Empir­i­cal and the­o­ret­i­cal rea­sons why the GFC is not behind us

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Preliminary Remarks

As noted in Debt­watch No. 44, I have stopped writ­ing the monthly Debt­watch Report to focus on my more long term research. I’m still post­ing occa­sional blog posts when I feel the need—like the two recently on Australia’s new resources tax—but gen­er­ally I’ll be work­ing on more tech­ni­cal mat­ters, and post­ing entries based on those here in lieu of the more top­i­cal Debt­watch. This post is a halfway post between the two: it’s a paper that I have just sub­mit­ted to the 2010 Aus­tralian Con­fer­ence of Econ­o­mists, which will be held in Syd­ney in Sep­tem­ber. I have writ­ten it largely as a brief­ing paper for main­stream econ­o­mists who would not have come across the analy­sis that I present here before, let alone the vast vol­ume of lit­er­a­ture in Post Key­ne­sian and Aus­trian eco­nom­ics.

There is one clas­sic SNAFU in going from Word to the blog for­mat, for the for­mat­ting of a table below;  I wasted too much time try­ing to fix it, so I’ll have to live with it for this post!


A major­ity of the 16 indi­vid­u­als iden­ti­fied in Beze­mer (2009) and (Full­brook (2010)) as hav­ing antic­i­pated the Global Finan­cial Cri­sis fol­lowed non-main­stream approaches to eco­nom­ics, with most of them iden­ti­fy­ing as Post-Key­ne­sian (Dean Baker, Wynne God­ley, Michael Hud­son, Steve Keen, Ann Pet­ti­for) or Aus­trian (Kurt Richel­bacher, Peter Schiff). The the­o­ret­i­cal foun­da­tions of these authors there­fore dif­fer sub­stan­tially from those of more main­stream neo­clas­si­cal econ­o­mists. In this paper I will restrict my atten­tion to the Post-Key­ne­sian sub­set, which I will here­inafter refer to as the Beze­mer-Full­brook Group. Beze­mer iden­ti­fied the fac­tors that these authors have in com­mon as:

the dis­tinc­tion between finan­cial wealth and real assets… A con­cern with debt as the coun­ter­part of finan­cial wealth… a fur­ther con­cern, that growth in finan­cial wealth and the atten­dant growth in debt can become a deter­mi­nant (instead of an out­come) of eco­nomic growth …[the] reces­sion­ary impact of the burst­ing of asset bub­bles… [and] Finally, empha­sis on the role of credit cycles in the busi­ness cycle… (Beze­mer (2009))

These authors made fre­quent ref­er­ences to the ratio of pri­vate debt to GDP, and the ratio of asset prices to com­mod­ity prices—both indi­ca­tors of finan­cial fragility that were empha­sized by Min­sky in his finan­cial insta­bil­ity hypoth­e­sis (Min­sky (1982)), which is a com­mon thread in the credit-ori­ented analy­sis of the Beze­mer-Full­brook Group. Since these indi­ca­tors are not com­monly con­sid­ered in main­stream eco­nomic analy­sis, I repro­duce this key data in the next 2 fig­ures, before con­trast­ing them to those fol­lowed by Ben Bernanke (the acknowl­edged main­stream expert on the Great Depres­sion) in his analy­sis of the Great Depres­sion.

Fig­ure 1: Ratio of pri­vate debt to GDP, USA and Aus­tralia

Fig­ure 2: US asset price bub­bles

The Great Depression: Errant Monetary Policy or the Dynamics of Debt?

Bernanke pre­cedes the sum­mary of his expla­na­tion for the Great Depres­sion with the state­ment that its causes must be found in fac­tors that caused a sharp decline in aggre­gate demand:

Because the Depres­sion was char­ac­ter­ized by sharp declines in both out­put and prices, the premise of this essay is that declines in aggre­gate demand were the dom­i­nant fac­tor in the onset of the Depres­sion. This start­ing point leads nat­u­rally to two ques­tions:

First, what caused the world­wide col­lapse in aggre­gate demand in the late 1920s and early 1930s (the “aggre­gate demand puz­zle”)?

Sec­ond, why did the Depres­sion last so long? In par­tic­u­lar, why didn’t the “nor­mal” sta­bi­liz­ing mech­a­nisms of the econ­omy, such as the adjust­ment of wages and prices to changes in demand, limit the real eco­nomic impact of the fall in aggre­gate demand (the “aggre­gate sup­ply puz­zle”)? Bernanke (2000, p. ix)

His expla­na­tion has two com­po­nents: a con­trac­tion in money caused by poor mon­e­tary man­age­ment (and a flawed sys­tem based upon the gold stan­dard), and the impact of non­mon­e­tary finan­cial fac­tors:

there is now over­whelm­ing evi­dence that the main fac­tor depress­ing aggre­gate demand was a world­wide con­trac­tion in world money sup­plies. This mon­e­tary col­lapse was itself the result of a poorly man­aged and tech­ni­cally flawed inter­na­tional mon­e­tary sys­tem…

I also have ascribed an impor­tant role to non­mon­e­tary finan­cial fac­tors, such as bank­ing pan­ics and busi­ness fail­ures, in chok­ing off nor­mal flows of credit and hence exac­er­bat­ing the world eco­nomic col­lapse. Bernanke (2000, p. ix)

With regard to the role of poor mon­e­tary man­age­ment in caus­ing the Great Depres­sion, Bernanke favourably cites Fried­man and Schwartz’s iden­ti­fi­ca­tion of “Four Mon­e­tary Pol­icy Episodes” where respec­tively a tight­en­ing or loos­en­ing of mon­e­tary pol­icy caused a decline or expan­sion dur­ing the Great Depres­sion (Bernanke (2002), cit­ing Fried­man and Schwartz (1963)). These four episodes are sum­ma­rized in Table 1.

Table 1: Fried­man-Schwartz iden­ti­fied peri­ods in US mon­e­tary pol­icy dur­ing the Great Depres­sion (Bernanke (2002))

Pol­icy Type Start End
Tighten Spring 1928 Octo­ber 1929
Tighten Sep­tem­ber 1931 Octo­ber 1931
Loosen April 1932 June 1932
Tighten 1933 March 1933

Bernanke largely dis­missed the debt-defla­tion expla­na­tion given by Fisher, on the grounds that debt-defla­tion was a dis­trib­u­tive mech­a­nism and not a macro­eco­nomic one:

debt-defla­tion rep­re­sented no more than a redis­tri­b­u­tion from one group (debtors) to another (cred­i­tors). Absent implau­si­bly large dif­fer­ences in mar­ginal spend­ing propen­si­ties among the groups, it was sug­gested, pure redis­tri­b­u­tions should have no sig­nif­i­cant macro­eco­nomic effects. Bernanke (1995, p. 17)

Bernanke then re-inter­preted Fisher from an equi­lib­rium per­spec­tive, whereas Min­sky accepted and built upon Fisher’s explicit non-equi­lib­rium basis:

We may ten­ta­tively assume that, ordi­nar­ily and within wide lim­its, all, or almost all, eco­nomic vari­ables tend, in a gen­eral way, toward a sta­ble equi­lib­rium… But the exact equi­lib­rium thus sought is sel­dom reached and never long main­tained…, in actual fact, any vari­able is almost always above or below the ideal equi­lib­rium…

The­o­ret­i­cally … there must be- over- or under-pro­duc­tion … and over or under every­thing else. It is as absurd to assume that, for any long period of time, the vari­ables in the eco­nomic orga­ni­za­tion, or any part of them, will “stay put,” in per­fect equi­lib­rium, as to assume that the Atlantic Ocean can ever be with­out a wave…

in the great booms and depres­sions … [there are] two dom­i­nant fac­tors, namely over-indebt­ed­ness to start with and defla­tion fol­low­ing soon after Fisher (1933, p. 341)

Min­sky adopted this dis­e­qui­lib­rium per­spec­tive, and argued that a reduc­tion in debt does have macro­eco­nomic effects, because it reverses the process of debt adding to aggre­gate demand that must occur dur­ing a period of expan­sion:

For real aggre­gate demand to be increas­ing … it is nec­es­sary that cur­rent spend­ing plans, summed over all sec­tors, be greater than cur­rent received income and that some mar­ket tech­nique exist by which aggre­gate spend­ing in excess of aggre­gate antic­i­pated income can be financed. It fol­lows that over a period dur­ing which eco­nomic growth takes place, at least some sec­tors finance a part of their spend­ing by emit­ting debt or sell­ing assets. Min­sky (1982, p. 6; empha­sis added)

Minsky’s thus defines aggre­gate demand as the sum of GDP plus the change in debt, and this demand is expended on both com­mod­ity and asset mar­kets, in con­trast to the main­stream macro­eco­nomic focus on com­mod­ity mar­kets alone. Bernanke’s inter­pre­ta­tion and sta­tis­ti­cal mea­sures of tight mon­e­tary pol­icy also implic­itly accepts the money mul­ti­plier expla­na­tion of the rela­tion­ship between base money and broader mea­sures of money such as M1. The Beze­mer-Full­brook Group instead argues that the money sup­ply is endoge­nously deter­mined, and that changes in base money fol­low rather than cause changes in broad money, so that there is no direct causal link between M0 and M1 (Moore (1979); see also Kyd­land and Prescott (1990)). The Bernanke-Fried­man-Schwartz asser­tion is that declines in the rate of growth of the money sup­ply ini­ti­ated by the Fed­eral Reserve caused the Great Depres­sion; the Beze­mer-Full­brook Group asserts instead that con­tract­ing debt caused the Great Depres­sion. These expla­na­tions can be com­pared empir­i­cally, by con­sid­er­ing the cor­re­la­tions between the rate of growth of the money sup­ply and unem­ploy­ment, ver­sus changes in the debt-financed pro­por­tion of aggre­gate demand and unem­ploy­ment.

Money and Unemployment in the Great Depression

Fig­ure 3 shows the rela­tion­ship between M0 and M1 over the period from 1920 to 1940. Though the two mea­sures move in con­cert with each other in the period from 1920 to 1930, it is obvi­ous that there was a break­down in the rela­tion­ship between these two aggre­gates in the period between 1931 and 1934. Infer­ences that are based on the appar­ent rela­tion­ship between M0 and M1 in 1920–1930 will thus be sus­pect in the period 1931–1934.

Fig­ure 3: Rates of change of M0 and M1 1920–1940

This is borne out by a com­par­i­son of the cor­re­la­tion of the rate of growth of the money sup­ply as mea­sured by M1 and unem­ploy­ment in the period 1930–1940, and the cor­re­la­tion using M0. Fig­ure 4 shows that the cor­re­la­tion is mod­er­ate and has the expected sign for M1 (-0.3): an increase in the rate of growth of M1 is cor­re­lated with a fall in unem­ploy­ment, as Bernanke, Fried­man and Schwartz hypoth­e­size (the rate of unem­ploy­ment is inverted on the right hand axis, to enhance visual inspec­tion of the cor­re­la­tion: when the two series move in the same direction—or high rates of money growth cor­re­spond to falling rates of unemployment—the hypoth­e­sized rela­tion holds).

Fig­ure 4: M1 Money sup­ply growth and unem­ploy­ment

The cor­re­la­tion with M0, on the other hand, has the wrong sign (0.42): increases in the rate of growth of M0 are cor­re­lated with increases in the rate of unem­ploy­ment.

Fig­ure 5: M0 Money sup­ply growth and unem­ploy­ment

The pos­si­bil­ity that this appar­ent para­dox reflects the fact that mon­e­tary pol­icy acts with a lag is dis­pelled in Table 2 on page 11, which shows that though the neg­a­tive cor­re­la­tion of changes in M1 does strengthen (peak­ing at –0.5 at a 12 month lag), the pos­i­tive cor­re­la­tion between changes in M0 and unem­ploy­ment remains. One way to make sense of this para­dox is to con­clude that, con­trary to Bernanke’s inter­pre­ta­tion, the Fed­eral Reserve dur­ing the 1930s did try to counter the Great Depres­sion by expand­ing the money sup­ply, but that not until 1938 were its attempts suc­cess­ful. This infor­ma­tion was masked by sta­tis­ti­cal analy­sis that used M1 rather than M0, since only M0 is directly under the con­trol of the Fed­eral Reserve. Sub­tract­ing M1 from M0 con­firms this hypoth­e­sis: non-M0 M1 is more strongly cor­re­lated with unem­ploy­ment than M1 alone (-0.41, peak­ing at –0.52 with an 8 month lag).

Fig­ure 6: Non-M0 M1 Money sup­ply growth and unem­ploy­ment

A sec­ond way to resolve the para­dox fol­lows from the first. Since M1 (and more expan­sive def­i­n­i­tions of the money sup­ply) is deter­mined by the actions of the pri­vate finan­cial sys­tem as well as the Fed­eral Reserve, the pub­lic and pri­vate money cre­ation sys­tems were work­ing in oppos­ing direc­tions in the 1930s. For the first eight years, the pri­vate sector’s reduc­tions in credit over­whelmed the pub­lic sector’s attempts to expand the money sup­ply. By mid-1938, when the USA’s pri­vate debt to GDP ratio had fallen to 140 per­cent of GDP (from its defla­tion-enhanced peak of 238 per­cent in 1932), sub­stan­tial increases in M0 were able to expand the aggre­gate money sup­ply and increase eco­nomic activ­ity by enough to cause unem­ploy­ment to fall.

This inter­pre­ta­tion brings us to the debt-dri­ven analy­sis of the Beze­mer-Full­brook Group, applied in this instance to the Great Depres­sion. From this per­spec­tive, both the boom of the 1920s and the slump of the Great Depres­sion were caused by chang­ing lev­els of debt in an econ­omy that had become fun­da­men­tally spec­u­la­tive in nature. Ris­ing debt used to finance spec­u­la­tion dur­ing the 1920s made that decade “The Roar­ing Twen­ties”, while pri­vate sec­tor delever­ag­ing when the spec­u­la­tive bub­ble burst caused a col­lapse in aggre­gate demand that ush­ered in the Great Depres­sion in the 1930a. Fig­ure 7 illus­trates both the ris­ing debt of the 1920s and the falling debt of the 1930s.

Fig­ure 7: US Pri­vate Debt and Nom­i­nal GDP, 1920–1940

Fig­ure 8 illus­trates how much the increase in debt dur­ing the 1920s added to demand, and then how much its fall in the 1930s sub­tracted from demand.

Fig­ure 8: Aggre­gate demand is the sum of GDP plus the change in debt

Fig­ure 9 cor­re­lates the change in debt with the unem­ploy­ment rate: the cor­re­la­tion has the expected sign, and is sig­nif­i­cantly larger than that for either M1 or M1-M0 (up to –0.85 for a lag of 15 months; see Table 2 on page 11).

Fig­ure 9: Change in pri­vate debt and unem­ploy­ment

Table 2: Lagged cor­re­la­tions between changes in mon­e­tary vari­ables and unem­ploy­ment

This brings us to the cur­rent finan­cial cri­sis, and why—on the analy­sis of those who pre­dicted it—this cri­sis is far from over.

The Great Moderation and the Great Recession

As is well known, a major topic in main­stream macro­eco­nomic debate was explain­ing the sources of “The Great Mod­er­a­tion” (Bernanke (2004); see also Davis and Kahn (2008) and Gali and Gam­betti (2009)). Now the focus­ing is on explaining—and hope­fully escap­ing from—“The Great Reces­sion” that fol­lowed it. From the point of view of the Beze­mer-Full­brook Group, these two events have the same cause, as did the Roar­ing Twen­ties and the Great Depres­sion before them: a debt-dri­ven spec­u­la­tive boom, fol­lowed by a delever­ag­ing-dri­ven down­turn. As an aside, there is no doubt that Ben Bernanke is apply­ing the lessons he took from the Great Depres­sion in his attempts to avoid a sec­ond such cri­sis. Fig­ure 10 shows the annual rate of change of M0, M1, M2 and M3 (which the Fed stopped record­ing in 2006) over the two decades since 1990. Growth in M0 is off the scale from late 2008 until early 2010, as the Fed­eral Reserve more than dou­bled the level of base money (the aver­age annual rate of growth of M0 over this period exceeded 100%). How­ever, as dur­ing the Great Depres­sion, broader mea­sures of the money sup­ply are fail­ing to respond as dra­mat­i­cally. While there has been growth in M1, it has been one sixth that of M0 (and mea­sured M0 now exceeds M1); M2’s growth never exceeded 10 per­cent and is now close to zero; it is likely that growth in the now unrecorded M3 is either ane­mic or neg­a­tive.

Fig­ure 10: Changes in US money stock lev­els since 1990

Changes in debt, on the other hand, were dra­matic. Fig­ure 11 and Fig­ure 12 are the mod­ern equiv­a­lent of Fig­ure 7 and Fig­ure 8 from the 1920s-1940s, and it is evi­dent that the level of debt-financed demand dur­ing “the Great Mod­er­a­tion” far exceeded the level of The Roar­ing Twen­ties.

Fig­ure 11: US pri­vate debt and GDP 1990–2010

Fig­ure 12: US aggre­gate demand 1990–2010

How­ever, the neg­a­tive con­tri­bu­tion from delever­ag­ing has yet to approach the max­i­mum lev­els set dur­ing the Great Depres­sion. The debt con­tri­bu­tion to demand began at a far higher level this time than last, peak­ing at 22% in 2008 ver­sus at 8.7% in 1928. On this basis, the fall in aggre­gate demand caused by pri­vate sec­tor delever­ag­ing today is more rapid than in the 1930s, has not reached the max­i­mum rate sus­tained dur­ing the Great Depres­sion, and shows no signs of abat­ing. Fig­ure 13 graphs the debt con­tri­bu­tion to aggre­gate demand—defined as the annual change in debt, divided by the sum of GDP plus the annual change in debt. On this mea­sure, delever­ag­ing since the peak level of debt in 2008 has been more severe than delever­ag­ing from the com­pa­ra­ble level in 1928, and the reduc­tion in demand from pri­vate sec­tor delever­ag­ing shows no signs of abat­ing.

Fig­ure 13: Com­par­ing the Great Depres­sion and the Great Reces­sion from both pri­vate and gov­ern­ment bor­row­ing

The rela­tion­ship between change in debt and unem­ploy­ment is also much stronger over the period 1990–2010 (a cor­re­la­tion of –0.95) than it was for the period from 1930 till 1940.

Fig­ure 14: Cor­re­la­tion of change in pri­vate debt and unem­ploy­ment, 1990–2010

Lags now make lit­tle dif­fer­ence to the results (pre­sum­ably because all data is now quar­terly or monthly in fre­quency).

Table 3: Lags add no explana­tory power to the cor­re­la­tions

On the indi­ca­tor of choice by the group that antic­i­pated the GFC, it there­fore appears that the GFC is far from over. This raises one final empir­i­cal issue before I con­sider the the­o­ret­i­cal foun­da­tions of the Beze­mer-Full­brook Group: if pri­vate sec­tor delever­ag­ing this time round is falling from a greater level and at a greater rate than in the 1930s, then why has the econ­omy sta­bi­lized (to some extent) now, ver­sus the almost relent­less decline of the Great Depres­sion? The answer appears to lie in the scale of the gov­ern­ment response to this cri­sis. Fig­ure 13 (on page 14) includes the impact of gov­ern­ment debt on aggre­gate demand. While this added sub­stan­tially to demand dur­ing the depths of the Great Depres­sion (more than 7% of aggre­gate demand between 1931 and 1933 was financed by gov­ern­ment debt), in 1930–2 years after the peak rate of growth of pri­vate debt in 1928—government debt added a mere 1.2% to aggre­gate demand. This time, given the fear of another Great Depres­sion that pol­i­cy­mak­ers had in 2008, the gov­ern­ment response has been far larger and more imme­di­ate. In 2010, gov­ern­ment debt was respon­si­ble for over 12% of aggre­gate demand, and this almost coun­ter­acted the –15% con­tri­bu­tion from pri­vate sec­tor delever­ag­ing. While this suc­cess is heart­en­ing, the fig­ures indi­cate that growth can­not be expected to con­tinue if the gov­ern­ment deficit is reduced. Pri­vate sec­tor delever­ag­ing is still accel­er­at­ing and has some time to go before it could be expected to slow. In the absence of net gov­ern­ment spend­ing, it is highly likely that the down­ward spi­ral in out­put and employ­ment would con­tinue.

Non-mainstream modeling of the GFC

Only two of the econ­o­mists in the Beze­mer-Full­brook Group employ math­e­mat­i­cal macro­eco­nomic mod­els in their research: Wynne God­ley (God­ley (1999), God­ley and Izuri­eta (2002), God­ley and Izuri­eta (2004), God­ley and Lavoie (2007)) and myself (Keen (1995), Keen (2000), Keen (2008), Keen (2009a), Keen (2009b), Keen (2009d)). Both authors’ mod­els dif­fer sub­stan­tially from main­stream “Neo­clas­si­cal” mod­els, in that they explic­itly eschew con­cepts of opti­miz­ing agents, work in aggrega­tive and gen­er­ally mon­e­tary terms, and dis­play non-equi­lib­rium-revert­ing dynam­ics.


Godley’s mod­els employed an account­ing frame­work he described as “stock-flow con­sis­tent” on the basis that account­ing must be cor­rect, and only a lim­ited degree of ratio­nal­ity is needed to accu­rately model eco­nomic behav­ior:

Post Key­ne­sian eco­nom­ics … is some­times accused of lack­ing coher­ence, for­mal­ism, and logic. The method pro­posed here is designed to show that it is pos­si­ble to pur­sue het­ero­dox eco­nom­ics, with alter­na­tive foun­da­tions, which are more solid than those of the main­stream. The stock-flow mon­e­tary account­ing frame­work pro­vides such an alter­na­tive foun­da­tion that is based essen­tially on two prin­ci­ples.

First, the account­ing must be right. All stocks and all flows must have coun­ter­parts some­where in the rest of the econ­omy. The water­tight stock flow account­ing imposes sys­tem con­straints that have qual­i­ta­tive impli­ca­tions. This is not just a mat­ter of log­i­cal coher­ence; it also feeds into the intrin­sic dynam­ics of the model.

Sec­ond, we need only assume, in con­trast to neo­clas­si­cal the­ory, a very lim­ited amount of ratio­nal­ity on the part of eco­nomic agents. Agents act on the basis of their bud­get con­straints. Oth­er­wise, the essen­tial ratio­nal­ity prin­ci­ple is that of adjust­ment. Agents react to what they per­ceive as dis­e­qui­lib­ria, or to the dis­e­qui­lib­ria that they take note of, by mak­ing suc­ces­sive cor­rec­tions. There is no need to assume opti­miza­tion, per­fect infor­ma­tion, ratio­nal expec­ta­tions, or gen­er­al­ized price-clear­ing mech­a­nisms. (Lavoie and God­ley (2000, p. 307))

Fig­ure 15 gives an exam­ple of the God­ley social account­ing matrix.

Fig­ure 15: An exam­ple of the God­ley social account­ing matrix (God­ley (1999, p. 395))

Fig­ure 16 shows a sim­u­la­tion from this model.

Fig­ure 16: Results of a sim­u­la­tion of the model in God­ley (1999, p. 400)

Mod­els are assem­bled from the stock-flow matrix. For exam­ple, house­hold dis­pos­able income in nom­i­nal terms is defined as:

Fig­ure 17: Equa­tion for house­hold dis­pos­able income in God­ley (1999, p. 405)

These terms are taken from the House­holds col­umn of Fig­ure 15, and are the sum of income from prof­its, wages and inter­est pay­ments plus changes in house­hold bank bal­ances. On the basis of pro­jec­tions using this frame­work and US data, God­ley observed in 2002 and again in 2004 that the US seemed inevitably headed for a seri­ous reces­sion:

So the medium term alter­na­tives for the US econ­omy look pretty stark. Either an uncon­venanted and sus­tained rise in net export demand pro­vides a motor for expan­sion in a quite new way; or the fis­cal pol­icy con­tin­ues to gen­er­ate twin (bud­get and bal­ance of pay­ments) deficits, pos­si­bly grow­ing …, or the US econ­omy relapses into stag­na­tion. (God­ley and Izuri­eta (2004, p. 138))


I con­cur with God­ley on the need for accu­rate account­ing, and the capac­ity to model macro­dy­namic behav­ior with only real­is­tic lev­els of rationality—by which I mean that agents ratio­nally react to their own sit­u­a­tion, but nei­ther know nor can pre­dict the char­ac­ter­is­tics or future behav­ior of the entire econ­omy. They there­fore employ “rules of thumb” in their reac­tions to rel­e­vant eco­nomic stim­uli (where these reac­tions tend to be con­sis­tent within each social class, but dif­fer between classes). The most impor­tant rule of thumb is that iden­ti­fied by Keynes in 1936:

The essence of this convention—though it does not, of course, work out quite so simply—lies in assum­ing that the exist­ing state of affairs will con­tinue indef­i­nitely, except in so far as we have spe­cific rea­sons to expect a change. Keynes (1936, p. 152)

The assump­tion of a con­tin­u­ance of cur­rent con­di­tions in the highly non­lin­ear real world (and its sim­u­lacrum in these mod­els) leads to unex­pected out­comes and hence changes in both the model and the state of expec­ta­tions. I add to Godley’s method an insis­tence on mod­el­ing social classes dis­tinctly (I do not employ an aggre­gate house­hold sec­tor, but instead divide agents into at the min­i­mum cap­i­tal­ists, work­ers and bankers), and I work in con­tin­u­ous time rather than the more awk­ward if sim­pler frame­work of dis­crete time (see Keen (2006) and Keen (2008)). I employ two dif­fer­ent frame­works in my mod­els: an exten­sion of Goodwin’s growth cycle model (Good­win (1967)) to include debt (Keen (1995)), and a devel­op­ment of Godley’s stock-flow con­sis­tent frame­work in con­tin­u­ous time (Keen (2008), Keen (2009a)). The for­mer set of mod­els gen­er­ate debt dynam­ics that, under some ini­tial con­di­tions, qual­i­ta­tively approx­i­mate the debt accu­mu­la­tion data seen in Fig­ure 1. The mod­els are expressed as sys­tems of cou­pled ordi­nary dif­fer­en­tial equa­tions (Fig­ure 18).

Fig­ure 18: Equa­tions for the model in Keen (2009d, p. 353)

In this sys­tem, the state vari­ables are respec­tively GDP, the wage rate, pri­vate debt, the level of spec­u­la­tive invest­ment as a frac­tion of GDP, labour pro­duc­tiv­ity, and pop­u­la­tion (g, ?r and ? are vari­ables rep­re­sent­ing the rate of growth, profit rate and the employ­ment rate that them­selves depend on the val­ues of the state vari­ables). With­out spec­u­la­tive borrowing—defined as bor­row­ing that finances spec­u­la­tion on asset prices but does not finance the con­struc­tion of new assets—the model gen­er­ates a cycli­cal sys­tem which gen­er­ally does not break down; with spec­u­la­tive bor­row­ing, the model almost inevitably approaches a cri­sis caused by the accu­mu­la­tion of debt to lev­els that exceed the economy’s debt ser­vic­ing capac­ity.

Fig­ure 19: Results of a sim­u­la­tion with the model in Keen (2009d)

Fig­ure 20: Results of a sim­u­la­tion with the model in Keen (2009d) con­tin­ued

My own ver­sion of Stock-Flow con­sis­tent mod­el­ing uses a tab­u­lar approach to build­ing sys­tems of cou­pled dif­fer­en­tial equa­tions. The sys­tem states are bank accounts attrib­uted to spe­cific social classes, and the rows in each table reflects flows between accounts. The mod­els are derived sim­ply by sym­bol­i­cally adding up the columns of the rel­e­vant matrix. An exam­ple sys­tem is shown in Table 4.

Table 4: A sam­ple table of finan­cial flows (Keen (2009c))

Bank Accounts

Assets (Reserves & Loans)

Lia­bil­i­ties (Deposits)

Actions Reserves (BR) Loans (FL) Firms (FD) Work­ers (WD) Banks (BI)
A Com­pound Inter­est


B Pay Inter­est




C Deposit Inter­est



D Wages



E Worker Inter­est



F+G Con­sump­tion




H Loan Repay­ment




I Money relend­ing




J Money cre­ation



K Res­cue Banks


Res­cue Firms


The dynam­ics of the model are sim­ply given by adding up the sym­bolic entries in each col­umn (Table 5):

Table 5: Dynam­ics of the model shown in Table 4 

Rate of change of… Equals…
Bank Reserves BR H-I+K
Firm Loans FL –H+I+J
Firm Deposits FD –B+C-D+F+G-H+I+J+K
Worker Deposits WD D+E+F
Bank Income BI +B-C-E-G

Each of the sym­bols A to K is replaced by a suit­able oper­a­tor based on the 5 sys­tem states in the model (Table 6):

Table 6: Sym­bolic sub­sti­tu­tions for the model in Table 5 

Action Descrip­tion Terms
A Com­pound Inter­est Out­stand­ing debt FL is increased at the rate of inter­est on loans rL.


B Pay Inter­est Accrued inter­est on out­stand­ing debt is paid. This involves a trans­fer from the firm sector’s deposits FD to the bank sector’s income account BI, and the record­ing of this trans­fer on the debt ledger FL.


C Deposit Inter­est Inter­est is paid (at the lower rate rD) on the bal­ance in the firm sector’s deposit account


D Wages This is a trans­fer from the firm sector’s deposit accounts to work­ers’ deposit accounts WD, using two insights from Marx: firstly that the sur­plus in pro­duc­tion is dis­trib­uted between work­ers and cap­i­tal­ists (in shares that sum to 1 in this model–so work­ers get 1-s and cap­i­tal­ists get s); sec­ondly that there is a turnover period (?S as a frac­tion of a year) between M and M+ (see Cap­i­tal II Chap­ter 12).


E Worker Inter­est The deposit inter­est rate times the bal­ance in work­ers’ accounts.


F+G Con­sump­tion This employs the con­cept of a time lag–the length of time it takes work­ers to spend their wages is 2 weeks (say) or 1/26th of a year so that ?W equals 1/26. Wealth­ier bankers spend their account bal­ances much more slowly.


H Loan Repay­ment The rate of loan repay­ment is pro­por­tional to the out­stand­ing level of loans divided by the time lag ?L in loan repay­ment (for a stan­dard hous­ing loan this would be shown as ?L =25)


I Money relend­ing The rate of new money cre­ation is the bal­ance in the bank­ing sector’s unlent reserves, divided by a turnover lag rep­re­sent­ing how rapidly exist­ing money is recy­cled.


J Money cre­ation The rate of new money cre­ation is the bal­ance in the firm sector’s deposit account, divided by a time lag that rep­re­sents the length of time it takes for the money sup­ply to dou­ble.


K Res­cue Banks This is a ‘Deus Ex Machina’ injec­tion of 100 cur­rency units one year after the cri­sis begins, for a period of one year, into either the bank­ing sec­tors reserves BR or the firm sector’s deposit accounts FD.


Res­cue Firms

The model’s equa­tions are as shown in

Fig­ure 21: Equa­tions for the model sim­u­lated in Keen (2009a) and Keen (2009c)

A sim­u­la­tion of a credit crunch and two dif­fer­ent pol­icy responses is shown in Fig­ure 22.

Fig­ure 22: Sim­u­la­tion of a credit crunch using the model in Keen (2009c)


The core propo­si­tions shared by the Beze­mer-Full­brook group were that the super­fi­cially good eco­nomic per­for­mance dur­ing “The Great Mod­er­a­tion” was dri­ven by a debt-financed spec­u­la­tive bub­ble, which would nec­es­sar­ily burst because the debt added to the economy’s ser­vic­ing costs with­out increas­ing its capac­ity to finance those costs. At some stage, the growth of unpro­duc­tive debt had to fal­ter, and when it did a seri­ous finan­cial cri­sis would ensue as aggre­gate demand col­lapsed. The pol­icy res­cues since that pre­dic­tion came true have not addressed the fun­da­men­tal cause of the cri­sis, which was the exces­sive level of pri­vate debt. The delever­ag­ing that the Group pre­dicted has thus been slowed to some degree by gov­ern­ment action, but the need for that delever­ag­ing has not been removed. As Fig­ure 13 in par­tic­u­lar empha­sizes, the scale of that poten­tial delever­ag­ing appears cer­tain to exceed that expe­ri­enced in the Great Depres­sion.

Bat­tellino, R. 2007, ‘Some Obser­va­tions On Finan­cial Trends’, Reserve Bank of Aus­tralia Bul­letin, vol. 2007, no. Octo­ber, pp 14–21.

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Gali, J. and Gam­betti, L. 2009, ‘On the Sources of the Great Mod­er­a­tion’, Amer­i­can Eco­nomic Jour­nal: Macro­eco­nom­ics, vol. 1, no. 1, pp 26–57.

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God­ley, W. and Izuri­eta, A. 2004, ‘The US Econ­omy: Weak­nesses of the ‘Strong’ Recov­ery’, Banca Nazionale del Lavoro Quar­terly Review, vol. 57, no. 229, pp 131–139.

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Keen, S. 1995, ‘Finance and Eco­nomic Break­down: Mod­el­ing Minsky’s ‘Finan­cial Insta­bil­ity Hypoth­e­sis.”, Jour­nal of Post Key­ne­sian Eco­nom­ics, vol. 17, no. 4, pp 607–635.

Keen, S. 2000, ‘The Non­lin­ear Eco­nom­ics of Debt Defla­tion’, in Com­merce, com­plex­ity, and evo­lu­tion: Top­ics in eco­nom­ics, finance, mar­ket­ing, and man­age­ment: Pro­ceed­ings of the Twelfth Inter­na­tional Sym­po­sium in Eco­nomic The­ory and Econo­met­rics, ed W. A. Bar­nett, Cam­bridge Uni­ver­sity Press, New York.

Keen, S. 2006, ‘The Need and Some Meth­ods for Dynamic Mod­el­ling in Post Key­ne­sian Eco­nom­ics’, in Com­plex­ity, Endoge­nous Money and Macro­eco­nomic The­ory: Essays in Hon­our of Basil J. Moore, ed M. Set­ter­field, Chel­tenham, U.K. and Northamp­ton, Mass: Elgar.

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Keen, S. 2009c, ‘The Global Finan­cial Cri­sis, Credit Crunches and Delever­ag­ing’, Jour­nal Of Aus­tralian Polit­i­cal Econ­omy, vol. 64, pp 18–32.

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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.
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  • aagold


    I prob­a­bly should have been more spe­cific. When I referred to change_in_e­quity, I wasn’t refer­ring to changes that hap­pen due to asset val­u­a­tion changes. I specif­i­cally meant issuance of new equity secu­ri­ties. When a cor­po­ra­tion needs to finance invest­ment expen­di­tures it has two ways to do so: issuance of new debt secu­ri­ties and issuance of new equity secu­ri­ties. Seems to me the effect on aggre­gate demand would be the same in either case.

    - aagold

  • aagold


    We’re prob­a­bly get­ting our “wires crossed” a bit. I just saw your sec­ond response after I posted my more spe­cific ques­tion.

    Your sec­ond response regard­ing debt issuance increas­ing the money sup­ply raises another ques­tion, how­ever. Isn’t it only increases in *bank credit* that cause an increase in the money sup­ply? If a cor­po­ra­tion issues new long-term debt secu­ri­ties (let’s leave out com­mer­cial paper for the moment), the buy­ers need to trans­fer money from some­where else to the cor­po­ra­tion. So no new money is cre­ated, right? Same as if the cor­po­ra­tion issues new equity secu­ri­ties.

    And this gets to the heart of what’s really been con­fus­ing me as I’ve tried to under­stand this topic. When I see the graphs of debt/GDP grow­ing in an appar­ently unsus­tain­able way, I keep won­der­ing if that’s the proper way to ana­lyze the econ­omy. Would it be more proper to ana­lyze money_supply/GDP? I mean, how could the Fed­eral Reserve (I’m an Amer­i­can) have allowed total credit out­stand­ing to grow so much faster than GDP all of these years? Has this really escaped their atten­tion? What does the graph of money_supply/GDP look like? Is that what they track?


  • mar­venger1


    The money raised in equity rais­ing is often bor­rowed, so this would also increase the money stock. But I guess it depends on where the money is bor­rowed from, if it was bor­rowed from the money mar­kets it might be prof­its look­ing for some­where to be rein­vested, if it was directly from a bank it might be freshly minted. 

    In a more finan­cially reg­u­lated sys­tem, includ­ing the gold stan­dard, it seems prof­its being rein­vested results in a more defla­tion­ary envi­ron­ment where assets and goods are increas­ing but the money sup­ply not so much. This seems bet­ter for work­ers — if you remain employed — when its hard for wages to go down. With dereg­u­la­tion you get more cash being gen­er­ated along with growth in assets so the nom­i­nal value of cap­i­tal­ists cap­i­tal isn’t going down and they have more con­trol over the cash in the sys­tem as the amount of cash has gone up hugely but work­ers salaries not so much. There is ini­tially more work for work­ers but they are not par­tic­i­pat­ing as much in pro­duc­tiv­ity gains, which is then made worse by increase in lever­aged buy­outs and mas­sive MNCs with huge power in race to the wages bot­tom where indus­tri­alised coun­tries indus­try gets hol­lowed out — bad for work­ers again. As the MNC’s prof­its pile up and there is less con­sumer demand as jobs are in low wage devel­op­ing coun­tries who are sav­ing like mad because of no social secu­rity, then there is a huge sup­ply of cash and not much need for the cre­ation of new cash except to con­tin­u­ally bailout selected asset hold­ers who don’t want to realise the real econ­omy doesn’t match the value of their assets. Then of course you have to fig­ure the pol­i­tics with China, Europe, US and the fund­ing of USs mil­i­tary.

    Abstract­ing more again; so in the reg­u­lated envi­ron­ment you really want to be a bond holder even though as you increase these posi­tions it cre­ates a greater and greater bur­den on the econ­omy, whereas in the unreg­u­lated sys­tem you want to con­trol cash, and the econ­omy turns into a gulag casino, the bond hold­ers who have less power are forced into accept­ing lower and lower inter­est rates to keep the econ­omy going until it doesn’t any­more — defal­tionary forces build­ing accom­pa­nied by bailouts and open bribes to get peo­ple to bor­row.

    Oh Mista Hart! Whatta mess!


    It seems it would all be bet­ter if you just did away with inter­est bear­ing secu­ri­ties and went all out equity hold­ing, with a whole lot of reg­u­la­tion to pre­vent volatil­ity. If spec­u­la­tors can’t make quick money and some flex­i­bil­ity and nim­ble­ness is lost — tough tit­ties — its a small price to pay for some sta­bil­ity for every­one. The prob­lem is there needs to be inter­na­tional co-oper­a­tion or any attempt at sta­bil­ity will never work and loop­holes a plenty will be exploited. Keynes was dead right on that.

  • team10­tim

    Hey hey Steve,

    A ques­tion about your data on the first graph (fig­ure 1) The debt to GDP ratio for the US is an unbro­ken line. I’ve plot­ted this same graph before using two data series, but there is a gap between them from 1945 to 1970. It is a small gap and the cor­re­la­tion between the two series dur­ing the over­lap is excel­lent.

    For 1916 to 1970 I used the His­tor­i­cal Sta­tis­tics of the United States, Colo­nial Times to 1970 (series 1) and for 1945 to present I used The Fed­eral Reserve Sta­tis­ti­cal Release (series 2) Series 1 has slightly higher val­ues than series 2 and I plot­ted them as sep­a­rate lines and just added a foot­note to explain.

    Eye­balling that graph it looks like you switched to the Fed data in 1945 when it first became avail­able.

  • mick­eyc

    It is amus­ing that such lengths as this paper are needed to prove that bor­row­ing money that you have no chance of pay­ing back is bad.
    Key­ne­sians argue that what is bad at the indi­vid­ual level and busi­ness level is sound at the gov­ern­ment level. The obvi­ous absur­dity of this is no bar­rier to belief. The utter col­lapse of gov­ern­ment after gov­ern­ment due to over indebt­ed­ness doesn’t reg­is­ter.
    The human race has an unquench­able belief in magic. Some of the smartest peo­ple in our mod­ern soci­eties will argue these points and can­not be con­vinced that 1 plus 1 can never equal 3. We give Nobel prizes to peo­ple like Krug­man who vocif­er­ously argues that the right thing to do when over­whelmed by debt is to bor­row more.
    The “debt is good” mantra is as sophis­ti­cated as the cargo cults of Papua New Guinea. One day we may get past this stage of devel­op­ment. I have my doubts though as the “some­thing for noth­ing” bug seems to be a hard wired flaw of the human race.

  • ak


    Please pro­vide a list of coun­tries which gov­ern­ments have col­lapsed on their inabil­ity to cre­ate money to ser­vice pub­lic debt denom­i­nated in the domes­tic cur­rency.

    Could you also prove that 5–10% infla­tion always leads to hyper­in­fal­tion? Could you prove that a coun­try expe­ri­enc­ing a period of defla­tion has a higher real GDP than a coun­try expe­ri­enc­ing mod­er­ate infla­tion?

    Can you prove that pri­vate debt is the same as pub­lic debt? What if the Marx­ist the­ory of class con­scious­ness is right and the idea that the finan­cial assets (back­ing up the pub­lic debt) must not be diluted or else the world will col­lapse is just a scam invented to pre­serve the income redis­tri­b­u­tion mech­a­nism cre­ated over the last few decades?

    Please be aware that while some West­ern coun­tries will per­form the bizarre rit­ual of stran­gu­la­tion of their economies due to the con­straints put on the bud­get deficits, the Chi­nese will print money when needed and power ahead. This is the “cre­ative destruc­tion” of the West. Let’s wait and see how global real resources will be redis­trib­uted in 10–20 years time. Let’s wait and see who wins the wars in the Mid­dle East and how the Euro­pean Union deals with their inter­nal prob­lems.

    Hint: look at Kosovo. The idea that they can vio­late the sov­er­eignty of a coun­try and then impose their own ideas of mul­ti­cul­tural soci­ety upon Serbs and Alba­ni­ans has been tested there over the last 10 years. The Euro bureau­crats know every­thing bet­ter and they think that they rule the whole Europe by dik­tat. Now it’s time to test mon­e­tarism or rather
    in action.

    Now they want to make Greece and other South­ern coun­tries look like Kosovo — an Euro­pean pro­tec­torate. They would like to make the whole Europe (except for Ger­many and France of course) to look like a pro­tec­torate. The neo­con­ser­v­a­tive pro­pa­ganda is just a tool to brain­wash peo­ple that “there is no alter­na­tive”.

    Maybe the West­ern civil­i­sa­tion built on the foun­da­tions of over­con­sump­tion, greed and sacro­sanct absolute prop­erty rights has already reached its use-by date. The West­ern pseudo-democ­racy where cor­po­ra­tions rule the coun­tries by prox­ies (by lob­by­ing) has lost its abil­ity to self-adjust. Every­thing except poor indi­vid­u­als is too big to fail. What if the mod­ernised Chi­nese post-com­mu­nist sys­tem is able to adjust bet­ter to the chang­ing global real­ity?

    I don’t think there will be a rev­o­lu­tion. There will be 10–20 years of stag­na­tion and then a new global order will slowly emerge when we start run­ning out of nat­ural resources. And our uni­ver­si­ties will keep teach­ing the same neo­clas­si­cal and Aus­trian eco­nom­ics so that nobody ques­tions the right of ren­tiers to get free lunch every day.

    The Chi­nese ren­tires of course.

  • Will do re the PDF of the Empir­i­cal paprt goidcc–sorry for miss­ing this request. I have a pre­sen­ta­tion and a num­ber of other things I’ll post soon as well. Greet­ings all from New York while in tran­sit to Boston!

  • michael­roberts

    Great piece. Much along the lines of my own thoughts although I would use Marx’s cat­e­gory of ‘fic­ti­tious cap­i­tal’ to cover the exces­sive debt the­sis. I’d like to send you a recent paper I am pre­sent­ing to the AHE con­fer­ence in Bor­deaux and have a look at my own blog at thenextrecession.wordpress.com/
    for sim­i­lar stuff.

  • Sleeper

    Steve, has you included for­eign cen­tral bank deposits at the FED in your cal­cu­la­tions?

  • ak

    Michael Roberts,

    I had a quick look at your blog, your book and I checked out a few papers writ­ten by some Chi­nese schol­ars. I will read more but I just don’t want to jump the queue. I can only spend about an hour a day on study.

    You may be right. This was also my gut feel­ing in 2008 — so sad that the lib­eral ideas I had believed in since the 1980-ties turned to some extent to dust.

    Since the West over­whelm­ingly rejects Post Key­ne­sian eco­nom­ics (con­tain­ing vital ele­ments of Marx­ism intro­duced by Michal Kalecki) the slo­gan “Social­ismo o Muerte” may get yet another mean­ing in the future. Marx­ism has not died despite the col­lapse of the East­ern Euro­pean “Real Social­ism” imple­men­ta­tion and is very much alive — in China and Viet­nam of course.

    When we finally screw up our envi­ron­ment and deplete our nat­ural resources the neolib­eral sys­tem has absolutely no chance to sur­vive no mat­ter how many Emis­sion Trad­ing Schemes are intro­duced. In the cap­i­tal­ist sys­tem peo­ple are sup­posed to con­sume more and they will con­sume to death. 

    Only the sys­tem based on cen­tralised allo­ca­tion of resources and medi­a­tion between con­flict­ing inter­ests of the agents is able to adjust. Marx­ists know that. Espe­cially the Chi­nese Marx­ists.


    The con­cept of “new eco­nomic man” just asks for a mul­ti­a­gent ver­i­fi­ca­tion show­ing that it describes the real­ity bet­ter than the “old eco­nomic man” (I have no doubts about that). The analy­sis based on dimin­ish­ing rate of prof­its (the profit cycle) should also be used to build a dynamic model. 

    Kalecki should meet Keynes — again. Oth­er­wise the sun will set over the Great West­ern Civil­i­sa­tion.

  • Amotzza


    Thanks for shar­ing such a great paper — what date in Sep­tem­ber are you pre­sent­ing it.
    You are a real reminder that Aus­tralia has not escaped the GFC. Being on the front line of dis­cre­tionary expen­di­ture busi­ness there con­tinue seri­ous defla­tion­ary pres­sures.

    I am appalled at the RBA increas­ing rates for that part of the econ­omy that is related to resources indus­try.
    I just received cer­tain life pol­icy state­ments from AMP in which the value of the invest­ment com­po­nent also declinin

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  • Steve, as I read more on bank­ing, I learn more. The M0 you men­tion isn’t meant for lend­ing at all, but for the sat­is­fac­tion of bank lia­bil­i­ties. It is noth­ing but cur­rency and Fed­eral funds, money that gen­er­ally cir­cu­lates between banks to sat­isfy lia­bil­i­ties between banks. The rea­son the level went up in the depres­sion wasn’t because there was a demand for more lend­ing, but a demand for more cash. Bank deposits in gen­eral aren’t cash, but bank cred­its cre­ated out of lend­ing. The trig­ger of the GFC wasn’t bad loans, but insol­ven­cies and illiq­uidi­ties between banks. If Citi had main­tained its deposit base along with its lend­ing, it wouldn’t have cre­ated the prob­lems it cre­ated, but while mak­ing an extremely large amount of new credit, it incurred siz­able fed fund lia­bil­i­ties to other banks. Of course Lehman and Bear also had prob­lems rolling their lia­bil­i­ties. Cus­tomers gen­er­ally don’t want cur­rency, but trans­act busi­ness in checks and other forms of trans­fers between accounts. Once bal­ances start falling, the lia­bil­i­ties between banks have to be liq­ui­dated as well. 

    An exam­ple is this report from the BIS labeled The US dol­lar short­age in Global bank­ing by Patrick McGuire and Goetz von Peter dated March 2009. In it they go into the var­i­ous means of sat­is­fy­ing the lia­bil­i­ties of banks as a result of lend­ing in cur­rency other than their home cur­rency. If a bank lends dol­lars, it owes them some­where. I the­o­rize that since the TED spread was so high dur­ing the first leg of the GFC that there weren’t enough dol­lars to keep the banks in Europe afloat and thus they couldn’t sat­isfy their lia­bil­i­ties with­out sell­ing assets in a bad mar­ket. I would bet a dime t a donut as they say in Amer­ica that the QE Bernanke did was designed to put cash in this sys­tem and unfreeze it. The result wasn’t more lend­ing because the banks already didn’t have enough cash to sat­isfy their already present lia­bil­i­ties. I am sure that Lehman was one of the coun­ter­par­ties tht pro­vided much of the imag­i­nary cash that the sys­tem ran on and absent Lehman, they needed more of the real stuff. The BIS said that these lia­bil­i­ties has swelled from $11 tril­lion in 2000 to $31 tril­lion in 2007.

    I think this answers a good part of the ques­tion as to why M0 doesn’t trans­late to M1. The banks already have lia­bil­i­ties greater than the cash they pos­sess and through expan­sion itself, liq­uid­ity is pro­duced. Absent expan­sion, there isn’t liq­uid­ity and it then has to be arti­fi­cial. As I have exam­ined the sys­tem, I have thought for some time the sup­posed mul­ti­plier effect of M0 is non­sense and the real lim­it­ing fac­tor in lend­ing is the capac­ity of banks to act as surety for the credit they extend, their net worth. With­out cap­i­tal, the capac­ity of banks to fill their non-deposit lia­bil­i­ties is dimin­ished.

    Min­sky, in Sta­bi­liz­ing an Unsta­ble Econ­omy goes into detail early about all the finan­cial inno­va­tion that had gone on since the banks had pretty much run out of good col­lat­eral to take to the Fed. It is this break­down that sig­nals the cri­sis. The story is this is what causes the cri­sis, but the cause is always spec­u­la­tive lend­ing.

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