Toward the Integration of Economic Science: Introduction and Overview

The Unfinished Revolution

Two key contributions of the Keynesian Revolution were:

1. its theoretical refutation of the classical assumption of a self-regulating economy (which was based on the unrealistic assumption of "perfect" competition and resulting flexibility of prices and wages); and
2. the implications of its macroeconomic model regarding government responsibility for managing the economy (mainly by the use of government deficit spending to replace business investment when that provides an inadequate outlet for personal saving).

But in the preface of his 1936 General Theory of Employment, Interest and Money Keynes recognized the difficulty of making this basic paradigm shift:

Unfortunately, Keynes was not entirely successful in making that escape, and the remaining confusions permitted a resurgence of the classical assumptions in monetarist and other neo-classical schools.

The Present Disarray

Economic "science" and policy are now in such serious disarray that they are again the butt of derisive jokes by businessmen, journalists, students and even economists, and spawn many kinds of economic quackery, much as they did before the Keynesian Revolution. Students (and others) justifiably feel that much of "economic theory" is irrelevant to the real world. The use of abstract high-tech mathematics and computer models in recent years has made it more complex and esoteric, but not more analytically incisive or policy-relevant. One is reminded of the complex Ptolemaic theory of planetary motion which assumed that the earth was the center of the universe. Things became much simpler after Copernicus revised this basic assumption.)

Econ. 101

The present disarray is painfully evident even in the latest edition of the reportedly most widely-used economics principles textbook. The following excerpts presumably exemplify the way economics is now being taught to our next generation of economists and political and business leaders: [ 1 ]

Requirements for economic science

An essential requirement for a true economic science is a system of clear and functionally appropriate analytical concepts. And it is precisely the most basic traditional economic concepts that are responsible for much of the present confusion. If Keynes were to review the way "Keynesian" theory is now debated in the literature and taught in colleges, he would probably recognize immediately its many confusions.

The General Theory was almost "pure theory" (based heavily on "psychological propensities" and hypothetical supply-and-demand schedules). This was largely unavoidable -- partly because Keynes wanted to confront classical theory in its own context. But also there were then no adequate data to test the new theory empirically. The National Income and Product WI) accounts were in a primitive stage of development, and it would be another 23 years before the Federal Reserve would start publishing the Flow of Funds (FoF) Accounts. [ 2 ]

We now have much more data. But much of it is still conceptually inappropriate because our NI and FoF accounting systems are still unintegrated. And that is partly because both still reflect some of the same traditional conceptual confusions that plagued Keynesian theory.

Clearly, there is urgent need to complete the Keynesian Revolution. But this faces the same basic difficulty that Keynes recognized so eloquently a half-century ago -- escaping from the old ideas.

This paper briefly summarizes the nature and sources of the traditional confusions and then summarizes an alternative system of analysis and policy which I tentatively call the Integrated Dynamic Money-Flow "model" (IDMF). The paper has three main parts.

Part 1

Part I analyzes the traditional confusions. It focuses mainly on the Keynesian system because that exemplifies many of these confusions yet is still considered the mainstream approach (to the extent that there can be said to be a mainstream).

These confusions are embodied in such concepts as credit money, credit creation, asset demand for money, liquidity preference schedule, IS/LM apparatus, interest rates as the key link between money growth and economic growth, NI accounting concepts of saving and investment, exogeneity of investment spending, investment multiplier, aggregate suppl and demand schedules, macroeconomic equilibrium, ceteris paribus, and federal deficits as economic "stimulants." [ 3 ]

Part 2

Part II describes the IDMF model. This model recognizes that every modern industrial economy is a managed economy, whether it is well or poorly managed. Laissez faire and "free market economy" are to a large extent classical myths. Thus, one of the main aims of the model is to develop conceptual and analytical tools, and empirical measures, which will facilitate socially responsible and effective economic management.

The model provides a conceptually integrated analytical framework, based empirically on FoF national accounting perspective, which facilitates a clearer and simpler explanation of how the economy works. Its main conceptual tools are:

1. The non-credit ("pseudo-commodity") concept of money and money creation -- This makes possible a clearcut conceptual distinction between money and credit: money is the "inventory stock" of what we actually pay bills and buy things with; credit is an advance of (pre-existing) money to another transactor with expectation of repayment. (Savings deposits and other "near moneys" are credit assets, not money.) This conceptual distinction clarifies and simplifies analysis of the functional link between money growth and GNP growth (in both Keynesian theory and the monetarists' "black box"). (See the description of money vs. credit.)

2. The Money Demand Ratio --
   MDR  =  adjusted trend value of M/GNP

   An analytically more useful alternative to the traditional "velocity" concept, this "structural" ratio becomes a basic tool in monetary analysis and policy. (See Figure 5 [not yet Web-rendered] and the description of money as inventory.)

3. The Primary Credit concept -- credit which actually finances GNP spending. Empirical data are derived from the FoF accounts by netting out intermediate credit flows the way the NI accounts net out intermediate product flows. This concept makes it possible to track empirically the flow of credit from initial financial saving to final GNP spending -- something which the NI accounts and the Keynesian analytical model cannot do. This concept also provides a more analytically usefuI measure of the economy's total supply and demand for credit (including the federal deficit) than the Net Funds Raised concept now published in the FoF accounts. (See the circular flow of money diagram, the description of "primary credit and the credit market", and IEA POCKET CHARTS, panels 11, 12, R-11A, R-11C.)

4. The structural model of saving, investment and monetary flows and stocks -- which effectively integrates the financial and nonfinancial aspects. These structural norms (normal ratios to GNP or other functionally appropriate macro variables) tend to remain relatively stable or change very slowly. (See the description of the structural model, the sources and uses of funds diagram, and IEA POCKET CHARTS and their historical supplement, pp. 8,9 [not yet Web rendered].)

5. The growth-trend perspective -- This facilitates estimating the empirical values of the structural model, and a more accurate analysis of the functional leads and lags of the fluctuations (deviations from their norms) of its individual components. For instance, it reveals that among the "leading indicators" of the Bureau of Economic Analysis (BEA) and National Bureau of Economic Research (NBER) only money growth and housing consistently lead. (See also the money growth formula description and the IDMF/NBER comparison.)

6. The graphic approach to economic analysis -- in both empirical research and presentation of the results. This makes possible very precise and detailed analysis of current developments. (See IEA POCKET CHARTS.)

Together these conceptual and analytical tools can facilitate:

• effective integration of our NI and FoF accounts, and improvement of their statistical integrity and stability;
• a simpler and more effective approach to economic analysis, with minimum use of hypothetical supply-and-demand curves and mathematics;
• more precise empirical guidance for national economic policy.

Part 3

Part III explains the main policy applications of the IDMF model. It provides better tools for managing the economy to achieve and maintain:

1. better economic statistics;
2. stable, non-inflationary, full-employment economic growth;
3. stable low interest rates;
4. stable prices and economically appropriate wage rates;
5. structural balance;
6. international economic coordination;
7. greater economic democracy;
8. global responsibility;
9. ecological sustainability.

Notes

1. Material which the full integration of economic science will render obsolete contributes much to the nearly five pound weight of this text. However textbook authors and editors should perhaps not be held responsible for obsolete material until a new approach is generally accepted. In other respects, this irreverently honest text has many excellent features.
   (back to ref 1)

2. Theory has two aspects concepts and explanation of relationships. When critical data is unknown (or even unknowable), theory is most needed to guide the quest for data. But as data becomes available for adequate empirical analysis of relationships, the useful role of abstract hypothetical analysis is reduced.
   (back to ref 2)

3. The book that this overview summarizes also analyzes the conceptual and analytical confusions embodied in the labor theory of value, National Bureau of Economic Research business cycle theory, Friedmanite theory of inflation, Phillips Curve, natural rate of unemployment, non-accelerating-inflation rate of unemployment (NAIRU), rational expectations theory, economic growth, and productivity.
   (back to ref 3)