Levy Paper

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This is just a very quick post to make my paper at the Levy Insti­tute avail­able. Later I’ll add a post of the paper itself and a video of the pre­sen­ta­tion.

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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  • glu­bilee

    @sj — its seems to me for­mal edu­ca­tion = for­mal influence.…somewhat par­al­lel, I find it inter­est­ing when I see self-made millionaire/billionaires busi­ness folks (not invest­ment guys) on finan­cial shows they always seem way more sen­si­ble than CEOs that did not build their busi­nesses but who sim­ply rose thru the ranks, a dif­fer­ent skill set than cre­at­ing, grow­ing a business…sometimes some of ini­tial suc­cess looks like a lot of luck, but guys like Bran­son, Mark Cuban, they seem to have much more lively, inde­pen­dent minds and seem, strangely, more con­nected to real eco­nomic world.

  • djc


    Con­grat­u­la­tions on your lat­est work. I agree that you are way ahead of the pack, but still a way to go (well, that will always be the case).

    Some thoughts on your equa­tion (15). As I under­stand it your basic equa­tions are (k=1/taus)

    PQ = kF (1)
    LW=k(1-s)F (2)
    Q=aL (3)

    Divid­ing (2) by (1) and sub­sti­tut­ing L/Q = 1/a from (3)and a minor rearrange­ment gives your result

    W/P = a(1-s) (4)

    I think this sim­ple deriva­tion shows firstly that an assump­tion of “equi­lib­rium” is not required. Equation(4) holds even when all vari­ables depend on time or on all the other vari­ables.

    The key assump­tion I think is that Q in (1) is the same as Q in (3). It seems to me that the sim­plest way to ensure this is to define Q as units sold rather than pro­duced, in which case pro­duc­tiv­ity a includes the efforts of work­ers in dis­tri­b­u­tion, sales, mar­ket­ing etc. With P defined as cash received by the firm (approx­i­mately the same as price but allow­ing for delays in pay­ment) I think (1)-(4) are exact. Such things as vari­able inven­to­ries could be allowed for with k as a func­tion of time. But since (4) is inde­pen­dent of k it is not affected. There is an obvi­ous advan­tage in hav­ing P under­stood as price in (4) but I think it would be much eas­ier to intro­duce a cor­rec­tion such as a time delay in a final result, rather than attempt to incor­po­rate delays in the dif­fer­en­tial equa­tions.

    Tak­ing (4)-(3) gives

    W/P-Q/L = –as

    again not requir­ing an equi­lib­rium assump­tion. In fact, I think this shows that equi­lib­rium is impos­si­ble and why your treat­ment is needed (rather than: there is an equi­lib­rium, but cap­i­tal­ists can’t make a profit). I think it also shows that equi­lib­rium can­not be con­sid­ered a rea­son­able approx­i­ma­tion (unless a and/or s vary with time, includ­ing neg­a­tive val­ues so that –as some­how aver­ages to zero; or if some angel is avail­able to sup­ply cash at the rate as). 

    It also seems to me that all these results fol­low in a multi-firm model with the vari­ables expressed as appro­pri­ately weighted aver­ages.

    When I can find the time I will have a go at QED.

  • Mar­co2

    @ AK and TruthIs­ThereIs­NoTruth

    I believe AK only meant to pro­vide an illus­tra­tion of unpro­duc­tive resource allo­ca­tion with the PhD guy design­ing HFT soft­ware exam­ple. That, I would say, does not mean IT is the only or indeed the main place where resources are this kind of thing hap­pens.

    The para­graph where AK men­tioned the PhD guy was pre­ceded by mea­sures to fix the “leaky bucket”: “Cap­i­tal gains tax and resources rental tax could help. Instead of hoard­ing money and spec­u­lat­ing peo­ple should be ‘gen­tly’ encour­aged (by a 90% cap­i­tal gains tax on real estate and 10% annual tax on wealth above $10mln for exam­ple) to invest in mod­ern pro­duc­tive tech­nolo­gies and move us away from depen­dency on fos­sil fuels”.

    This, it seems to me, implies that resources are allo­cated unpro­duc­tively in other mar­kets. Per­haps AK had min­ing and real estate in mind as he wrote that? 

    As I am not in IT, I can’t judge by myself, on my own expe­ri­ence, but I find it quite pos­si­ble that TruthIs­ThereIs­NoTruth has a point when he states that FIRE IT is chiefly con­cerned with other kind of things.

    This, I sup­pose, does not mean that TruthIs­ThereIs­NoTruth is deny­ing that FIRE sec­tor is indeed inno­v­a­tive and that some of these inno­va­tions are indeed detri­men­tal to the sta­bil­ity of the sys­tem.

    From my hum­ble per­spec­tive, the morals of the story is: this dis­cus­sion (as is often the case with dis­cus­sion ide­o­log­i­cally moti­vated) started by some­one mis­read­ing some­one else’s prob­a­bly unfor­tu­nate exam­ple.

    Just my two cents. Now, please, by all means, carry on.

  • djc

    I’m get­ting a mes­sage: zipped folder is invalid or cor­rupted when I try to open QED on my com­puter. Any­one else?

  • Mar­co2

    I’ve found Robert Samuelson’s arti­cle quite instruc­tive:

    Eco­nom­ics: the shaky sci­ence

    In short: Mr. Samuel­son is AFRAID that the stim­u­lus-gen­er­ated deficit and debt will some­how cause a cat­a­stro­phe.

    One should be afraid too, Mr. Samuel­son seems to believe.

    In Samuelson’s words: 

    This means that the ben­e­fits of higher deficits can be lost in many ways:
    [1] through higher inter­est rates if greater debt FRIGHTENS investors;
    [2] through declines in pri­vate spend­ing if con­sumers and busi­nesses lose con­fi­dence in gov­ern­ments’ abil­ity to con­trol bud­gets; and
    [3] through a bank­ing cri­sis if bank cap­i­tal — which con­sists heav­ily of gov­ern­ment bonds — declines in value.
    There’s a tug of war between the stim­u­lus of big­ger deficits and the FEARS inspired by big­ger deficits.”

    Samuel­son makes it appear that there are two sep­a­rate chan­nels (i.e. [1] and [3]) through which the finan­cial mar­kets could col­lapse.

    That’s not true. Samuel­son explains it as two sep­a­rate, dif­fer­ent chan­nels, but it is only one (I guess, two things look scarier than one).

    You see, the present value of a bond is related to the coupons paid to the bond-holder and the inter­est rate by the fol­low­ing for­mula:

    V = C/r [*]

    In this for­mula, V is the present value of the bond, which is also its mar­ket value; C is the coupon, and r is the inter­est rate. If inter­est rate goes up (i.e. r “grows”), as the coupon does not change, then V falls as well, and so falls the mar­ket value of the bond. 

    So, it’s mis­lead­ing to explain this as two sep­a­rate things: inter­est rates increases and falling bonds mar­ket val­ues go together. 

    But this does not address the ques­tion: is it likely that inter­est rates will go up?

    Curi­ously, Samuel­son admits he doesn’t have any imme­di­ate rea­son to be afraid: “Inter­est rates on 10-year Trea­surys are just over 3 per­cent”. So, no, they aren’t high right now. 

    Thus, what­ever the risks of a finan­cial col­lapse are, they seem remote. Con­se­quently, “lenders haven’t lost con­fi­dence in U.S. Trea­sury bonds”.

    But even though inter­est rates are ris­ing now, is there any rea­son why inter­est rates in the US should go up any time soon? No, not really. Infla­tion in the US is low and in the US as in Aus­tralia, cen­tral banks con­sider their main duty to con­trol infla­tion.

    Fur­ther: the deci­sion to increase inter­est rates belongs to the Fed. By ris­ing inter­est rates, the Fed also hurts the employ­ment per­spec­tives of mil­lions of Amer­i­cans. How­ever, nobody seems to care much for them. In par­tic­u­lar, Mr. Samuel­son does not even men­tion them. But he is very con­cerned about US bank stock­hold­ers… Hmmm.

    But if this is how things are in the US, what about Europe, where the debt sit­u­a­tion is, in some senses, worse than in the US

    Let’s par­tic­u­larly have a look at Ire­land, where the local experts have done what Mr. Samuel­son wants the Amer­i­can Gov­ern­ment to do (i.e. cut down Gov­ern­ment spend­ing and taxes):

    A Ter­ri­ble Ugli­ness is Born

    In Ire­land, a Pic­ture of the High Cost of Aus­ter­ity

    And let’s have a look at Ice­land, another lit­tle island, not too far from Ire­land, where the Gov­ern­ment could not do what local experts wanted to do:

    The Ice­landic Post-Cri­sis Mir­a­cle

    So, the Irish have done what Mr. Samuel­son asks, and they aren’t doing too well. The Ice­landers haven’t done it, and the sky hasn’t fallen.

    This is clear a sign that Mr. Samuel­son is right, no doubt… Hmmm.

    As we have seen many times here, mon­e­tary pol­icy in Europe fol­lows a largely dif­fer­ent set of rules than in the US, because of the Mon­e­tary Union. As it has been treated here before, prob­a­bly much bet­ter than I’d man­age, I will save myself the trou­ble.

    Okay, we have dealt with three of the chan­nels Mr. Samuel­son con­sid­ers things can go pear shaped. What about the remain­ing chan­nel, that is [2]?

    What hap­pens if peo­ple lose con­fi­dence?

    Frankly, I don’t know. The poten­tial con­se­quences, I believe, might range from peo­ple jump­ing off a cliff; to just tak­ing a warm shower, a cold beer and going to bed early. Your guess is as good as mine.

    Is there any rea­son to believe the loss of con­fi­dence will be cat­a­strophic? No, there isn’t. As far as I know: no real data, no the­ory. Nada.

    By the way, I don’t know what the con­se­quences could be, but nei­ther does Mr. Krug­man (and he is a Nobel Prize):

    The Con­ven­tional Super­sti­tion

    Does Mr. Samuel­son know? He might, but thank­fully, he spared us the shilling details.

    How­ever, for some­one who is so awfully con­cerned about pan­ics and loss of con­fi­dence, Mr. Samuel­son seems very com­fort­able scar­ing peo­ple, as his arti­cle does. Maybe he should have cam­paigned to get the Obama admin­is­tra­tion to impose more rigid con­trols and reg­u­la­tions on the finan­cial indus­try, as Frau Merkel wanted to do in the recent G20 meet­ing.


    [*] Any Macro 101 NEOCLASSICAL book, avail­able pretty much any­where, con­tains either this for­mula or an equiv­a­lent. Those inter­ested need just to search for it.

  • scep­ti­cus

    Hi again steve. I am not fiished read­ing this lat­est out­put of yours but I wanted to ques­tion this bit:

    Cir­cuit the­ory
    gives the best foun­da­tion for under­stand­ing the dynam­ics of credit cre­ation, but ini­tial attempts
    to devise a model from this the­ory reached para­dox­i­cal results—in par­tic­u­lar, the wide­spread
    con­clu­sion that cap­i­tal­ists could not make prof­its in the aggre­gate if they had to pay inter­est on
    bor­rowed money, or if work­ers saved any of their wages”

    I ten­ta­tively sug­gest that the ini­tial con­clu­sion above is cor­rect. Sec­toral bal­ances tell us that if we assume no gov­ern­ment sec­tor then the income of the busi­ness sec­tor must equal the deficit of the house­hold sec­tor. These are flows.

    These flows can only be sus­tain­able (e.g. avoid an increase in pri­vate debt) if the busi­ness sec­tor spends all its prof­its such that they recir­cu­late as wages.

    How­ever to expect such recir­cu­la­tion with­out some dis­si­a­p­a­tive effect in a closed zero growth econ­omy seems to me to be a mat­ter of the­o­ret­i­cal license.

    Is it not the case that ris­ing pub­lic sec­tor debt com­bined with the illu­sion of the per­pet­ual reli­a­bil­ity of sov­er­eign AAA rat­ings has served to keep the house­hold sec­tor afloat and mask the essen­tial and inescapable con­clu­sions of busi­ness-house­hold sec­tor bal­ance iden­ties?

    Had peo­ple not believed 1980–2010 in the infal­li­bil­ity of soveraign debt then exist­ing pri­vate debt-gdp lev­els could not pos­si­bly have reached the heights they have actu­ally attained.

    I am sug­gest­ing that the excess busi­ness sec­tor prof­its that have been realised 1980–2010 above that which was actu­ally sus­tain­able long term can more or less now be mea­sured as the global pub­lic sec­tor deficit.

  • djc


    Fur­ther to my com­ments on your eq(15): mod­i­fy­ing the basic equa­tions to allow for some heli­copter money to be dropped on the econ­omy (H in $/time) gives

    PQ = kF
    LW=k(1-s)F + H

    which leads to a steady-state (“bal­anced”) econ­omy when H = sPQ. This leads to W/P = a instead of your W/P = a(1-s). The source of H could be fiat money cre­ated at the rate g ($/time) com­bined with credit cre­ated at the rate m.g where m is a dimen­sion­less mul­ti­plier. Then g(1+m) = sPQ is required for steady-state. Tak­ing s=0.4 (which I think from mem­ory you have used) and PQ as GDP then g(1+m) needs to be 40% of GDP. This seems plau­si­ble — say, g=0.1*GDP, m=3. Note that this is a no-growth econ­omy, so actual observed val­ues for g(1+m) are likely to be higher. BTW, this for­mu­la­tion doesn’t imply that m is fixed and that g deter­mines m.g but rather that together they need to be such that g(1+m) = sPQ for steady-state. For instance, it seems to me that in the US Bernanke has been sub­stan­tially increas­ing g because m is too small.

    My thought is that steady-state val­ues for the vari­ables might lead to a bet­ter fit of your model to data than the “equi­lib­rium” val­ues, with­out much change to the qual­i­ta­tive dynam­ics; that is, dP/dt = b(Pss-P) rather than b(Pe-P), etc