Home > Uncategorized > What’s in a model… (an economic one, that is)

What’s in a model… (an economic one, that is)

What’s an economic model? A little semantic intro (don’t worry, we will get to Keynes in a moment)

I work together with biologists, agronomists and even test animal specialists on a regular basis. These people use words like ‘conceptual models’ or ‘even ‘animal model’ all the time. Check this:  ‘Mouse Models of Diabetic Nephropathy‘. Yes, a live animal is considered to be a scientific model. I had to get used to this as this use of the word ‘model’ transcended the boundaries used in the world I came from. But mastering these concepts prooved enightening. Conceptual models are described by Andrew Powell-Morse in the following way:

conceptual model is a representation of a system that uses concepts and ideas to form said representation… a model is intrinsically a thing unto itself, but that model also contains a concept of what that model represents — what a model is, as opposed to what a model represents.  (think of the mouse and diabetes, M.K.) … conceptual modeling is used as a way to describe physical or social aspects of the world in an abstract way. For example, in the realm of software development, a conceptual model may be used to represent the relationships of entities within a database. Whether written down via text or diagrammed visually, such a conceptual model can easily represent abstract concepts of the relationships between objects in the system, such as Users and their relationship to Accounts.

Did I mention that monetary transactions like investments or wages paid are relationships between abstract concepts like ‘household’ and ‘the government’ and ‘non-financial companies and the like which are estimated using the national accounts? Well, they are. Which brings us to Keynes and the national accounts. A conceptually pathbreaking article of Keynes was ‘How to pay for the war’. For the first time, as far as I know, an estimated system of national accounts with different income groups (low-income and high income) was used for policy analysis and prescriptions.  Keynes’ World War I experience had taught him the difference between profit inflation and wage inflation. Price increases during WWI were mainly caused by increasing profit margins. Good for ‘capitalists’ (or the high income class in ‘How to pay for the war’), bad for ‘labor’ (the low income class). He wanted England to be able to free resources for the War Effort without unwanted social consequences. Keynes was keenly aware that simply raising government spending would do the trick, but at the price of profit inflation and hence suffering of the poor without suffering of the rich. A nasty twist to this: Utsa Patnaik shows that the 1942/1943 famine in Bengal, at that time part of the English colony India, was caused by a deliberate English policy of profit inflation. He also shows that in all probability Keynes was at least keenly aware of this. The point: the way we measure the macro economy and the concepts we use to do this matters. A lot. It’s sometimes about life and death.

Why all this? Because of a little twitter fitty I had with the esteemed @Noahpinion. I do not use ‘esteemed’ in an ironic sense. He’s very well read, has very informed opinions and writes very well. I learn a lot from him. More importantly: he is really expanding the realm of data based economic discussion – something I only dream off. This time he however stated: “accounting is not a model of the economy“. Which is wrong. The national accounts are a model of the economy. And economists have to learn it is. The way the entities are conceptually defined matters as this also defines the monetary relations we see. Concepts and definitions matter. What is included, or not, in ‘financial institutions’ or ‘investments’ is conceptual and an important choice. I, for one, think that artificial hips should be included in the definition of investments and fixed capital as these have a monetary production cost as well as a monetary price while they do know some kind of depreciation. The accounts (together with the manuals, I should say) are a conceptual model of our economy (think of the mouse and diabetes again). And choices are made how to do this. Examination question: why was Keynes’ highly useful, estimated and influential conceptual innovation not incorporated in the post WWII national accounts?

Noah Smith links to a Brad De Long blogpost which states (while approvingly mentioning Paul Krugman and Noah and Mark Thomas):

it turns out in economics to be remarkably hard for lots of people to distinguish between:

  • behavioral relationships–things that tell you how people will change their behavior to respond to changes in the economic environment and economic policy;
  • equilibrium conditions–things that tell you what configurations of the economic environment are consistent and are not rapidly-changing out-of-equilibrium phenomena seen for an eyeblink of time, if that long; and
  • accounting identities–things true by the metaphysical necessity of the definitions that are devoid of interesting substantive implications.

Brad is totally right that we should distinguish these. But he is wrong about the accounting identities: the accounting identities we measure are dependent on the way the national accounts model the economy. Also they are not metaphysical. They are a and emergent consequence of the legal and social and cultural aspects of money and monetary contracts. You do not need all three aspects for a model of the economy.  To come back to ‘How to pay for the war’: all of these three items were present albeit sometimes in a rather implicit way. But the ‘definitions’ were not devoid of ‘interesting substantive implications’, the conceptual difference between profit and wage inflation in relation to a delineation of different groups of households was crucial (Keynes being Keynes the income groups were already measured, See this article of E. Rothbarth). To do this, Rothbarth used guided by Keynes a conceptual model of the economy with multiple income groups. National accounts do use a model of the economy, the accounting identities are based on the fundamental social properties of money and monetary transactions but for the way we measure them a conceptual model is key.

Why this rant? I’m having the idea that in the MMT discussion some economists have trouble with the definition of ‘model’. They have to be more precise when using this word. Alas, a conspicuous use of fuzzy definitions is, as Veblen already noted in 1909, not a bug but a feature of neoclassical economics. Look at this model by Bokan e.a., which does not know if it has to measure labor in hours or persons and uses undefined ‘labour services’ instead. We can do better than that.

  1. Ikonoclast
    April 6, 2019 at 10:13 am

    Read this paper by Blair Fix;

    Click to access 20190100_fix_the_aggregation_problem_bpearq_preprint.pdf

    It might dent your confidence that national accounts, GDP measures etc. measure the real economy in any objective way. Then investigate the Bichler/Bitzan Archives and their Capital as Power (CasP) theory and book. This work puts a very serious question mark over how money and finance capital, along with national accounts, really model the economy. The answer seems to be quite frankly: Not at all.

    I don’t want to rain on your parade but it is not all certain that accounting is a model of the economy. Classical economics pretends it is but the pretences of classical economy are very dubious to say the least.

    Speaking from my own investigations, there is no mystery about what a model is in basic terms. Model = A simplified representation of a more complex original.

    Of course, the complications arise when you try to classify models. The taxonomy would be very long with many branches. Here’s a few examples in no particular order or classification set up;

    Scale model
    Static model
    Dynamic model
    Ideational model
    Mathematical model
    Virtual Model
    Scientific model
    Teaching model
    Investigative model
    False model
    True model

    Well worth reading is this paper;

    “Models as mediating instruments” – Margaret Morrison and Mary S. Morgan

    • merijntknibbe
      April 6, 2019 at 11:31 am

      NO, it does not dent my idea that the national accounts measure the real economy. They measure the nominal economy. One aspect of calculating the real economy by deflating nominal values with a price index is the idea that money and monetary transactions are a veil and do not matter. They do. And that’s why the national accounts measure these nominal values. ‘Real’ values are not measurements but estimations. Which of course can be valuable. Aside of this one can measure really real flows, like CO2 or wheat or whatever. But to do this, one also needs the national accounts…

  2. lobdillj
    April 6, 2019 at 3:17 pm

    The NIPA accounts today conflate REAL economy labor income with RENTIER income. This was once not so. But, now this definitional change makes Sectoral Balances plots show that financial sector income from the bail out of the 2008 crash benefited private sector income. This conflates the REAL economy with the RENTIER (parasitical) economy and makes it appear that the 2008 crash resulted in a huge increase in private sector income. (See https://en.wikipedia.org/wiki/Sectoral_balances).

  3. April 6, 2019 at 8:24 pm

    Perhaps someone here can answer a Sectoral Balance question for me.

    This is from the Wikipedia Sectoral balances description:
    “(1) Y = C + I + G + (X – M)
    (2) Y = C + S + T
    You can then drop the C (common on both sides) and you get:
    (4) S + T = I + G + (X – M)”

    But the definition of C in (1) is “Compensation of employees, paid” and the definition of C in (2) is “Personal consumption expenditures” – and mathematically one can “drop the C” only if the two values are equal, which they’re not.

    What am I missing?

    • merijntknibbe
      April 6, 2019 at 8:49 pm

      I checked the wikipedia page. C is in both cases consumption.

      • Edward Zimmer
        April 6, 2019 at 10:33 pm

        But these equations are the NIPA GDP/GDI equations and what I gave are the NIPA definitions.

  4. Ikonoclast
    April 6, 2019 at 10:28 pm


    I may well have misunderstood your post. I agree that money is not neutral. It is used to control. Anything used to control a system is certainly not neutral with regard to that system. Money does not measure the real economy as it cannot measure it. It is used to control the real economy. There can be a model of how money is used to control the real economy. This may well be what you meant, in which case I agree.

    What really controls people and real quantities in the economy is the complete
    money-property-law- violence system. What I mean is this. Money is used to control the allocation and reallocation of property. Property is used to control access to income and life requirements. State law and the state’s monopoly on violence enforce compliance with the rules of the money-property system, in a functional capitalist state.

    If you are coming from an MMT or functional finance position, there is nothing I have written above which would disagree with that position. MMT argues, with considerable justification, that money is used currently in a certain neoliberal manner to control the economy and that it could be used in another manner to get more equitable results and reduce unemployment and capacity under-utilization. I agree, up to a point.

    Initially, using MMT precepts would be like pushing with a pole. It would work up to a point, I believe. Beyond that point, it will become like pushing with a string. Something that could likely work up to a point should certainly be tried. There would still be the issue of the real limits to growth which we are rapidly approaching. MMT seems to presuppose faster economic growth via better capacity utilization. If that is qualitative growth well and good. If part of it is still quantitative growth then it will soon come up against limits to growth. MMT per se also does not tackle the issue of the ownership of production; late stage capitalism’s construction of the money-property-law-violence system. The issue of the effective ownership and control of the money system it certainly does tackle and that is a point in its favor.

  5. April 7, 2019 at 8:43 pm

    From Keynes’ fatal blunder to the true economic model
    Comment on merijntknibbe on ‘What’s in a model … (an economic one, that is)’

    Merijntknibbe refers to a post of Noah Smith: “This time he however stated: ‘accounting is not a model of the economy’. Which is wrong. The national accounts are a model of the economy. And economists have to learn it is. The way the entities are conceptually defined matters as this also defines the monetary relations we see.”

    Under the heading Formal Models vs. Guru-Based Theories Noah Smith demanded: “These days, most economic theories are collections of mathematical models. If you want to know what the theory says, you can parse out the models and see for yourself. You don’t have to go ask Mike Woodford what New Keynesian theory says. You don’t have to go ask Ed Prescott what RBC theory says. You can go read a New Keynesian model or a Real Business Cycle model and figure it out on your own. MMT is different. There are many wordy explainers and videos that will explain some of the concepts behind MMT, or tell you some of MMT’s policy recommendations. But that’s different than having a formal model of the economy.”#1

    The problem with economics is this: microfoundations are false and because of this, ALL microeconomic models are false. Supply-demand-equilibrium is proto-scientific garbage. However, macrofoundations are also false and because of this, ALL macroeconomic models are false since Keynes. Proofs have been given elsewhere.#2

    The question of correct macrofoundations is closely related to macroeconomic accounting. Merijntknibbe is spot on: “National accounts do use a model of the economy, the accounting identities are based on the fundamental social properties of money and monetary transactions but for the way we measure them a conceptual model is key.”

    The problem with both orthodox and heterodox economists is that they are too stupid for the elementary mathematics that underlies macroeconomic accounting.#3, #4, #5

    From the overall failure of economics follows that a new theory has to be macrofounded but not Keynesian because Keynes messed things up. What is required is the Paradigm Shift from false microfoundations and false Keynesian macrofoundations to true macrofoundations.

    From true macrofoundations follows the macroeconomic Profit Law as Q=Yd+(I−S)+(G−T)+(X−M). The Profit Law, in turn, yields the correct macroeconomic sectoral balances equation (I−S)+(G−T)+(X−M)−(Q−Yd)=0 which compares to the false Keynesian/Post-Keynesian/MMT equation (I−S)+(G−T)+(X−M)=0. The equations are testable with the precision of two decimal places. Exactly here, macroeconomic accounting is needed in order to settle matters empirically.

    Because neither orthodox nor heterodox economists got the foundational concepts, the elementary math, and the basic accounting identities right, ALL macroeconomic models are provably false from Keynes onward to this day.#6

    Egmont Kakarot-Handtke

    #1 Noah Smith, Examining an MMT model in detail

    #2 The miracle cure of economists’ micro-macro schizo

    #3 Wikipedia and the promotion of economists’ idiotism (II)

    #4 The Common Error of Common Sense: An Essential Rectification of the Accounting Approach

    #5 For details of the big picture see cross-references Accounting

    #6 MMT and the canonical macroeconomic model

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