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 

| Open Player in New Win­dow

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.


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.


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 Record Loan Ledger Entry


B Com­pound Debt Ledger Entry


2 Pay Inter­est Money Trans­fer



C Record Pay­ment Ledger Entry


3 Deposit Inter­est Money Trans­fer



4 Wages Money Trans­fer



5 Deposit Inter­est Money Trans­fer



6 Con­sump­tion Money Trans­fer




7 Repay Loan Money Trans­fer



D Record Repay­ment Ledger Entry


Sum of Flows






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



2 Record Loan Ledger Entry


3 Com­pound Debt Ledger Entry


4 Pay Inter­est Money Trans­fer



5 Record Pay­ment Ledger Entry


6 Deposit Inter­est Money Trans­fer



7 Wages Money Trans­fer



8 Deposit Inter­est Money Trans­fer



9 Con­sump­tion Money Trans­fer




10 Repay Loan Money Trans­fer



11 Record Repay­ment Ledger Entry


12 New Money Money Cre­ation


13 Record Loan Ledger Entry


14 Gov­ern­ment pol­icy Exoge­nous injec­tion into either



Sum of Flows






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
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.


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



Com­ments, para­me­ters and ini­tial val­ues



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

Profit rate

Wage bill


The wage bill is wages times labour employed


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

Employ­ment rate




Out­put and labor pro­duc­tiv­ity deter­mine employ­ment


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


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

Rate of growth


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


= 1%; N(0) = 330

Labour pro­duc­tiv­ity

= 2%; a(0) = 1


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 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


Bat­tellino, R. (2007). “Some Obser­va­tions on Finan­cial Trends.” Reserve Bank of Aus­tralia Bul­letin
Octo­ber 2007: 14–21.

Bellofiore, R., G. F. Davan­zati, et al. (2000). “Marx Inside the Cir­cuit: Dis­ci­pline Device, Wage Bar­gain­ing and Unem­ploy­ment in a Sequen­tial Mon­e­tary Econ­omy.” Review of Polit­i­cal Econ­omy
12(4): 403–417.

Bernanke, B. S. (1983). “Non­mon­e­tary Effects of the Finan­cial Cri­sis in Prop­a­ga­tion of the Great Depres­sion.” Amer­i­can Eco­nomic Review
73(3): 257–276.

Bernanke, B. S. (1995). “The Macro­eco­nom­ics of the Great Depres­sion: A Com­par­a­tive Approach.” Jour­nal of Money, Credit, and Bank­ing
27(1): 1–28.

Bernanke, B. S. (2000). Essays on the Great Depres­sion. Prince­ton, Prince­ton Uni­ver­sity Press.

Bernanke, B. S. (2002). Remarks by Gov­er­nor Ben S. Bernanke. Con­fer­ence to Honor Mil­ton Fried­man. Uni­ver­sity of Chicago, Chicago, Illi­nois.

Bernanke, B. S. (2004). Panel dis­cus­sion: What Have We Learned Since Octo­ber 1979? Con­fer­ence on Reflec­tions on Mon­e­tary Pol­icy 25 Years after Octo­ber 1979, St. Louis, Mis­souri, Fed­eral Reserve Bank of St. Louis.

Boden­horn, H. and M. Hau­pert (1996). “The Note Issue Para­dox in the Free Bank­ing Era.” Jour­nal of Eco­nomic His­tory
56(3): 687–693.

Chick, V. (2001). Cas­san­dra as opti­mist. Finan­cial Key­ne­sian­ism And Mar­ket Insta­bil­ity: The Eco­nomic Legacy of Hyman Min­sky. R. Bellofiore and P. Ferri. Chel­tenham, Edward Elgar Pub­lish­ing. I: 35–46.

Dim­itro­vsky, I. (2008). “News from 1930.” from

Disy­atat, P. (2010) “The bank lend­ing chan­nel revis­ited.” BIS Work­ing Papers
297, 35.

Fisher, I. (1933). “The Debt-Defla­tion The­ory of Great Depres­sions.” Econo­met­rica
1(4): 337–357.

Fried­man, M. (1969). The Opti­mum Quan­tity of Money. The Opti­mum Quan­tity of Money and Other Essays. Chicago, MacMil­lan: 1–50.

God­ley, W. (1999). “Money and Credit in a Key­ne­sian Model of Income Deter­mi­na­tion.” Cam­bridge Jour­nal of Eco­nom­ics
23(4): 393–411.

God­ley, W. and M. Lavoie (2007). Mon­e­tary Eco­nom­ics: An Inte­grated Approach to Credit, Money, Income, Pro­duc­tion and Wealth, Hound­mills, U.K. and New York:

Pal­grave Macmil­lan.

Good­win, R. (1967). A growth cycle. Social­ism, Cap­i­tal­ism and Eco­nomic Growth. C. H. Fein­stein. Cam­bridge, Cam­bridge Uni­ver­sity Press: 54–58.

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Spring: 1–26.

Graziani, A. (2003). The mon­e­tary the­ory of pro­duc­tion. Cam­bridge, UK, Cam­bridge Uni­ver­sity Press.

Gruen, N. (2008). “Go early, Go hard, Go house­holds.” 2010, from

Holmes, A. R. (1969). Oper­a­tional Con­traints on the Sta­bi­liza­tion of Money Sup­ply Growth. Con­trol­ling Mon­e­tary Aggre­gates. F. E. Mor­ris. Nan­tucket Island, The Fed­eral Reserve Bank of Boston: 65–77.

Keen, S. (1993). “The Mis­in­ter­pre­ta­tion of Marx’s The­ory of Value.” Jour­nal of the His­tory of Eco­nomic Thought
15(2): 282–300.

Keen, S. (1993). “Use-Value, Exchange Value, and the Demise of Marx’s Labor The­ory of Value.” Jour­nal of the His­tory of Eco­nomic Thought
15(1): 107–121.

Keen, S. (1995). “Finance and Eco­nomic Break­down: Mod­el­ing Minsky’s ‘Finan­cial Insta­bil­ity Hypoth­e­sis.’.” Jour­nal of Post Key­ne­sian Eco­nom­ics
17(4): 607–635.

Keen, S. (2009). “Bail­ing out the Titanic with a Thim­ble.” Eco­nomic Analy­sis & Pol­icy
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

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25(3): 5–13.

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2(1): 49–70.

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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.

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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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  • Uriah

    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.


  • 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.

  • Uriah

    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.


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  • Lewis

    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;

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  • scep­tic

    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.

  • kys

    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?)

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