directly impacting on the scope of reality itself. the question of “uncertainty” derives from the outcome of a decision on profits and losses but the ultimate uncertainty is the final outcome as the progression implodes. The final bubble reveals that it is ‘certainty’ that is lost in a progressive fallacy of success. The disillusionment depicted in Cosmopolis is the pathology of pure success and the meaningless of its succession without the human experience realized in the challenge of uncertainty. Insulated from the realties of the external world and anesthetized by astronomical figures in finance, the protagonist is takes massive losses as he meanders through Manhattan on his way to get a “haircut” from the barber that cared for his father (read into that what you will…).
I doubt that anyone truly recognized DeLillo’s incredible insights in this work and his accurate rendition of international finance on the brink of self destruction. Anyone seeing it today with a half of aneye open would have to concede that he hit the genius switch with neon signs lit up for 2007 and thereafter.
All economic activity involves land, either extractively or, more commonly, because location is critical to the success of that activity.
If the model does not include land and the apparent 18-year cycle that seems to be due to the interaction between the market in land titles and the banking system, (which itself needs closer study) then the model is of little worth and not worth investing time in studying what is a misleading picture.
Economics and money systems are the least humanly integrated of our systems. The scientific/reductionist bias of modernity has alienated Man from both his systems and himself. Any grand synthesis in these systems must be a swing back toward both a fuller consideration of the individual and sat the same time psychologically better enables his best capabilities.
It is laudable to direct students away from irrelevant economic models.
Orthodox economics is irrelevant from Jevons to DSGE. The problem is that Heterodoxy from Veblen to Minsky is only slightly better. With a critical stance it is easy to identify and to avoid the worst blunders of standard theory. Davidson is a case in point. Of course, the ergodic hypothesis is inapplicable in economics. Keynes was right word for word in what he said about uncertainty (1937, p. 214). The point is that this was only revolutionary vis-à-vis the ‘classical’ economists. Outside this intellectually closed sphere the argument is trivial. The next taxi driver can tell you that ‘the price of copper and the rate of interest twenty years hence’ is uncertain. If this is scientific progress it is not terribly impressive. It is a sad fact that heterodox economists have a strong bias to draw the wrong conclusions from correct observations. Which brings us to Minsky.
Minsky (2008, p. 160) states correctly “What determines profits? is a key question for understanding how our economy works.” Clearly, it is irresponsible to give economic advice without a proper understanding of profit. With his zero-profit economy Walras demonstrated a complete lack of understanding. Therefore, he and the neo-Walrasians are out. However, the General Theory is also based on a wrong profit theory (Tómasson und Bezemer, 2010), which has not been rectified by the Post-Keynesians (Kakarot-Handtke, 2013), (Desai, 2008, p. 10). Therefore, Keynesian models, including bastardizations like IS-LM are out, too.
What about Minsky in particular? He tells us:
“The simple equation “profit equals investment” is the fundamental relation for a macroeconomics that aims to determine the behavior through time of a capitalist economy with a sophisticated, complex financial structure.” (2008, p. 161)
Unfortunately, this simple equation covers only a limiting case. This is not much in absolute terms but considerably more than what IS-LM, which is a zero-profit model, ever had to offer.
It seems to be a mission impossible these days to direct students to relevant economic models.
References
Desai, M. (2008). Profit and Profit Theory. In S. N. Durlauf, and L. E. Blume
(Eds.), The New Palgrave Dictionary of Economics Online, pages 1–11. Palgrave
Macmillan, 2nd edition. URL http://www.dictionaryofeconomics.com/article?id=
pde2008_P000213.
Kakarot-Handtke, E. (2013). Why Post Keynesianism is Not Yet a Science. Economic
Analysis and Policy, 43(1): 97–106. URL http://www.eap-journal.com/
archive/v43_i1_06-Kakarot-Handtke.pdf.
Keynes, J. M. (1937). The General Theory of Employment. Quarterly Journal of
Economics, 51(2): 209–223. URL http://www.jstor.org/stable/1882087.
Minsky, H. P. (2008). Stabilizing an Unstable Economy. New York, NY, Chicago,
IL, San Francisco, CA: McGraw Hill, 2nd edition.
Tómasson, G., and Bezemer, D. J. (2010). What is the Source of Profit and
Interest? A Classical Conundrum Reconsidered. MPRA Paper, 20557: 1–34.
URL http://mpra.ub.uni-muenchen.de/20557/.
“The problem is that Heterodoxy from Veblen to Minsky is only slightly better.” Discuss in detail please. I find economists stating all the time that “heterodoxy” does not offer a valid alternative to “orthodoxy” and then the subject dropped. If we are to get anywhere in designing a new curriculum for economics, then it has to be discussed.
i guess my view is unless you are dealing with something like a free particle schrodinger equation, with everything unbounded (with variants like diffusion/brownian motion or levy walks) there is going to be an ergodic assumption in there somewhere (and even in the cases mentioned in the previous sentence you can change the coordinate frame so it will be ergodic) (crutchfield at sfi wrote on this awhile back tho i am not a fan of his approach—christian beck of uk is more my style).
given this, profit is investment. and even income inequality is just a sampling error (yakovenko/cockshott/rosser etc.)
i see lee smolin of perimeter has backed away from the ‘timelesss universe’ but maybe that is because he’s busy. for people at perimeter, profit is real. (but in the long run we’re all dead) .
heterodoxy—meet the new boss, same as the old boss. a few nonlinearities. (and the question is how many, and which are important? see hilbert’s 10th problem and later results).
http://www.bu.edu/historic/hs/september03.html#hoopes
Volume V, Number 1
MANAGERIALISM: ITS HISTORY AND DANGERS
by James Hoopes
“Jefferson’s prescient warning that “power believes it has a great soul” and is therefore always suspect is more and more likely to be forgotten (or rather proven) in favor of the unwittingly undemocratic claim that our officials are moral leaders. The danger, of course, is that our leaders, and we too, may question our democratic right to doubt such paragons.”
More from Hoopes (read sample:Amazon)
Try it free
Sample the beginning of this book for free
False Prophets: The Gurus Who Created Modern Management And Why Their Ideas Are Bad For Business
Lars from Mynsky? “The greatness of The General Theory was that Keynes visualized [the imperfections of the monetary-financial system] as systematic rather than accidental or perhaps incidental attributes of capitalism … Only a theory that was explicitly cyclical and overtly financial was capable of being useful …”.
If Mynsky said that, good for him! I’ve never seen Keynes better summarised.
What is still coming out in the comments here is a failure to understand the difference between ergodic deviations in observations and the same in the events observed, which actually influence the behaviour and even structure of the system. Just writing them off in the theory is equivalent to the laissez faire political argument that nothing should be done in reality about errors resulting from chance, because in the long run they will sort themselves out.
After Keynes’ premature death Shannon and Weiner showed what a load of rubbish that is: one can and does steer a ship or car and if one acts early enough one can recognise and correct data errors before they corrupt the intended activity, adaptive programming or institutional system structure. Keynes refused to accept that gross unemployment was an inevitable and acceptable result of random interactions, and in advance of Shannon’s mathematical theory, justified his position by successfully showing how to restore employment to an acceptable level: by infrastructure investment, paying better wages, progressive taxation and controlling international finance. What a pity about the “missing step” that Minsky noted: “the explicit consideration of capitalist finance within a cyclical and speculative context”. Bent financiers with self-interested money-making objectives remained able to bend to their own objective both the system and what economic observers were seeing. Had a solution for stagflation and technological redundancy been sought in Keynes instead of dishonest critics like Hayek, it would have been found in his suggestion of shortening working weeks and increased focus on cultural activities.
The unexpected event which let loose bent empire-building financiers and unreliable employment was the political charisma of the naive (so easily misguided) Thatcher and Reagan. A Keynesian vision of economic cycles akin to those of Nature’s four seasons was successfully reduced by them to Bruce’s “Austrian [financial] business cycle” of deliberate bubble-blowing, bursting and scavenging built on misrepresentation institutionalised in fraudulent money.
So Minsky is right. To build an honest economics we need not only honest money based on a true understanding of it (as an indicator of credit-worthiness?) but also the reduction to a commonplace of the principle that because brains have four parts, people are of four basic types, play four specialised roles and have four different types of motivations which in the game of life are all auxilliary to the ultimate objective of a good time being had by one and all. Perhaps Plato’s ‘Republic’ is on the right lines. The problem (until we learn better) is that we see what is there to be seen and experience only our own motivations. Thus we tend to judge people by our own standards and see life as in practice a war game in which the aim is to win, to lose is to die and the winner’s captains take all. Better the game of life in which livelihoods are assured and prizes for honour can be earned by all.
Along those lines in response to Egmont’s comment, the world profits and our activities are honourable when we invest the wealth and energy we already have in making our bit of the world (including ourselves) a better (more sustainable, more reliable, more interesting, more beautiful, more enjoyable) place. If [most?] heterodox economic doctrines are only marginally better than the ‘orthodox’ crap (which is self-righteous rather than right), is that not because their criterion of ‘better’ is quantitative rate of growth rather than what the growth and development of humanity is being directed to?
Apologies for WordPress having stripped out most of my spacing.
“Systems were made for men, and not men for systems, and the interest of man which is self-development, is above all systems, whether theological, political or economic.”
C. H. Douglas
I was an economics student in the early 1980s. How I wish I had had MInsky’s book at the time. I read it two years ago – a very old dog-eared copy with hand-written notes in the margin borrowed from the library of a major red-brick university. I was the first person to borrow it in nearly 10 years.
It is good news that IS-LM is disappearing from undergraduate textbooks but it is a scandalously gradual process given that it still appears at all.
PS. I’m not an economist, but I am in the economy.
Steve: thanks for the wonderfully apt Douglas quote. It is nice to be reassured that someone has read what one has written.
Bruce: ditto the Jefferson quote. My saying Thatcher was easily led was to let her off the hook, according to my son. I agree, she was arrogant and wicked in her own right, and here’s why: “Power believes it has a great soul”.
I hope others will follow your link and make time to read Hoopes’s piece on “the right of the manager to manage”, for it parallels in the political field my own comments on money representing debt, not value. I would, however, point out that the management hierarchy is not just foremen-workers but has above them directors-owners (including governmental direction of the nation), where likewise democracy can be a sham. I say “can be”, for it all depends on how information is interpreted by the personalities involved. I commend the negative interpretation as more likely to defuse managerial hubris, though unfortunately spoiled children may still become self-righteous bullies.
James Hoopes: False Prophets: The Gurus Who Created Modern Management And Why Their Ideas Are Bad For Business Today
Ending Poverty: Jobs, Not Welfare by Minsky, Hyman P. (Apr 11, 2013)
Ending Poverty: Jobs, Not Welfare [Kindle Edition]
Hyman P. Minsky (Author)