Saturday, January 28, 2012

A little JKH paradigm riff


At Asymptosis a few days back, something wonderful from JKH:
Finally (for now), here’s a little JKH paradigm riff on the role of accounting in economics:

Consider a change in the economy between point A and point B.

The following things are true:

a) A and B as economic conditions can always be represented in accounting terms

b) Economic behaviour determines the change from A to B

c) Standard accounting identities always hold * – at A, B, every point in between, and every point before and after

d) The LEVEL of the numerical accounting variables within the identities can change from A to B, but not the identities themselves as generic accounting truths

e) BEHAVIOUR determines the change in the LEVEL at which the identities hold

f) The identities CONSTRAIN behavioral outcomes, such that c) is always true

* This assumes of course that identities are always correctly formulated, including for example various permutations around S, I, national saving, closed economies, etc.

MMT recognizes all of this, I think. It’s not necessary to be an MMTer to understand it, but it’s a big plus for their camp, IMO.

IMHO, there are two people (outside of MMT) who I always think of immediately, in terms of their understanding of the relationship between accounting and economics.

I think Paul Krugman understands it (even though he’s demonstrated occasional wobbliness in understanding the details of central bank accounting).

And I think John Maynard Keynes understood it. I think it infuses the GT, and that his ripping apart of the classics using the fallacy of composition at a general level was informed by his inherent understanding of the mathematically closed nature of double entry bookkeeping. (Sorry, that’s not such a humble observation on my part, so maybe I should attribute my own paradigm at least in part to Keynes.)

One reason I mention Krugman is that this accounting identity stuff is quite prominent in his bashing of Chicago in “Dark Age of Macroeconomics”, etc. including recently. If you read Krugman’s posts closely, he’s very careful about putting accounting in proper context, which is what this is all about. He’s very cognizant of the required logical relationship between economic behaviour and accounting.
 
The value of accounting principles to economics is in the discovery and elimination of mathematical error.

Economic behavior always determines what happens in the economy; and human nature cannot be changed.

The LEVELs of numerical accounting variables -- economic quantities -- can and do change. These levels are what concern me, always. Changes in levels can and do result in imbalances which make the economy inoperative. As a result of excessive private debt, for example, the rate of economic growth slows; and forty years of policy devices intended to boost private-sector credit use have not solved the problem.

The LEVELs must serve as a guide to policy; the purpose of policy is to guide behavior.

LEVELs above all.

18 comments:

Greg said...

Hey Art

Just a little gratuitous self congratulating here. I came up with a little motto ..... "If you cant get the accounting right you cant get the economics right"
I posted it in the comments section here at Traders Crucible

http://traderscrucible.com/2012/01/25/monetary-realism-and-mmt/

And then he made a post out of my comment.

http://traderscrucible.com/2012/01/27/if-you-cant-get-the-accounting-right-you-cant-get-the-economics-right/

I thought it was kinda neat.


That JKH is one sharp dude, you would be wise to follow his site and his comments at various other sites.

Steve Roth said...

Thanks for the link! I've been thinking a lot about this constraint thing.

It seems to me that accounting constrains our *reasoning.* (Or should.) If you can't make your reasoning comport with coherent accounting, your reasoning is wrong.

For instance, suppose you come up with some thinking about increasing exports to get countries out of a recession. If you start thinking that all the countries can do this -- an accounting impossibility -- your reasoning is wrong.

Ditto the notion that more "saving" (at least by the non-economist's definition) creates "loanable funds." Since spending just transfers funds between banks, and saving just...doesn't, the accounting makes no sense. So the reasoning makes no sense.

??

Greg said...

Well put Steve.

"If you can't make your reasoning comport with coherent accounting, your reasoning is wrong."


For me it gets down to why we have accounting. We have accounting so we can determine WHO has HOW MUCH of WHAT. The whole point of economics discussions is getting the "what" to the "whos" that most deserve it..... no? We also care about the "how much" of what because that tells us whos best. (Economic life is really a glorified pissing contest isnt it?)

One can take this talk to ridiculous levels but my point is that accounting is THE ONLY tool we have for keeping up with our stuff. How can anyone make a prescription for which stuff needs to get where (including dollars) if we dont know where stuff is to start with ? The accounting must be first because accounting is our measurement tool.

nanute said...

Great point, Greg. I think the reason why we can't seem to get the economy back on track is because financiers and policy makers are deliberately falsifying the accounting. I'm reminded of the Monty Python Merchant Banker Skit:http://youtu.be/UVRQK58jrbw

Jazzbumpa said...

IIRC, Karl Smith had a post a while back on why you can't do economics by accounting identity.

While the identities are valid, they are not determinative. That is, the quantities on both sides of the identity equation are resultants. Driving one side does not drive the other side to the value you might anticipate, because there are second order effects and feed back loops. Accounting identities are snapshots in time that have no predictive value.

As an aside, I've come to believe that the fundamental flaw of economics is its reliance on equilibrium models, when almost nothing in the real world actually equilibrates.

Cheers!
JzB

The Arthurian said...

Congrats, Greg. Feels good when somebody appreciates what you're thinkin' ...I hesitated to reply because (like Keen) I am no accountant.

Steve, yes, I think the accounting can do what Neil Wilson does for Steve Keen: prevent some errors in reasoning or (as I called it in the post) mathematical error.

Another Smith (Noah) has relevant words: "Accounting identities are mostly just definitions. Very rarely do definitions tell us anything useful about the behavior of variables in the real world."

What matters most are the economic forces. Understanding behavior MAY help us understand the forces. Applying accounting CAN catch errors of logic. But I always look to the time series to see what's out of balance. Ergo, the LEVELs.

Greg said...

Jazz

" Karl Smith had a post a while back on why you can't do economics by accounting identity."

Agreed, and that is not what I am arguing for. Lets just say its possible to do "correct" accounting and still come up with bad economics but its not possible to do bad accounting and good economics.

The bad accounting will always lead you astray.



"While the identities are valid, they are not determinative. That is, the quantities on both sides of the identity equation are resultants. Driving one side does not drive the other side to the value you might anticipate, because there are second order effects and feed back loops. Accounting identities are snapshots in time that have no predictive value"

Agreed again! But this doesnt take form my original point I dont think. You cant rely simply on the accounting to get you the correct economics that is for sure.........BUT if you think your economics is right, only the accounting can tell you its right. Accounting is the only method we have for measuring our economic landscape...... what else is there?

To be sure, one must do stock flow consistent accounting across all periods to understand what is happening (Im speaking mainly of macro national accounting here) MMT is very rigid in how investment, savings, assets and liabilities are measured and chronicled. Its important to be consistent


"As an aside, I've come to believe that the fundamental flaw of economics is its reliance on equilibrium models, when almost nothing in the real world actually equilibrates."


I have a different take on this. I would say that equilibrium is mostly used as a term to imply a state of tranquility or goodness and that disequilibrium is somehow worse. I disagree with this whole notion, We are always in equilibrium because the universe requires it ........every action is offset by an equal and opposite reaction. But just because we are in equilibrium says nothing about whether we are in a good place. There are lots of equilibriums that are bad to be in.

Art


"What matters most are the economic forces. Understanding behavior MAY help us understand the forces. Applying accounting CAN catch errors of logic. But I always look to the time series to see what's out of balance. Ergo, the LEVELs."


What are time series? Are they not accounting? How are levels measured? Is that not accounting?

See, without consistent and accurate measuring tools and systems we have no idea where anything is and how much of it there is.

The real value of MMT (IMHO) is that it says "Ok, lets measure all saving like this, all investment like that all liabilities on the balance sheet over here and all assets over there and see where we are" It simply wants to standardize all measurments.

Its kinda like pricing everything in dollars or in euros. You can do one or the other but you cant do both at the same time and come up with a coherent picture.

The Arthurian said...

Time series show that the debt/money ratio varies. "Money is debt" (I think) arises from accounting.

Steve Roth said...

Jazz: "because there are second order effects and feed back loops"

Right: interacting incentives and constraints, with resulting behavior.

Accounting can only tell us if our predictions of future behavior are impossible (and that only sometimes). It cannot tell us which of the possible behaviors *will* happen.

Steve Roth said...

Greg: "BUT if you think your economics is right, only the accounting can tell you its right"

I don't think so. I think it can only tell you if it is wrong.

Greg said...

Steve

Yes, you are correct. It only tells you if its wrong

Jazzbumpa said...

Greg -

I wasn't intending to disagree. My statements are complementary (or maybe supplementary) to yours.

I do disagree about being in equilibrium most of the time, irrespective of whether is is a desired state or not.

I'll have to give this some more thought. But not at midnight.

Cheers!
JzB

Greg said...

Jazz

Regarding the equilibrium notion. I think many who use that term do not know what it means (not saying you dont).

A car moving at 100mph is at equilibrium. Just as much at equilibrium as a car at rest. I think guys like Nick Rowe uses equilibrium as a substitute word for "a state where everyone is happy and the central bank isnt having to consider stimulus or putting on the brakes", which of course is ........never. Others use it to describe a steady state where nothing is changing...... again not a description of anywhere involving life. Yes you can look at an isolated glass of water sitting still and measure the types of things which change when ink is added and it is stirred. You can come up with ways to describe what happens when x grams of ink is added and stirring is at 20 rpms and compare this to 2x grams of ink and 30 rpms. These new states are called a disequilibrium relative to the initial clear and still water but they are in equilibrium as well. Its all a succession of new equilibriums

I think equilibrium is a poor word the way it is used by economists because we are both always AND never at equilibrium depending on how you see it.

The market monetarist like Sumner and Rowe really irk me with their talk about long term price equilibriums. The talk about long term price levels blah blah blah is really silly to me. The long term is just a succession of short terms added together so any attempt to predict the long term correctly requires the knowledge of many many short terms. These guys cant predict the price of oil in 3 months, how can they expect to know overall inflation?

Steve Roth said...

I *think* what they tend to mean is homeostasis. But since they're working with static, of-an-instant models, it's a meaningless term in that context. There's no homeostasis in an instant.

I could be way wrong, but I think they tend to switch between instantaneous equilibrium (the *forces* are in balance) and homeostasis (the *changes* are in balance) without telling us.

Must think more. There's a wikipedia entry on this, not sure it makes sense...

The Arthurian said...

Steve, that is a most interesting insight.

Greg said...

I think you are probably right Steve. This speaks to the pseudoscience nature of economics. They want to coopt all these sciency sounding words so it adds credibility to their analyses when they are mostly high priests in religious type belief systems.

Greg said...

Which is why MMT is appealing (and why Sumner can thinks he has a valid criticism by calling it too concrete)since it is based in *proper* accounting.


Dont tell me "deficits" are bad. Deficits are necessary if people wish to save dollars and a country wants to be a net importer. There can be no other way.

Additionally, dont just tell me we then need to be more of an exporter. We cant control our exports, other countries do. They determine our export level not us, if they dont want it we cant sell it. We can decide to stop buying from other countries but we are buying because we want their stuff cuz its cheap. How will we replace that stuff without making it cost more?

Understanding sectoral balances helps you avoid making unrealistic prescriptions and expecting magical things to happen.

Steve Roth said...

Greg: "Understanding sectoral balances helps you avoid making unrealistic prescriptions and expecting magical things to happen."

Right. Because your reasoning -- your prediction -- is contradicted by accounting identities. It's one situation where accounting proves the reasoning to be wrong.

Accounting won't always serve that purpose. But here, it does.