Sorry MMTers, the Economy Doesn't Exist and GDP is Bogus

Republished with permission from EconomicPolicyJournal.com

The other day, a practitioner of Modern Monetary Theory (MMT), Robert Koerner, called for a sythesis between MMT and Austrian Economics. Robert Wenzel, at EPJ Central, provided an Austrian rebuttal here, which provoked an interesting discussion in the comments. Unfortunately, this appears to be part of a trend, in which the bogus constructs of MMT are passed off as somehow part of Austrian economics, which they are most definitely not. This post will demonstrate that MMT is simply a justification for the broken and irreparable status quo, but with a novel face.

Friend of EPJ, Robert Murphy, provides some background and criticism of its foundations,here*. To say that so-called MMTers come to some rather unconventional conclusions is understated, and something from which they do not run. For instance, Murphy writes, "if the federal government runs a budget surplus, then by simple accounting the private sector can't save."

However, at its heart, MMT appears to be based on accounting identities derived from national income accounting methods, which are themselves based upon imperfect abstractions. These are the same familiar equations [sadly] taught in nearly every economic intro course:

 

GDP = C + I + G + (X — M)

and

GDP = C + S + T

 

Austrian economist, Frank Shostack, tears apart GDP and its foundations here (emphasis mine):

To gain insight into the state of an economy, most people rely on a statistic called Gross Domestic Product (GDP). The GDP framework looks at the value of final goods and services produced during a particular time interval, usually a quarter or a year. This statistic is constructed in accordance with the view that what drives an economy is not the production of wealth but rather its consumption. What matters here is demand for final goods and services. Since consumer outlays are the largest part of overall demand, it is commonly held that consumer demand sets in motion economic growth.

 

By focusing exclusively on final goods and services, the GDP framework lapses into a world of fantasy wherein goods emerge because of people's desires. This is in total disregard to the facts of reality (that is, the issue of whether such desires can be accommodated). All that matters in this view is the demand for goods, which in turn will give rise almost immediately to their supply. Because the supply of goods is taken for granted, this framework completely ignores the whole issue of the various stages of production that precede the emergence of the final good.

 

In the real world, it is not enough to have demand for goods: one must have the means to accommodate people's desires. Means—i.e., various intermediate goods that are required in the production of final goods—are not readily available; they have to be produced. Thus, in order to manufacture a car, there is a need for coal that will be employed in the production of steel, which in turn will be employed to manufacture an array of tools. These in turn are used to produce other tools and machinery and so on, until we reach the final stage of the production of a car. The harmonious interaction of the various stages of production results in the final product.

 

The GDP framework gives the impression that it is not the activities of individuals that produce goods and services, but something else outside these activities called the "economy." However, at no stage does the so-called "economy" have a life of its own independent of individuals. The so-called economy is a metaphor—it doesn't exist.

 

By lumping the values of final goods and services together, government statisticians concretize the fiction of an economy by means of the GDP statistic. By regarding the economy as something that exists in the real world, mainstream economists reach a bizarre conclusion that what is good for individuals might not be good for the economy, and vice versa. Since the economy cannot have a life of its own without individuals, obviously what is good for individuals cannot be bad for the economy.

 

The GDP framework cannot tell us whether final goods and services that were produced during a particular period of time are a reflection of real wealth expansion, or a reflection of capital consumption.

 

For instance, if a government embarks on the building of a pyramid, which adds absolutely nothing to the well-being of individuals, the GDP framework will regard this as economic growth. In reality, however, the building of the pyramid will divert real funding from wealth-generating activities, thereby stifling the production of wealth.

 

Because the GDP framework completely disregards the intermediate stages of production, it can be of little help in the assessment of boom-bust cycles. It is little wonder then that mainstream economists are forced to conclude that recessions are a response to a sudden fall in consumer spending. Consequently, it is quite logical within the GDP framework to advocate loose monetary policies to revive the "economy."

 

The whole idea of GDP gives the impression that there is such a thing as the national output. In the real world, however, wealth is produced by someone and belongs to somebody. In other words, goods and services are not produced in totality and supervised by one supreme leader. This in turn means that the entire concept of GDP is devoid of any basis in reality. It is an empty concept.

Quoting the Austrian masters on the fallacy of national accounting:

According to Mises the whole idea that one can establish the value of the national output is somewhat far-fetched:

The attempt to determine in money the wealth of a nation or the whole mankind are as childish as the mystic efforts to solve the riddles of the universe by worrying about the dimension of the pyramid of Cheops.

Furthermore,

If a business calculation values a supply of potatoes at $100, the idea is that it will be possible to sell it or replace it against this sum. If a whole entrepreneurial unit is estimated at $1,000,000 it means that one expects to sell it for this amount the businessman can convert his property into money, but a nation cannot.

 

In addition to all these issues, there are serious problems regarding the calculation of the GDP statistic. To calculate a total, several things must be added together. To add things together, they must have some unit in common. It is not possible to add refrigerators to cars and shirts to obtain the total of final goods. Since the total real output cannot be meaningfully defined, obviously it cannot be quantified.

 

To solve this problem, economists employ total monetary expenditure on goods which they divide by an average price of those goods. There is, however, a serious problem with this. What is price? It is the rate of exchange between goods established in a transaction between two individuals at a particular place and a particular point in time. The price, or the rate of exchange of one good in terms of another, is the amount of the other good divided by the amount of the first. In the money economy, price will be the amount of money divided by the amount of the first good.

 

Suppose two transactions were conducted. In the first transaction, one TV set is exchanged for $1,000. In the second transaction, one shirt is exchanged for $40. The price or the rate of exchange in the first transaction is $1000/1TV set. The price in the second transaction is $40/1shirt. In order to calculate the average price, we must add these two ratios and divide them by 2. However, $1000/1TV set cannot be added to $40/1shirt, implying that it is not possible to establish an average price.

 

It is interesting to note that in commodity markets, prices are quoted as Dollars/barrel of oil, Dollars/ounce of gold, Dollars/tonne of copper, etc. Obviously, it wouldn't make much sense to establish an average of these prices. On this Rothbard wrote, "Thus, any concept of average price level involves adding or multiplying quantities of completely different units of goods, such as butter, hats, sugar, etc., and is therefore meaningless and illegitimate."

More on the fallacy of average price level, and getting to the heart of the matter (that GDP is simply a tool of coercion for the ruling class):

The employment of various sophisticated methods to calculate the average price level cannot bypass the essential issue that it is not possible to establish an average price of various goods and services. Accordingly, various price indices that government statisticians compute are simply arbitrary numbers. If price deflators are meaningless, however, so is the real GDP statistic.

So what are we to make out of the periodical pronouncements that the economy, as depicted by real GDP, grew by a particular percentage? All we can say is that this percentage has nothing to do with real economic growth and that it most likely mirrors the pace of monetary pumping.

As a rule, the more money created by the central bank and the banking sector, the larger the monetary spending will be. This in turn means that the rate of growth of what is labeled as the real economy will closely mirror rises in money supply.

 

So it is no wonder that in the GDP framework, the central bank can cause real economic growth, and most economists who slavishly follow this framework believe that this is so. Much so-called economic research produces "scientific support" for popular views that, by means of monetary pumping, the central bank can grow the economy. It is overlooked by all these studies that no other conclusion can be reached once it is realized that GDP is a close relative of the money stock.

 

One is tempted to ask, why it is necessary to know the growth of the so-called "economy"? What purpose can this type of information serve? In a free unhampered economy, this type of information would be of little use to entrepreneurs. The only indicator that any entrepreneur relies upon is profit and loss. How can the information that the so-called "economy" grew by 4 percent in a particular period help an entrepreneur make profit?

 

What an entrepreneur requires is not general information but rather specific information regarding the demand for his specific product, or products. The entrepreneur himself has to establish his own network of information concerning a particular venture.

 

Things are quite different, however, when the government and the central bank tamper with businesses. Under these conditions, no businessman can ignore the GDP statistic since the government and the central bank react to this statistic by means of fiscal and monetary policies. Likewise, participants in financial markets closely follow the GDP statistic in order to assess the likely responses of the central bank.

 

The entire army of economists is busy guessing whether the central bank will lower, or raise, interest rates. Moreover, to provide a rationale for all this, a new form of economics labeled macroeconomics was invented.Needless to say, this type of economics doesn’t deal with the real world but rather with a nonexistent entity called the economy.

 

By means of the GDP framework, government and central bank officials generate the impression that they can navigate the economy. According to this myth, the "economy" is expected to follow the growth path outlined by omniscient officials. Thus whenever the rate of growth slips to below the outlined growth path, officials are expected to give the "economy" a suitable push. Conversely, whenever the "economy" is growing too fast, the officials are expected to step in to cool off the "economy's" rate of growth.

The powerful conclusion:

If the effect of these policies were confined only to the GDP statistic then the whole exercise would be harmless. However, these policies tamper with activities of wealth producers and thereby undermine people's well-being. To take a particular instance, by acting to make the nonexistent entity the "economy" more efficient, U.S. government officials are busy destroying a major wealth generator—Microsoft.

 

Likewise, by means of monetary pumping and interest rate manipulations, the Federal Reserve doesn't help generate more prosperity, but rather sets in motion a "stronger GDP" and the consequent menace of the boom-bust cycle—i.e., economic impoverishment.

We can thus conclude that the GDP framework is an empty abstraction devoid of any link to the real world. Notwithstanding this, the GDP framework is in big demand by governments and central bank officials since it provides justification for their interference with businesses. It also provides an illusory frame of reference to assess the performance of government officials.

Bob Roddis writes in the comments in Wenzel's post about MMT's intellectual heritage:

Never forget that MMT godfather Abba Ptachya Lerner’s magnum opus was “The Economics of Control”:

 

Chapter l. INTRODUCTION. THE CONTROLLED ECONOMY

The fundamental aim of socialism is not the abolition of private property but the extension of democracy. This is obscured by dogmas of the right and of the left. The benefits of both the capitalist economy and the collectivist economy can be reaped in the controlled economy.

And again, in a subsequent comment:

More things I have dug up on MMT…

 

1. Abba Lerner was a longtime economic Stalinist. He writes in the preface to “The Economics of Control” that he was long resistant to the any “free market” analysis but finally he thanks Joan Robinson for getting him to overcome his prejudices against “Mr. Keynes great advancement in economic understanding”. Great. A Stalinist tempered with some Keynesianism. That’ll work, right? This is their starting point and helps explain how they can be so joyous when they explain “The government is not revenue constrained!!! [how cool is that??]”

 

2. In 1980, two years before he died, Abba Lerner (1903-1982) was dabbling in the following price control system based upon this article by David Colander, a co-author of a 1980 book with Lerner:

Lerner found the implications of sellers’ inflation so important that, beginning in the 1960s, he changed his research program to center on finding cures for sellers’ inflation. Initially he toyed with various administrative wage and price control policies, but he found those lacking and soon gave them up. He replaced them, first, with a tax based incomes policy and ultimately, a market based[??!!!] incomes policy in which property rights in prices are set and individuals have to buy the right to change prices from others who change their price in the opposite direction. It was this idea that formed the basis of our market [???!!!!] anti inflation (MAP) book. (Lerner and Colander 1980) Under MAP, rights in value added prices would be tradable so that any firm wanting to change its nominal price would have to make a trade with another firm that wanted to change its nominal price in the opposite direction. Thus, by law, the average price level would be constant but relative prices would be free to change [@page 12]

http://tinyurl.com/4rfk3jk

 

So, we now know enough about MMT to know that Abba Lerner wrote a book in 1980 proposing a ghastly and barbaric Rube Goldberg system where one would be precluded from raising (setting) one’s one prices without trading the right to do so with somebody else under penalty of statist law. But I thought the MMTers could cure inflation just by changing the tax code. Hmmm.

And it was Keynes, himself, in collaboration with a few other economists and statisticians at the beginning of World War II, who invented the national accounting constructs that would give rise to GNP and GDP. All for the purpose of justifying a protracted, expensive war. Writes Judo Cuyvers in the Economic Journal:

The elaboration of national economic accounts and detailed national income estimates is generally considered to be a direct result of Keynes's emphasis on the main macroeconomic determinants of employment and aggregate demand.

Scholars have repeatedly stressed Keynes's impact in the course of the first few years of the Second World War, or have pointed to Colin Clark's pioneering calculations during the 1930s. However, as we shall show in the following pages, it was at the very beginning of the Second World War, not in 1937 nor in 1941, that British national income accounting entered a critical phase. Determined to convince the authorities and public opinion of the necessity of financing the war effort properly, Keynes immediately set himself the task of elaborating a proposal based on statistical evidence. It was during the period between Octboer-November 1939 and February 1940, when Keynes was working on his December 1939 article in this JOURNAL and subsequently on his pamphlet How to Pay for the War, in close statistical collaboration with Erwin Rothbarth, that the first double-entry national accounts were developed and the still very crude accounting and estimation procedures became essential steps in economic policy making.

In true Ministry of Truth fashion, decades of Keynesian and related indoctrination continues to facilitate and propagate the lie that the banking system is somehow not regulated enough--too free market. As Tom Woods recently wrote:

She likewise thinks the banking system is pretty close to a free market – after all, hasn’t she seen news reports about bank "deregulation"? To the contrary, the banking system is perhaps the least free-market sector of the entire economy. The whole system is overseen by the government-created Federal Reserve System, which presides over a system-wide cartel. It involves monopolistic legal tender laws, a monopoly of the note issue, artificial disabilities on other media of exchange apart from the depreciating dollar, and various forms of bailout guarantees. For a sense of what a free market in banking would actually look like, read Murray N. Rothbard’sThe Mystery of Banking.

Even if we ignore MMT's dubious historical origins and assume beneficent intent, it's important that Austrian economics not be conflated with MMT and the work of its practitioners, such as Wray, Mosler*, Aureback, Mitchell, Fullwiler. Why make the distinction? As governments and economies fail around the world, there is and will be increasing demand for alternatives. MMT ensures the status quo ante. It's simply another system for central planning and price fixing.  And prices matter.

 

 

* EPJ Regular, Taylor Conant, produced a series of critiques of Warren Mosler's book called "Seven Deadly Frauds of Economic Policy", which itself is based upon MMT.

Comments

[THE DORK OF CORK]

Many MMTers are free marketers as in they do not see a large goverment role in the economy - they may just provide the goverment chips to private actors.

I come from a more statist European perspective where the Goverment once spent its own money - for example before deregulation of the electrical utility sector in Europe the Goverment owned the sector.

Sometimes Governments have a strategic goal - this legacy was a artifact of more classical Keynesian war spending.

Perhaps the most successful endeavour in Europe using this policey was the French civilian nuclear programme - after the oil shock it decided to become more independent and given that it had poor quality coal and little oil / gas decided to use the military industrial complex to persue civilian endeavours.

It however needs a functioning large beaucracey with independent judgement - this model is unlikely to work in the States now and is perhaps the reason why MMT policey failed so catastrophically in the 1990s as Goverment spending is such a small part of US GDP especially after post cold war disarmament ( Goverment did not extract enough of deposits back then according to the MMTers facilating a malinvestment of resourses)

[hooligan2009]

just a thought...its not the governments money..its yours. its not the government borrowing money ..its you..statism that captures your mind in this way is 1984 by any other name..i think the goal is to move to ownership and direct accountability of government to ...you...this is why proportional representation cant work..it simply isnt democracy and is not accountable to anyone..policies are determined only after an election, not before in a manifesto..there is no need of a large functioning bureaucracy..beaurocracy merely renders your money worth less by employing beaurocrats to come up with delays and inefficiencies..one more reason why europe is so buggered..all bureaucrocy and no government....just saying.

[EB]

I know MMTers talk a semi-free market game, and many of them probably believe it.  It seems to me, however, there might be a concerted effort to ride the coattails of recent (and limited) Austrian fame.  Even if MMT is correct (I don't believe it is), it has virtually nothing to do with Austrian economics.  Whether there is an intent to deceive is another matter.  I would note John Mauldin dishonestly introduced Rob Parenteau as an Austrian economist in this letter.  The entire article was about MMT and its sector balances.

"Extracting deposits" seems to be a backwards way of looking at things.  Those excess deposits (and their corresponding malinvestments on the banks' asset side) should not have existed in the first place.  Of course, who is to determine "excess"?  Clearly the Fed failed in both banking supervision and in the conduct of monetary policy.  A free banking system avoids this.  I linked to The Mystery of Banking above.  Here's the free PDF:

http://mises.org/Books/mysteryofbanking.pdf

[THE DORK OF CORK]

You can be a extreme free marketer and yet be a MMTer - for instance Goverment spending on the military need not be to goverment soldiers.

MMTers differ from Austrians in their understanding of energy systems in my opinion - MMters think you can take a infinite amount of energy from the future using human ingenuity while many Austrians think its lost forever once consumed - I like to take a middle ground.

And free banking systems - no thanks , the 19th century experiments was  not so successful experiment in that regard.

Without goverment money you have no goverment - without goverment you have no independence.

I am a believer in national money systems  - whats missing is final payment in international trade - which is a very different medium.

[BigJim]

Without goverment money you have no goverment - without goverment you have no independence.

I get the "without goverment you have no independence" bit, but why do you believe that "without government money you have no government"?

If you mean, that without access to money, the government can't function, I agree; if you mean the government has to oversee and produce money, please explain why you believe this.

A government can still raise money by declaring a particular money (gold for instance) to be the only means by which a citizen/company can extinguish their tax debts. The government itself doesn't need to produce that gold.

[THE DORK OF CORK]

Governments without monopoly control of currency could rapidly become subservient to other non state actors and be no longer in a position to govern - the free banks for instance created private money during the 19th century with devastating results to the commons

When I vote I want to vote for people with power to act - I do not want to see free competion for Goverment monopoly - goverment executives are naturally a monopoly.

Also paying debts in Gold is not a wise policey in my opinion - Gold is best used to settle foregin trade imbalances.

We live in such strange times because a Government's money is the worlds reserve currency - any goverment would abuse such a privilege.

[EB]

" for instance Goverment spending on the military need not be to goverment soldiers."

Hiring private mercenaries doesn't restrain the government's direction of capital into warmaking efforts.  I don't see how that is free market at all.  In practice, it's even worse, as there is virtually guaranteed to be no oversight under the claim of "national security".  

The banking system in the 19th century was not free at all.  It still relied on fractional reserve banking, the excesses of which led to panics, and the Treasury bailed out favored institutions time and again (moral hazard).  Central banking simply made socialization of losses more efficient.  

[THE DORK OF CORK]

Heh EB - I'm against mercenaries also , I was just giving a extreme example to make a point (its a pity thats its reality now)

I have no problem with private full reserve banks once the goverment produces the new money , however it needs to deal with other external govermental actors - and without Gold in international trade vast structural imbalances become inevitable.

(Free banks as far as I understand them produce their own private currency which I do not beleive in)

However Gold is tied into the fractional reserve system now although it need not be - witness the Libyan central banks gold reserves which is not a BIS member.

[EB]

I have no delusions that a free banking system will emerge out of the post-dollar rubble.  If we do get some quasi-hard money system, it only takes a few generations to forget why it was desirable in the first place.  On a long enough timeline the survival rate for every state currency system drops to zero.

[TaxSlave]

All your base are belong to us.

Because all your money is debt, bitch!

[InconvenientCou...]

any measure of GDP that includes financial services is suspect.

[Clueless Economist]

Wow, my beady little eyes are about to pop out of my fat ugly head!  I am so angry with this article.  The Austrians are fools Mises, Rothbard and the whole lot!

Long live John Maynard Keynes.

[sgt_doom]

Agreed!  The best beginning to this post would have been if he explained why the "GNP" was changed to the "GDP" and the facts behind that change.

[Yancey Ward]

God, the nom de plume and the photo are priceless brilliance.  Bravo!!

[TruthInSunshine]

Dr. Krugman,

I understand your anger at being presented with credibility in economics, rather than the STD-infested filth that composes the underpinnings of Keynesianism.

Keep viewing the world through Keynes' eyes and trying to make every economic problem conform to some hypothetical solution that Keynes may/may not have proposed.

Reality will get on without Keynes.

[Popo]

Do not soil the name of Keynes.   Krugman is a socialist central planner.

Keynes believed in raising interest rates during boom times.  Krugman has been a fan of stimulus during both booms and busts.   He likes one half of Keynesianism, and ignores the other half which is inconvenient to his agenda.

He is a frightening little zealot who won a Nobel prize for dissing George Bush.

[BigJim]

Keynes was a socialist central planner. How else is a government to be "raising interest rates during boom times" unless the state (directly or indirectly) is controlling the money supply?

[TaxSlave]

And if Trotsky hadn't been betrayed, the dictatorship of the proletariat would have blossomed and given us worldwide utopia.  Central planning For Your Own Good, using your own debt-slavery as currency, always works if the right Enlightened Experts are in charge.  Now, all we have to do is find the right expert.  Right.

[gdogus erectus]

You lost me at C + I + G + (X — M).

[Zero Govt]

no worries, it wasn't you that got lost there it was the academic ...most all of them are lost (in the space)