Circuit Theory and the state of Post Keynesian Economics

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I gave the fol­low­ing pre­sen­ta­tion at the 4th Dijon Mon­ey con­fer­ence (Decem­ber 10–12 2009):

Steve Keen’s Debt­watch Pod­cast 

| Open Play­er in New Win­dow

Briefly, my paper explained how var­i­ous conun­drums that have stymied the devel­op­ment of Cir­cuit The­o­ry for 20 years were in fact the result of con­fus­ing a stock (an ini­tial loan) with a flow (the eco­nom­ic trans­ac­tions that loan could ini­ti­ate over a year). With a prop­er dynam­ic approach, using the “tab­u­lar” method that I out­lined here in “The Rov­ing Cav­a­liers of Cred­it”, the conun­drums are eas­i­ly solved–watch the pre­sen­ta­tion to see how (click here for my Pow­er­point pre­sen­ta­tion, and the two Vis­sim files that I ran are linked here and here (you will need to “right click” to down­load them, oth­er­wise you’ll just get a text file). If you don’t have the free Vis­sim View­er,  it is down­load­able from here. This is one of the Math­cad files that I showed (use a right-click for this one too; it’s poor­ly structured–written for my use rather than pub­lic consumption–but if you have Math­cadyou’ll be able to fol­low your way around it).

I pre­sent­ed in a par­al­lel ses­sion, the morn­ing after the con­fer­ence din­ner, and had a pre­dictably small audi­ence. How­ev­er that dis­ad­van­tage had a for­tu­nate side, because that tiny audi­ence includ­ed the two con­fer­ence organ­is­ers Louis-Philippe Rochonand Claude Gnos, as well as Basil Moore and Allin Cot­trell. Basil is the ven­er­a­ble father of the propo­si­tion that the mon­ey sup­ply is endoge­nous­ly deter­mined, rather than set exoge­nous­ly by the Cen­tral Bank, as is still taught (in wild con­flict with both the empir­i­cal data and actu­al Cen­tral Bank knowl­edge and prac­tice) in almost all macro­eco­nom­ics cours­es; Louis-Philippe and Claude are well-known and respect­ed Post Key­ne­sian mon­e­tary econ­o­mists; Allin is a very capa­ble expo­nent of Marx­i­an eco­nom­ics, who unlike most Marx­ists uses com­put­er mod­el­ling exten­sive­ly in his analy­sis (I just wish he’d update his web­page, which does­n’t appear to have changed since 1997!).

The dis­cus­sion was there­fore pos­si­bly bet­ter than it would have been, had I pre­sent­ed in a ple­nary:

Steve Keen’s Debt­watch Pod­cast 

| Open Play­er in New Win­dow

How­ev­er though I was pleased with the way my paper was received by those present, I was very dis­ap­point­ed with most of the pre­sen­ta­tions at the con­fer­ence. Though there were some notable exceptions–one of which I’ll com­ment on below–the papers were either non-ana­lyt­ic (“What Keynes said was…”, “Econ­o­mists must take uncer­tain­ty seri­ous­ly…”), bom­bas­tic (“The fatal flaw in the cap­i­tal­ist sys­tem is …”), or used graph­i­cal ana­lyt­ic meth­ods that could not eas­i­ly be dis­tin­guished from the con­tent of an ordi­nary macro­eco­nom­ic text­book. There were one or two block dia­gram expo­si­tions, but they too were graph­i­cal only–mere draw­ings, not influ­ence dia­grams, and cer­tain­ly not sys­tems dynam­ics mod­els.

There are many lead­ing Post Key­ne­sians who weren’t at this conference–including quite a few who attend­ed the Aus­tralian Soci­ety of Het­ero­dox Econ­o­mists con­fer­ence that Peter Kriesler organ­is­es at much the same time every year–so I’m not claim­ing that the papers here are utter­ly rep­re­sen­ta­tive of the gen­er­al state of Post Key­ne­sian eco­nom­ics today. Nev­er­the­less, if they were even mild­ly rep­re­sen­ta­tive of the work that Post Key­ne­sian econ­o­mists are doing in the midst of the biggest cri­sis that cap­i­tal­ism has faced in sev­en­ty years–and one which is caus­ing a cri­sis in neo­clas­si­cal eco­nom­ics as well–then they will fail to shift eco­nom­ic the­o­ry at all. After ten or fif­teen years of eco­nom­ic pain, the neo­clas­si­cal ortho­doxy will be reassembled–since it will be true that “there is no alternative”–and Post Key­ne­sians will remain a noisy and large­ly ignored minor­i­ty.

Papers like these, though they are intend­ed to crit­i­cise the unre­al­i­ty of neo­clas­si­cal eco­nom­ics, or to point out issues (uncer­tain­ty, bound­ed ratio­nal­i­ty, open sys­tems, non-ergod­ic­i­ty, what­ev­er) that should be tak­en seri­ous­ly in eco­nom­ics, actu­al­ly strength­en the resolve of neo­clas­si­cal econ­o­mists to do noth­ing of the sort, since they lack any coher­ent alter­na­tive ana­lyt­ic approach.

Neo­clas­si­cals who attend such presentations–which almost always include dis­parag­ing remarks about the absurd assump­tions neo­clas­si­cal econ­o­mists make–walk away quite jus­ti­fi­ably think­ing that “if that’s the best you can do with real­ism, then I’ll stick to my ‘absurd assump­tions’!”

We can and must do bet­ter than that. But to do so, non-ortho­dox econ­o­mists have to find tools that can express their vision of the econ­o­my ana­lyt­i­cal­ly, either as math­e­mat­i­cal or com­put­er mod­els. If we don’t, then what­ev­er might be said by “Crit­i­cal Real­ists” about the inap­pro­pri­ate­ness of math­e­mat­i­cal analy­sis in eco­nom­ics, or how one can’t mod­el open sys­tems math­e­mat­i­cal­ly, the crit­ics will be side­lined in a not too dis­tant future by those who do use such models–and who care a good deal less about real­ism than the crit­ics do. Yet again, the crit­ics may win the philo­soph­i­cal bat­tle, only to lose the method­olog­i­cal war.

That’s why I’ve put in the effort to learn the meth­ods of dynam­i­cal analy­sis in math­e­mat­ics (sys­tems of dif­fer­en­tial equa­tions), engi­neer­ing (sys­tems dynam­ics), and com­put­ing (mul­ti-agent mod­els), and it’s why I’m try­ing to devel­op alter­na­tives to those which make sense in the con­text of eco­nom­ic modelling–notably my tab­u­lar method to devel­op sys­tems mod­els.

These dynam­ic mod­els enable us to put our thought process­es into a sys­tem­at­ic frame­work, and to explore rela­tions that are sim­ply too com­plex to fol­low ver­bal­ly. This is a major ben­e­fit to math­e­mat­i­cal analy­sis that is lost in the cri­tiques non-ortho­dox econ­o­mists tend to make of how neo­clas­si­cals abuse math­e­mat­ics: when we out­line a causal mech­a­nism ver­bal­ly, we are in fact stat­ing a dif­fer­en­tial equa­tion ver­bal­ly. If we say that “Fac­tor X caus­es changes in vari­able Y”, we are actu­al­ly say­ing “the rate of change of Y is a func­tion of (amongst oth­er things) Fac­tor X”. In math­e­mat­i­cal nota­tion, this is d/dt (Y) = F(X).

The advan­tage of express­ing these con­cepts math­e­mat­i­cal­ly, as well as ver­bal­ly, is that the math­e­mat­i­cal ren­di­tion keeps track of all the feed­backs and com­plex inter­ac­tions that sim­ply over­whelm our capac­i­ty to fol­low a com­plex causal process ver­bal­ly, and they give us a means to pro­vide a rough quan­tifi­ca­tion of how strong those feed­back effects are.

The fail­ure to do this with­in Cir­cuit The­o­ry is why a sim­ple con­fu­sion of stocks with flows–mistaking the stock of mon­ey for the flows that are ini­ti­at­ed by a giv­en stock of mon­ey over a year–has stymied for twen­ty years the devel­op­ment of Grazian­i’s bril­liant insights into a work­able the­o­ry. As I show in the talk above, the sim­ple expres­sion of the flows ini­ti­at­ed by a loan are suf­fi­cient to solve all the “conun­drums” of Cir­cuit The­o­ry. The conun­drums were sim­ply the prod­uct of apply­ing the wrong type of analysis–simultaneous equa­tions, “peri­od analy­sis” with its implic­it dif­fer­ence equa­tion form, or worse still mere words–to the issue. A sim­ple appli­ca­tion of flow analy­sis in con­tin­u­ous time shows up all those conun­drums for what they real­ly are: con­fu­sions result­ing from bad analy­sis and inap­pro­pri­ate ana­lyt­ic meth­ods.

Now I also have to exhort my fel­low Post Key­ne­sians to learn at least some of the appro­pri­ate meth­ods. Get out of the com­fort zone of ver­bal expo­si­tion, his­to­ri­og­ra­phy, simul­ta­ne­ous equa­tions and graph­i­cal analysis–and even the much more sophis­ti­cat­ed stock-flow con­sis­tent frame­work of God­ley and Lavoie (While this method is cer­tain­ly a major step in the right direc­tion, using it to try to explain where prof­it comes from was rather like try­ing to under­stand how a horse runs, using pho­tographs of a run­ning horse tak­en at one hour intervals)–and learn dif­fer­en­tial equa­tions, or sys­tems dynam­ics, or com­put­er pro­gram­ming. It’s hard, but the effort is worth it. And if you don’t do it, then pre­pare to once again be dom­i­nat­ed by neo­clas­si­cal econ­o­mists once the Glob­al Finan­cial Cri­sis has passed.

I’ll end on one very pos­i­tive note: there was one excep­tion­al piece of work done by a PhD stu­dent (who is also a full-time school teacher) Pas­cal Seppech­er. He has devel­oped a mul­ti-agent mod­el in Java that also sim­u­lates the mon­e­tary cir­cuit, and reach­es much the same result as I do from a dif­fer­en­tial equa­tions per­spec­tive. His mod­el is called Jamel: Java Agent-based Macro­Eco­nom­ic Lab­o­ra­to­ry. It’s a bril­liant piece of work and I do rec­om­mend explor­ing it.

If a full-time school-teacher with a fam­i­ly can nonethe­less acquire the skills and find the time need­ed to do qual­i­ty work like this, then it’s high time aca­d­e­m­ic Post Key­ne­sians did the same. Stick­ing with what you are used to, when what you are used to mere­ly lets you point out what “should be” done rather than actu­al­ly doing it, is no longer good enough.

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About Steve Keen

I am Professor of Economics and Head of Economics, History and Politics at Kingston University London, and a long time critic of conventional economic thought. As well as attacking mainstream thought in Debunking Economics, I am also developing an alternative dynamic approach to economic modelling. The key issue I am tackling here is the prospect for a debt-deflation on the back of the enormous private debts accumulated globally, and our very low rate of inflation.