Use of the Revision: Scientific Explanation and Purposeful Application

There is nothing as practical as good theory.

A good theory explains how elements really relate to one another.  It reduces or completely removes mystery.  It provides a basis and a framework for criticism.

It guides us in our operation of the system.

A good theory is reached by real analysis of the concrete process.

real analysis (is) identifying money with what money buys. … And that is the source of the problem in real analysis.  If you want to treat money that doesn’t make a difference, you can have a beautiful liberal monetary theory.  But it doesn’t say the way the thing works. [CWL 21, Editors’ Introduction, xxviii  quoting Lonergan]

A good theory articulates causes.

A systematic explanation, then, requires a normative theoretical framework.  The basic terms and relations of such a framework would specify the distinctions and correlations that articulate the causes, which are not necessarily visible, of events that are apparent to all.  The framework would thus stand to the ordinary apprehension of the booms and slumps of the trade cycle in much the same way that the explanatory grasp of acceleration as the second derivative of a continuous function of distance and time stands to the ordinary, commonsense grasp of what it is to be going faster.  [CWL 15, Editors’ Introduction lv]

A good theory identifies explanatory functional interrelations, reveals a mechanism to be operated, and provides norms for operation and adaptation. Recall:

It is the viewpoint of the present inquiry that, besides the pricing system, there exists another economic mechanism, that relative to this system man is not an internal factor but an external agent, and that the present economic problems are peculiarly baffling because man as external agent has not the systematic guidance he needs to operate successfully the machine he controls. [CWL 21, 109]

… it will be possible to distinguish stable and unstable combinations and sequences of rates in the three main areas and so gain some insight into the long-standing recurrence of crises in the modern expanding economy. [CWL 15, 53-54]

Now as the statistical approach differs from the descriptive, the analytic differs from both.  Out of endless classificatory possibilities it selects not the one sanctioned by ordinary speech nor again the one sanctioned by facility of measurement but the one that most rapidly yields terms which can be defined by the functional interrelations in which they stand. [CWL 21, 112]

A good theory sublates Keynesianism.

In brief Lonergan is looking for an explanation in which the terms are defined by the relations in which they stand, that is, by a process of implicit definition. … No doubt Keynes was an economist first and a methodologist second … Lonergan, for his part, is perhaps a methodologist first and an economist second, but he was able to push his economic reflections further than Keynes because he had a firmer grasp of the essentials of an effective theory. … Lonergan’s critique (shows that) … the emphasis shifts … to searching heuristically for the maximum extent of (functional) interconnections and interdependence; and that the variables (of the mechanism) discovered in this way might not resemble very much the objects (or the aggregates) (such as coincidental prices) which, in the first instance, (the non-methodologist) was thinking about.   [Gibbons 1987]

A good theory of macroeconomics is independent of human psychology and anthropology.

So, the purpose of the Revision of the NIPA in the form of diagram and equations is explanation for use:

  • to visualize a mechanism symbolized and represented by the form and defined by a coherent set of scientific, explanatory relations
  • to formalize the classical and statistical laws of the economy’s productive schemes of recurrence ; what are the forms and what are the probabilities of occurrence?
  • to, thus, provide the Theory of Functional Macroeconomic Dynamics for test and verification
  • to grasp the central tendencies implying the norms for human adaptation in stable and expanding phases
  • to interpret price changes as real and relative or monetary and absolute, and not be misguided by inflation
  • to grasp the concept and the practical significance of “macroeconomic profit”
  • to avoid overinvestment stemming from misinterpretation of rising prices in a surplus expansion
  • … the lack of adaptation in the free economies to the requirements of the pure cycle … is an inability to distinguish between the significance of a relative and an absolute rise or fall of monetary prices.  A relative (i.e. “real”) rise or fall is, indeed, a signal for a relatively increased or reduced production (of one product relative to another) … (much)… Inversely, the rising prices of the surplus expansion are not real and relative but only monetary and absolute rising prices; to allow them to stimulate production is to convert the surplus expansion into a boom (which must be followed out of systematic necessity by a correlative and devastating slump).  This I believe is the fundamental lack of adaptation to the productive cycle that our economies have to overcome.  The problem, however, has many ramifications of which the most important is the relativity of the significance of “macroeconomic profits”  [CWL15, 139-140]
  • to, thus, avoid a painful, but systematically necessary, correction
  • to avoid, to the extent possible, inflation and deflation
  • … the dummy (money) must be constant in exchange value, so that equal quantities continue to exchange, in the general case, for equal quantities of goods and services.  The alternative to constant value in the dummy is the alternative of inflation and deflation.  Of these famous twins, inflation swindles those with cash to enrich those with property or debts, while deflation swindles those with property or debts to enrich those with cash; in addition to the swindle each of these twins has his own way of torturing the dynamic flows; deflation gives producers a steady stream of losses; inflation yields a steady stream of gains to give production a drug-like stimulus. [CWL 21, 37-38]
  • to grasp the limits and constraints on any expansion, given the current finitudes of population, skills and techniques, culture, technology, and institutions
  • As the table makes clear, a variation in G’ is much more significant that a variation in G”.  … Inversely, when G” is 90% and G’ is really 10% but estimated to be 20% by over-zealous depreciation charges and by depressed wages, then a normative proportion of 9 is given a monetary distribution corresponding to a proportion of 4.5.  The result is an overproduction or an insufficient purchasing power or a maldistribution (or whatever it is safe to call it, for superficial economists fancy the thing cannot exist) that generously slices off about half of existing economic activity. [CWL 21, 55 (for full explanation of “about half”)]
  • to grasp a) the deviations from a central tendency, for which the process has a systematic exigence, and the magnitudes of the stresses and strains, and b) the nature, magnitude, and significance of the restorative forces of recession or depression being generated

Jack London’s character could locate on a thermometer 75below zero, but he did not grasp the significance of 75below zero.  He froze to death. [London, Jack, “To build a Fire”]

By an explanatory arrangement of the NIPA the reader should be helped to see all in a single view, for to understand one functional flow – defined by its functional relation to other flows – is to grasp the entire system of flows.

Moreover, once initial difficulties are overcome and basic insights are reached, the investigation approaches a supreme moment when all data suddenly fall into a single perspective, … [CWL 3, 47/71]

As in the circle, so in the macroeconomy; all concepts tumble out together.

If one grasps the necessary and sufficient conditions for the perfect roundness of this imagined plane curve, then one grasps not only the circle but also the point, the line, the circumference, the radii, the plane, and equality.  All the concepts tumble out together, because all are needed to express adequately a single insight.  All are coherent, for coherence basically means that all hang together from a single insight.  [CWL 3, 12/36]

A Revision of the NIPA must include both the Diagram of Rates of Flow, for visualization of dynamic interrelations, and a set of coherent and comprehensive equations stating the explanatory relations.  Every flow through both the normative and the superposed circuits of the Diagram must have a measure of its velocity.  The measures must be entered on the Diagram and included in the equations.  The reader should easily be able to “see” the current rates of flows and understand the implication of any deviations of product flows or prices from relational norms.

… the diagram can be said to have a heuristic significance.  In Lonergan’s usage, ‘heuristic’ denoted the sorts of innovations that expedite the occurrence of certain acts of consciousness, particularly insights. Thus the diagram as itself a visual image can facilitate the occurrence of insights.  For example, while the text of Section 13 works out in great detail sets of relations among terms, the diagram makes it easy to understand that the exchange economy consists of two circuits of payments, basic and surplus; that these circuits are mutually and dynamically interdependent (diagrammed as the crossovers) ; and that these circuits are dependent upon the activities of the redistributive function (infusing for transactions the proper amount of money into the system). [CWL 15, 179]

A revision is vital for the nation to avoid recession by helping to understand and properly interpret the systematic significance of a)  “macroeconomic profit” (“pure surplus income” in an older parlance) and its career of rise to peak and its return to zero; and b) the interpretation of pricing vis a vis the phase of the process and as either real and relative or monetary and absolute.

At the root of the depression lies a misinterpretation of the significance of pure surplus income. In fact it is the monetary equivalent of the new fixed investment of an expansion…..our culture can not be accused of mistaken ideas on pure surplus income as it has been defined…; for on that precise topic it has no ideas whatever… Thus pure surplus income may be identified best by calling it net aggregate savings and viewing them as functionally related to the rate of new fixed investment [CWL 15, 152-53]

… economic developments are finite, and so no economic development will accelerate indefinitely.  They operate against an increasing resistance, to justify Juglar’s celebrated pronouncement: “the only cause of depression is prosperity.” (as quoted from Schumpeter, History, 1240

A revision will reveal the current phase of the cycle so as to advise the participants of the adaptation required by the norms of the current phase.

The participants will be brought to appreciate the constraints of finitudes and technological relations in rates of return.  In certain circumstances the extraction of an excessive rate of return would systematically reduce employment and the growth of the economy and call for a refreshment via philanthropy of the economic process.

 “One could rework the calculations … replacing the by s>c, where s-c corresponds to goods and money taken outside the equilibrium production model via an exogenous interest rate claimed by the banker-producer combination….Then the endogenous growth and interest rate…falls per the formula below.  This would become negative if c corresponded to the stationary state values of r = i = 0. “ [Burley and Csapo 1992-1, 140]

It is critical that economists at the BEA develop and implement an arrangement of the NIPA which explains the current, purely dynamic, economic process, rather than provides a mere convenient statistical compilation of what accountants report to have happened in the past.

Let the double-circuited, crossover-balanced, credit-centered Diagram of Rates of Flow become the primary comprehensive diagram for all macroeconomists, replacing the matrices constituting essentially macrostatic models of the economy.  Let the Diagram be a poster on the office wall of every professor of macroeconomics.

The Diagram of Rates of Flow is a framework for all of us.  To the practical Uses of explanation bulleted above, we add additional practical Uses:

  • In the light of the implications of that diagram’s generalized scheme and by the time series of explanatory functional flows we can measure and explain the evolution of equilibrated or disequilibrated combinations of flows in all six diagonal operative channels, plus we can measure their equilibrated or disequilibrated interaction with the flows in the eight horizontal and vertical channels of responsible and irresponsible borrowing and lending
  • We can shine a bright light on the granting of quantities of good and bad credit to whom and for what purpose, so that excesses such as the consumer credit of both the 1990s and early 2000s can be brought to light as they are occurring, can be properly monitored, and can be avoided.
  • By identifying the pricing and quantity components of flows, we can distinguish real and relative price changes vs. monetary, absolute and general price changes; this will help to avoid a disastrous misinterpretation of the rising prices of a surplus expansion as a signal to invest beyond the technical bounds.
  • We can determine whether or not seeds are being sown in the soil of the boom of an overgrowth which will systematically consume itself.
  • By identifying the phase of the economy – static, proportionate expansion, surplus expansion, basic expansion – we can judge a) how much a price change is attributable to lags from initiation to completion of production, and b) how much is due to the Central Bank’s artifice.
  • By comparing the rate of infusion of money with the rate of real growth we can determine how much money is getting out of the banking system and into the operative circuits and whether the Fed is putting the secondary markets on pricing steroids or applying a stranglehold to those same markets.
  • We can bring Functional Macroeconomic Dynamics to bear upon the ideas of Steven Gjerstad, and Vernon Lewis and we can bring their ideas regarding excess credit to bear upon the misinterpretations and crises explained by Functional Macroeconomic Dynamics
  • We can demonstrate that the prices of consumer goods naturally tend to rise during the lag in a surplus expansion
  • We can understand the nature and role of the secondary markets of previously issued stocks, bond, and works of past art vis a vis financial operations, insurance operations, retirement savings, business operations planning, and speculation.
  • By use of superposed circuits, we can understand the nature of fiscal imbalances, trade imbalances, and money-supply imbalances and how they mitigate and conceal problems in the private sector.

All this is to say that Functional Macroeconomic Dynamics is a theory which explains for us a) how the economy can and should work, and b) how we can avoid its divergence into disequilibria generating systematically necessary, painful corrections.

Thus we define the financial problem as the problem of working out and applying the view that money is public bookkeeping. The grounds for this position may be summarized as follows. … Money is an instrument invented by man to make possible a large and intricate exchange process.  While there is no simple and even perhaps no ascertainable correlation between the quantity of money and the volume of exchange activity, it remains true that variations in the volume, if not to result in inflation or deflation, postulate some variations in the quantity.  Now in the long run these variations in quantity can be had only by the introduction of a money of account, but if the money of account – its title to be called money was indicated in Section 18 (pp. 37-41) – stands side by side with a commodity money (e.g. in a fixed price of exchange for an ounce of gold), then not only are there the undue perturbances of the exchange process from international movements of capital and from financial crises and crashes, but the whole economy comes to be regulated, not by the social good, not by the exigencies of the economy itself, but by the money invented to serve the objective process and the social good. [CWL 21, 104]