New Paper: Stützel’s Theory of Business Cycles (Part II: Monetary Aspects)

The paper Prof. Johannes Schmidt (Karlsruhe) first presented at our Seminar “Introduction to New European Political Economics” at BI Norwegian Business School (see overview , video recordings of all presentations, and background reading) in November 2017 has now been published in the European Journal for the History of Economic Thought, Volume 26, 2019 – Issue 6:

Its title is “Balance Mechanics and Business Cycles“: read it by clicking here. Watch the video of Johannes Schmidt’s Oslo presentation of this paper by clicking here.

Schmidt lays out how Wolfgang Stützel offers an overall shared framework (based on law and a specified sectoral accounting model of a closed economy) within which both orthodox “real” and orthodox and heterodox “monetary” theories of business cycles can be meaningfully related to one another. By relating both views back to the general framework, the special areas of applicability of the cases described by orthodox and heterodox models, as well as orthodox and heterodox overgeneralizations, can be clearly identified, so that their seeming incommensurability is replaced by an integrated view. This view precisely identifies where each theory has its rightful place and where it overgeneralizes, therefore needs to be corrected. Rather than vague “tolerant” pluralism or a confrontative view of “incommensurability” of orthodox and heterodox models, this straightforward approach aims at (and, in our view, offers) integrative progress in both the Keynes’ (GT Chap. 1) and Thomas S. Kuhn’s sense. This was Stützels general methodological strategy. He also used it to formulate a general theory of valueing and pricing, including the previous theories as special cases.

In presenting the monetary aspects of Stützel’s theory of business cycles, Schmidt demonstrates this for theories that deal with “money” in different ways: (1) Walrasian tradition “real business cycle” theories, (2) theories based on some form of the quantity theory of money (such as monetarism or today’s “100% money” proposals, (3) Post Keynesian (including Minskyan) “monetary production” models and (4) New Keynesian models.

To put Schmidt’s paper in context, it may be helpful to watch the previous presentations of the seminar, especially Nicolas Hofer’s presentation of the “bipartite division of monetary theory” into stocks/flows of means of payment vs. stocks/flows of net financial assets (see here) and Thomas Weiss’ presentation of Part I of Stützel’s theory of business cycles, covering aggregate demand/supply constellations and how their effects differ when they hit upon existing market tensions: buyer’s vs. seller’s markets (see here).

The accounting relationships presupposed there will be familiar to MMTers, but get crucially more specific, precisely distinguishing three types of flows of monetary wealth, thereby introducing the bipartite division of the theory of money into stocks/flows of (1) means of payment and (2) net financial assets (aka financial net worth), the latter representing the crucial “missing link” between the “monetary” sphere of financial assets/debt and “real” sphere of nonfinancial assets. Stützel adopted this distinction of three types of flows of monetary wealth from standard german business accounting; it was originally developed as a financial accounting concept for business accounting by Eugen Schmalenbach and is known as the ‘Schmalenbach-Staircase’ (for the shape of its geometrical depiction):

It is also described in more detail in Johannes Schmidt’s 2015 paper, “Reforming the Undergraduate Macroeconomics Curriculum: The Case for a Thorough Treatment of Accounting Relationships” (pdf here) and Fabian Lindner’s 2012 paper “Saving does not finance Investment – Accounting as an Indispensable Guide to Economic Theory” (pdf here).

Stützel adds one additional concept, “lockstep”, which is at the core of Schmidt’s paper: if my inflow of means of payment (receipts) is equal to my cash outflow (payments) for a period, my stock of means of payment does not change; if this applies to all economic subjects, inflows and outflows of means of payment move in lockstep for the whole economy. If my net lending (increase of net financial assets) equals my net borrowing (decrease of net financial assets) for a period, my stock of net financial assets does not change (i.e. my balance on current account, mostly made up of the balance of trade, is zero). If this applies to all economic subjects, net lending and net borrowing are moving in lockstep for the whole economy. If there is lockstep both on the level of means of payment and the level of net financial assets – an empirically highly unlikely special case which can nevertheless be analytically useful – then money of any form becomes a neutral numeraire within a ‘real exchange-‘ or barter economy, as in the Walrasian tradition.

On this problem, Keynes had famously written in 1933:

“The divergence between the real-exchange economics and my desired monetary economics is, however, most marked and perhaps most important when we come to the discussion of the rate of interest and to the relation between the volume of output and the amount of expenditure.

Everyone would, of course, agree that it is in a monetary economy in my sense of the term that we actually live. Professor Pigou knows as well as anyone that wages are in fact sticky in terms of money. Marshall was perfectly aware that the existence of debts gives a high degree of practical importance to changes in the value of money. Nevertheless it is my belief that the far-reaching and in some respects fundamental differences between the conclusions of a monetary economy and those of the more simplified real-exchange economy have been greatly underestimated by the exponents of the traditional economics; with the result that the machinery of thought with which real-exchange economics has equipped the minds of practitioners in the world of affairs, and also of economists themselves, has led in practice to many erroneous conclusions and policies. The idea that it is comparatively easy to adapt the hypothetical conclusions of a real wage economics to the real world of monetary economics is a mistake. It is extraordinarily difficult to make the adaptation, and perhaps impossible without the aid of a developed theory of monetary economics.

One of the chief causes of confusion lies in the fact that the assumptions of the real-exchange economy have been tacit, and you will search treatises on real-exchange economics in vain for any express statement of the simplifications introduced or for the relationship of its hypothetical conclusions to the facts of the real world. We are not told what conditions have to be fulfilled if money is to be neutral. Nor is it easy to supply the gap.” (J.M. Keynes 1933: A Monetary Theory of Production. First published in ‘Der Stand und die nächste Zukunft der Konjunkturforschung: Festschrift für Arthur Spiethoff‘. Munich: Duncker & Humboldt, pp.123-25, full text here)

Stützel clearly identifies the implicit ‘assumption of the real exchange economy’ that renders ‘money’ ‘neutral’ in the ‘classical model’ – an assumption originally made by Walras. It is the implicit ‘lockstep’ assumption. Schmidt develops this point in detail in his paper, showing how the approaches of naive quantity theory, post-keynesian models and new keynesian models offer partial attempts to overcome the implicit lockstep assumption by modelling different partial aspects of empirical finance and the empirical financial system.

Some more information on Wolfgang Stützel’s work, one of the major foundations for the seminar and papers above, can be found in the 2019 article by Sauer & Sell: “Lost in Translation – a Revival of Wolfgang Stützel’s Mechanics of Balances” (see here). It has been among the Top 10 Most Read Articles of 2018 in the European Journal for the History of Economic Thought.

Some biographical background on Stützel: Stützel came from an entrepreneurial family. After his 1952 Ph.D. dissertation on “Price, Value and Power – Analytical Theory of the Relation between the Market and the State” and writing his foundational “Paradoxa der Geld- und Konkurrenzwirtschaft” in 1953 (which was to be published only in 1979), he worked at Berliner Bank from 1953-1956, and at Deutsche Bundesbank in 1957/58, before becoming a Professor at University of Saarland, heading the department for banking and monetary macroeconomics. He developed the foundations of his macroeconomic model during the 1950s already in his 1952 Dissertation, his 1953 “Paradoxa …” (see above) and his 1958 “Volkswirtschaftliche Saldenmechanik” (which became a classic of german macroeconomics literature), consistently refining and specifying them on through the 1980s. From 1966-1966, he was part of the german Sachverständigenrat zur Begutachtung der Gesamtwirtschaftlichen Entwicklung (German Council of Economic Experts).

So again, to read Johannes Schmidt’s paper, click here. To watch the video of Johannes Schmidt’s Oslo presentation of this paper, click here.

Seminar at BI Norwegian Business School 2017: First Video now Online

On Nov. 01-03, 2017, we held a Seminar at BI Norwegian Business School, Oslo (details here).

Our main goals were (1) to present an overview of the current state of our work and get some feedback from the perspective of BI staff and students from different disciplines (Business, Law, Economics, Political Science), and (2) to personally and institutionally connect Legal Institutionalism to Wolfgang Stützel’s work.   To that end, we had invited Geoff Hodgson (University of Hertfordshire), founder of Legal Institutionalism and editor of the Journal of Institutional Economics, Johannes Schmidt (Hochschule für Technik und Wirtschaft Karlsruhe), one of the few experts on Wolfgang Stützel’s work, and Charlotte Bruun (Aalborg University), who was the first to publish on Stützel in english with her excellent 1995 dissertation, “Logical Structures and Algorithmic Behavior in a Credit Economy“, to attend and contribute presentations.

The first presentation: “Legal and Accounting Foundations of Western Civilization” (Wolfgang Theil) is now online. To view it on youtube, click on the image (opens in new tab):

We will publish the other presentations given at the seminar within the next few weeks.  Here’s an overview:

Wolfgang Theil’s presentation “Legal and Accounting Foundations of Western Civilization” (above) explicitly lays out the basic, historically specific legal institutional foundations of double entry bookkeeping in roman law, making explicit the two basic inherent dialectic conflicts of western civilization:  that between the state (public law) and the market (private law), and that between state-mediated, impersonal legal relations (state legislation and private contracts) and traditional personal, kinship-based relations of informal reciprocity.

The first conflict historically led to anacyclosis, a swing back and forth between more centralized and more decentralized forms of government which was well known to republican thinkers from Aristoteles over Polybios and Cicero to Machiavelli, Vico and Kant.  Just like in the 1930s, after a phase of liberalism and democracy followed by a major crisis we are now witnessing a renaissance of more centralized forms of governing, often termed the “democratic recession“. From a long term historical perspective, this does not come as a surprise but fits in with a bigger pattern within western civilization that has been recurring ever since classical greco-roman antiquity.

The second conflict, that between state-mediated and and kinship based relations, creates the whole phenomenon of “corruption” (including nepotism, now to be found in the White House as well).

Both conflicts are historical constants, as Francis Fukuyama has brilliantly shown in his two recent books on the comparative history of the state, “Origins of Political Order” (2011) and “Political Order and Political Decay” (2014 – see his own overview here).  They represent challenges for development and transition economics, but remain present in so-called “developed” economies as well.

Nicolas Hofer’s presentation “Accounting, Money & Banking in terms of Law” picks up on that and presents some crucial distinctions in business accounting in terms of law – actual business practice serves as the microfoundation of our macro model.

After clearly distinguishing 1st order objects of law (things) from 2nd order objects of law (rights vis a vis other legal persons who hold corresponding obligations), he distinguishes flows of monetary wealth affecting (1) the stock of means of payment, (2) net financial assets, and (3) net worth (equity), making clear that on the level of net financial assets, capitalism is a zero sum game – but not on the level of net worth (profit & loss statement), where “everyone wins” (achieves a profit within a period) is possible just as much as “everyone loses” (suffers a loss within a period).

Special emphasis is given to the category of net financial assets and flows of monetary wealth on that level, which forms the key of Stützel’s theory of business cycles that we adopt.  It allows for a precise distinction between “real” and “purely financial” transactions and to conceptualize balances of trade and on current account.   Morris Copeland’s flow of funds accounts do not include that balance – or any balances, for that matter – therefore it is no wonder sources and uses do not add up to the same number as they should (Perry Mehrling vaguely notices some symptoms of this, but does not fix it – click on the link and watch 4:45 to 10:00).

Nicolas takes this more precise accounting system up to our legally grounded version of the sectoral balances approach (routinely used in national accounting), which connects micro to macro accounting and then serves as a foundation for an ex ante macro model of business cycles within a circular flow model of a closed economy.

Thomas’ Weiss builds on that and takes this further into macroeconomics, presenting an overview over Wolfgang Stützel’s Theory of Business Cycles.  Stützel used the sectoral balances approach to build a coherent theory of business cycles that renders superfluous the controversy between Keynesians and Anti-Keynesians, which was epitomized in 2015/16 by the clash between Yanis Varoufakis and Wolfgang Schäuble.  It is still present today between an apparent new quasi-Keynesian consensus forming internationally, vs. the old german austerity & export surplus strategy, now put into practice by new finance minister Olaf Scholz (SPD) who retained most of Schäuble’s personnel in the ministry of finance.

Key to Stützel’s integration is the precise, theoretically coherent demonstration of what has been guessed in practice all along:  that the holy grail of Keynesianism – demand-led output and employment – does apply, but not generally, not to every situation:  it applies only to the special case of buyer’s market situations.  In extreme buyer’s market situations, the paradox of thrift holds true, and anti-cyclical government surplus expenditures are necessary.  But constant demand stimulus policies gradually dismantle buyer’s markets and then, if continued, transform them into stagflatory seller’s market situations.  And in that situation, the mirror phenomenon of the paradox of thrift – what we call the paradox of surplus expenditure – applies.  On seller’s markets, employment and output stimulus can only be brought about by government austerity, which gradually will dismantle seller’s markets and build buyer’s markets again, completing the cycle.

Thus, Stützel’s theory is genuinely one of business cycles.  It coherently demonstrates why neither permanent demand stimulus nor permanent austerity is needed, but rather more generally: anti-cyclical policy.  In the words of Keynes: “The most important Agenda of the State relates not to those activities which private individuals are already fulfilling, but to those functions which fall outside the sphere of the individual, to those decisions which are made by no one if the State does not make them. The important thing for Government is not to do things which individuals are doing already, and to do them a little better or a little worse; but to do those things which at present are not done at all.” (J.M. Keynes. 1926. The End of Laissez-Faire. In: Keynes, J.M. 1931. Essays in Persuasion. London: Macmillan 1931). 

For present Germany, whose private household sector and corporate sector have consistently been net savers in terms of net financial assets over the past years, that would mean to end pro-cyclical government budget consolidation, and instead to increase government expenditure for useful investment into infrastructure and education, thereby easing the pressure on the foreign sector to take all the additional net debt corresponding to the continous german domestic surpluses.   From our perspective, Germany within Europe should not press so much for austerity as it should press for building comparably reliable, relatively incorrupt state & legal institutions across the Eurozone and EU. 

Johannes Schmidt’s presentation  “Stützel’s Theory of Business Cycles and Current Macroeconomics” builds on that and shows how Stützel’s theory of business cycles can function as a General Theory, capable of integrating current theories of business cycles and financial crises as describing special cases:  New Classical Macroeconomics and Real Business Cycle, Post Keynesian (including Minskyan) and New Keynesian Models are covered, and “Full Money” proposals are also included.

He accomplishes this by introducing a concept unique to Stützel’s approach to accounting based macroeconomics, the concept of lockstep behavior of partial groups. It can apply on the levels of (1) net financial assets and/or (2) means of payment.  Lockstep behavior means that for all individual legal persons within a closed economy, inflows and outflows of (1) net financial assets (nfa) or (2) means of payment (mop) equal one another so that stocks of nfa and mop remain unchanged.  For example, lockstep behavior of all nations with regard to net financial assets would mean that all nations maintain balanced trade vis a vis the rest of the world, i.e. their total sales of goods and services to the foreign sector would equal their total purchases of goods and services from the foreign sector (in terms of monetary value), leaving each nation’s net financial position – its net international investment position – unchanged (Keynes’ 1940’s Clearing Union idea was actually designed to work towards that goal). On the contrary, if inflows of nfa and/or mop deviate from respective outflows, there will be a change in the stock of nfa and/or mop.

On that basis, Schmidt shows that “money does not matter” in new classical models because they implicitly assume lockstep behavior on both the levels of flows of net financial assets and flows of means of payment (lockstep mop: yes, nfa: yes): a special case that is indeed possible but very unlikely to be the normal case. But because of this implicit assumption, situations based on the other three cases: lockstep (mop: yes, nfa: no); (mop: no, nfa: yes); (mop: no, nfa: no) cannot be modeled.

Naive quantity theory can be shown to presuppose lockstep on the level of net financial assets, but not on the level of means of payment (lockstep mop: no, nfa: yes) – another special case that has some historical applications but today is an unlikely case. While the monetarist version of the quantity theory has mostly been abandoned, naive quantity theory has reappeared after 2008 as a renaissance of “full money” proposals (inspired by Irving Fisher’s 100% money) which in some ways could be called “supermonetarist” (Heiner Flassbeck).

Stay tuned to find out how New Keynesian Macroeconomics and Post Keynesian/Minskyan Models fit in this integrative schema – Schmidt’s presentation will be online soon.

This underlines that Stützel’s work, other than heterodox approaches viewing themselves as an alternative to the neoclassical model, is capable of functioning as a General Theory (like Keynes had intended), integrating both neoclassical and heterodox models as special cases within a coherent general framework.  In fact, it was one of Stützel’s explicit goals to render superfluous the controversy between Keynesians and Anti-Keynesians by demonstrating the specific conditions under which each position applies, thus correcting their overgeneralizations.

Geoff Hodgson’s presentation “Legal Institutionalism: Capitalism and the Constitutive Role of Law” presents an overview of Legal Institutionalism, delineating how it crucially differs from New Institutional Economics which still underconceptualizes law and the constitutive role of the state for legal relations.  He clearly demonstrates this using the examples of property rights & contract and the firm (corporation) as a juridical person – a fictitious legal entity defined by the legal capability to enter contracts, to sue and being sued, and obliged to pay taxes, and makes a strong case for a legal institutionalist definition of capitalism.

Stay tuned, we will publish all these over the next few weeks – and we are looking forward to your comments, criticisms, questions and suggestions – you can post them below.  Thanks!