Naked Capitalism and My Scary Minsky Model

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I met with Yves Smith of Naked Cap­i­tal­ism on the week­end, at a superb Japan­ese restau­rant that only New York locals could find (and I’ll keep its loca­tion qui­et for their benefit–too much pub­lic­i­ty could spoil a spec­tac­u­lar thing). Yves was kind enough to post details of my lat­est aca­d­e­m­ic paper at her site in a post she enti­tled “Steve Keen’s scary Min­sky mod­el”.

Yves found the mod­el scary, not because it revealed any­thing about the econ­o­my that she did­n’t already know, but because it so eas­i­ly repro­duced the Ponzi fea­tures of the econ­o­my she knows so well.

I have yet to attempt to fit the mod­el to data–and giv­en its non­lin­ear­i­ty, that won’t be easy–but its qual­i­ta­tive behav­ior is very close to what we’ve expe­ri­enced. As in the real world, a series of booms and busts give the super­fi­cial appear­ance of an econ­o­my enter­ing a “Great Moderation”–just before it col­laps­es.

The motive force dri­ving the crash is the ratio of debt to GDP–a key fea­ture of the real world that the main­stream econ­o­mists who dom­i­nate the world’s aca­d­e­m­ic uni­ver­si­ty depart­ments, Cen­tral Banks and Trea­suries ignore. In the mod­el, as in the real world, this ratio ris­es in a boom as busi­ness­es take on debt to finance invest­ment and spec­u­la­tion, and then falls in a slump when things don’t work out in line with the euphor­ic expec­ta­tions that devel­oped dur­ing the boom. Cash flows dur­ing the slump don’t allow bor­row­ers to reduce the debt to GDP ratio to the pre-boom lev­el, but the peri­od of rel­a­tive sta­bil­i­ty after the cri­sis leads to expectations–and debt–taking off once more.

Ulti­mate­ly, such an extreme lev­el of debt is accu­mu­lat­ed that debt ser­vic­ing exceeds avail­able cash flows, and a per­ma­nent slump ensues–a Depres­sion.

There are 4 behav­iour­al func­tions in the mod­el that mim­ic the behav­iour of the major pri­vate actors in the economy–workers, cap­i­tal­ists and bankers. Work­ers wage ris­es are relat­ed to the lev­el of employ­ment and the rate of infla­tion; cap­i­tal­ists invest­ment and debt repay­ment plans are relat­ed to the rate of prof­it; and the will­ing­ness of banks to lend is also a func­tion of the rate of prof­it.

The mod­el is explic­it­ly monetary–with bank accounts for work­ers, bankers and capitalists–and the cri­sis is marked by a col­lapse in deposits and a rise in inac­tive bank reserves.

The same phe­nom­e­non is evi­dent in the data, though the sharp­ness of the turn­around is far greater than can be repli­cat­ed by the smooth func­tions in my mod­el.

There’s a lot more work to do before the mod­el is complete–notably includ­ing the impact of a gov­er­ment sec­tor that can add its own spend­ing pow­er to a depressed economy–but its basic fea­tures ful­fil Min­sky’s chal­lenge:

Can “It”-a Great Depres­sion-hap­pen again? And if “It” can hap­pen, why did­n’t “It” occur in the [first 35] years since World War II? These are ques­tions that nat­u­ral­ly fol­low from both the his­tor­i­cal record and the com­par­a­tive suc­cess of the past thir­ty-five years. To answer these ques­tions it is nec­es­sary to have an eco­nom­ic the¬ory which makes great depres­sions one of the pos­si­ble states in which our type of cap­i­tal­ist econ­o­my can find itself.

This is the first eco­nom­ic mod­el ever that meets Min­sky’s stan­dards for real­ism. Its final stage empha­sis­es a mes­sage that Michael Hud­son, one of the very few oth­ers to see this cri­sis com­ing, puts very sim­ply: “Debts that can’t be repaid, won’t be repaid”. As Amer­i­cans now seem to be real­is­ing, the finan­cial cri­sis has not gone away, because the debt that caused it is still there.

Hav­ing got our­selves into a debt-induced eco­nom­ic cri­sis, the only per­ma­nent way out is to reduce the debt–either direct­ly by abol­ish­ing large slabs of it, or indi­rect­ly by inflat­ing it away. I have very lit­tle con­fi­dence in the abil­i­ty of the Fed­er­al Reserve to do the lat­ter, while the for­mer will take a lev­el of polit­i­cal for­ti­tude that is far beyond our cur­rent politi­cians.

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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.