Are We “It” Yet?

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If you've downloaded and read the paper and presentation I posted in my previous entry, then there's nothing new for you to read in the body of this post; the main addition is the video below of my talk.

Steve Keen's Debtwatch Podcast 

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That in part gives you rather too good a view of the back of the heads of Randy Wray and Dimitry Papadimitriou, both of whom sat down in front of the camera after my talk began, but the slides are still easily visible.

Soon I'll publish another post with the video of the talk I gave in New York to Debtwatch members, which has substantially more background on the model and the approach I take to modelling in general, and an extremely good and lengthy discussion.

Abstract

My 1995 paper on modeling Minsky's Financial Instability Hypothesis concluded with the statement that its "chaotic dynamics … should warn us against accepting a period of relative tranquility in a capitalist economy as anything other than a lull before the storm" ((Keen 1995, p. 634)). That storm duly arrived, after the lull of the "Great Moderation". Only a Fisher-Keynes-Minsky vision of the macroeconomy can make sense of this crisis, and the need for a fully fledged Minskian monetary dynamic macroeconomic model is now clearly acute.

I also introduce a new free tool for dynamic modeling which is tailored to modeling financial flows--QED. See pages 49-53 the Appendix for details.

Empirics

As Vicki Chick so succinctly put it, Minsky the Cassandra was an optimist ((Chick 2001)). The stabilizing mechanisms that Minsky initially felt would help prevent "It" from happening again ((Minsky 1982)) have been overwhelmed by a relentless accumulation of private sector debt, which have reached levels that dwarf those which caused "It" eighty years ago. Though "It" has not yet definitively happened again, neither did our forebears in the 1930s realize that they were in "It" at the time—as a perusal of the Wall Street Journal from those days will confirm:

Market observers are watching the current rally closely since it has lasted about 10 days, or about the same as the technical rally starting in late April that gave way to a renewed bear movement. It's believed "ability of the rising trend to carry on for several days more would strengthen indications of a definite turn in the main trend of prices." (Dimitrovsky 2008, Wall Street Journal June 16 1931)

A comparison of 1930s data to today emphasizes that the same debt-deflationary factors that gave us the Great Depression are active now; the only differences are that both the private sector deflationary forces and the government reaction are much greater today.

Private sector debt is far higher today than in the 1930s, both in the USA and elsewhere in the OECD. The data shown in Figure 1 for the USA and Australia is replicated to varying degrees by most OECD nations ((See Table 1 in Battellino 2007, p. 14)).

Figure 1: Debt to GDP ratios in the USA and Australia over the long term

So too is the impact of debt-financed economic activity, both as an engine of apparent prosperity during the "Great Moderation", and as the force causing the "Great Recession" now. Following Minsky, I regard aggregate demand in our dynamic credit-driven economy as the sum of GDP plus the change in debt:

If income is to grow, the financial markets … must generate an aggregate demand that, aside from brief intervals, is ever rising. 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)

That debt-financed component of demand (where that demand is expended upon both commodity and asset markets) was far greater during the false boom after the 1990s recession than it was during the 1920s, and the negative contribution today is also larger than for the comparable time in the 1930s.

Figure 2 shows the levels of debt and GDP in 1920-1940, while Figure 3 shows how much debt added to demand during the 1920s, and subtracted from it during the 1930s.

Figure 2: Debt and GDP before and during the Great Depression

Figure 3: Aggregate demand as the sum of GDP plus the change in debt

The change in debt was so great that it dominated the impact of GDP itself in determining changes in the level of employment. Figure 4 correlates the change in debt with unemployment; over the boom and bust years of 1920-1940, the correlation was -0.938—rising debt was strongly correlated with falling unemployment, and vice versa.

Figure 4: Change in debt and unemployment before and during the Great Depression

The same metrics have played out between 1990 and today, but with far greater force. As Figure 5 shows, the debt dominates GDP even more now than it did when "It" happened.

Figure 5: Private debt and GDP 1990-2010

The debt contribution to demand during the boom years till 2008 is therefore much greater (Figure 6).

Figure 6: Aggregate demand 1990-2010

The correlation of changes in private debt with unemployment, at -0.955 between 1990 and today, is even stronger than in the 1920-30s.

Figure 7: Change in debt and unemployment, 1990-2010

A useful metric in gauging the impact of debt on demand is to compare the change in debt to the sum of GDP plus the change in debt (the dynamic measure of aggregate demand as per (Minsky 1982, p. 6)). Figure 8 measures this from the point at which the debt contribution to demand was the greatest in the boom prior to the crises of 1930 and 2008—mid-1928 and December 2007 respectively. It also includes the contribution to aggregate demand from government debt. This, more than any other measure, tells us that the GFC is bigger than the Great Depression, and that we are still in its early days.

Figure 8: The turnaround in debt-financed demand, Great Depression and today

Firstly, the contribution to demand from rising private debt was far greater during the recent boom than during the Roaring Twenties—accounting for over 22% of aggregate demand versus a mere 8.7% in 1928. Secondly, the fall-off in debt-financed demand since the date of Peak Debt has been far sharper now than in the 1930s: in the 2 1/2 years since it began, we have gone from a positive 22% contribution to negative 20%; the comparable figure in 1931 (the equivalent date back then) was minus 12%. Thirdly, the rate of decline in debt-financed demand shows no signs of abating: deleveraging appears unlikely to stabilize any time soon.

Finally, the addition of government debt to the picture emphasizes the crucial role that fiscal policy has played in attenuating the decline in private sector demand (reducing the net impact of changing debt to minus 8%), and the speed with which the Government reacted to this crisis, compared to the 1930s. But even with the Government's contribution, we are still on a similar trajectory to the Great Depression.

What we haven't yet experienced—at least in a sustained manner—is deflation. That, combined with the enormous fiscal stimulus, may explain why unemployment has stabilized to some degree now despite sustained private sector deleveraging, whereas it rose consistently in the 1930s (Figure 9).

Figure 9: Comparing unemployment then and now

Here some credit may be due to "Helicopter Ben". Though Bernanke and Greenspan clearly played a role in encouraging private debt to reach the heights it did, it is certainly conceivable that his enormous injection of base money into the system in late 2008 averted a nascent deflation (Figure 10).

Figure 10: Inflation, deflation and base money growth 2005-Now

Here Bernanke is replaying the tune from 1930s—though much more loudly. Though he accused his 1930 counterparts of causing the Great Depression via tight monetary policy (Bernanke 2000, p. ix), a closer look at the data shows that he was merely more decisive and successful than his predecessors: they too boosted M0 in an attempt to restrain deflation, but nowhere near as much, as quickly, or in such a sustained way.

Figure 11: Inflation, deflation and base money growth in the 1930s

What he shares with them is partial responsibility for causing the Great Recession, since like them he ignored the impact of private debt on economic performance ((Bernanke 1995, p. 17) and (Bernanke 1983, p. 258 & note 5)), when that—and not "improved control of inflation" ((Bernanke 2004))—was the real "positive" cause of the "Great Moderation, as it is now the defining negative factor of the Great Recession.

Whether this suc­cess can con­tinue is now a moot point: the most recent infla­tion data sug­gests that the suc­cess of “the logic of the print­ing press” may be short-lived. The stub­born fail­ure of the “V-shaped recov­ery” to dis­play itself ((Lazear and Mar­ron 2009, p. 54)) also reit­er­ates the mes­sage of Fig­ure 7: there has not been a sus­tained recov­ery in eco­nomic growth and unem­ploy­ment since 1970 with­out an increase in pri­vate debt rel­a­tive to GDP. For that unlikely revival to occur today, the econ­omy would need to take a pro­duc­tive turn for the bet­ter at a time that its debt bur­den is the great­est it has ever been (Fig­ure 12).

Fig­ure 12: Debt to GDP and unem­ploy­ment 1970-Now

Debt-financed growth is also highly unlikely, since the trans­fer­ence of the bub­ble from one asset class to another that has been the by-product of the Fed’s too-successful res­cues in the past ((Min­sky 1982, pp. 152–153.)) means that all pri­vate sec­tors are now debt-saturated: there is no-one in the pri­vate sec­tor left to lend to (Fig­ure 13).

Fig­ure 13: US debt by sec­tor, 1920-Now

Mod­el­ing Minsky

How do we make sense of this empir­i­cal real­ity? Cer­tainly main­stream eco­nom­ics, with its equi­lib­rium fetish and igno­rance of credit, is a waste of time—it func­tioned more as a means to divert atten­tion from what mat­tered in the econ­omy than as a means to under­stand it. Min­sky pro­vides the foun­da­tion from which our predica­ment can be under­stood, but our ren­di­tion of his vision is still sparse com­pared to the worth­less but elab­o­rate Neo­clas­si­cal tapes­try. We need an inher­ently mon­e­tary, his­tor­i­cally real­is­tic and non-equilibrium macroeconomics.

My con­tri­bu­tion to this has been to extend my orig­i­nal Min­sky model ((Keen 1995))—built on the foun­da­tions of Goodwin’s model of a cycli­cal econ­omy (Good­win 1967) —by devel­op­ing mod­els of endoge­nous money cre­ation derived from Cir­cuit The­ory ((Graziani 1989), (Graziani 2003)), and by–tentatively–combining the two.

My basic Min­sky model extended Goodwin’s pio­neer­ing “predator-prey” model of a cycli­cal econ­omy by replac­ing the unre­al­is­tic assump­tion that cap­i­tal­ist invest all their prof­its with the real­is­tic non­lin­ear propo­si­tion that they invest more dur­ing booms and less dur­ing slumps—with the vari­a­tion accom­mo­dated by a finan­cial sec­tor that lends money at inter­est. That led to a chaotic model which could, given appro­pri­ate ini­tial con­di­tions, gen­er­ate a debt-induced crisis—but which had a sta­ble equi­lib­rium. This was part of the way towards Min­sky. How­ever, while the fact that the equi­lib­rium was sta­ble was con­sis­tent with (Fisher 1933, p. 339, point 9), it was rather awk­ward when judged against Minsky’s famous state­ment that “Stability—or tranquility—in a world with a cycli­cal past and cap­i­tal­ist finan­cial insti­tu­tions is desta­bi­liz­ing” ((Min­sky 1982, p. 101)).

What was miss­ing in my orig­i­nal Min­sky model was Ponzi finance. Put sim­ply, this is debt-financed spec­u­la­tion on asset prices, which we can now see as the dri­ving force behind the accu­mu­la­tion of debt in the last two decades, and the con­se­quent infla­tion of asset prices. In my orig­i­nal model, all debt was related to the con­struc­tion of new cap­i­tal equip­ment, which is inher­ently a non-Ponzi behav­ior. I intro­duced a sim­u­lacrum of Ponzi finance ((Keen 2009)), with addi­tional debt being taken on when the rate of growth exceeds a thresh­old level, with­out adding to the cap­i­tal stock (the 4th equa­tion in ). This sim­u­lates spec­u­la­tion on asset prices, though with­out explic­itly mod­el­ing asset prices themselves.


That gen­er­ated a model in which sta­bil­ity was desta­bi­liz­ing, and in which the level of debt that trig­gered a break­down was rather closer to the cur­rent empir­i­cal record (see Fig­ure 14).

Fig­ure 14: The model in equa­tion as a sys­tems engi­neer­ing flow­chart

Cir­cuit Theory

Though my Min­sky model incor­po­rates debt, it is not an explic­itly mon­e­tary model, and the active role that the finan­cial sec­tor has played in caus­ing this cri­sis makes it obvi­ous that its own dynam­ics must be incor­po­rated in any real­is­tic model of our cur­rent predica­ment. 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 ((Graziani 1989, p. 5); (Bellofiore, Davan­zati et al. 2000, p. 410 note 9); (Rochon 2005, p. 125)).

It is rel­a­tively easy to show that this con­ven­tional Cir­cuitist con­clu­sion is the prod­uct of con­fus­ing stock—specifically here an ini­tial injec­tion of money into an economy—with a flow—the amount of eco­nomic activ­ity that the stock of money can gen­er­ate in a given time frame. I have done this by mod­el­ing a pure credit economy—one with­out fiat money in any sense—not because that is our actual finan­cial sys­tem, but because it is sim­pler to illus­trate that cap­i­tal­ists can bor­row money, pay inter­est, and make a net profit in a model in which the only source of finance is pri­vately issued debt.

To avoid being dis­tracted by sev­eral con­tentious but, in this con­text, side-issues amongst mon­e­tary the­o­rists, I demon­strate that cap­i­tal­ists can indeed make mon­e­tary prof­its in a model of the short-lived 19th cen­tury “Free Bank­ing” sys­tem ((Keen 2010)). The basic “con­stant money stock” model sim­u­lates a pri­vate bank that has printed N of its own dol­lar notes like those shown in Fig­ure 15, and then lends them to firms, who hire work­ers that pro­duce out­put that is then sold to cap­i­tal­ists, work­ers and bankers.

Fig­ure 15: Bank of Flo­rence (Nebraska) dol­lar note ((Smith­son­ian Insti­tu­tion 2010))

The basic flow oper­a­tions that apply in this sys­tem are that:

  1. The bank lends notes from its vault BV to the firms’ deposit accounts FD;
  2. Firms pay inter­est on the loans from their deposit accounts to the bank’s trans­ac­tions account BT;
  3. The bank pays inter­est from its trans­ac­tions account to the firms’ deposit accounts;
  4. Firms pay wages from their deposit accounts into work­ers’ deposit accounts WD;
  5. The bank pays inter­est from its trans­ac­tions account on work­ers’ account balances;
  6. Bank and work­ers pay for con­sump­tion of the out­put of firms; and
  7. Firms repay their loans by trans­fer­ring dol­lars from their deposit accounts to the bank’s vault.

These oper­a­tions are shown in the rel­e­vant rows in Table 1, and since, as Wynne God­ley so prop­erly insisted, “every flow comes from some­where and goes some­where” (God­ley 1999, p. 394), these oper­a­tions sum to zero on each row.

How­ever there are oper­a­tions in bank­ing that are not flows, but account­ing entries made on the debt ledger:

  1. The record­ing of the lend­ing of money by the bank to the firms on the debt ledger FL;
  2. The com­pound­ing of debt at the rate of interest;
  3. The record­ing of pay­ments of inter­est in row 2 above by deduct­ing the amount paid from the level of out­stand­ing debt; and
  4. The record­ing of pay­ments of prin­ci­pal in row 7 above by deduct­ing the amount paid from the level of out­stand­ing debt.

Table 1: Basic finan­cial trans­ac­tions in a Free Bank­ing econ­omy

Row Trans­ac­tion Type Bank Vault (BV) Bank Trans­ac­tion (BT) Firm Loan (FL) Firm Deposit (FD) Worker Deposit (WD)
1 Lend Money Money Trans­fer

–A

A

A Record Loan Ledger Entry

A

B Com­pound Debt Ledger Entry

B

2 Pay Inter­est Money Trans­fer

C

–C

C Record Pay­ment Ledger Entry

–C

3 Deposit Inter­est Money Trans­fer

–D

D

4 Wages Money Trans­fer

–E

E

5 Deposit Inter­est Money Trans­fer

–F

F

6 Con­sump­tion Money Trans­fer

–G

G+H

–H

7 Repay Loan Money Trans­fer

I

–I

D Record Repay­ment Ledger Entry

–I

Sum of Flows

I-A

C-D-F-G

A+B-C-I

A-C+D-E+G+H-I

E+F-H

The columns in this table rep­re­sent the equa­tions of motion of this model of free bank­ing, and the rate of change of each account is given by the sym­bolic sum of each column:


With the sub­sti­tu­tions shown in Table 2, the fol­low­ing model results:


Table 2: Finan­cial oper­a­tions in the Free Bank­ing model

Oper­a­tion Descrip­tion
A Loans to firms at the rate bV times the bal­ance in the vault at time t BV(t) bv.BV(t)
B The rate of inter­est on loans rL times the level of loans at time t FL(t) rL.FL(t)
C Pay­ment of inter­est on loans rL.FL(t)
D Pay­ment of inter­est on firm deposits FD(t) at the rate rD rD.FD(t)
E Pay­ment of wages by firms at the rate fD times firm deposits at time t FD(t) fD.FD(t)
F Pay­ment of inter­est on deposits at the rate rD rD.WD(t)
G Pay­ment for goods by banks at the rate bT times the level of the bank trans­ac­tion account at time t BT(t) bT.BT(t)
H Pay­ment for goods by work­ers at the rate wD times the level of the bank trans­ac­tion account at time t WD(t) wD.WD(t)
I Repay­ment of loans at the rate fL times the out­stand­ing loan bal­ance at time t FL(t) fL.FL(t)

As is eas­ily shown, with real­is­tic para­me­ter val­ues (see Table 3; the val­ues are explained later) this describes a self-sustaining sys­tem in which all accounts set­tle down to equi­lib­rium val­ues, and in which cap­i­tal­ists earn a mon­e­tary profit.

Table 3: Para­me­ter val­ues

Para­me­ter Value Descrip­tion
bV ¾ Rate of out­flow of notes from the vault BV
rL 5% Rate of inter­est on loans
rD 2% Rate of inter­est on deposits
fD 2 Rate of out­flow of notes from FD to pay wages
bT 1 Rate of out­flow of notes from BT to pay for bankers consumption
wD 26 Rate of out­flow of notes from WD to pay for work­ers consumption
fL 1/7 Rate of repay­ment of loans

Fig­ure 16 shows the dynam­ics of this sys­tem; with an ini­tial stock of N=100 mil­lion dol­lar notes.

Fig­ure 16: Bank account bal­ances over time

The equi­lib­rium val­ues can be solved for sym­bol­i­cally in this con­stant money stock model:


From account bal­ances to incomes

The yearly wages of work­ers and gross inter­est earn­ings bankers can be cal­cu­lated from the sim­u­la­tion, and they in part explain why, in con­trast to the con­ven­tional belief amongst Cir­cuitist writ­ers, cap­i­tal­ists can bor­row money, pay inter­est, and still make a profit. Though only $100 mil­lion worth of notes were cre­ated, the cir­cu­la­tion of those notes gen­er­ates work­ers’ wages of $151 mil­lion per annum (given the para­me­ter val­ues used in this sim­u­la­tion), 1.5 times the size of the aggre­gate value of notes in circulation.

Fig­ure 17: Wages and Gross Inter­est

This indi­cates the source of the Cir­cuitist conun­drums: the stock of money has been con­fused with the amount of eco­nomic activ­ity that money can finance over time. A stock—the ini­tial amount of notes cre­ated in this model—has been con­fused with a flow.
In fact, for a wide range of val­ues for the para­me­ter fD, the flows ini­ti­ated by the money bor­rowed by the firms over a year exceed the size of the loan itself.

This is pos­si­ble because the stock money can cir­cu­late sev­eral times in one year—something that Marx accu­rately enun­ci­ated over a cen­tury ago in Vol­ume II of Cap­i­tal (though his numer­i­cal exam­ple is extremely large):

Let the period of turnover be 5 weeks, the work­ing period 4 weeks… In a year of 50 weeks … Cap­i­tal I of £2,000, con­stantly employed in the work­ing period, is there­fore turned over 12½ times. 12½ times 2,000 makes £25,000.” (Marx and Engels 1885, Chap­ter 16: The Turnover of Vari­able Capital)

Aggre­gate wages and aggre­gate prof­its there­fore depend in part upon the turnover period between the out­lay of money to finance pro­duc­tion and the sale of that pro­duc­tion. This turnover period can be sub­stan­tially shorter than a year, in which case fD will be sub­stan­tially larger than 1, as I explain below.

The mak­ing of mon­e­tary profits

A sec­ond fun­da­men­tal insight from Marx lets us explain what fD is, and simul­ta­ne­ously derive an expres­sion for prof­its: the annual wages bill reflects both the turnover period, and the way in which the sur­plus value gen­er­ated in pro­duc­tion is appor­tioned between cap­i­tal­ists and work­ers. The value of fD there­fore reflects two fac­tors: the share of sur­plus (in Sraffa’s sense) that accrues to work­ers; and the turnover period mea­sured in years—the time between M and M+. Labelling the share going to cap­i­tal­ists as s and the share to work­ers as (1-s), and labelling the turnover period as and express­ing it as a frac­tion of a year, I can per­form the sub­sti­tu­tion shown in Equation :


Money wages are there­fore:


Since national income resolves itself into wages and prof­its (inter­est income is a deduc­tion from other income sources), we have also iden­ti­fied gross profit:


Using a value of s=40%—which cor­re­sponds to his­tor­i­cal norm of 60% of pre-interest income going to work­ers (see Fig­ure 18)—this implies a value for of 0.3.

Fig­ure 18: Wages per­cent­age of US GDP

This means that the turnover period in Marx’s ter­mi­nol­ogy is roughly 16 weeks. This is much longer than in Marx’s numer­i­cal illus­tra­tion above, but still suf­fi­cient to give cap­i­tal­ists prof­its that are sub­stan­tially greater than the ser­vic­ing costs of debt. Fig­ure 19 shows the annual incomes for each class in soci­ety over time; all are pos­i­tive and the equi­lib­rium lev­els (once account lev­els sta­bi­lize) are $151 mil­lion, $98 mil­lion and $2.5 mil­lion for work­ers, cap­i­tal­ists and bankers respec­tively out of a national income of $192 mil­lion (see Equation ).


Fig­ure 19: Class incomes after inter­est pay­ments

The value of also deter­mines the ratio of nom­i­nal GDP to the pro­por­tion of the money stock in cir­cu­la­tion (the equiv­a­lent of M1-M0 in mon­e­tary sta­tis­tics, since in this pure credit model there is no fiat money), which is 3 given the para­me­ters used in this sim­u­la­tion. This is within the highly volatile range sug­gested by his­tor­i­cal data (see Fig­ure 20).

Fig­ure 20: US GDP to Money Sup­ply ratios

Table 4 sum­marises the equi­lib­rium val­ues for account bal­ances, gross and net incomes in this hypo­thet­i­cal pure credit economy:

Table 4

Account Bal­ances Class Incomes Net Incomes
Bank Vault 16 N/A N/A
Firm Loans 84 N/A N/A
Firms 75.6081 100.811 (prof­its) 98.123
Work­ers 5.8205 151.216 (wages) 151.333
Bankers 2.5714 4.2 (debt servicing) 2.571
Totals 84 (Deposits) 252.027+4.2 252.027

Other para­me­ters and time lags

The para­me­ters rL and rD are nom­i­nal inter­est rates and their val­ues are roughly in line with his­tor­i­cal norms at times of low-inflation; that leaves the para­me­ters bV, fL,wD and bT to account for.

The val­ues for bV and fL were cho­sen so that the equi­lib­rium value of BV would be roughly the value noted by (Boden­horn and Hau­pert 1996, p. 688) of 15 per­cent of avail­able notes:


The para­me­ters wD and bT sig­nify how rapidly work­ers and bankers respec­tively spend their bank bal­ances on the out­put pro­duced by firms: work­ers turnover their accounts 26 times a year, while bankers turnover their account just once.

In the remain­der of the paper, these para­me­ters are expressed using the sys­tems engi­neer­ing con­cept of a time con­stant,
which gives the fun­da­men­tal fre­quency of a process. In every case, the time con­stant is the inverse of the para­me­ter used thus far; for instance, the value of 26 for wD cor­re­sponds to work­ers’ con­sump­tion hav­ing a fun­da­men­tal fre­quency of 1/26th of a year, or two weeks.

Table 5: Time con­stants in the model

Para­me­ter and value Time con­stant and value Mean­ing
bV = ¾ Banks lend their reserve hold­ings of notes every 15 months
fL= 1/7 Firms repay their loans every 7 years
wD = 26 Work­ers spend their sav­ings every 2 weeks
bT = 1 Bankers spend their sav­ings every 1 year
Time con­stant in price set­ting (intro­duced in Equation )
Banks dou­ble the money sup­ply every 15 years (intro­duced in Table 7 on page 31)

Pro­duc­tion, prices and mon­e­tary profits

Con­sider a sim­ple pro­duc­tion sys­tem in which out­put is pro­por­tional to the labor input L with con­stant labor pro­duc­tiv­ity a:

Labor employed in turn equals the mon­e­tary flow of wages divided by the nom­i­nal wage rate W:

Prices then link this phys­i­cal out­put sub­sys­tem to the finan­cial model above. In equi­lib­rium, it must be the case that the phys­i­cal flow of goods pro­duced equals the mon­e­tary demand for them divided by the price level. We can there­fore derive that in equi­lib­rium, the price level will be a markup on the mon­e­tary wage, where the markup reflects the rate of sur­plus as defined in this paper.

To answer Rochon’s vital ques­tion, M becomes M+ via a price-system markup on the phys­i­cal sur­plus pro­duced in the fac­tory sys­tem. This markup can be derived sim­ply by con­sid­er­ing demand and sup­ply fac­tors in equi­lib­rium. The flow of demand is the sum of wages and prof­its (since inter­est pay­ments are a trans­fer and do not con­tribute to the value of output—despite Wall Street’s bleat­ings to the con­trary). The mon­e­tary value of demand is thus:

The phys­i­cal units demanded equals this mon­e­tary demand divided by the price level:

In equi­lib­rium this phys­i­cal demand will equal the phys­i­cal out­put of the economy:

Solv­ing for the equi­lib­rium price Pe yields:

The markup is thus the inverse of work­ers’ share of the sur­plus gen­er­ated in pro­duc­tion. Cir­cuit the­ory there­fore pro­vides a mon­e­tary expres­sion of Marx’s the­ory of sur­plus value, as it was always intended to do.

With these phys­i­cal and price vari­ables added to the sys­tem, we are now able to con­firm that profit as derived from the finan­cial flows table cor­re­sponds to profit as the dif­fer­ence between the mon­e­tary value of out­put and the wage bill (in this sim­ple single-sectoral model).

Table 6: Para­me­ters and vari­ables for phys­i­cal pro­duc­tion sub­sys­tem

Vari­able, Para­me­ter or Ini­tial Condition Def­i­n­i­tion Value
a Labour pro­duc­tiv­ity a = Q/L 2
W Nom­i­nal wage 1
Pe Equi­lib­rium price 0.833
P0 Ini­tial Price 1
Le Equi­lib­rium employment 151.216
Qe Equi­lib­rium output 302.432

Using the val­ues given in Table 6, it is eas­ily con­firmed that the equi­lib­rium level of prof­its derived from the finan­cial flows cor­re­sponds to the level derived from the phys­i­cal pro­duc­tion system:


The price rela­tion given above applies also only in equi­lib­rium. Out of equi­lib­rium, it is rea­son­able to pos­tu­late a first-order con­ver­gence to this level, where the time con­stant reflects the time it takes firms to revise prices. This implies the fol­low­ing dynamic pric­ing equation:

A sim­u­la­tion also con­firms that the mon­e­tary flows (demand) and the mon­e­tary value of phys­i­cal flows (sup­ply) con­verge over time (Fig­ure 21).

Fig­ure 21: Sup­ply, Demand and Price con­ver­gence

This solves the para­dox of mon­e­tary prof­its: it was not a para­dox at all, but a con­fu­sion of stocks with flows in pre­vi­ous attempts to under­stand the mon­e­tary cir­cuit of production.

Analysing the GFC

We can now use this frame­work to con­sider one aspect of the cur­rent finan­cial cri­sis: if a “credit crunch” occurs, what is the best way for gov­ern­ment to address it?—by giv­ing fiat money to the banks to lend, or by giv­ing it to the debtors to spend?

Our cur­rent cri­sis is, of course, more than merely a “credit crunch”—a tem­po­rary break­down in the process of cir­cu­la­tion of credit. It is also arguably a sec­u­lar turn­ing point in debt akin to that of the Great Depres­sion ((Keen 2009)), as Fig­ure 22 illus­trates. How­ever the model devel­oped here can assess the dif­fer­en­tial impact of a sud­den injec­tion of fiat money to res­cue an econ­omy that has expe­ri­enced a sud­den drop in the rate of cir­cu­la­tion and cre­ation of pri­vate credit. This is an impor­tant point, since although the scale of gov­ern­ment response to the cri­sis was enor­mous across all affected nations, the nature of that response did vary: notably, the USA focused its atten­tion on boost­ing bank reserves in the belief, as expressed by Pres­i­dent Obama, that the money mul­ti­plier made refi­nanc­ing the banks far more effec­tive than res­cu­ing the borrowers:

And although there are a lot of Amer­i­cans who under­stand­ably think that gov­ern­ment money would be bet­ter spent going directly to fam­i­lies and busi­nesses instead of banks – “where’s our bailout?,” they ask – the truth is that a dol­lar of cap­i­tal in a bank can actu­ally result in eight or ten dol­lars of loans to fam­i­lies and busi­nesses, a mul­ti­plier effect that can ulti­mately lead to a faster pace of eco­nomic growth. (Obama 2009, p. 3. Empha­sis added)

Fig­ure 22: Pri­vate debt to GDP ratios, USA & Aus­tralia

The Aus­tralian pol­icy response to the GFC, on the other hand, was pith­ily summed up in the advice given by its Trea­sury: “go early, go hard, go house­holds” ((Gruen 2008)). Though many other fac­tors dif­fer­en­ti­ate these two countries—notably Australia’s posi­tion as a com­mod­ity pro­duc­ing sup­plier to China—the out­comes on unem­ploy­ment imply that the Aus­tralian mea­sures more suc­cess­ful than the Amer­i­can “money mul­ti­plier” approach (See Fig­ure 23).

Fig­ure 23: Unem­ploy­ment rates USA and Aus­tralia

The model is extended in the next sec­tion to con­sider a grow­ing econ­omy, and then a dif­fer­en­tial response to a credit crunch is con­sid­ered: an iden­ti­cal injec­tion of funds at the same time into either the banks’ equity accounts—simulating the USA’s pol­icy response—or into the Work­ers’ Deposit accounts—simulating the Aus­tralian response.

Endoge­nous money cre­ation and eco­nomic growth

To model a credit crunch in a grow­ing econ­omy, while oth­er­wise main­tain­ing the struc­ture of the Free Banking/pure credit money model above, I move beyond the lim­i­ta­tions of a pure paper money sys­tem to allow for endoge­nous money cre­ation as described in (Moore 1979):

In the real world banks extend credit, cre­at­ing deposits in the process, and look for the reserves later” ((Moore 1979, p. 539) cit­ing (Holmes 1969, p. 73); see also more recently (Disy­atat 2010, “loans drive deposits rather than the other way around”, p. 7)).

In the model, new credit to sus­tain a grow­ing econ­omy is cre­ated by a simul­ta­ne­ous increase in the loan and deposit accounts for the borrower.

The finan­cial flows in this sys­tem are given in Table 7. The two changes to Free Bank­ing model are the addi­tion of row 12 (and its ledger record­ing in row 13), with the qual­i­ta­tively new oper­a­tion of Money Cre­ation being added to the pre­vi­ous oper­a­tion of Money Trans­fer; and a “Deus Ex Machina” injec­tion of fiat money into either Bank Equity or Worker Deposit accounts at a after a credit crunch.

Table 7: Endoge­nous money cre­ation

Row Trans­ac­tion Type Bank Equity (BE) Bank Trans­ac­tion (BT) Firm Loan (FL) Firm Deposit (FD) Worker Deposit (WD)
1 Lend Money Money Trans­fer

–A

A

2 Record Loan Ledger Entry

A

3 Com­pound Debt Ledger Entry

B

4 Pay Inter­est Money Trans­fer

C

–C

5 Record Pay­ment Ledger Entry

–C

6 Deposit Inter­est Money Trans­fer

–D

D

7 Wages Money Trans­fer

–E

E

8 Deposit Inter­est Money Trans­fer

–F

F

9 Con­sump­tion Money Trans­fer

–G

G+H

–H

10 Repay Loan Money Trans­fer

I

–I

11 Record Repay­ment Ledger Entry

–I

12 New Money Money Cre­ation

J

13 Record Loan Ledger Entry

J

14 Gov­ern­ment policy Exoge­nous injec­tion into either
BE
or
WD

K

K

Sum of Flows

I-A+K

C-D-F-G

A+B-C-I+J

A-C+D-E+G+H-I+J

E+F-H+K

Again, sim­ply to illus­trate that the sys­tem is viable, a con­stant growth para­me­ter has the banks dou­bling the stock of loans every 15 years (see Table 3 on page 18):


A credit crunch is sim­u­lated by vary­ing the three cru­cial finan­cial flow para­me­ters , , and at an arbi­trary time in the fol­low­ing sim­u­la­tion (at t=25 years):
and are dou­bled and is halved, rep­re­sent­ing banks halv­ing their rates of cir­cu­la­tion and cre­ation of new money and firms try­ing to repay their loans twice as quickly. The gov­ern­ment fiat-money res­cue is mod­elled as a one-year long injec­tion of a total of $100 mil­lion one year after the credit crunch.

Pre-credit crunch Post-credit crunch Impact of Credit Crunch
?V = 4/3 years

Banks lend their reserve hold­ings of notes every 15 months
?L= 7 years

Firms repay their loans every 3.5 years
? M= 15 years

Banks dou­ble the money sup­ply every 30 years
K=$100 mil­lion Injected either into Bank Equity BE or Worker Deposit WD at year 26, one year after the credit crunch

Sev­eral exten­sions to the phys­i­cal side of the model are required to model eco­nomic growth. In the absence of Ponzi spec­u­la­tion, growth in the money sup­ply is only war­ranted if eco­nomic growth is occur­ring, which in turn requires a grow­ing pop­u­la­tion and/ or labour pro­duc­tiv­ity. These vari­ables intro­duce the issue of the employ­ment rate, and this in turn raises the pos­si­bil­ity of vari­able money wages in response to the rate of unemployment—a Phillips curve. These addi­tional vari­ables are spec­i­fied in Equation :


The para­me­ter val­ues and func­tional form for this phys­i­cal growth exten­sion are shown in Table 8.

Table 8: Para­me­ters and func­tion for growth model

Vari­able or parameter Descrip­tion Value
Rate of growth of labor productivity 1% p.a.

Rate of growth of population 2% p.a.
Pop Pop­u­la­tion Ini­tial value = 160
Employ­ment rate Ini­tial value = 94.5%
Phillips curve:

Fig­ure 24 shows the impact of the credit crunch upon bank accounts: loans and deposits fall while the pro­por­tion of the money sup­ply that is lying idle in bank reserves rises dramatically.

Fig­ure 24: Bank accounts before and after a Credit Crunch

The US empir­i­cal data to date has dis­played a sim­i­lar pat­tern, though with a much sharper increase in bank reserves as shown in Fig­ure 25.

Fig­ure 25: St Louis FRED AJDRES and BUSLOANS

A very sim­i­lar pat­tern to the empir­i­cal data is evi­dent in the model when the US pol­icy of increas­ing bank reserves is sim­u­lated (Fig­ure 26).

Fig­ure 26: Sim­u­lat­ing US bank-oriented pol­icy towards a credit crunch

The sim­u­la­tion of the Aus­tralian household-oriented poli­cies gen­er­ates a very dif­fer­ent dynamic .

Fig­ure 27: Sim­u­lat­ing Aus­tralian household-oriented pol­icy towards a credit crunch

Cru­cially from the pol­icy per­spec­tive, the household-oriented approach has a far more imme­di­ate and sub­stan­tial impact upon employ­ment (Fig­ure 28). Con­trary to the expec­ta­tions of Pres­i­dent Obama and his main­stream eco­nomic advis­ers, there is far more “bang for your buck” out of a house­hold res­cue than out of a bank rescue.

Fig­ure 28: Com­par­ing bank-oriented and household-oriented poli­cies

The para­dox of mon­e­tary prof­its is there­fore solved sim­ply by avoid­ing the prob­lem so wit­tily expressed by Kalecki, that eco­nom­ics is “the sci­ence of con­fus­ing stocks with flows” ((cited in God­ley and Lavoie 2007)). With that con­fu­sion removed by work­ing in a frame­work that explic­itly records the flows between bank accounts and the pro­duc­tion and con­sump­tion they drive, it is obvi­ous that Cir­cuit The­ory achieves what it set out to do: to pro­vide a strictly mon­e­tary foun­da­tion for the Marx-Schumpeter-Keynes-Minsky tra­di­tion in eco­nom­ics. As an explic­itly mon­e­tary model, it also pro­vides an excel­lent foun­da­tion for explain­ing the processes that led to the “Great Reces­sion”, and for test­ing pos­si­ble pol­icy responses to it.

Mon­e­tary Minsky

To develop an explic­itly mon­e­tary Min­sky model, I use the same tab­u­lar approach to mod­el­ling the finan­cial sys­tem, but include non­lin­ear func­tions that model the real-world phe­nom­e­non that firms bor­row money to finance invest­ment under­taken with “euphoric” expec­ta­tions dur­ing booms, and repay banks by invest­ing less than prof­its dur­ing slumps.

Table 9: Finan­cial oper­a­tions in a basic mon­e­tary Min­sky model

Bank Equity Bank Trans­ac­tion Firm Loan Firm Deposit Worker Deposit
BE BT FL FD WD
Com­pound Debt A
Pay inter­est B –B
Record pay­ment –B
Debt-financed invest­ment C C
Wages –D D
Deposit inter­est –E-F E F
Con­sump­tion –G G+H –H
Debt repay­ment I –I
Record repay­ment –I
Lend from capital –J J
Record Loan J

Whereas the pre­vi­ous model replaced these flow mark­ers with con­stant para­me­ters, in this model non­lin­ear func­tions that mimic gen­eral ten­den­cies in actual behaviour–workers secur­ing higher nom­i­nal wage rises when unem­ploy­ment is low, cap­i­tal­ists invest­ing more than prof­its when the rate of profit is high.

Table 10: Sub­sti­tu­tions

Oper­a­tion Descrip­tion
A Loan Inter­est
B Pay­ment of inter­est on loan
C Invest­ment as a non­lin­ear func­tion of the rate of profit
D Wages (W) as a non­lin­ear func­tion of the rate of employ­ment and the rate of inflation
E Inter­est on Firm deposits
F Inter­est on work­ers deposits
G Bank con­sump­tion
H Worker con­sump­tion
I Loan repay­ment as a non­lin­ear func­tion of the rate of profit
J Relend­ing by banks as a func­tion of the rate of profit

The fol­low­ing model of finan­cial flows results:

Fig­ure 29: Finan­cial sec­tor dynamic model, gen­er­ated in Math­cad

This now has to be com­bined with a model of the labour and phys­i­cal flows, in which phys­i­cal out­put is now a func­tion of cap­i­tal as in the orig­i­nal Good­win model:


The rate of change of phys­i­cal cap­i­tal is a func­tion of invest­ment minus depre­ci­a­tion, where invest­ment is a non­lin­ear func­tion of the rate of profit:


The rate of profit is the mon­e­tary value of out­put minus wages and inter­est pay­ments, divided by the mon­e­tary val­u­a­tion of the cap­i­tal stock:


Prices, labor pro­duc­tiv­ity and pop­u­la­tion growth are as defined ear­lier. Wage set­ting how­ever has one mod­i­fi­ca­tion: nom­i­nal wages are shown as respond­ing to both the employ­ment level and the rate of inflation:


The full sys­tem is now as shown in Fig­ure 30.

Fig­ure 30: Full mon­e­tary Min­sky model

The dynam­ics of this sys­tem com­bine the short-term trade-cycle behav­ior of the ear­lier non-monetary model, and add the phe­nom­e­non of a debt-deflation, in which falling prices amplify the debt to GDP ratio once the cri­sis commences.

Fig­ure 31: Bank accounts

This is a model only of the process by which a cri­sis devel­ops; it does not con­tem­plate what might hap­pen in its after­math to end it–such as bank­ruptcy and debt mora­to­ria reduc­ing the out­stand­ing debt and allow­ing eco­nomic activ­ity to com­mence again. The ter­mi­nal col­lapse that fol­lows from the run­away growth of debt in this model empha­sises the point that Michael Hud­son has made so often: “Debts that can’t be repaid, won’t be repaid”.

Fig­ure 32: Cycli­cally ris­ing debt to GDP

The employment-wages share dynam­ics of the orig­i­nal Good­win model give way to a finan­cial vor­tex that dri­ves wages share cycli­cally down prior to the com­plete debt-deflationary collapse.

Fig­ure 33: Wage share falls cycli­cally as debt defla­tion approaches

The final debt-driven col­lapse, in which both wages and prof­itabil­ity plunge, gives the lie to the neo­clas­si­cal per­cep­tion that crises are caused by wages being too high, and the solu­tion to the cri­sis is to reduce wages.

What their blink­ered igno­rance of the role of the finance sec­tor obscures is that the essen­tial class con­flict in finan­cial cap­i­tal­ism is not between work­ers and cap­i­tal­ists, but between finan­cial and indus­trial cap­i­tal. The ris­ing level of debt directly leads to a falling worker share of GDP, while leav­ing indus­trial capital’s share unaf­fected until the final col­lapse dri­ves it too into oblivion.

Fig­ure 34: Income dis­tri­b­u­tion cycles and the sec­u­lar trend to falling wages and a ris­ing finance share

The macro­eco­nomic per­for­mance before the cri­sis would also fool any econ­o­mist who ignored the role of the finance sec­tor and the dan­ger of a ris­ing debt to GDP ratio–as indeed neo­clas­si­cal econ­o­mists did in the runup to this cri­sis, when they waxed lyri­cal about “The Great Moderation”:

As it turned out, the low-inflation era of the past two decades has seen not only sig­nif­i­cant improve­ments in eco­nomic growth and pro­duc­tiv­ity but also a marked reduc­tion in eco­nomic volatil­ity, both in the United States and abroad, a phe­nom­e­non that has been dubbed “the Great Moderation.”

Reces­sions have become less fre­quent and milder, and quarter-to-quarter volatil­ity in out­put and employ­ment has declined sig­nif­i­cantly as well.

The sources of the Great Mod­er­a­tion remain some­what con­tro­ver­sial, but as I have argued else­where, there is evi­dence for the view that improved con­trol of infla­tion has con­tributed in impor­tant mea­sure to this wel­come change in the econ­omy. (Bernanke 2004)

Fig­ure 35: Mod­er­a­tion is not good for your eco­nomic health

Instead of a sign of eco­nomic suc­cess, the “Great Mod­er­a­tion” was a sign of fail­ure. It was the lull before the storm of the Great Reces­sion, where the lull was dri­ven by the same force that caused the storm: ris­ing debt rel­a­tive to GDP in an econ­omy that had become beholden to Ponzi finance.

Appen­dix

Table 11: Details of the Min­sky model with Ponzi Finance exten­sion in Equa­tion

Ele­ment

Equa­tion

Com­ments, para­me­ters and ini­tial values

Out­put

Y
=
K
/n

Cap­i­tal stock and the accel­er­a­tor deter­mines out­put; Y(0) = 300; v
= 3

Cap­i­tal stock

The rate of change of cap­i­tal stock is invest­ment minus depre­ci­a­tion; ? = 1%

Profit

P
=
Y
-
W
-
r
×D

Profit is out­put minus wages and inter­est pay­ments; R
= 3%

Profit rate

Wage bill

W
=
w
×L

The wage bill is wages times labour employed

Wages

A Phillips curve rela­tion for wage deter­mi­na­tion; w(0) = 1

Employ­ment rate

l
=
L
/N

Labour

L
=
Y
/a

Out­put and labor pro­duc­tiv­ity deter­mine employment

Debt

The rate of change of debt equals invest­ment minus prof­its plus spec­u­la­tion; D(0) = 0

Spec­u­la­tion

The rate of change of Ponzi spec­u­la­tion is a non-linear func­tion of the rate of growth; P?(0) = 0

Rate of growth

Invest­ment

Invest­ment is a non-linear func­tion of the rate of profit

Phillips curve

Wage change is a non-linear func­tion of the rate of employment

Ponzi behav­iour

Spec­u­la­tion is a non-linear func­tion of the rate of growth

Gen­er­alised exponential

Gen­er­alised expo­nen­tial; argu­ments (xv, yv) coor­di­nates, slope at (xv, yv) and min­i­mum value m

Pop­u­la­tion

?
= 1%; N(0) = 330

Labour pro­duc­tiv­ity

?
= 2%; a(0) = 1

QED

QED stand for “Ques­nay Eco­nomic Dynam­ics”. It is a new soft­ware pro­gram that has been devel­oped by a cor­re­spon­dent and col­lab­o­ra­tor (who for the moment wishes to remain anony­mous) which imple­ments my tab­u­lar method of devel­op­ing dif­fer­en­tial equa­tions.

It can be down­loaded for free from www.debtdeflation.com/blogs/qed. Updates will be posted fre­quently as is devel­oped fur­ther over time.

To test run the pro­gram, choose File/Open and select the model “FreeBankingModel.sgr”. This is the first model devel­oped in this paper. To see the model itself, click on the “Actions” menu item and select “God­ley Table”. This table will then appear:

God­ley Table

Fig­ure 36: The core of QED, the God­ley Table

Vari­ables and Equations

The equa­tions in the model are stored in two other tables acces­si­ble from the “Actions” menu item on the main win­dow: “Var/Equations” and “C.O.D. Equa­tions” respec­tively. The for­mer gives val­ues to para­me­ters and the like; the lat­ter gives the equa­tions for the flows between the accounts:

Fig­ure 37: The ele­ments of the dynamic sys­tem are defined here

To run the model, click on the “Phillips Dia­gram” menu item on the main QED pro­gram win­dow, which will show the fol­low­ing dynamic flow­chart that was gen­er­ated by this table. Now click on the “Show Player” check­box at the top of the win­dow, and a player will appear down the bot­tom. Click on “Play” and the amounts in the reser­voirs (bank accounts) and flow valves (labelled A to I and with the same descrip­tors as in the left hand col­umn of the Ques­nay Table) will change. If you run it for five years (watch the “MODELTIME” counter in the top right hand side of the dia­gram and click on Stop), you should see the following:

Phillips Dia­gram

Fig­ure 38: The sim­u­la­tion is dis­played live in a “hydraulic” model, in hon­our of Bill Phillips

There is also a “For­rester Dia­gram”, which is more like a con­ven­tional sys­tems engi­neer­ing pro­gram. You can also add vari­ables and rela­tions between them here, as with pro­grams like Vis­sim and Simulink–click on the type of entity to be cre­ated (Stock, flow, text, vari­able) and insert a new one by hold­ing down the con­trol key when you click any­where on the dia­gram. Double-click on any entity to see and/or alter its definition.

For­rester Diagram

Fig­ure 39: Sim­i­lar to pro­grams like Simulink, this dia­gram is pro­duced auto­mat­i­cally from the God­ley Table

There’s a lot more to the pro­gram, as you will find if you play with it, using the two mod­els here and also devel­op­ing your own mod­els. To my knowl­edge it’s the only pro­gram around that uses a tab­u­lar inter­face to develop dynamic mod­els, and also pro­vides seam­less each-way devel­op­ment of a sys­tems engi­neer­ing dia­gram from a table of equa­tions. It is ide­ally suited to mod­el­ling finan­cial flows, and it’s my (and my collaborator’s) con­tri­bu­tion to help­ing the world under­stand how money works–which is the first step in under­stand­ing why our finan­cial sys­tem has per­formed so badly.

Fig­ure 40: Up to four graph sur­faces can be defined

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Bernanke, B. S. (1983). “Non­mon­e­tary Effects of the Finan­cial Cri­sis in Prop­a­ga­tion of the Great Depres­sion.” Amer­i­can Eco­nomic Review
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Bernanke, B. S. (2000). Essays on the Great Depres­sion. Prince­ton, Prince­ton Uni­ver­sity Press.

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39(1): 3–24.

Keen, S. (2009). “House­hold Debt-the final stage in an arti­fi­cially extended Ponzi Bub­ble.” Aus­tralian Eco­nomic Review
42: 347–357.

Keen, S. (2010). “Solv­ing the Para­dox of Mon­e­tary Prof­its.” Eco­nom­ics
Spe­cial Issue on Man­ag­ing Finan­cial Insta­bil­ity in Cap­i­tal­ist Economies.

Lazear, E. P. and D. B. Mar­ron (2009). Eco­nomic Report of the Pres­i­dent. Coun­cil of Eco­nomic Advis­ers. Wash­ing­ton, United States Gov­ern­ment Print­ing Office

Marx, K. and F. Engels (1885). Cap­i­tal II. Moscow, Progress Publishers.

Min­sky, H. P. (1982). “Can ‘It’ Hap­pen Again? A Reprise.” Chal­lenge
25(3): 5–13.

Min­sky, H. P. (1982). Can “it” hap­pen again? : essays on insta­bil­ity and finance. Armonk, N.Y., M.E. Sharpe.

Moore, B. J. (1979). “The Endoge­nous Money Stock.” Jour­nal of Post Key­ne­sian Eco­nom­ics
2(1): 49–70.

Obama, B. (2009). Obama’s Remarks on the Econ­omy. New York, New York Times.

Rochon, L.-P. (2005). The exis­tence of mon­e­tary prof­its within the mon­e­tary cir­cuit. Mon­e­tary The­ory of Pro­duc­tion: Tra­di­tion and Per­spec­tives. G. Fontana and R. Real­fonzo. Bas­ingstoke, Pal­grave Macmil­lan: 125–138.

Smith­son­ian Insti­tu­tion. (2010). “National Numis­matic Col­lec­tion (NNC).” from http://americanhistory.si.edu/collections/numismatics/.

About Steve Keen

I am a professional economist 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 debts accumulated in Australia, and our very low rate of inflation.
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13 Responses to Are We “It” Yet?

  1. Pingback: Are We It Yet posted | Steve Keen's Debtwatch

  2. Uriah says:

    Hi Steve,

    1) I’ve been strug­gling to under­stand the idea of pri­vate debt dri­ving GDP. What I think you’re try­ing to say is that, the change in pri­vate debt shows us a change in peo­ples ‘mar­ginal propen­sity to invest’ for lack of a bet­ter word.

    So, although debt is just a trans­fer of wealth from 1 group to another. Given a change in debt, this sug­gests that there has been some other change in the economy.

    This change could be a change in income:
    – Such as a gen­eral increase in nom­i­nal GDP, with a pro­por­tion­ate change in nom­i­nal debt. (Such as a coun­try build­ing wealth, and becom­ing richer)
    – An increase in 1 sec­tor of the economies income, at the expense of another, how­ever this sec­tor which received the increase has a dif­fer­ent val­u­a­tion of invest­ment. (Such as a coun­try see­ing a huge mid­dle class, who has a very opti­mistic view of hous­ing investment)

    Or it could just be a change in per­cep­tion, such that in times of booms there is over-investment, and in times of busts, underinvestment.

    Is this about right? I would be inter­ested in see­ing an arti­cle on the very basics of this logic, with­out the mea­sure­ment, maths, and empir­ics. Though I can often just fol­low these, I strug­gle to under­stand the ide­ol­ogy of this, and how it differs.

    2) When you’re talk­ing about the view 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”, isn’t prof­its in that con­text talk­ing about eco­nom­ics prof­its, which include a risk pre­mium, and oppor­tu­nity costs. So they aren’t mak­ing abnor­mal prof­its when adjust­ing for risk, and oppor­tu­nity costs. How­ever, what I think you’ve gone on to talk about is account­ing prof­its, which I don’t think any­body argues “you can’t make account­ing prof­its”. Though I haven’t read the arti­cles ref­er­enced. Am I miss­ing some­thing here? If they are talk­ing about account­ing prof­its, how do they ratio­nal­ize this?

    3) When you’re talk­ing about the growth of money beyond the orig­i­nal stock, isn’t this the money mul­ti­plier? Where account­ing shows the “same” dol­lar in sev­eral peo­ples accounts, since it is loaned out, and loaned out, and loaned out, until the amount of reserves banks want to hold (or are forced to hold) decrease it to 0. You men­tion the money mul­ti­plier later, but in a dif­fer­ent con­text, which makes me think it’s a dif­fer­ent con­cept, but I’m not see­ing the differences.

    Any help on these is much appreciated.

    Thanks!

  3. Steve Keen says:

    Hi Uriah, re #2:

    No, a growth in debt is not a trans­fer of wealth from one group to another: it’s an increase in aggre­gate debt. There’s an increase in finan­cial claims by one sec­tor of soci­ety (the banks) on the rest, and an aggre­gate increase in the level of money held by the rest of soci­ety (the bor­row­ers) at the same time.

    Much of the con­fu­sion on this issue comes from implictly treat­ing debt as a trans­fer of some­thing pre-existing from one loca­tion to another. The whole point of the endoge­nous money approach is that this is an increase in exist­ing lev­els of debt and money, not a trans­fer of pre-existing money from one loca­tion to another.

    Sec­ondly, think of the three ways we mea­sure GDP: pro­duc­tion, income and expen­di­ture. Con­sider the stan­dard def­i­n­i­tion of aggre­gate demand as being the first two; con­sider my def­i­n­i­tion (GDP plus change in debt) as being the third one, but this time expanded to include money spent pur­chas­ing pre-existing assets as well.

    Thirdly, for­get con­cepts like abnor­mal prof­its, blah blah; these are neo­clas­si­cal con­structs that I believe hin­der under­stand­ing how cap­i­tal­ism works. Cap­i­tal­ists make mon­e­tary prof­its; whether these are higher or lower for some groups of cap­i­tal­ists than oth­ers is a sec­ondary issue. The Post Keynesian/Circuitist con­fu­sion over this argued that cap­i­tal­ists couldn’t make mon­e­tary prof­its at all, an obvi­ous fallacy.

    Finally, no I’m not talk­ing about the money mul­ti­plier. If you haven’t read the Rov­ing Cav­a­liers post, I sug­gest you do. The reserve ratio has not been an effec­tive con­straint on the capac­ity of banks to cre­ate addi­tional debt and money.

  4. Uriah says:

    Hi Steve,

    That Rov­ing Cav­a­liers post is excel­lent, I now have a much bet­ter idea of the Post-Keynsian approach. If we were to attempt to visu­al­ize this in the Keyn­sian cross dia­gram, we would never be at equi­lib­rium, as only rarely would Aggre­gate Expen­di­ture equal Aggre­gate Demand.

    Also you say this is an endoge­nous money approach, which is cor­rect, but in my mind it’s more effec­tive to see it as an exoge­nous credit approach. As such, the IS-LM, AS-AD, and sim­i­lar mod­els would all need to take this into account, and they’d either need to “rede­fine” equi­lib­rium, or aban­don it. Given the neo­clas­si­cal schools pen­chant for equi­lib­rium, I’d sug­gest they’d just rede­fine it. Though the fur­ther they rede­fine it, the less use­ful a con­cept it becomes, regard­less of whether it now reflects real­ity more.

    I’ll have to think about this more, and try to use it in real­ity, before I come to even a rea­son­able sem­blance of an under­stand­ing of this idea.

    Thanks!

  5. Pingback: Debt Outstanding, GDP and Income: Who Are They Fooling? | Best Debt USA

  6. Lewis says:

    Fas­ci­nat­ing, and of course more than a lit­tle fright­en­ing.
    It occurs to me that the main­stream has gen­er­ally treated defla­tion as the cause (via incen­tive to defer pur­chases) of depres­sion. By con­trast, you seem to describe it as a symp­tom of the sys­tem­atic delever­ag­ing that causes depres­sion.
    This would explain of course why snap­ping the credit cri­sis has not cleared the way for dra­matic recovery.

    I won’t pre­tend to under­stand the full equa­tions spelled out here, so of course I’m left a lit­tle unsure as to the dri­ving force of your final graph­i­cal con­clu­sions. What dynamic makes banks so prof­itable in the final years?
    If this were to hap­pen, I don’t see any other path besides mass nation­al­iza­tion as the end result.

    On an unre­lated note, I am curi­ous to hear if you have any famil­iar­ity with or opin­ions on agent-based mod­el­ing;
    http://www.economist.com/node/16636121

  7. Pingback: The Public Debt and Deficit Debate as a Conflict of Types of Ethical Systems « Meta-economics

  8. Pingback: The Public Debt and Deficit Debate as a Conflict Between Ethical Systems « Meta-economics

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  11. sceptic says:

    This is an essen­tial post?
    I saw the good pro­fes­sor talk on Rus­sia Today and thought I’d check his site.
    What a con­fus­ing non­sense. I am no fool, but i do not even grasp what point your are try­ing to make here, let alone the dri­vel ratio­nal­is­ing it.
    In my expe­ri­ence, peo­ple who know what they are talk­ing about can explain them­selves quite clearly and sim­ply.
    Peo­ple who can­not are either try­ing to deceive or are just plain wrong.
    Im assum­ing Pro­fes­sor Keen is one of the army of closet com­mu­nists that rule over the Aus­tralian edu­ca­tion sys­tem.
    I shall give my eco­nomic the­ory based on my expe­ri­ence in the real world , not the clos­ets of uni­ver­si­ities.
    The econ­omy is a rigged game . And the house is the Roman Catholic Church.

    And our good social­ist teach­ers work for them, whether they know it or not.

  12. kys says:

    Hi Steve,

    I tried to re-study your mod­els and found some new ideas quite dif­fer­ent from last time I read them, may share with this blog later, but first:

    –Table 5

    Tv = 4/3 years mean­ing that banks lend their reserve hold­ings of notes every “15” months. (or 16 months?)

    –The equa­tion right below Table 6

    (1-s)/Ts * Fde = 100.811 (or s/Ts *Fde = 100.811?)

    –The table below Table 7

    Tv = 8/3 years mean­ing 15 monts (or 32 months?)

  13. Pingback: Ireland is in a worse state than it was before the bailout says economists! - Page 24

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