Two Economic Mechanisms; Two Components of Concrete Relations; Two Simultaneous Roles for Human Participants; Consequent Responsibilities for Both Academics and Everyday People

Two Parts:

Part I. Two economic mechanisms. Two components of concrete relations. Two simultaneous roles for human participants

Part II. Two perspectives by which to interpret prices. Prices do not explain; they beg to be explained. Consequent responsibilities for both academics and everyday people

Part I.

Two economic mechanisms. Two components of concrete relations. Two simultaneous roles for human participants

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

What the analysis reveals is a mechanism distinct though not separable from the price mechanism which spontaneously coordinates a vast and ever shifting manifold of otherwise independent choices from demand and of decisions from supply. It is distinct from the price mechanism, for it determines the channels within which the price mechanism works.  It is not separable from the price mechanism, for a channel is irrelevant when nothing flows through it. [CWL15, 17]

An advanced economy is constituted by production and exchange for money rather than by production and barter.  The production and exchange for money is called the exchange solution.

… the exchange solution is a dynamic equilibrium resting on the equilibria of markets. … every product of the exchange economy must mate through exchange with some other product, and the ratio in which the two mate is the exchange value.  The generality of this equilibrium makes it indifferent to endless complexity and endless change; for it stands on a level above all particular products and all particular modes of production.  While these multiply and vary indefinitely, the general equilibrium of the exchange process continues to answer with precision the complex question, Who, among millions of persons, does what, among millions of tasks, in return for which, among millions of rewards?  Nor is the dynamic solution unaccompanied by a continuous stimulus to better efforts and more delicate ingenuity.  For the uniformity of prices means that the least efficient of those actually producing will at least subsist, while every step above the minimum efficiency yields a proportionately greater return. [CWL 21, 34-35]

Analysis of the economic process must distinguish two economic mechanisms: 1) the microeconomic mechanism called the pricing system, 2) the macroeconomic mechanism constituted by aggregate surgings and taperings whose “mechanics” are explained by Functional Macroeconomic Dynamics.

A mechanism may be defined broadly here as an entity or process whose design is such as to produce a certain type of result.

Examples of mechanisms:

  1. A ratchet wrench or a timepiece whose constituent elements are materials designed so as to spontaneously effect a precise advancing movement when power is applied.
  2. The microeconomic pricing mechanism whose constituent factors include humans producing and purchasing at prices, such that the process effects the result of “Who, among millions of persons, does what, among millions of tasks, in return for which, among millions of rewards?”
  3. The macroeconomic system of surges and taperings, exhibiting normative principles and laws (the design and “mechanics”) of interdependent, hierarchically-tiered, and time-lagged flows of products and money such as to effect optimal realization of its potential.

Elsewhere we have treated “The Two Components of Concrete Relations.“  In world process, which includes economic process, there is a) a set of abstract primary relativities which generally govern the process, and b) secondary determinations of variables in the non-systematic manifold.  FMD specifies two sets of abstract primary relativities: 1) the primary relativities constuting the general and universally relevant laws of equilibratedinterdependent, functional flows of products and payments, and 2) the general laws providing the abstract norms for saving and investment in any pure cycle of expansion.  These abstract primary relativities constitute the process’s normative mechanics.  The concrete secondary determinations of quantities and prices in the ever shifting non-systematic manifold (including the price called the interest rate) are supplied by the pricing system.

The human participants have two simultaneous roles: one as inner constituents of the microeconomic pricing system and one as respecting the abstract principles and laws of an equilibrated macroeconomic process.

In the pricing system man is an internal factor.  He stands inside the pricing-system machine; he is part of it; he is an element of the process.

On classical analysis, economic mechanism is the pricing system.  It coordinates spontaneously a vast and ever shifting manifold of otherwise independent choices of demand and decisions of supply.  But man does not stand outside this machine; he is part of it; his choices and decisions are themselves the variables in the system.  It follows that there is no possibility of setting down methodically, on the one hand, the exigencies of the machine and, on the other, the consequent performance of man. [CWL 21, 109]

The mechanism called the pricing system is an ever shifting manifold.  It is not a simple, precisely designed ratchet wrench or a timepiece.  The pricing-system “machine” itself has no exigencies which we can methodically set down.  Thus there is no conformative obedient performance to be demanded because there are no exigencies for the secondary determinations in a complex, ever shifting, non-systematic manifold.  So, with no laws for my performance, there is no basis for criticism of my decisions and choices.  I can buy bread rather than scones at any price I don’t mind paying, depending upon how I feel at the moment.  However, no matter what behooves my individual interest, the process effects “Who, among millions of persons, does what, among millions of tasks, in return for which, among millions of rewards?”

But, besides the pricing system, there exists another economic mechanism.

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

FMD’s objective economic process is independent of the human psychology expressing itself in the microeconomic pricing system.  It has an objective mechanical structure

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]

Relative to the objective mechanism of FMD, man is not an internal factor; rather he stands, so to speak, outside; he is an efficient cause; i.e. an external agent who must adapt to the normative exigencies relevant to the support and constraint of the surgings and taperings constituting the realization of the most advantageous performance of the process.

Further, in conducting the macroeconomic process, the human participants being human may, out of ignorance or other waywardness, violate the laws and norms such as to require a systematically necessary corrective adjustment back to the exigent norm.

What the analysis reveals is a mechanism distinct though not separable from the price mechanism which spontaneously coordinates a vast and ever shifting manifold of otherwise independent choices from demand and of decisions from supply. It is distinct from the price mechanism, for it determines the channels within which the price mechanism works.  It is not separable from the price mechanism, for a channel is irrelevant when nothing flows through it. [CWL 15, 17]

Part II.

Two perspectives by which to interpret prices; prices do not explain; they beg to be explained; Consequent responsibilities for both academics and everyday people

Happenstance is not norm.  Happenstantial, ever shifting prices in the non-systematic manifold do not constitute ultimate norms.  Prices do not explain; prices do not constitute variables of scientific significance.  Prices beg to be explained in the context of the abstract significant variables of the primary explanatory relativities of the economic process.

Prices in the pricing system are neither absolute bases for analysis nor ultimate norms. Proponents of the IS-LM and AD-AS models and of the Phillips Curve correlation are at sea in the dark when they postulate that prices are fundamental variables of scientific and explanatory significance.  The IS-LM model’s price of money, the AD-AS model’s prices of products, and the Phillips Curve’s correlation of price changes (inflation or deflation) and unemployment are a) static, b) secondary determinations in a non-systematic manifold, and c) devoid of any methodical and systematic grounding in the functional dynamics of the objective, functional, dynamic process. Prices are in need of interpretation and explanation in the light of the significant variables which explain the process.

Lonergan’s intention was ‘to formulate the laws of an economic mechanism more remote and, in a sense, more fundamental than the pricing system…laws which men themselves administrate in the personal conduct of their lives. In 1978 he began to refer to Nicholas Kaldor in support of his judgment that the significance traditionally accorded to price theory by conventional economics since Adam Smith’s Wealth of Nations (1776) amounted to a virtual derailment of economic theory. [CWL 15, Editors’ Introduction xlv]

“The lack of ultimacy that Lonergan ascribes to prices and price theory can scarcely be overemphasized.”  Prices are not ultimate norms; rather balanced, interdependent flows are the ultimate norms.

……….Lonergan’s interest in Kaldor’s sweeping statement was to emphasize that prices and their changes are not explanatory but accountants’ entities.  For a first approximation of what Lonergan means here, let us draw an analogy to empirical scientific inquiry.  The physicist’s antecedent job of measuring and plotting measurements on graphs in physical science might be compared to tracing movements of prices as the exchange economy ebbs and flows.  What Lonergan has called ‘grasping in the scattered points the possibility of a smooth curve,’ or determining an indeterminate function in physics, would then be comparable to working out an economic theory that specifies the channels through which money circulates. Lonergan insists that the mechanism of the pricing system does not furnish economists with distinctions among significant variables of aggregate surplus (or point-to-line-goods) and basic (or point-to-point-goods) supply and demand with their determinate yet flexible velocitiesand accelerations, any more than Galileo Galilei’s discrete measurements of distances and times at the Tower of Pisa of themselves provided the law of the acceleration of falling bodies…….the lack of ultimacy that Lonergan ascribes to prices and price theory can scarcely be overemphasized. [CWL 15, Editors’ Introduction xlvi-xlvi]

Prices are not to be accepted as a given, automatic generators, explaining the entire dynamic process, and requiring no interpretation or explanation (as proponents of the IS-LM and AD-AS models and the Phillips curve correlation would have it); rather the analyst must know “what are the significant variables in the light of which price changes are to be interpreted.”

The trade cycle of booms and slumps is an aberration of the pure cycle for which the trade cycle has an exigence.  Traditional macroeconomic theory postulates but does not explain the trade cycle of booms and slumps constituted by aberrant flows.

… positive or negative transfers to basic demand (D’-s”I’) and consequent similar transfers to surplus demand (D”-s”I”) belong to the theory of booms and slumps. They involve changes in (aggregate basic or aggregate surplus) demand, with entrepreneurs receiving back more (or less) than they paid out in outlay (which includes “profits” of all kinds). The immediate effect (of these aberrational monetary transfers) is on the price levels at the final markets, and to these changes (in price), enterprise as a whole responds to release an upward (or downward)  movement of the whole economy.  But the initial increased transfers to demand [that is, excess transfers along (D’-s’I’) and (D”-s”I”) ] are not simply to besupposed.  For that would be postulating without explaining the boom or slump. [CWL 15, 64]

Lonergan agreed with Schumpeter on the importance of 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]

Lonergan contended that 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 (MD:ECA 13, 17).  Such a system comes to light as bookkeeper’s entities that form the basis of the preliminary descriptive classifications that need to be explained: they are similarities that are 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. [CWL 15, Editors’ Introduction xlvi]

Functional analysis is needed to explain the causes and variations in prices.

Previously I have suggested a lack of adaptation in the free economies to the requirements of the pure cycle.  What that lack is can now be stated.  It 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) … 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 (of the ideal pure cycle) into a (trade cycle of) boom (which must be followed out of systematic necessity by a correlative and devastating slump).  This I believe is the fundamental lack of adaptation to the productive cycle that our economies have to overcome. [CWL15, 139-140]

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 (MD:ECA 75-80, 113-20) or of a relative and an absolute rise or fall of monetary prices, only such an explanatory framework will make possible a correct interpretation of their significance. [CWL 15, Editors’ Introduction  lvi-lvii] [1]

… from the foregoing dynamic configuration of conditions during a limited interval of time, there is deduced a catalogue of possible types of change in the configuration over a series of intervals. There results a closely knit frame of reference that can envisage any total movement of an economy as a function of variations in rates of payment, and that can define the conditions of desirable movements as well as deduce the causes of breakdowns.  Through such a frame of reference one can see and express the mechanism to which classical precepts are only partially adapted; and through it again one can infer the fuller adaptation that has to be attained. [CWL 21, 111]

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

Prices provide a mechanism; but happenstantial prices in an ever shifting, non-systematic manifold  are not significant explanatory variables by which to guide decisions.

From the premises and conclusions of this analysis it will then be argued 9) that prices can not be regarded (by the stewards of the economy) as ultimate norms guiding strategic economic decisions, 10) that the function of prices is merely to provide a mechanism for overcoming the divergence of strategically indifferent decisions or preferences, and 11) that, since not all decisions and preferences possess this indifference, the exchange economy is confronted with the dilemma either of eliminating itself by suppressing the freedom of exchange or of certain classes of exchanges, or else of effectively augmenting the enlightenment of the enlightened self-interest that guides exchanges.   [CWL 15, 5-6]

The facts of the economy are already well known. What is lacking is a clear and precise understanding of the mechanism behind such obvious facts as the relations between expansion and contraction of the economy, employment and unemployment, inflation and deflation, and many other things that are just common knowledge. [CWL 15, 12]

On such a methodological model (i.e. functional analysis and implicit, explanatory definition replacing nominal definition and accountant’s categories)… classes of payments quickly become rates of payment standing in the mutual conditioning of a circulation; to this mutual and, so to speak, internal (monetary) conditioning there is added the external (monetary) conditioning that arises out of transfers of money from one circulation to another; in turn this twofold conditioning in the monetary order is correlated with the conditioning constituted (in the hierarchical productive order) by productive (and sequential) rhythms of goods and services;[2]and from the foregoing dynamic configuration of conditions during a limited interval of time, there is deduced a catalogue of possible types of change in the configuration over a series of intervals. There results a closely knit frame of reference that can envisage any total movement of an economy as a function of variations in rates of payment, and that can define the conditions of desirable movements as well as deduce the causes of breakdowns.  Through such a frame of reference one can see and express the mechanism to which classical precepts are only partially adapted; and through it again one can infer the fuller adaptation that has to be attained. [CWL 21, 111]

Diagram of Rates of Flow 2

Diagram of Rates of Flow

 

 

 

 

 

 

 

 

 

 

To be sure, human actions cause the flows of products-at-prices to be what they happen to be.  But willy-nilly human actions effecting booms, slumps and their associated misery do not ultimately constitute the normative theory, the formal cause, or the prior immanent intelligibility to which humans must instead adapt.  Note the similarity of the driver of the automobile to the participants in the economic process.  The driver of the automobile ignorantly and recklessly violates the mechanism of the car, the profile of the road, the posted speed limits, etc. and steers the automobile into a ditch; the participants in the objective economic process ignorantly and recklessly ignore its normative theory and practical precepts of adaptation and drive the process into booms, slumps, and human misery.

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]

Other examples of external agents violating the objective laws of a system would be the operator overloading a set of electrical circuits, or the operator of gates or pumps overflooding the channels in a system of hydrodynamic conduits.

Macroeconomics is not primarily an analysis of psychology, sociology, or anthropology.  The laws of FMD are conceptually prior to and independent of psychological tendencies.  Analysis in macroeconomics is, first of all, a matter of discovering the objective laws of an objective economic process to which human participants must adapt.  But if the objective intelligibility of macroeconomics were presumed to include, in a single piece, the inscrutable  psychology, sociology, and anthropology of its human drivers, criticism could be no more than haphazard.

Again, a Copernican revolution is promulgated.

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]

Academic macroeconomists must ask, How would the human participants act if, rather than being constituted merely as a bundle of desires, and fears, and cognitive biases, and ignorance of the laws of the process, they actually understood the laws of the process and the precepts for adaptation yielded by the laws?  The question is to suggest that there exists a discoverable set of normative laws, prior to and independent of human psychology, so superior as to simultaneously override ignorance and induce human participants to enlightenedly adapt to the laws.  And, if so, is not the primary task of professors of macroeconomics to educate and enlighten participants as to the prior, fundamental laws of the process rather than merely to study and classify the participants’ inscrutable inclinations as to utility and preference? – or to report the statistics of what did happen rather than to understand, promulgate, and prescribe what should happen.

Further, we caution that the macroeconomic interest rate is in fact only one superstructural internal relation among all relations among the significant, explanatory variables of the entire process.  And its relation is that of a price of money congruent with a rate of return.  It is a price no more or less sacred than the cost of materials, legal services, sales efforts, etc. are a price. To misconstrue the macroeconomic interest rate in its manifestation as a market interest rate as an all-purpose, all-powerful, external lever is to misunderstand the complete set of internal normative relations among significant flows of the intrinsically-cyclical, dynamic process as it expands in phases of the cycle.

Adjustments to saving and borrowing according to the requirements of the phase of the expansion of the economic process are prior to and more effective than manipulating 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]

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. … …  Evidently, then, suitable migrations are a means of providing adjustments in the community’s rate of saving.  To increase the rate of saving, increase the income of the rich; while they may be too distant from the current operations of the economic process to judge, at least they can put their money into the bank or bonds or stocks, and perhaps others there will see how it can best be used.  To decrease the rate of saving, increase the income of the poor. … The foregoing is the fundamental mode of adjusting the rate of saving to the phases of the productive cycle. [CWL 15, 133-134]

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]

The use of conventional meanings of investing and interest distract from the needed functional economic analysis.

The most famous instance of such distraction 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]