Video of Whit­lam Insti­tute Talk

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Last month I spoke at a sem­i­nar on the finan­cial cri­sis organ­ised by The Whit­lam Insti­tute, in reply to a speech by Pro­fes­sor John Quig­gin. Guy Debelle, the Assis­tant Gov­er­nor (for Finan­cial Mar­kets) of the Reserve Bank of Aus­tralia, was the other dis­cus­sant.

The Insti­tute has put together a very pro­fes­sional video of the dis­cus­sion, which has been picked up by SlowTV, a free inter­net TV chan­nel run by The Monthly, an Aus­tralian mag­a­zine of com­ment and analy­sis which, amongst many other things, pub­lished Aus­tralian Prime Min­is­ter Kevin Rudd’s lengthy essay on the Global Finan­cial Cri­sis in which he explic­itly cri­tiqued neolib­er­al­ism.

The video comes in 4 parts, which are respec­tively

The Ques­tion and Answer ses­sion with the audi­ence isn’t avail­able at SlowTV, but it is on YouTube in three parts:

The Pow­er­point pre­sen­ta­tion that I gave is avail­able here.

My pre­sen­ta­tion includes sim­u­la­tions of two dynamic mod­els that are the core of my analy­sis of the finan­cial cri­sis:

  • The Min­sky Model sim­u­lates a cycli­cal econ­omy with debt in the form of both pro­duc­tive borrowing–where the money bor­rowed finances increases in pro­duc­tive capacity–and “Ponzi” borrowing–which gam­bles on asset prices (which are not explic­itly mod­elled here as yet) and there­fore adds to debt with­out increas­ing pro­duc­tive capac­ity;
  • The Cir­cuit Model mod­els the endoge­nous cre­ation of credit in a pure credit econ­omy, and also sim­u­lates a cri­sis caused by a sud­den shift in the will­ing­ness to lend and to take on debt–a “credit crunch”. I also model an “exoge­nous” gov­ern­ment res­cue one year into the cri­sis in one of two ways: 
    • By inject­ing a $100 bil­lion sum into banks unlent reserves over a one year period; and
    • By inject­ing the same sum into the bank accounts of the debtors (firms in this model) over the same period

The sim­u­la­tions are run in the visual sim­u­la­tion pro­gram Vis­sim; I have embed­ded a link to down­load the free Vis­sim Viewer into the pre­sen­ta­tion; that embed­ded link may no longer work, but the one given here should do so after a reg­is­tra­tion process (I use Vis­sim mainly to show­case the mod­els; I develop them in the math­e­mat­i­cal pro­gram Math­cad).

My main research objec­tive for the next year is to com­bine these two mod­els to develop an explic­itly mon­e­tary model of finan­cial insta­bil­ity. This will be the bedrock of the book Finance and Eco­nomic Break­down that will be pub­lished by Edward Elgar Pub­lish­ers.

Finally, my speech is embed­ded below (Reuters will soon start pub­lish­ing a reg­u­lar vid­cast by me, and I’ll repro­duce it on this site.)

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  • I don’t often rec­om­mend a Peter Hartcher piece–while I gen­er­ally find him OK on inter­na­tional issues, he’s just stan­dard MSM on economics–but the jokes he relays in this report of a talk are well worth read­ing:

    http://www.smh.com.au/opinion/friendly-banter-in-the-back-channels-that-nurture-an-alliance-20090824-ewg5.html?page=-1

  • LT

    Hi Steve,
    I’m still very inter­ested in any thoughts you had on my orig­i­nal query re the impli­ca­tions of increased bank reserve ratios if you had time?
    Thanks very much,
    Lyall

  • Hi LT,

    It’s eas­ily side­stepped by banks’ innate abil­ity to cre­ate credit inde­pen­dently of gov­ern­ment money cre­ation. Check the Rov­ing Cav­a­liers on that front–the reserve ratio and money mul­ti­plier are the tail wgged by the pri­vate sec­tor lend­ing dog.

  • LT

    Hi Steve,
    Sorry I should have been clearer & more spe­cific — I was refer­ing to the ques­tion on the impli­ca­tions of bank’s reserve ratios increas­ing over time as delever­ag­ing ensures. I’ve repro­duced the ear­lier post in full below. You men­tioned at the time that you would come back to me on this point.
    Cheers,
    LT

    Orig­i­nal post:

    Thanks for another very inter­est­ing and per­sua­sive pre­sen­ta­tion. I’m a big fan of your inno­v­a­tive analy­sis which has cer­tainly con­tributed enor­mously to my under­stand­ing of how credit-dri­ven economies actu­ally work.
    I do have a few ques­tions on the model how­ever: firstly, what even­tu­ally hap­pens to all the excess reserves that accu­mu­late in banks dur­ing the delever­ag­ing? I have read your cav­a­liers of credit piece, and can see how the ces­sa­tion of growth in PSC con­tribues to a sharp reduc­tion in agge­gate demand. How­ever, when peo­ple attempt to delever­age, the repay­ment of loans, if they are not relent out by banks (which in aggre­gate needs to hap­pen if delever­ar­ing is to occur), become excess reserves (although obvi­ously some are needed merely to replen­ish equity against bad loans). I note in your mod­el­ling out­comes, unem­ploy­ment rises, debt/GDP declines over time, and also back reserves increase mate­ri­ally.
    I can see how when new credit growth occurs, new “money” and aggre­gate demand is cre­ated. but when the debt is paid back, that “money” does not dis­ap­pear – it just gets pulled tem­porar­ily out of cir­cu­la­tion but remains very much real on the bal­ance sheet of banks. this would seem to imply a mas­sive excess of cap­i­tal and ulti­mately very low inter­est rates for a long time. I guess my ques­tion is, what are the impli­caitons of this? Seems unre­al­is­tic to think banks are going to have equity/asset ratios of 20–30%??
    Thanks in advance,
    Rgds

  • Sorry LT!

    Yes, the model does show excess reserves accu­mu­lat­ing, and this is also hap­pen­ing in the real world. I think that in the longer term the banks would find them­selves hav­ing to write off debt on a grand scale, and this raises the ques­tion of the mechan­ics of that process vis a vis their reserves. This is where I would have to defer to my col­leagues who have a bet­ter knowl­edge of the rules on such things, but my feel­ing is that the rise in reserves would to some degree counter the fall in their assets from the debt write-off process. How­ever at some point they would become tech­ni­cally insol­vent.

    It’ some­thing I’ll con­sider in full detail when I get into writ­ing the book; at the moment that’s the best I can do. Sorry for an inad­e­quate answer at this stage, as well as a wrong-headed one ini­tially!

  • LT

    PS it would seem that the dynam­ics of credit cre­ation you out­line in your cav­iliers of credit piece result in an expan­sion of the money sup­ply, as banks lend first and then find reserves later. If I am cor­rect, the lat­ter is facil­i­tated by the RB cre­at­ing addi­tional money.

    How­ever, when the process goes into reverse the credit-cre­ated money does not get destroyed through a rever­sal of the said process, because the excess reserves held at banks do not trig­ger the RB to destroy money to despose of the excess reserves. In fact to the con­trary, global reserve banks are cur­rently inclined towards cre­at­ing still more reserves to wage a bat­tle against defla­tion.

    So you have all this credit-money cre­ated dur­ing the great credit expan­sion which now has to go some­where. What are the impli­ca­tions of this? Low interst rates and asset price infla­tion would prima facie seem to be two likely con­se­quences, the begin­ning of which we are start­ing to see. And per­haps ulti­mately we need huge con­sumer price infla­tion to effec­tively effec­tively “mop up” all the excess money sup­ply, much as a share con­sol­i­da­tion reduces the shares out­stand­ing but increases the price?

    Very inter­ested in your thoughts on this as I’m still try­ing to fig­ure out what all this means.

    Rgds,
    LT

  • LT

    Hi Steve,
    As I posted the above while you were writ­ing your reply, I had not had the ben­e­fit of read­ing your pre­vi­ous reply.
    That was my ini­tial thought too, but ulti­mately all the bank needs to do is swap out debt for equity to remain sol­vent, which is what banks have been doing by rais­ing sig­nif­i­cant equity. From a money sup­ply per­spec­tive, giv­ing a bank $1 in the form of equity or debt makes no dif­fer­ence.

    This equity is needed to off­set the bad loans, but ulti­mately under a delever­ag­ing sce­nario there would also be a large cash inflow from the steady repay­ment of good loans. So this would not seem to resolve the prob­lem of there being a sys­temic excess money/reserves in the bankign sys­tem, which need to be relent. Per­haps the great depres­sion played out dif­fer­ently because the aggre­gate money sup­ply was shrink­ing so reserves fell this way?

    Cheers,
    LT

  • LT

    PS no prob­lem re your reply — appre­ci­ate you tak­ing the time. Will look for­ward to hear­ing more of your thoughts when you have a chance, and will eagerly antic­i­pated the release of your book!!
    Rgds,
    LT

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