The IS-LM, AS-AD Models and the Phillips Curve Correlation

 

In General:

In this section, we are contrasting familiar textbook models of macrostatic equilibrium, with Lonergan’s explanatory theory of macrodynamic equilibrium.  We are contrasting a macrostatic toolkit with a purely relational field theory of macroeconomic dynamics. Lonergan discovered  a theory which is more fundamental than the traditional wisdom based upon human psychology and imaginary endogenous reactions to external forces.  His Functional Macroeconomic Dynamics is a set of relationships between n objects, a set of intelligible relations linking what is implicitly defined by the relations themselves, a set of relational forms wherein the definitive form of any element is known through its dynamic relations to all other elements.  His field theory is a single explanatory unity; it is purely relational, completely general, and universally applicable to every configuration in any instance.

The textbook models employ comparative statics:  Certain quantities are accepted as given;  their determination is exogenous, i.e. they are changed by external shocks; they are considered to be parameters over which the endogenous firms and households have no initial control.  Other quantities are endogenous variables determined within the comparative-statics framework for adjustments.  For example: in an initial configuration, prices may be exogenously given and determinate of a certain endogenous intersection-equilibrium of quantities along the supply and demand curves.  Then, an exogenous, unexplained shift in prices is assumed, to which the internal human agents of supply and demand respond to effect a different intersection of the quantities of supply and demand.  Comparative statics is, thus, characterized by exogenous givens, unexplained shifts in the exogenous givens, and adjustments by endogenous households and firms to the endogenous variables such as to be the efficient cause of a new intersection of  the endogenous variables.

While comparative statics demonstrates the general principles of supply equaling demand and of quantities having prices, it does not explain the dynamic economic process by the terms and relations of interdependent functionings.  In comparative statics there is a whole lot of assuming and guessing going on with respect to the shape of curves and the nature, direction, and extent of a reaction.  CS is a huge tangle of psychopolitical guesses regarding profit-seeking firms contending with utility-seeking households, reactions to change and to the expectations of change, and the speed of the reactions.  And it stakes its explanations in the winds of the imagination.  In such an imaginary tangle, so-called pundits can cherry-pick elements in order to extrapolate as they feel, and make predictions as they will when in the general case predictions of the longer term are impossible.  So, we have financial talk shows and political debates.

In contrast, Functional Macroeconomic Dynamics is a theory of the formal cause or immanent intelligibility, or primary relativities, of a current, continuous or semicontinuous, purely dynamic process of interdependent, functional flows.  Its basic terms are few and easily handled; they are precisely defined by the functional relations in which they stand with one another; they are of scientific and explanatory significance; and their magnitudes are determinate.  FMD is purely relational.  It is a dynamical analysis of a dynamic process.  It is conceptually prior to, more fundamental than, and independent of human psychology.  It is also a normative theory which provides the norms and precepts to which human psychology must adapt.

In a review of the above plus of topics presented elsewhere on this website, features of Functional Macroeconomic Dynamics include:

  • It adopts a scientific and explanatory heuristic.
  • Rather than merely describe or report, it explains the objective economic process in the form of terms related to one another
  • The process is always the current process.
  • The process, as a process, evolves.  It is dynamic; and the analysis and explanation must be adequate to a dynamic process.  It must be in terms of first and second order differentials: d2θ/dt2, d2x/dt2, d2y/dt2.  FMD finds no explanatory value in the momentary intersections of macrostatics.
  • It prescinds from human psychology; it is conceptually and explanatorily prior to and more fundamental than human psychology; it explains the objective process to which psychological humans must adapt; human agents are, as it were, outside the laws of the process.
  • It is a theory comprising the immanent intelligibility or formal cause of the process, not a narrative describing the actions of human agents, who are, as it were, acting as efficient cause from outside the process.
  • It employs implicit definition to reach precise analytical terms of explanatory significance; these terms mutually define and mutually condition one another
  • The process to be explained by an explanatory theory is always the current process
  • The explanatory theory must be comprised of invariant principles and laws; it must be completely general; it must be at an adequate level of abstraction, and universally explanatory a) of all configurations, and b) in every instance
  • The explanatory terms must be defined by the functional relations in which they stand with one another
  • The analysis is purely functional and purely relational
  • Its basic terms are the velocities of interdependent functionings
  • It discovers and analytically distinguishes circuits of accelerator and accelerated functionings, requiring explication of their vital, crossover interactions with respect to timing and magnitude
  • The basic terms are terms of scientific and explanatory significance upon which  a superstructure of relations comprising a completely explanatory theory may be constructed
  • It explains in the perspective of a circuit; it bears resemblance in some respects – but only is some respects – to the explanatory science of hydrodynamic flows in channels and the explanatory science of electrical-current flows through wires and junctions
  • It rejects accounting unities; accounting is in the realm of common sense rather than in the realm of science; and accounting does not provide indexes of scientific and explanatory significance
  • It understands that the goal of science is verification of understanding, not prediction 
  • It is a normative theory yielding precepts for adaptation, yet comprehending violations of the norms and precepts; so, as completely explanatory, it is a theory of both normative equilibria and violative disequilibria
  • It is a purely relational field theory, a theory of the relation of n objects among themselves
  • Money is a dummy invented by man to make possible a vast and intricate economic process, not a commodity to be hoarded
  • Inflation is explained as disproportionate flows of products and of money
  • The data whose pattern it explains are the data of the current functional flows of production and payments
  • It is composed of invariant primary relativities which can be applied to secondary determinations or boundary conditions –, such as the quantities and prices of the non-systematic manifold – in order to derive particular laws.
  • The interest rate is an internal relation, not an external lever – as in the IS-LM model
  • By the nature of a transaction, supply and demand are concomitant in any and all transactions
  • Prices and quantities are not a given – as in the static AD-AS model; rather they are secondary determinations to be explained in light of the significant variables. P’/p’ = a’ + a”p”Q”/p’Q’
  • The root of the recession or depression is an inability of the efficient-cause-participants to understand a) the difference between real and relative prices vs. monetary and absolute prices (P’/p’ = a’ + a”p”Q”/p’Q’), b) the significance of pure surplus income as merely the monetary correlate of the expansion of the process (f = vw), c) that the process is a finite process and, as finite, has limits, and d) that the criterion of ever-increasing earnings and stock prices is in conflict with the systematic rise and fall of pure surplus income.
  • It understands that, in the general case, prediction of the longer term is impossible

FMD prescinds from a vaguely defined psychological situation. A Copernican revolution is attempted.

our inquiry differs radically from traditional economics, in which the ultimate premises are not production and exchange but rather exchange and self-interest, or later, exchange and a vaguely defined psychological situationOur aim is to prescind from human psychology that, in the first place, we may define the objective situation with which man has to deal, and, in the second place, define the psychological attitude that has to be adopted if man is to deal successfully with economic problems.  Thus something of a Copernican revolution is attempted: instead of taking man as he is or as he may be thought to be and from that deducing what economic phenomena are going to be, we take the exchange process in its greatest generality and attempt to deduce the human adaptations necessary for survival. [CWL 21,42- 43]

We set out to indicate the existence of an objective mechanical structure of economic activity, of something independent of human psychology, of something to which human psychology must adapt itself if economic activity is not to become a matter of standing in a tub and trying to lift it. [CWL 21, 56]

Taking into account past and (expected) future values does not constitute the creative key transition to Functional Macroeconomic Dynamics.  Those familiar with elementary statics and dynamics (in physical mechanics) will appreciate the shift in thinking involved in passing from (static) equilibrium analysis (of, say, a suspended weight with subscripts for time not needed)…to an analysis (of, say, the motions of planets or pendula) where attention is focused on second-order differential equations, on d2θ/dt2, d2x/dt2, d2y/dt2, on the primary relativities of a range of related forces, central, friction, whatever.  Particular secondary boundary conditions, past and future pricings and quantities (analogous to a planet’s particular past or future position, velocity, acceleration), are relatively insignificant for the analysis of the primary relativity immanent in, and applicable to, every instance of the process.  What is significant is the Leibnitz-Newtonian shift of context. [McShane, 1980, 127]

General laws contain a primary relativity and are applied to the concrete “only through the addition of further determinations, and such further determinations pertain to a non-systematic manifold. … it is not enough to think about the general law; one has to add further determinations (such as prices and quantities) that are contingent from the very fact that they have to be obtained from a non-systematic manifold. [CWL 3, 492/516]

Einstein’s position …  follows quite plausibly from the premise that empirical science seeks not the relations of things to our senses but their relations to one another.  For, as has been remarked, observations give way to measurements; measurements relate things to one another rather than to our senses; and it is only the more remote relations of measurements to one another that lead to empirical correlations, functions, laws.  [CWL 3, 41/65]

The one issue is the locus of that control.  Is it to be absolutist from above downwards? Is it to be democratic from below upwards? Plainly it can be democratic only in the measure in which economic science succeeds in uttering not counsel to rulers but precepts to mankind, not specific remedies and plans to increase the power of bureaucracies, but universal laws which men themselves administrate in the personal conduct of their lives … To deny the possibility of a new science and new precepts is, I am convinced, to deny the possibility of the survival of democracy.35

For a preliminary visual contrast, from left to right below are Lonergan’s three diagrams of a) Rates-of-Flow and Conditions of Equilibrium, b) Rates-of-Change-Over-a-Pure-Cycle, and c) the Pure Surplus Income Ratio and Its Elements . Below them are three textbooks’ models: These macrostatic models can be found in most textbooks of macroeconomics.  These particular renditions are taken from [Dornbusch and Fischer and Startz 2004] 96 ff., 118-21, 259 ff.; [Baumol and Blinder, 1998] 776-78; [Krugman and Wells, 2013] 896 ff., 916 ff.; [Blanchard, 2009]: 93-98, 141-46,165-71.  From left to right, a) IS-LM model, b) AD-AS model, and c) the Phillips Curve, The textbook models result from an impoverished static heuristic rather than from an adequate dynamic and scientific heuristic.

Diagram of Rates of Flow 2

 

The Diagram of Rates of Flow and Conditions of Equilibrium represents a system of velocities and the systematics of their interdependencies; it is general and universally applicable in any instance.  It is an image of a set of primary relations among flows which, like the general and universally-applicable primary relations of the simple, ideal pendulum, or the formula for the range R of a projectile subject to a gravitational force, g, in terms of its initial velocity vand initial angle θ0, with y= 0 or ground level .

d2θ/dt2+ (g/L)sinθ = 0   

R = v02sin2θ0/g

is always currently relevant.  So, “in any instance” means “in any event”, “at any moment”, “in any configuration of secondary determinations”.  It is completely general and universally applicable.  And other instances of complete generality and universal relevance would be Newton’s F = ma, Hamilton’s H = T + V, and Einstein’s Gab = 8πTab   [d”inverno, 1992,169]

The second and third Lonergan diagrams represent how a normative pure cycle of expansion might play out over time. The horizontal axes of each represent time.  The diagrams represent normative, thus equilibrated, differentials of evolutions rather than the textbooks’ comparative snapshots of shocks and shifts.

Each of the textbook models should be contrasted separately against all three of Lonergan’s models, so that the reader can understand and reflect upon the feasibility of verification and the degree of usefulness or uselessness of the textbook models.

In the three textbook models, the three horizontal axes represent indexes (output and unemployment) of the productive order; the three vertical axes represent indexes of monetary elements – a) interest rates and their changes, b) absolute price levels, and c) the inflation rate of wages (or possibly of prices in general, or possibly of the expected inflation rate), which is of course a measure of price change.

The IS-LM and AD-AS models are plots of the points where supply equals demand in the markets for goods and for money; the plots purport an intersection at a price for money (IS-LM model) or a price for goods (AD-AS model) at which activities in both markets are in equilibrium.  The Phillips Curve is a fitted curve of unemployment coincident with inflation.  In a comparative macrostatics, the productive and monetary activities are purported to be interdependent and mutually conditioning.  In the three models, interest rates, prices, inflation, unemployment, demand, and supply are initially assumed to be primary givens subject to unexplained shocks; they are, for the analyst, first in the analysis.  They are what he notices first and, so, assumes to be fundamental, elemental terms of scientific significance upon which he can base a science.

There are two distinct views of how you, and we mean you, reach understanding: either you puzzle over some given situation and arrive at an understanding that leaves you with what is called a concept, or you somehow pick up concepts as you move through life, or an economic class, and you have to analyze them to make sense of them.  the first view we call the MAC view; the second view we call the McA view. The first view, in which the A stands for ah? and ah! is the view of Aristotle, Aquinas, Lonergan, you and us.  The second view is the dominant view, the view of Mankiw, to which we return in the second section.  It is associated with Scotus (1265-1308) and with the British tradition of Conceptual Analysis.  It is a view that murders education. [McShane, 2002-1, 51]

Unless you are very alert and detached, you assume the orientation of the teacher.  This is all the more true if the orientation of the teacher corresponds to the orientation of the whole department, the whole school.  It is even worse if that orientation controls the textbooks, the journals, the publications. … after a while, or a year, or a degree in economics, such principles can become a fairly fixed point of view, especially as they are supported by by Establishment Economics.  So, no other set of assumptions seems feasible. … All that is expected of Establishment Economics, more so at its higher level, is advanced mathematical tinkering. … present economic assumptions are a pretty poor collection of descriptive counsels, … [McShane, 2002-1, 57]

Mankiw’s view leaves out of consideration questions and insights.  Concepts are his key focus.  they seem to just spring to mind. … … our two models of knowing. McA and MAC.  the first is the Establishment model.  You have a mind; you pick up concepts – the small c may remind you that what you pick up thus, memorize or whatever, is small! – You may have to analyze them to get them clear.  The second model is our model: You have a mind; it leads you to analyze – ? and ! – and with patience and luck you arrive at a concept. [McShane, 2002-1, 60]

But in Functional Macroeconomic Dynamics, they are neither given nor explanatory; rather they are secondary determinations to be explained in the light of precisely defined terms and relations of scientific and explanatory significance.  They are, for the FMD analyst, last in the analysis.

Wedded to the difficulty of conceiving capital … is the difficulty of conceiving change. Nor can this be surprising if the accusation of macrostatic thinking is valid. … An early villain was Leon Walras. … As Schumpeter notes, “the exact skeleton of Keynes’ system belongs, to use terms proposed by Ragnar Frisch, to macrostatics, not macrodynamics.” [McShane 1980, 105]

Frisch’s failure to develop a significant theory typifies the failure of economists who search for a dynamic heuristic.  As well as a fundamental disorientation of approach there is also a tendency to shift to an inadequate level of abstraction with a premature introduction of boundary conditions in a determinate set of differential and difference equations. [McShane, 1980, 114]

One might be reminded here of a parallel in hydrodynamics: if what is at issue is a general specification of the dynamics of free water waves, a premature introduction of general boundary conditions or worse, specific channel conditions, botches the analytic possibilities….the Robinson-Eatwell analysis is hampered … by their building the economic priora quoad nos of profits, wages, prices, etc., into explanation, when in fact the priora quoad nos[1] are last in analysis: they require explanation. [McShane, 1980, 124[2]

Lonergan agreed with Schumpeter on the importance of a systematic or analytic framework in order to explain, rather than merely record or describe, the aggregate phenomena of macroeconomics; he agreed with Schumpeter that to be able to explain the booms, slumps, and crashes of the trade or business cycles the economist’s analysis had to be as dynamic as the subject matter under investigation; and he agreed that the economist had to know what are the significant variables in the light of which price changes are to be interpreted.  According to Lonergan, standard economic theory had successfully achieved none of these desiderata. [CWL 15, Editors’ Introduction liii]

[1]The priora quoad nos– first for us – are the things which we notice first because they are related to our sensitive selves, e.g. hot, cold, fast, slow.  The priora quoad se– first among themselves – are the things or terms which are related to each other, e.g. pressure, volume, temperature, space, time, mass, etc.

[2]More fully, the quote is: One might be reminded here of a parallel in hydrodynamics: if what is at issue is a general specification of the dynamics of free water waves, a premature introduction of general boundary conditions or worse, specific channel conditions, botches the analytic possibilities….the Robinson-Eatwell analysis is hampered, not only by an absence of paradigmatic heuristic thinking in a field whose principles involve ends, but also by their building the economic priora quoad nos of profits, wages, prices, etc., into explanation, when in fact the priora quoad nos are last in analysis: they require explanation. [McShane,1980, 114]

In contrast to the given shocks-and-follow-on-round-bottomed-dominoes of macrostatics, Functional Macroeconomic Dynamics first seeks the significant variables in the light of which prices, quantities, interest rates and inflation are to be interpreted.   With its scientific and dynamic heuristic, FMD makes precise precise analytical distinctions – point-to-point and point-to-line; t, t-a, t-b, t-c, etc.; expenditures P’Q’ and costs p’a’Q’ and p”a”Q” – among the naturally interdependent, functional, productive flows, and then goes on to discover the differential primary relativities and the explanatory relations among these mutually-conditioning productive flows; these analytic functional distinctions and explanatory primary relativities are analytically prior to, and more fundamental than … coincidental boundary conditions such as price levels and patterns, interest rates and profits, and so forth, which lie at the heart of the textbook models.  Again, as pendular, parabolic, and elliptical positions and velocities are explained generally in the light of scientifically significant variables, so prices, quantities, etc. are explained in the light of scientifically significant terms and relations:

to be able to explain the booms, slumps, and crashes of the trade or business cycles the economist’s analysis had to be as dynamic as the subject matter under investigation; and … the economist had to know what are the significant variables in the light of which price changes are to be interpreted. According to Lonergan, standard economic theory had successfully achieved none of these desiderata. [CWL 15, Editors’ Introduction liii]

Lonergan stands alone in identifying significant functional variables and formulating relationships isomorphic with the patterns of the economic process and ratios in the light of which monetary events may be interpreted.

Lonergan is alone in using this difference in economic activities to specify the significant variables in his dynamic analysis… no one else considers the functional distinctions between different kinds of (rhythmic production flows) prior to, and more fundamental than, … price levels and patterns, … interest and profits, and so forth….only Lonergan analyzes booms and slumps in terms of how their velocities, accelerations, and decelerations are or are not equilibrated in relation to the events, movements, and changes in two distinct monetary circuits of production and exchange as considered both in themselves (with circulatory, sequential dependence) and in relation (of interdependence) to each other by means of crossover payments. [CWL 15, Editors’ Introduction, lxii]

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.  This technique (implicit definition) has been used to great effect by David Hilbert in his Foundations of Geometry in which, for example, the meaning of a point and a straight line is fixed by the relation that two, and only two points, determine a line.  “The significance of implicit definition is its complete generality.  The omission of nominal definition is the omission of a restriction to objects which, in the first instance, one happens to be thinking about.  The exclusive use of explanatory or postulational elements concentrates attention upon the set of relationships in which the whole scientific significance is contained.” [Gibbons, 1987, 313]

We keep insisting that the economic process is always the current process; and it is purely dynamic, purely functional, and purely relational.  Functional Macroeconomic Dynamics is a field theory of dynamics rather than of statics; and the genuinely scientific macroeconomist must employ a scientific and dynamic heuristic which guide him towards a purely relational explanation of the dynamics of the economic process.  The scientific macroeconomist must advance through his field of inquiry to the level of dynamic system.  His theory, like that of electric circuits, or hydrodynamic flows, or planetary motion, is universally relevant and always explanatory of the current process; and, thus, the primary relativities of his theory must be general, universal, and applicable in any and every instance.

… a science emerges when thinking in a given field moves to the level of system. Prior to Euclid there were many geometrical theorems that had been established.  The most notable example is Pythagoras’ theorem on the hypotenuse of the right-angled triangle, which occurs at the end of  book 1 of Euclid’s Elements.  Euclid’s achievement was to bring together all these scattered theorems by setting up a unitary basis that would handle all of them and a great number of others as well. … Similarly, mechanics became a system with Newton.  Prior to Newton, Galileo’s law of the free fall and Kepler’s three laws of planetary motion were known.  But these were isolated laws.  Galileo’s prescription was that the system was to be a geometry; so there was something functioning as a system.  But the system really emerged with Newton.  This is what gave Newton his tremendous influence upon the enlightenment.  He laid down a set of basic definitions, and axioms, and proceeded to demonstrate and conclude from general principles and laws that had been established empirically by his predecessors.  Mechanics became a science in the full sense at that point where it became an organized system. … Again, a great deal of chemistry was known prior to Mendeleev. But his discovery of the periodic table selected a set of basic chemical elements and selected them in such a way that further additions could be made to the basic elements.  Since that time chemistry has been one single organized subject with a basic set of elements accounting for incredibly vast numbers of compounds.  In other words, there is a point in the history of any science when it comes of age, when it has a determinate systematic structure to which corresponds a determinate field. [Method,241-42]

FMD is a single, yet comprehensive, explanatory unity.

Newton set down laws of motion and proceeded to demonstrate that if a body moves in a field of central force, its trajectory is a conic section.  He set out with a minimal cluster of insights, definitions, postulates, axioms and proceeded to account for the laws that had previously been empirically established, bringing them into a single explanatory unity.  ¶A single insight yields a conception, a definition, an object of thought; but from a cluster of insights, you build up a system of definitions, axioms, postulates, and deductions.  We have to note that a system is quite an achievement; systems are not numerous. [CWL 5, 52]

FMD focuses on the formal cause, or explanatory primary relativities, or immanent intelligibility of the objective process rather than on the efficient cause of feckless, psychological humans, whether in their preferences or in their manipulation of interest rates.

We set out to indicate the existence of an objective mechanical structure of economic activity, of something independent of human psychology, of something to which human psychology must adapt itself if economic activity is not to become a matter of standing in a tub and trying to lift it. [CWL 21, 56]

Ought there not to be introduced a technical term to denote this type of intelligibility?  … The intelligibility that is neither final nor material nor instrumental nor efficient causality is, of course, formal causality…What we have called the intelligibility immanent in sensible data and residing in the relations of things to one another might be named more briefly formal causality… [CWL  3, 78/101-102]

Paraphrasing [CWL  3, 78/101-102]: Ought there not to be introduced a technical term to denote this type of intelligibility in the macroeconomic process?  … The intelligibility that is neither final ( i.e. purposive and preferential) nor material nor instrumental nor efficient causality is, of course, formal causality…what we have called the field theory of the relations among n objects,or the intelligibility immanent in sensible data of the dynamic economic process and residing in the relations of interdependent, mutually conditioning, functional flows to one another, might be named more briefly the formal causality of the economic process… CWL Insight, 78; x/x

Lonergan discovered a field theory of macroeconomics, a theory more fundamental than the traditional and conventional macroeconomics based upon human psychology and purported endogenous reactions to external forces.  His Functional Macroeconomic Dynamics is a set of relationships between n objects, a set of intelligible relations linking what is implicitly defined by the relations themselves, a set of relational forms wherein the form of any element is known through its relations to all other elements.  His field theory is a single explanatory unity; it is purely relational, general, and universally relevant and applicable in every instance.

… again, as to the notion of cause, Newton conceived of his forces as efficient causes, and the modern mechanics drops the notion of force; it gets along perfectly well without it.  It thinks in terms of a field theory, the set of relationships between objects.  The field theory is a set of intelligible relations linking what is implicitly defined by the relations themselves; it is a set of relational forms.  The form of any element is known through its relations to all other elements. What is a mass?  A mass is anything that satisfies the fundamental equations that regard masses.  Consequently, when you add a new fundamental equation about mass, as Einstein did when he equated mass with energy, you get a new idea of mass.  Field theory is a matter of the immanent intelligibility of the object. [CWL 10, 154]

Paraphrasing [CWL 10, 154]   … again, as to the notion of cause, macroeconomists mistakenly conceive of subjective and maximizing preferences, interest rates, price levels, inflation, or unemployment, as formal causes.  Functional Macroeconomic Dynamics does not consider these notions as primary; it gets along perfectly well without them.  It thinks in terms of a field theory, a set of explanatory relationships between interdependent, implicitly defined functional activities.  The field theory of Functional Macroeconomic Dynamics is a set of intelligible functional relations linking functionings which are implicitly defined by the relations in which they stand with one another; it is a set of relational forms.  The form of any macroeconomic functioning is known through its relations to all other elements.  ….  Field theory is a matter of the immanent intelligibility of the object in a determinate field.

First, we’ll show again here three familiar macrostatic models: the IS-LM model, AD-AS model, and the Phillips Curve; second, we’ll provide some context which is relevant to the interpretation of the these inadequate models; third, we’ll comment on each model.

These macrostatic models can be found in most textbooks of macroeconomics.  These particular renditions are taken from Dornbusch and Fischer and Startz, 2004: 96 ff., 118-21, 259 ff.; Baumol and Blinder, 1998: 776-78; Krugman and Wells, 2013: 896 ff., 916 ff.; Blanchard, 2009: 93-98, 141-46,165-71.

 

 

 

 

 

 

Elements of Context (notated by double asterisks):

**There is a sense in which supply always equals demand.  A good or service is under process until it is actually and finally sold, at which moment it is actually supplied rather than still merely under process or sitting in finished-goods inventory.  And a good or service is actually demanded when it is actually and finally purchased, so as to exit the process and no longer be under process.

The concomitance of outlay and expenditure follows from the interaction of supply and demand.  The concomitance of income with outlay and expenditure is identical with the adjustment of the rate of saving to the requirements of the productive process. [CWL 15, 144]

A condition of circuit acceleration was seen … to include the keeping in step of basic outlay, basic income, and basic expenditure, and on the other hand, the keeping in step of surplus outlay, surplus income, and surplus expenditure.  Any of these rates may begin to vary independently of the others, and adjustment of the others may lag. But any systematic divergence[1]brings automatic correctives to work. [CWL 15, 144]

Lonergan’s implicit field equations may be viewed as constraints upon the simultaneous effecting of quantities and prices.  (See d’Inverno, 1992, 169)   At any and every moment of the actual transacting comprising the process, actual supply equals actual demand in both the market for goods and the market for money; and, no matter the fact of imperfect competition with its range of prices and no matter whether calculated or not, there theoretically exists some determinate index of exchange values, determinate index of costs, determinate risk-adjusted interest rates of various maturities, and determinate rate of inflation or deflation, including zero.  But this momentary equality of supply and demand for goods and for money and this existence of momentary prices and rates tells us nothing about where we are in the differential evolution of the process; it tells us nothing about the current phase of the double-circuited, time-lagged, dynamic expansion and its requirements for savings vs. consumption; and therefore it tells us nothing about the magnitude of crossover balance, excess or deficient money supply, ratio of credit to earnings, government or trade imbalances.  The textbooks’ thought experiments – called the  IS-LM, AD-AS, and Phillips Curve models – don’t tell us much that is useful for the current monitoring and equilibrating of the dynamic, double-circuited, time-lagged, credit-centered process of flows.

In implicit equations, the terms are implicitly defined by the relations in which they stand with one another.

In [d”inverno, 1992] under the heading of “Chapter 13, The Structure of the Field Equations”, Ray d’Inverno reads Einstein’s implicit field equations from right to left, left to right, and back and forth.  He states:

Before attempting to solve the field equations we shall consider some of their important physical and mathematical properties in this chapter.  The full field equations (in relativistic units) are

Gab= 8πTab

  • The field equations are differential equations for determining the metric tensor gab from a given energy-momentum tensor Tab. Here we are reading the equations from right to left.  … one specifies a matter distribution and hen solves the equations to ascertain the resulting geometry.
  • The field equations are equations from which the energy-momentum tensor can be read off corresponding to a given metric tensor gab. Here we are reading the equations from left to right.
  • The field equations consist of ten equations connecting twenty quantities, namely, the ten components of gab and the ten components of Tab. Hence, from this point of view, the field equations are to be viewed as constraints on the simultaneous choice of  gab and Tab.  This approach is used when one can partly specify the geometry and the energy-momentum tensor from physical considerations and then the equations are used to try and determine both quantities completely. [d’Inverno, 1992, 169]

Analogously, focusing on one of Lonergan’s implicit equations, the terms are implicitly defined by the relations in which they stand with one another.

P’Q’ = p’a’Q’ + p”a”Q”  [CWL 15, 158-60]

We may read from left to right, right to left, or back and forth between right and left.  From left to right, expenditures-receipts P’Q’ define  and determine concomitant macroeconomic costs, p’a’Q’ and p”a”Q”,  as they are defined (CWL 15, 156-58)  From right to left,  basic and surplus costs-outlays constitute the incomes which define and determine what is concomitantly spent for basic products.  Travelling back and forth between left and right, the equals sign mandates the reciprocal constraining influence on one another of pretio-quantial expenditures-receipts and pretio-quantital costs-outlays constituting basic incomes. Revenues and costs contend and compromise with one another.

Thus, there is a sense in which one may speak of the fraction of basic outlay that moves to basic income as the “costs” of basic production. It is true that that sense is not at all an accountant’s sense of costs; … But however remote from the accountant’s meaning of the term “costs,” it remains that there is an aggregate and functional sense in which the fraction… is an index of costs.  For the greater the fraction that basic income is of total income (or total outlay), the less the remainder which constitutes the aggregate possibility of profit.  But what limits profit may be termed costs. Hence we propose ….to speak of c’O’ and c”O” as costs of production, having warned the reader that the costs in question are aggregate and functional costs… . [CWL 15 156-57]

Thus, there is a sense in which supply always equals demand.  A good or service is under process until it is actually and finally sold, at which moment it is concomitantly supplied rather than merely under process or sitting in finished-goods inventory.  And a good or service is concomitantly demanded when it is actually and finally purchased, so as to exit the process and no longer be under process.

Concomitance is a keeping in step.  The electric current in series or parallel circuits keeps in step. A system of hydrodynamic flows is engineered so that the flows keep apace.  Equilibrated monetary flows are normatively in step, though perhaps requiring credit to bridge a brief time gap; disequilibrated flows are out of sync and require systematically necessary correction.

Concomitance is, I would claim, the key word in Lonergan’s economic thinking. Philip McShaneFusion 1,  page 4, ftnt 10

**In any transaction involving an exchange of goods or services for money, what is outflow to Jones is simultaneously inflow to Smith.  Thus, for example, payments of interest are classified as inflows or receipts by the lender and as outflows or purchases by the borrower.  The lender then allocates his interest inflows according to his situation, and the borrower allocates his interest outflows according to his situation.

**Interest payments circulate as do other payments; they are functional flows of the payments of rent for the use of money; they may be classified functionally according to the loan’s purpose.  The interest payment is alternatively

  1. A component of a basic outlay necessitated by borrowing so as to produce a point-to-point, basic supply
  2. A component of a basic expenditure necessitated by borrowing so as to purchase a consumable
  3. A component of a surplus outlay necessitated by borrowing so as to produce a point-to-line supply
  4. A component of a surplus expenditure associated with borrowing so as to purchase point-to-line products
  5. A transfer payment necessitated by borrowing so as to gamble within the redistributive function

Thus in the terminology of the Diagram of Rates of Flow, if money is borrowed for a basic purchase, the interest payments are part of basic expenditures.  If for pure surplus investment, the interest payments are part of pure surplus investment expenditures.  If for basic supply, the interest payments are part of basic outlays.  If for surplus supply, the interest payments are part of surplus outlays.  If for gambling, they remain within the Redistributive Function as transfer payments.

Payments of interest by the borrower Smith to the lender Jones Bank circulate just like any other payments for goods and services – whether payments to a bank for a loan, payments to a supermarket for groceries, or payments to a department store for clothing.  The receipts of Jones bank go to pay Jones’ obligations.  The bank, which exists as an ongoing unit of enterprise performing a certain service, will use its receipts to cover:

  • Initial payments of wages and salaries to the bank’s employees
  • Transitional payments to the bank’s suppliers of pens, pencils, computers, space, etc
  • Transfer payments to depositors (and any other class of lenders to the bank)
  • Dividends to owners
  • Repair and maintenance curing the depreciation of capital equipment
  • Expansion of the bank’s premises and operations

**The money supply, invented by man to avoid the friction of barter and to make possible divided transactions throughout the vast and complex economy, is not necessarily a fixed amount. The Central Bank can supply more money to the circuits as the process of production and exchange grows and as transactions increase in magnitude and/or frequency.

**The utterances “interest rate” and “interest payment” may have different meanings for participants having different points of view:

  • On the Income Statement of a household or a unit of enterprise, interest is income or expense.
  • In Burley’s game-theoretic models, [Burley and Csapo, 1992-1, 133-41] [Burley, 1992-2, 269-80]), the normative interest rate is an inner relationship; it equals the productive growth rate provided by the (root – 1) of the model’s characteristic equation; and this interest rate changes throughout the accelerations and taperings of the expansion of the process.

 

 

  • In a Statement of Gross Domestic Functional Flows, which the Bureau of Economic Analysis might construct (but as yet does not), interest payments should be classified in the five ways listed above.
  • In the nuanced theory of Functional Macroeconomic Dynamics, the theoretical interest rate is equal to a calculated growth rate determined by the changing magnitudes of the multiplier (kn) and time lag (t-a) of the serial lagged accelerations (positive or zero) as expressed generally in the lagged technical accelerator. (See CWL 15, 37 for perspective and context)

kn[f’n(t-a)-Bn] = f”n-1(t) – An-1[CWL 15, 37]

Also, in the event of exogenous artificial manipulation of the interest rate by the Fed, one needs to identify and distinguish the effects of 1) the response by participants as to saving vs. consuming , vs. 2) the response of investing entrepreneurs to higher or lower costs of borrowing as it affects their liquid investment vs. long-term fixed investment.  Artificial manipulation of interest rates is not the answer.

The purpose of this section is to inquire into the manner in which the rate of saving is adjusted to the phases of the pure cycle of the productive process. Traditional theory looked to shifting interest rates to provide suitable adjustment.  In the main we shall be concerned with factors that are prior to changing interest rates and more effective.  [CWL 15, 133]

The traditional doctrine of thrift and enterprise looked to the supply of and demand for money to adjust interest rates and the adjusted rates to adjust the rate of saving to the requirements of the productive process.  But it can be argued that a) this view was not sufficiently nuanced in its estimate of the requirements of the productive process, b) that it missed the magnitude of the problem, and c) that it tended to lump together quite different requirements. … [CWL 15, 140, ftnt. 197]

**Interest payments themselves are just one among many endogenous, constituent, monetary flows which – like payments for food, clothing, shelter, commodities, machinery, factories, and services of all kinds – circulate among Person Smith, Person Jones, Unit-of-Enterprise Smith, and Unit-of-Enterprise Jones within and between the point-to-point and point-to-line circuits.

**Most academics and government authorities mistakenly characterize – as in their treatment of the IS-LM and AD-AS models – the manipulability of the internal interest rate as the flexibility of an effective external lever, a magic wand, an electrically charged prod, which may always be used to set things right. But, theoretically, it must be understood as a calculated relationship among the conceptually prior and more fundamental, inner, constituent functional flows in a dynamic, credit-centered, multi-circuited process.

to be able to explain the booms, slumps, and crashes of the trade or business cycles the economist’s analysis had to be as dynamic as the subject matter under investigation; and he agreed that the economist had to know what are the significant variables in the light of which price changes are to be interpreted.  According to Lonergan, standard economic theory had successfully achieved none of these desiderata. [CWL 15, Editors’ Introduction liii]

**If the actual flows of interest payments conform to the relationships of the primary relativities applied to the carefully estimated secondary normative boundary conditions, then the actual interest rate equals the normative rate. But if either the charged interest rate, or the accelerator and accelerated actual flows are manipulated away from their normative level and balance, then there is a systematic requirement for correction.

**The private sector, importantly including the banking system, is primarily responsible for enlightened management of the objective economic process.

Lonergan argued that  previous depressions could be understood in terms of a tendency by producer-banker combinations with price fixing powers to hang onto the Kaccumulation profit cum interest rather than raise wages, even after the economy was tooled up to the requirements of the new stationary state.   [Burley and Csapo, 1992-1, 139]

 “One could rework the calculations … replacing the c 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 corresponded to the stationary state values of r = i = 0. “ [Burley and Csapo 1992-1, 140]

Lonergan’s point is that there is no automatic mechanism creating monetary boundary conditions for a shift into this final distribution and price system.  Attempts to persist in accumulation (of capital) stage incomes would rather eventually be frustrated by the labour supply boundary condition…producers could only lay off workers to avoid a growing hoard of the new tool…Lonergan suggests we consider more cooperative solutions based on a collective understanding of his more sophisticated national income accounting which illustrates the full employment need to substitute for accumulation incomes which have lost their dynamic profit motivation. (i.e. they are sitting in the secondary markets doing nothing useful.) [Burley and Csapo, 1992-1, 139]

The idea of an expansion is not a future contraction. [CWL 21, 104]

**The interest rate negotiated for longer-maturity loans for fixed capital cannot escape the necessity of estimates by both lender and borrower.  Thus the longer-term rates are measures of perceived longer-term opportunity. When invention and innovation are dormant, or when opportunity for adequately successful investment is scant, or when taxation of risk-takers is too high, there is a paltry demand by savvy entrepreneurial risk-takers for money to invest.  Though the rate offered by lending institutions might be low, as especially in a slump succeeding a vast (excessive) expansion, what entrepreneur in his right mind would decide to borrow so as to invest in excess capacity?  But when, as a result of invention, innovation, etc., the potential in the system becomes great and opportunities for economic advance become plentiful, even if actual interest rates have moved higher, it may still be beneficial to borrow and invest.

**One of the Fed’s responsibilities is to supply the right amount of money to the process.  But the right amount is not easy to discern. (See especially CWL 15, 53-60)

It is to be observed that there is no simple correlation between quantities of money added to the circuits or subtracted from them and, on the other hand, the rates of flow in the circuits.  For the rates of flow in the circuits are not just quantities of money but quantities multiplied by velocity [CWL 15, 52]

…  the work for money to do is to move, say, wheat from the western plains to the householder’s table, and increasing the number of owners that intervene in the process gives no more tan a phenomenal increase in the velocity of money. … the velocity of money in the main circuits is tied to the velocity with which goods are produced and sold. …the velocity of money in the main circuits coincides with the velocity, the time interval, between the initiation of production and the moment of final sale. [CWL 21, 61-62]

Now every unit of enterprise involves a turnover magnitude and a turnover frequency.  The statement would be merely a truism if it meant no more than that the rates of payment received and made by the unit of enterprise involved quantities and velocities of money.  But the statement is not a truism, for it involves a correlation between the quantities and velocities of rates of payment and the quantities and velocities of goods and services. CWL 15, 57

the quantity alternative in the rates of payment is conjoined with the quantity alternative in the rate of production, and the frequency alternative in the rate of payment is conjoined with the frequency alternative in the rate of production.  The two cases of quantity-velocity are not only parallel but also correlated. CWL 15, 57

**As regards inflation, there can be several possible combinations of rates of flow of money outstripping the rates of flow of what money buys – finished products of units of enterprise and productive services of wage earners:

  • In the early stage of expansion, when more money is moving along c”O” (in the Diagram of Rates of Flow) to increase basic income, while, for a temporary lack of capacity, there is not a proportionate increase in the flow of basic products.
  • The basic, consumables, point-to-point circuit is, by an imbalance of the crossovers, directly draining money from the surplus, accelerator, point-to-line circuit.
  • The government is taxing point-to-line income too much and point-to-point income too little, so that the basic circuit of consumables is inflating while the point-to-line circuit is being indirectly drained.
  • The government is incurring a deficit and effecting a superposed circuit so as to flood the basic circuit without any associated increased production of goods and services.
  • When, in a fair exchange or act of goodwill, lower-propensity-to-consume Smith pays money to greater-propensity-to-consume Jones
  • Expectations of inflation, which may vary in severity from mild to painful and in timing from who-knows-when to who-knows-when, prompt buy-now-sell-later attitudes. Thus, this expectation of future inflation may result in a realization of expected inflation in the actual here and now.
  • Speculation by earlier contributors in the production series results in excess buying of productive services and of liquid inventories
  • Money injected into the bond market for “quantitative easing” may stay in the secondary markets for stocks and bonds and inflate prices therein.
  • Speculative optimism may inflate prices in any and all primary and secondary markets.

**The seemingly endless quandary over how the dynamic process actually works and what are the explanations and significance of the interest rate and of inflation distracts academics, fiscal and monetary authorities, and every financial talk-show “pundit”; and it disorients them into the conventional efficient-cause, shocks-and-dominoes static heuristic and away from the needed functional and explanatory economic analysis and theory which FMD supplies.

The most famous instance of such distractions is John Hicks’ simplistic focus on interest –  in the financial sense  –  in 1937 which turned Keynes’ effort of 1936 into a simpler business of jollying along with IS/LM curves.  (On debates around the IS/LM muddlings, see my Pastkeynes Pastmodern Economics, 65-69) [McShane 2016, 33]

From Lonergan’s perspective, this failure truly to work out a new paradigm for economic science had an adverse effect upon Keynesian interpretation of the relationships between monetary events (such as government deficit spending, interest rates, credit volume, and the volume of the supply of money) and the determination of demand, not to mention other economic conditions. [CWL 15, Editors’ Introduction l]

Particular Macrostatic Models – Preliminaries:

Functional Macroeconomic Dynamics is a theory which explains what is always the current, purely dynamic economic process.

This subsection’s textbook models are macrostatic; the horizontal axis does not represent the passage of time; rather the models relate momentary intersections of magnitudes rather than the evolution of magnitudes over a period of time.  The central ideas of FMD relevant to assessment of these models are that a) the economist must know what are the significant variables – velocitous functional flows –  in the light of which monetary phenomena such as interest rates, price levels, and inflation are to be interpreted, b) in order to determine particular laws, the general laws, i.e. the primary relativities, among the significant variables are applied to the concrete realm through the application of further secondary determinations – such as the boundary conditions of prices and quantities – of a non-systematic manifold, c) the interest rate in particular should be understood as a current inner relation within the primary relativities among explanatory functional flows rather than as an external lever, and d) price levels and inflation should not be understood as given external forces but rather as current inner determinations explained by the application of the primary relativities to these normative or violative secondary determinations of the non-systematic manifold.

Lonergan agreed with Schumpeter on the importance of a systematic or analytic framework in order to explain, rather than merely record or describe, the aggregate phenomena of macroeconomics; he agreed with Schumpeter that to be able to explain the booms, slumps, and crashes of the trade or business cycles the economist’s analysis had to be as dynamic as the subject matter under investigation; and he agreed that the economist had to know what are the significant variables in the light of which price changes are to be interpreted. According to Lonergan, standard economic theory had successfully achieved none of these desiderata. [CWL 15, Editors’ Introduction liii]

The IS-LM Model, the Efficient vs. Formal Causality Muddle, and the Proper Money Supply:

In the IS-LM model, the interest rate is central.  It is a concept; therefore it emerges in an insight yielding concepts in their relations to one another.  It is not a starting point or a given.  It is an aspect of a primary relativity of the economic process.

There are two distinct views of how you, and we mean you, reach understanding: either you puzzle over some given situation and arrive at an understanding that leaves you with what is called a concept, or you somehow pick up concepts as you move through life, or an economic class, and you have to analyze them to make sense of them.  The first view we call the MAC view; the second view we call the McA view. The first view, in which the A stands for ah? and ah! is the view of Aristotle, Aquinas, Lonergan, you and us.  The second view is the dominant view, the view of Mankiw, to which we return in the second section.  It is associated with Scotus (1265-1308) and with the British tradition of Conceptual Analysis.  It is a view that murders education. [McShane, 2002-1, 51]

The interest rate is one of the primary relativities in the immanent intelligibility of the interdependent functional flows constituting the objective economic process.  Economists have treated it as an external lever and placed it to lie at the heart of the frequently-encountered macrostatic IS-LM and AD-AS models.  It is the vertical axis of the IS-LM model and it is implicit in the demand for money represented in the AD curve.

The charged interest rate is the price actually paid for the rental of money.  One of the motives for renting money is to invest in, and benefit from, a project which will widen or deepen the economic process.  As a price that has been negotiated, the interest rate has mistakenly become to the traditional economist an absolute given, a primary term, a first in the analysis. But, though the actually charged rate is a cost that has been negotiated, the explanatory interest rate remains an internal relation among flows of products and money; it must be interpreted in the light of the system’s scientifically-significant explanatory terms and relations.

The economists’ so-called real interest rate, also called the neutral interest rate or the natural interest rate, is defined in the textbooks as that rate which can cause full employment by forcing from without a proper balance within of a) supply with demand in the market for goods, and b) supply with demand in the market for money. For many macroeconomists, that manipulable interest rate may function multiply, and faster or slower, as a magic wand, control dial, external lever, and irresistible electric prod.  For them it is to be taken unquestioned as the primary given whose manipulation is the all-purpose tool for managing the economic process.

The textbook IS-LM model typically assumes a) a single-circuit economy lacking lags and crossover dependencies, b) a fixed money supply, and c) a range of possible levels of the manipulable interest rate.  It depicts supply-demand equilibria in the market for goods (IS Curve) against supply-demand equilibria in the market for the dummy money (LM curve) at a range of possible levels of the interest rate.  And there is two-direction causality.  On one hand, the intersection of the two curves may be viewed as occurring at the interest rate caused by the interactions of the productive and monetary orders.  On the other hand, if one insists – as do the Fed and New Keynesians – that it is the interest rate that causes the levels of economic activity in the short run, then the graph may be claimed to demonstrate the reverse causation, i.e. the interest rate is the causal factor; it will determine the short run supply and demand in the market for goods and the market for money. The macroeconomists fantasize that, thus, that li’l old interest rate and its changes can be transmitted to the minds and hearts of entrepreneurs and households, so as to induce them to respond as the macroeconomists imagine they will respond.  These macroeconomists do not understand the always current process in the light of FMD’s single explanatory unity, all of whose primary relativities are coherent with one another, and together with the secondary determinations comprise complete explanation.

A mere congeries of laws will not suffice. For if one is to operate upon the concrete, one must be able to employ at once several laws.  To employ several laws at once, one must know the relations of each law to all the others.  But to know many laws, not as a mere congeries of distinct empirical generalizations, but in the network of interrelations of each to all the others, is to reach a system. [CWL 3, 76/99]

The theoretical interest rate is a relation among the inner constituent flows of the functional economic process.  It is a monetary aspect of the process.  It is a relation within the immanent intelligibility of the process.  It exists within the realm of primary relativity.  It is not meant to function as the external, all-purpose, efficient cause of the process.

Burley’s linear, game-theoretic models, in which the intervals can be shortened so as to approximate a continuous system, demonstrate a calculation of the interest rate as a complicated relation among flows. [Burley and Csapo, 1992-1, 140], and [Burley, 1992-2, 277]:

Burley’s formulations are instructive because they demonstrate the interest rate’s relational dependence upon the interdependence and mutual constraints among the several finitudes of labor, capital, productivity, and depreciation.  In Burley’s evolutionary model, for example, in a situation of full employment, the growth factor  (1+growth rate or 1+r)  and the interest factor (1+interest rate or 1+i) are defined within the characteristic equation of a matrix game relating the coefficients of land and labor (l, lN, l’N), the productivity (k, kN) of old and new capital, and the depreciation (d and dN) of old and new capital. [Burley, 1992-2, 277]

Burley has written several essays which provide a von Neumann representation of a dynamic Lonergan-Schumpeterian, creative-destruction economy:

  • [1] Burley, P. (1989), A von Neumann Representation of Lonergan’s production problem, Economic Systems Research, 1 (3), p.317
  • [2] P. Burley, 1993: Lonergan as a Neo-Schumpeterian, (Lanham, Md., Australian Lonergan Workshop, University Press of America, ed. William J. Danaher)
  • [3] Burley, P. and Csapo, Laszlo, (1992) Money Information in Lonergan-von Neumann Systems, Economic Systems Research, Vol 4, No. 2, 1992
  • [4] Burley, P. (1992) Evolutionary von Neumann Models, Journal of Evolutionary Economics 2 , 269-80
  • [5] Burley, P. (2002), A 3-Level Lonergan-von Neumann Model, Australian Lonergan Workshop 2, ed. Matthew C. Ogilvie and William J. Danaher, Sydney: Novum Organum Press 68-74
  • [6] Burley, P. (2002), Lonergan and Interest Rates, Australian Lonergan Workshop 2, ed. Matthew C. Ogilvie and William J. Danaher, Sydney: Novum Organum 61-67

Elsewhere on this website we will be reviewing in some detail, as time and priorities allow, essays numbered [4] and [6] above. (See Why Study Peter burley’s Models.)

In estimations about the risk-filled future, FMD’s interest rate is an estimation of a rate of benefit; and this estimated benefit can be divided into financing tranches assuming more or less of the total risk involved.  And the financial analyst can use it as a discount factor for comparison among available risky opportunities of different durations.  Still, though the past is known and estimates of the future are unavoidable negotiating interest rates, we remain interested exclusively in the current process and in a complete theory of equilibria and disequilibria constituted by the primary relativities immanent in every instance of the current process.

A mere congeries of laws will not suffice. For if one is to operate upon the concrete, one must be able to employ at once several laws.  To employ several laws at once, one must know the relations of each law to all the others.  But to know many laws, not as a mere congeries of distinct empirical generalizations, but in the network of interrelations of each to all the others, is to reach a system. [CWL 3, 76/99]

Taking into account past and (expected) future values does not constitute the creative key transition to Functional Macroeconomic Dynamics.  Those familiar with elementary statics and dynamics (in physical mechanics) will appreciate the shift in thinking involved in passing from (static) equilibrium analysis (of, say, a suspended weight with subscripts for time not needed)…to an analysis (of, say, the motions of planets or pendula) where attention is focused on second-order differential equations, on d2θ/dt2, d2x/dt2, d2y/dt2, on the primary relativities of a range of related forces, central, friction, whatever.  Particular secondary boundary conditions, past and future pricings and quantities (analogous to a planet’s particular past or future position), are relatively insignificant for the analysis of the primary relativity immanent in, and applicable to, every instance of the process.  What is significant is the Leibnitz-Newtonian shift of context. [McShane, 1980, 127]

General laws contain a primary relativity and are applied to the concrete “only through the addition of further determinations, … … conjugate forms are defined implicitly by their explanatory and empirically verified relations to one another.  Still, such relations are general laws; they hold in any number of instances; they admit application to the concrete only through the addition of further determinations, and such further determinations pertain to a non-systematic manifold. There is, then, a primary relativity that is contained in the general law; it is inseparable from its base in the conjugate form which implicitly it defines;[1] and to reach the concrete relation that holds at a given place and time, it is not enough to think about the general law; one has to add further determinations[2] that are contingent from the very fact that they have to be obtained from a non-systematic manifold. [CWL 3, 492/516] (In addition, read in the entirety [CWL 3, 491-6/514-20])

Paraphrasing: [CWL 3, 492/516]   … conjugate terms and forms ( such as vectors P’, Q’, and dot-product scalars [P’Q’ revenues], [p’a’Q’ basic “costs”], and [p”a”Q” surplus “costs”]) are defined implicitly by their explanatory and empirically verified relations to one another.  …  Such relations, e.g.

  • P’Q’ = p’a’Q’ + p”a”Q”Basic circuit R&M [CWL 15, 158]
  • da’ = a'(dq’/q’ – dQ’/Q’) [CWL 15, 159]
  • d(P’Q”) = d(p’a’Q’) + d(p”a”Q”)  [CWL 15, 158]
  • P’/p’ = a’ + a”p”Q”/p’Q’ [CWL 15, 158]
  • J = a’ + a”R [CWL 15, 158]
  • d(P’/p’) = dJ = da’ + a”dR + Rda”  [CWL 15, 158]
  • kn[f’n(t-a)-Bn] = f”n-1(t) – An-1  [CWL 15, 37]
  • dI’= Σ(widni+ nidwi+dnidwi)yi  [CWL 15, 134]
  • dΣFi= dvI”  [CWL 15, 150]
  • f = vw [CWL 15, 148-49]
  • df = vdw + wdv  [CWL 15, 148-49]
  • DZ = PQ[(dP/P + dQ/Q + dPdQ/PQ) cos (A + dA) – 2 sin(dA/2) sin(A + dA/2)] [CWL 15, 108-9]

are general and universally applicable; they hold in any number of instances; the differential equations admit application to the concrete only through the addition of further determinations (such as the indices and coefficients of price and quantity), (however) such further determinations pertain to a non-systematic manifold.[3]  There is then, a primary relativity (correspondence of compensated factors of production with integral products [qi= ΣΣqijk [CWL 15, 30]] exiting into the standard of living and the correlation of dummy-money payments with accelerator and accelerated flows of products and services P’Q’ = p’a’Q’ + p”a”Q”; ) that is contained in the general law (dJ = da’ + a”dR + Rda”); it is inseparable from its base in the conjugate form which implicitly it defines; and to reach the concrete relation that holds at a given place and time, it is not enough to think about the general law; one has to add further determinations (such as coincidental pricings and quantities) that are contingent from the very fact that they have to be obtained from a non-systematic manifold. (In addition, read in the entirety CWL 3, 491-96/514-20)

The whole structure is relational: one cannot conceive the terms without the relations nor the relations without the terms. Both terms and relations constitute a basic framework to be filled out, [CWL 3, 492/516]  (In addition, read in the entirety [CWL 3, 491-6/514-20]

Paraphrasing:  Functional Macroeconomic Dynamics is a field theory; its whole structure is purely relational: one cannot conceive the precisely analytical, implicitly-defined terms – “basic”, “surplus”, “macroeconomic costs”, “macroeconomic pure surplus income” (capital expansion’s monetary correlate) – without the relations nor the relations without the terms. Both terms and relations constitute a basic framework to be filled out, [CWL 3, 492/516]  (In addition, read in the entirety [CWL 3, 491-6/514-20]

The IS-LM model – with the interest rate as central – describes the real-neutral-natural interest rate as that rate at which supply equals demand in both the market for goods and the market for money.  But that macrostatic model is insufficiently nuanced; it overlooks a) the double edge of the manipulation of interest rates, b) the ineffectiveness and the unintended counterproductivity of manipulation of interest rates through open-market operations, c) the existence of two or more distinct functional circuits, and d) the nuanced dynamics of the surges and taperings of the process. The model leaves the careful reader unsatisfied and wondering.

Further, as we have noted, in both theory and practice there is a sense in which supply and demand are always equal and in which there always exists an interest rate.  There is concomitance.

The concomitance of outlay and expenditure follows from the interaction of supply and demand.  The concomitance of income with outlay and expenditure is identical with the adjustment of the rate of saving to the requirements of the productive process. [CWL 15, 144]

A condition of circuit acceleration was seen … to include the keeping in step of basic outlay, basic income, and basic expenditure, and on the other hand, the keeping in step of surplus outlay, surplus income, and surplus expenditure.  Any of these rates may begin to vary independently of the others, and adjustment of the others may lag. But any systematic divergence[1] brings automatic correctives to work.  [CWL 15, 144]

The continuity and equilibrium of the normative process is constituted by a) a rate of saving  calibrated to the ascending and descending requirements of the series of phases of the economic process, b) balance of the crossovers between operative circuits, c) conformity to the limits or constraints of finitudes, and d) implementation of the basic expansion normatively subsequent to the surplus expansion.  In particular, the balancing of the crossovers to achieve the proper rate of saving should be achieved by shifts in income distribution, – mostly in an enlightened private sector, as Henry Ford knew – which shifts are normatively prior to the IS-LM model’s prescribed manipulation of interest rates and more effective. Again,

The purpose of this section is to inquire into the manner in which the rate of saving is adjusted to the phases of the pure cycle of the productive process. Traditional theory looked to shifting interest rates to provide suitable adjustment.  In the main we shall be concerned with factors that are prior to changing interest rates and more effective.  [CWL 15, 133]

The traditional doctrine of thrift and enterprise looked to the supply of and demand for money to adjust interest rates and the adjusted rates to adjust the rate of saving to the requirements of the productive process. But it can be argued that a) this view was not sufficiently nuanced in its estimate of the requirements of the productive process, b) that it missed the magnitude of the problem, and c) that it tended to lump together quite different requirements. … [CWL 15, 140, ftnt. 197]

The difficulty with (traditional) theory is that a.) it lumps together a number of quite different things and b.) it overlooks the order of magnitude of the fundamental problem… [CWL 15,  141-144]

Any manipulation of the interest rate at the heart of the IS-LM model is double-edged, whereas, as Henry Ford knew, shifts in income distribution are prior and more effective.  The manipulation may cause effects which conflict, and at different rates.  Higher long term rates which are intended to encourage savings so as to finance greater desirable investment will, at the same time, discourage investment by increasing the costs of investment.  Conversely, lower interest rates, intended to discourage saving, encourage full consumption of the bounty of capital, and prevent excess investment, will at the same time encourage borrowing to finance unsound projects, thus sowing the seeds of defaults and bankruptcies.  Plus, flooding the redistributive function to achieve lower interest rates (excessive quantitative easing) will cause an increase the values of secondary, previously-issued stocks and bonds amounting to a bifurcation of purchasing power in the operative circuits vs. within the redistributive circuit.

Fiscal and Fed authorities should not try to manage the economy by manipulating interest rates through the money supply.  The Fed a) should just be admonitory to the banking system regarding degree of risk in the system, and b) should seek to supply the right amount of money to facilitate sound transactions in the current phase of the process.

Money should neither be too plentiful nor too scarce. However, we are the first to admit that it is not easy to ascertain the proper supply of money to the system.  How will units of enterprise in a productive series manage time and money in their individual turnovers and magnitudes?  How quickly will they make their dummy money perform a circuit of work? (See CWL 15, 53-60, 65-70)

It is to be observed that there is no simple correlation between quantities of money added to the circuits or subtracted from them and, on the other hand, the rates of flow in the circuits.  For the rates of flow in the circuits are not just quantities of money but quantities multiplied by velocity. [CWL 15, 52]

the work for money to do is to move, say, wheat from the western plains to the householder’s table, and increasing the number of owners that intervene in the process gives no more than a phenomenal increase in the velocity of money. … the velocity of money in the main circuits is tied to the velocity with which goods are produced and sold. …the velocity of money in the main circuits coincides with the velocity, the time interval, between the initiation of production and the moment of final sale. [CWL 21, 61-62]

(In a capital expansion,) unless the quantity of money in circulation expands as rapidly as prices rise and, as well, as rapidly as the productive expansion of quantities requires, there will result a contraction of the process: then, instead of adjusting the rate of saving to the requirements of the productive cycle, the productive cycle is arrested to find adjustment to the rate of saving. [CWL 15, 135-37]

the quantity alternativein the rates of payment is conjoined with the quantity alternativein the rate of production, and the frequency alternativein the rate of payment is conjoined with the frequency alternativein the rate of production.  The two cases of quantity-velocity are not only parallel but also correlated. [CWL 15, 57]

Dummy money is not a commodity to be hoarded.  And a further note, it should not be pegged to a gold standard.

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 (CWL 21, 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]

The interest rate – as a rate of current return to lenders – is bound to rise and fall in a pure cycle of long-term expansion.  If, as Burley and others argue, one meaning of the term “interest rate” is an indicator of the risk-adjusted production growth rate and, thus, the risk-adjusted rate of return to the lenders and investors who support this growth, then Lonegan’s analysis (CWL 15, §7 – “Division of the Productive Process”, pp. 23-28) and (CWL 15,144-56) of a) the pure point-to-line income ratio, (f = vw), b) the total pure point-to-line income (ΣFi), and c) average point-to-line income (F/O), indicates that all three of these measures will systematically ascend, peak, and return to zero in a long-term expansion.

 

And, thus, the riskless “interest rate” would return to zero, except for the amount needed by the lender to pay its employees and suppliers for their services and materials.

And, the reader will note, this systematic rise and fall of the rate of return to lenders and entrepreneurs is in conflict with the criterion of ever rising net incomes and stock prices.  However, Lonergan’s theory of the transitional dynamics of rise and fall in a particular expansion is not to deny the possibility of new expansions being continually superposed on tapering expansions such that a free and creative society may be continually moving to an ever-improving standard of living and good-of-order within humanity’s scale of values: vital, social (such as the good of order), cultural, personal, and religious. [CWL 14, Method, 31].

Finally, we note briefly that the IS-LM model implicitly relies on the quantity theory of money which must be replaced by the magnitude-and-frequency theory of money.

The AD-AS Muddle:

Equilibrium in the AD-AS model is a momentary equilibrium determining and determined by a price level.  In contrast, equilibrium in Functional Macroeconomic Dynamics is a dynamic equilibrium constituted by the keeping pace and the balancing of production-justified monetary flows.

To explain the continuity and equilibrium of the trade cycle, one must advance from the corporate bookkeeper’s microeconomic terms and relations to significant macroeconomic terms and relations which reveal similarities that reside in the relations of real economic functioning to one another.  That is, one must advance from commonsense description to a science that explains.

Lonergan is alone in using this difference in economic activities to specify the significant variables in his dynamic analysis… no one else considers the functional distinctions between different kinds of (rhythmic production flows) prior to, and more fundamental than, … price levels and patterns, … interest and profits, and so forth. … [CWL 15, Editors’ Introduction, lxii]

Prices are first to us and often mistakenly accepted as a given and the starting point in analysis; but functional analysis seeks an explanatory system known first in itself.

the set of terms and relations capable of explaining the phenomena of the business or trade cycle would not be the same as any given pricing system that automatically coordinates a vast coincidental manifold of decisions of demand and decisions of supply.  Such a system comes to sight as bookkeeper’s entities that form the basis of the preliminary descriptive classifications that need to be explained: they are the similarities “first-for-us.”  The relevant set of explanatory terms and relations would have to expose similarities that reside in the relations of things to one another or what is “first-in-itself”: namely both the dynamic elements and the differentials of the economic mechanism which reveal the significance of aggregate changes in prices that by themselves are in need of interpretation.  To repeat, then, Lonergan holds that prices as a concern for the bookkeepers or accountants are known- first-to-us by description and commonsense classification; and that his own functional analysis of production and circulation reveals an explanatory system known-first-in-itselfOnly such an explanatory framework will enable the all-important discrimination either of the causes and the variations in prices (CWL 15, 75-80, 113-20) or of a relative and an absolute rise or fall of monetary prices, and only such an explanatory framework will make possible a correct interpretation of their significance. [CWL 15, Editors’ Introduction lvi]

Here we simply print four pieces, upon which we will comment in the course of this section:

  1. P’Q’ = p’a’Q’ + p”a”Q”  [CWL 15, 158-60]   

P’/p’ = a’ + a”[p”Q”/p’Q’]  [CWL 15, 158-60]

i.e.    J = a’ + a”R  [CWL 15, 158-60]

and    dJ = da’ + a”dR + Rda”  [CWL 15, 158-60]

2.    For contrast to the macrostatic AD-AS model’s simplistic treatment of price-change shocks, we point the reader to Lonergan’s explicitly nuanced treatment of the evolution of the basic price-spread ratio (J = a’ + a”R [CWL 15, 158-60]) in a cycle of expansion through phases. (CWL 15, pp 114 ff)  Lonergan interprets and defines pricing spreads and their changes explicitly in the light of the significant variables of production flows (Q’ and Q”), production-acceleration ratios (a’ and a”), and monetary flows (P’Q’, P”Q”, p’Q’, and p”Q”) by which these price spreads and their changes are to be interpreted – not accepted as given, but rather interpreted analytically as real and relative or monetary and absolute..

3.    A heuristic analysis of dJ/dt over the phases of an economic expansion reveals cyclic fluctuations of the basic price spread which are reminiscent of cycles noted by Kitchin, Crum, and Juglar. [McShane, 1980, 128]

4.    … Lonergan is alone in using this difference in economic activities to specify the significant variables in his dynamic analysis… no one else considers the functional distinctions between different kinds of (rhythmic production flows) prior to, and more fundamental than, … price levels and patterns, … interest and profits, and so forth….only Lonergan analyzes booms and slumps in terms of how their (explanatory) velocities, accelerations, and decelerations are or are not equilibrated in relation to the events, movements, and changes in two distinct monetary circuits of production and exchange as considered both in themselves (with circulatory, sequential dependence) and in relation to each other by means of crossover payments. [CWL 15, Editors’ Introduction, lxii]

********************************************************************************

The Aggregate Demand – Aggregate Supply model exhibits a momentary intersection of the possible supply of goods (AS curve), depending upon prices, and the possible demand constituted by money to purchase these goods (the AD curve), depending upon prices. The static balance occurs at a determinate price level (on the vertical axis) and a determinate level of outputs (on the horizontal axis).

In the typical textbook, there is depicted an initial equilibrium to which shocks – often euphemized as “shifts”, though sudden and unexplained – are applied, with the character of external forces, as it were, in order to demonstrate how new production and monetary magnitudes are then effected by the responses of human agents to these shocks.  The initial shock might be a one-sided supply shock, or a one-sided demand shock, or a shock in prices, or a shock in quantities, or a shock in the rental price of money, or in a change in expectations about the quantities or prices of any element of the model.  The adjustment brought about by respondent profit-seeking firms and utility-maximizing households effects a new momentary “equilibrium” of productive and monetary elements.

But FMD, in contrast to snapshot economics, is a field theory of a dynamic evolving system.  It is a theory at an adequate level of abstraction of the immanent intelligibility, the formal cause, the primary relativities of the evolving process ,  While comparative macrostatics  regards the efficient causality of exogenous shocks, and of the adjustments by profit-seeking firms and utility-maximizing households, FMD prescinds from the psychology of firms and households and treats psychological human agents as outside the system, as it were, and acting as efficient causes.  But their preferences, utilities, and attitudes do not comprise the deepest, most fundamental, primary intelligibility of the objective macroeconomic system.  Just as

  • the geometer is interested in the always-explanatory immanent intelligibility of the circle rather than how an individual drew a particular round curve
  • the physicist is interested in the immanent intelligibility of the ideal pendulum rather than a report of who initiated a particular swing and what he or she actually did
  • Newton was interested in discovering a complete system explaining all motions rather than reporting an autumn wind causing the fall of a particular apple and his reaction to a sore head
  • Mendeleyev was  interested in discovering a system explaining the relations among themselves of all possible chemical elements rather than a catalog describing aspects of common elements,

so, FMD is interested in neither the anthropology nor the psychology of efficient-causal participants; it is not interested in compiling a catalog of coincident statistics; rather FMD is interested in achieving an always relevant unitary explanation of the dynamics of the dynamic economic process.   

Market pricing is central to the AD-AS model.  This market pricing and its changes are explained by a) acceleration factors (a’ and a”), and b) the ratio of surplus to basic production activity (p”Q”/p’Q’), and the changes in these.

P’Q’ = p’a’Q’ + p”a”Q”  [CWL 15, 158-60]

P’/p’ = a’ + a”[p”Q”/p’Q’]  [CWL 15, 158-60]

i.e.    J = a’ + a”R  [CWL 15, 158-60]

and    dJ = da’ + a”dR + Rda”  [CWL 15, 158-60]

Correction of disequilibria – supposedly signaled in the AD-AS model by shocks of different sorts, and, in the Phillips Curve model by inflation of prices or higher unemployment  – is not to be achieved by artificial manipulation of interest rates.

The traditional doctrine of thrift and enterprise looked to the supply of and demand for money to adjust interest rates and the adjusted rates to adjust the rate of saving to the requirements of the productive process.  But it can be argued that a) this view was not sufficiently nuanced in its estimate of the requirements of the productive process, b) that it missed the magnitude of the problem, and c) that it tended to lump together quite different requirements. … [CWL 15, 140, ftnt. 197]

The AD-AS snapshot schematic” interprets” neither rising nor falling prices, nor disequilibria, yet proper interpretation of rising and falling prices is critical to avoiding the booms and slumps of trade cycles (as distinguished from a normative pure cycle).  At the root of the disequilibrated trade cycle is the equilibrated pure cycle for which the objective process has an exigence.  The explanation of the trade cycle, with its excesses and deficiencies in prices and quantities, is maladaptation rooted in the inability to interpret rising and falling prices.

… 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 bust).  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]

This relativity of the significance of profits – “normal profit” to maintain existing plant, equipment, etc., and”pure macroeconomic profit” correlated with the investment for a subsequent greater abundance for society – is expressed in the basic price-spread ratio, P’/p’.

P’Q’ = p’a’Q’ + p”a”Q”  [CWL 15, 158-60]

P’/p’ = a’ + a”[p”Q”/p’Q’]  [CWL 15, 158-60]

i.e.    J = a’ + a”R  [CWL 15, 158-60]

and    dJ = da’ + a”dR + Rda”  [CWL 15, 158-60]

d(P’/p’) = da’ + a”d(p”Q”/p’Q’) + (p”Q”/p’Q’)da”  [CWL 15, 158-60]

In general, a pricing change is not to be understood as a shock out of the blue .  To describe it as a shock is to fail to put it in the proper perspective of a secondary determination whose implications are to be understood in the light of the abstract primary relativities.  It can be explained only in the light of significant variables.  Pricing exists not as an absolute to be understood in and of itself.  Rather current pricing is to be understood within a set of implicit relations of which it is an element.  Its implications are implicitly related to 1) the ratio of production quantities to sale quantities (a’ and a”), 2) the ratio of the rate of current surplus production to current basic production (p”Q”/p’Q’), 3) the amount of money available through savings or credit in order to finance the expansion of the process, 4) the level of usage of present capacity determining the amount of slack in the system, 5) degree of competition and pricing power among price setters or wage setters, and 6) present contractual agreements for wages, salaries, and fees.

Contrary to macrostatics, per Functional Macroeconomic Dynamics pricing is not to be understood as a momentary static given in the perspective of the intersection of two curves; rather it is a dynamic phenomenon to be explained in the light of a current configuration of flows of products and money.  Pricing is not first in the analysis, as macrostatics would have it; rather it is last in the analysis.  It is not an element which explains; rather it is one among several secondary determinations to be explained relativistically.  First in the analysis come the functional distinctions between different kinds of (rhythmic production flows) prior to, and more fundamental than, … price levels and patterns, … interest and profits, and so forth. Prices are boundary conditions to which the primary relativities of the process are to be applied.

… a premature introduction of general boundary conditions or worse, specific channel conditions, botches the analytic possibilities….The Robinson-Eatwell analysis is hampered … by their building the economic priora quoad nos of profits, wages, prices, etc., into explanation, when in fact the priora quoad nos[4] are last in analysis: they require explanation. [McShane, 1980, 124]

In contrast to comparative macrostatics, FMD treats psychological human agents as outside the system, as it were, and acting as efficient causes, but not comprising the fundamental immanent intelligibility of the system.  Thus for example, per comparative macrostatics’ assumptions, suppositions and wonderings, an efficient-causal psychological expectation of higher selling prices in the near future might or might not sooner or later induce higher profit-motivated output, which in turn might or might not sooner or later cause higher employment, which in turn might or might not sooner or later force higher wages, which in turn might or might not sooner or later cause either a) even higher selling prices and the greater expansion of a boom, or b) higher production costs and the contractions of a slump.  At every step of such a doubtful surmising, an FMD theorist, with his invariant primary relations, begs to understand the present pricing in light of the prior and more fundamental theory of Functional Macroeconomic Dynamics.

Is there a technical term for the set of primary relativities in which the terms implicitly define one another by the relations in which they stand with one another?

Ought there not to be introduced a technical term to denote this type of intelligibility?  … The intelligibility that is neither final nor material nor instrumental nor efficient causality is, of course, formal causality…What we have called the intelligibility immanent in sensible data and residing in the relations of things to one another might be named more briefly formal causality… [CWL  3, 78/101-102]

Paraphrasing [CWL  3, 78/101-102]: Ought there not to be introduced a technical term to denote this type of intelligibility in the macroeconomic process?  … The intelligibility that is neither final nor material nor instrumental nor efficient causality is, of course, formal causality…what we have called the field theory or the intelligibility immanent in the sensible data of the dynamic economic process and residing in the relations of functional flows to one another, might be named more briefly the formal causality of the economic process

A Copernican revolution in macroeconomic thinking is attempted and validated.

Our aim is to prescind from human psychology that, in the first place, we may define the objective situation with which man has to deal, and, in the second place, define the psychological attitude that has to be adopted if man is to deal successfully with economic problems.  Thus something of a Copernican revolution is attempted: instead of taking man as he is or as he may be thought to be and from that deducing what economic phenomena are going to be, we take the exchange process in its greatest generality and attempt to deduce the human adaptations necessary for survival. [CWL 21,42- 43]

One seeks to explain.

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.  …  The exclusive use of explanatory or postulational elements concentrates attention upon the set of relationships in which the whole scientific significance is contained.” [Gibbons, 1987, 313] 

FMD seeks to discover the laws of the process which serve as premises for a criticism of participants.

A study of the mechanics of motor-cars yields premises for a criticism of drivers, precisely because the motor-cars, as distinct from the drivers, have laws of their own which drivers must respect.  But if the mechanics of motors included, in a single piece, the anthropology of drivers, criticism could be no more than haphazard. [CWL 21, 109]

The whole comparative-macrostatics community is mired in snapshot Walrasian statics and efficient causality.  A shock is an external force, suddenly acting as an efficient cause to effect a quantum leap to a new intersection.  Consequently, the analyst is in the dark regarding a method to investigate a dynamic evolutionary process; he/she is rendered incapable of penetrating to the deeper intelligibility that is a field theory reminiscent of the work of Legendre, Lagrange, Hamilton, and later Einstein, the immanent and objective intelligibility of the always current, invariant, formal interdependence among n objects.  

again, as to the notion of cause, Newton conceived of his forces as efficient causes, and the modern mechanics drops the notion of force; it gets along perfectly well without it.  It thinks in terms of a field theory, the set of relationships between objects.  The field theory is a set of intelligible relations linking what is implicitly defined by the relations themselves; it is a set of relational forms.  The form of any element is known through its relations to all other elements.  What is a mass?  A mass is anything that satisfies the fundamental equations that regard masses.  Consequently, when you add a new fundamental equation about mass, as Einstein did when he equated mass with energy, you get a new idea of mass.  Field theory is a matter of the immanent intelligibility of the object. [CWL 10, 154]

…  First, Special Relativity regards all physical principles and laws, but Newtonian dynamics is concerned primarily with mechanics.  Secondly, Special Relativity is primarily a field theory, that is, it is concerned not with efficient, instrumental, material, or final causes of events, but with the intelligibility immanent in data; but Newtonian dynamics seems primarily a theory of efficient causes, of forces, their action, and the reaction evoked by action.  [CWL 3, 43/67]

Functional Macroeconomic Dynamics is a methodological doctrine that regards the mathematical expression of principles and laws of the dynamic economic system.  But comparative macrostatics is stated as a doctrine that describes exogenous shocks to initial prices and quantities and the endogenous leaps effected by efficient-causal human agents to a new set of prices and quantities.

… Special Relativity (with its postulate of invariance) is stated as a methodological doctrine that regards the mathematical expression of physical principles and laws, but Newtonian dynamics is stated as a doctrine about the objects subject to laws. [3, 43/67]

the economist’s analysis had to be as dynamic as the subject matter under investigation; and he agreed that the economist had to know what are the significant variables in the light of which price changes are to be interpreted.  According to Lonergan, standard economic theory had successfully achieved none of these desiderata. [CWL 15, Editors’ Introduction liii]

Again, Lonergan stands alone.

Lonergan is alone in using this difference in economic activities to specify the significant variables in his dynamic analysis… no one else considers the functional distinctions between different kinds of (rhythmic production flows) prior to, and more fundamental than, … price levels and patterns, … interest and profits, and so forth….only Lonergan analyzes booms and slumps in terms of how their (explanatory) velocities, accelerations, and decelerations are or are not equilibrated in relation to the events, movements, and changes in two distinct monetary circuits of production and exchange as considered both in themselves (with circulatory, sequential dependence) and in relation to each other by means of crossover payments. [CWL 15, Editors’ Introduction, lxii]

And again, taking into account past and (expected) future prices in the fog of the AD-AS model does not constitute the creative key transition to dynamics.

Taking into account past and (expected) future values does not constitute the creative key transition to dynamics.  Those familiar with elementary statics and dynamics (in physical mechanics) will appreciate the shift in thinking involved in passing from equilibrium analysis (of a suspended weight or a steel bridge)…to an analysis where attention is focused on second-order differential equations, on d2θ/dt2, d2x/dt2, d2y/dt2, on a range of related forces, central, friction, whatever.  Particular boundary conditions, “past and future values” are relatively insignificant for the analysis.  What is significant is the Leibnitz-Newtonian shift of context. [McShane, 1980, 127]

One might be reminded here of a parallel in hydrodynamics: if what is at issue is a general specification of the dynamics of free water waves, a premature introduction of general boundary conditions or worse, specific channel conditions, botches the analytic possibilities….the Robinson-Eatwell analysis is hampered … by their building the economic priora quoad nos of profits, wages, prices, etc., into explanation, when in fact the priora quoad nos[5] are last in analysis: they require explanation. [McShane, 1980, 124][6]

We repeat what we have said in so many words above: The reader should note the contrast between how Lonergan treats pricing analytically in a double-circuited, dynamic and evolving system in CWL 15,  Section 28 entitled “The Cycle of the Aggregate Price-Spread Ratio,” and how the AD-AS model simply assumes shocks and dominoes in a simplistic and fitful single-circuit system.   Lonergan states what are the prior and more fundamental significant variables in the light of which price changes are to be interpreted.”  [CWL 15, Editors’ Introduction liii]

Finally, we repeat an earlier passage:

the set of terms and relations capable of explaining the phenomena of the business or trade cycle would not be the same as any given pricing system that automatically coordinates a vast coincidental manifold of decisions of demand and decisions of supply.  Such a system comes to sight as bookkeeper’s entities that form the basis of the preliminary descriptive classifications that need to be explained: they are the similarities “first-for-us.”  The relevant set of explanatory terms and relations would have to expose similarities that reside in the relations of things to one another or what is “first-in-itself”: namely both the dynamic elements and the differentials of the economic mechanism which reveal the significance of aggregate changes in prices that by themselves are in need of interpretation.  To repeat, then, Lonergan holds that prices as a concern for the bookkeepers or accountants are known- first-to-us by description and commonsense classification; and that his own functional analysis of production and circulation reveals an explanatory system known-first-in-itself.  Only such an explanatory framework will enable the all-important discrimination either of the causes and the variations in prices (CWL 15, 75-80, 113-20) or of a relative and an absolute rise or fall of monetary prices, and only such an explanatory framework will make possible a correct interpretation of their significance. [CWL 15, Editors’ Introduction lvi]

 

The Phillips Curve:

 

 

 

 

 

The Phillips Curve’s correlation of unemployment and the rate of inflation was looking consistent to economists until the mid to late 1970s, but for, as it turns out, reasons no one really understood.  It was purported to be a reliable guide for FRB and fiscal policy regarding tradeoffs and choices between inflation and unemployment.  But it was invalidated when it failed to explain stagflation, in which high unemployment and a high rate of inflation continued to exist without any tradeoffs between one and the other.  And, in addition to the invalidation, the stagflation offered evidence that the single circuit of the textbooks must be replaced by the double-circuited, credit-centered Diagram of Rates of Flow; that single circuit could not conceptualize a) point-to-point and point to line distinctions, b) varying crossover flowings throughout the phases of an economic expansion, c) possible direct or taxational draining of one circuit by another, and d) disproportionate flows of products and money in the channels of the system,

… the U.S. economy was experiencing the phenomenon of ‘ stagflation’ – a clearly discernible overturning of the conventional economic wisdom about the tradeoff between inflation and unemployment so neatly expressed in the Phillips Curve.  So-called ‘Keynesian fine tuning onto the neoclassical track’ was not working; and forms of socialist planning only promised to deepen rather than resolve the anomalies of welfare economics. … (Lonergan) believed he had an explanation for what, in a statement from the essay we are editing, he described as a “situation – sometimes thought mysterious – in which consumer prices continuously inflate, new enterprise is evaded, unemployment becomes chronic, and despite inflation the value of stocks declines.” [CWL 15, Editors Introduction, xli]

It seems the latter alternative that is more likely to occur. … the surplus circuit is being drained of funds while the basic circuit is invited to expand or inflate or enter the redistribution market. … Conventional wisdom favors taxing the rich and resists taxing the masses, and so T” is encouraged to be too big and T’ too small.  Again, it is thought that government spending should not compete against private enterprise.  But then Z” will have to be small, and from the nature of the case Z’ will be the normal outlet for government spending. [CWL 15, 175]

Stable prices and inflation of prices are simple to explain in general.

 (We) state the necessary and sufficient condition of constancy or variation in the exchange value of the dummy.  To this end we compare two flows of the circulation: the real flow of property, goods, and services, and the dummy flow being given and taken in exchange for the real flow….Accordingly, the necessary and sufficient condition of constant value in the dummy lies in its concomitant variation with the real flow….More briefly, if there is concomitance between the two flows, then the proportion in which dummies and goods exchange remains the same.  If there is lack of concomitance, then this proportion changes. But exchange value is a proportion. Therefore, the concomitance of the two flows is the condition of constant exchange value. CWL 21, 37-39

One instance of inflation would be the rising prices in a surplus expansion, as explained by the basic price-spread ratio and its differential.

P’/p’ = a’ + a”p”Q”/p’Q’  [CWL 15, 158-60]

or J = a’ + a” R [CWL 15, 158-60]

and dJ = da’ + a”dR + Rda”   [CWL 15, 158-60]

In the surplus expansion, basic capacity has not yet been expanded, but initially the fraction R is increasing, dR and its coefficient a’’ are both positive, da’’ is initially positive to expand the basic price spread and induce speculators in the production series to stock up on materials, semi-finished goods, and finished goods.  The flow of surplus outlays crossing over into the basic circuit combines with the flow of money in the basic circuit to outstrip the flow of goods available in the basic circuit.  The flow of money is disproportionate to the flow of goods.[CWL 15, 160-61]

Need the moral be repeated?  There exist two circuits, each with its own final market.  The equilibrium of the economic process is conditioned by the balance of the two circuits: each must be allowed the possibility of continuity, of basic outlay yielding an equal basic income and surplus outlay yielding an equal surplus income, of basic and surplus income yielding equal basic and surplus expenditure, and of these grounding equivalent basic and surplus outlay.  But what cannot be tolerated, much less sustained, is for one circuit to be drained by the other. [CWL 15, 175]

 

Diagram of Rates of Flow 2

Diagram of Rates of Flow