Dude! Where’s My Recovery?

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I initially planned to call this post "Economic Growth, Asset Markets and the Credit Accelerator", but recent negative data out of America makes me think that this title is more in line with conversations currently taking place in the White House.

(Click here for this post in PDF)

According to the NBER, the "Great Recession" is now two years behind us, but the recovery that normally follows a recession has not occurred. While growth did rise for a while, it has been anaemic compared to the norm after a recession, and it is already trending down. Growth needs to exceed 3 per cent per annum to reduce unemployment—the rule of thumb known as Okun's Law—and it needs to be sub­stan­tially higher than this to make seri­ous inroads into it. Instead, growth barely peeped its head above Okun’s level. It is now below it again, and trend­ing down.

Fig­ure 1

Unem­ploy­ment is there­fore ris­ing once more, and with it, Obama’s chances of re-election are rapidly fading.

Fig­ure 2

Obama was assured by his advi­sors that this wouldn’t hap­pen. Right from the first Eco­nomic Report of the Pres­i­dent that he received from Bush’s out­go­ing Chair­man of the Coun­cil of Eco­nomic Advis­ers Ed Lazear in Jan­u­ary 2009, he was assured that “the deeper the down­turn, the stronger the recov­ery”. On the basis of the regres­sion shown in Chart 1–9 of that report (on page 54), I am sure that Obama was told that real growth would prob­a­bly exceed 5 per cent per annum—because this is what Ed Lazear told me after my ses­sion at the Aus­tralian Con­fer­ence of Econ­o­mists in Sep­tem­ber 2009.

Fig­ure 3

I dis­puted this analy­sis then (see “In the Dark on Cause and Effect, Debt­watch Octo­ber 2009″), and events have cer­tainly borne out my analy­sis rather than the con­ven­tional wis­dom. To give an idea of how wrong this guid­ance was, the peak to trough decline in the Great Recession—the x-axis in Lazear’s Chart—was over 6 per­cent. His regres­sion equa­tion there­fore pre­dicted that GDP growth in the 2 years after the reces­sion ended would have been over 12 per­cent. If this equa­tion had born fruit, US Real GDP would be $14.37 tril­lion in June 2011, ver­sus the recorded $13.44 tril­lion in March 2011.

Fig­ure 4

So why has the con­ven­tional wis­dom been so wrong? Largely because it has ignored the role of pri­vate debt—which brings me back to my orig­i­nal title.


Eco­nomic Growth, Asset Mar­kets and the Credit Accelerator


Neo­clas­si­cal econ­o­mists ignore the level of pri­vate debt, on the basis of the a pri­ori argu­ment that “one man’s lia­bil­ity is another man’s asset”, so that the aggre­gate level of debt has no macro­eco­nomic impact. They rea­son that the increase in the debtor’s spend­ing power is off­set by the fall in the lender’s spend­ing power, and there is there­fore no change to aggre­gate demand.

Lest it be said that I’m par­o­dy­ing neo­clas­si­cal eco­nom­ics, or rely­ing on what lesser lights believe when the lead­ers of the pro­fes­sion know bet­ter, here are two appo­site quotes from Ben Bernanke and Paul Krugman.

Bernanke in his Essays on the Great Depres­sion, explain­ing why neo­clas­si­cal econ­o­mists didn’t take Fisher’s Debt Defla­tion The­ory of Great Depres­sions (Irv­ing Fisher, 1933) seri­ously:

Fisher’s idea was less influ­en­tial in aca­d­e­mic cir­cles, though, because of the coun­ter­ar­gu­ment that debt-deflation rep­re­sented no more than a redis­tri­b­u­tion from one group (debtors) to another (cred­i­tors). Absent implau­si­bly large dif­fer­ences in mar­ginal spend­ing propen­si­ties among the groups, it was sug­gested, pure redis­tri­b­u­tions should have no sig­nif­i­cant macro-economic effects… (Ben S. Bernanke, 2000, p. 24)

Krug­man in his most recent draft aca­d­e­mic paper on the cri­sis:

Given both the promi­nence of debt in pop­u­lar dis­cus­sion of our cur­rent eco­nomic dif­fi­cul­ties and the long tra­di­tion of invok­ing debt as a key fac­tor in major eco­nomic con­trac­tions, one might have expected debt to be at the heart of most main­stream macro­eco­nomic models—especially the analy­sis of mon­e­tary and fis­cal pol­icy. Per­haps some­what sur­pris­ingly, how­ever, it is quite com­mon to abstract alto­gether from this fea­ture of the econ­omy. Even econ­o­mists try­ing to ana­lyze the prob­lems of mon­e­tary and fis­cal pol­icy at the zero lower bound—and yes, that includes the authors—have often adopted representative-agent mod­els in which every­one is alike, and in which the shock that pushes the econ­omy into a sit­u­a­tion in which even a zero inter­est rate isn’t low enough takes the form of a shift in everyone’s preferences…

Ignor­ing the for­eign com­po­nent, or look­ing at the world as a whole, the over­all level of debt makes no dif­fer­ence to aggre­gate net worth — one person’s lia­bil­ity is another person’s asset. (Paul Krug­man and Gauti B. Eggerts­son, 2010, pp. 2–3; empha­sis added)

They are pro­foundly wrong on this point because neo­clas­si­cal econ­o­mists do not under­stand how money is cre­ated by the pri­vate bank­ing system—despite decades of empir­i­cal research to the con­trary, they con­tinue to cling to the text­book vision of banks as mere inter­me­di­aries between savers and borrowers.

This is bizarre, since as long as 4 decades ago, the actual sit­u­a­tion was put very sim­ply by the then Senior Vice Pres­i­dent, Fed­eral Reserve Bank of New York, Alan Holmes. Holmes explained why the then fad­dish Mon­e­tarist pol­icy of con­trol­ling infla­tion by con­trol­ling the growth of Base Money had failed, say­ing that it suf­fered from “a naive assump­tion” that:

the bank­ing sys­tem only expands loans after the [Fed­eral Reserve] Sys­tem (or mar­ket fac­tors) have put reserves in the bank­ing sys­tem. In the real world, banks extend credit, cre­at­ing deposits in the process, and look for the reserves later. The ques­tion then becomes one of whether and how the Fed­eral Reserve will accom­mo­date the demand for reserves. In the very short run, the Fed­eral Reserve has lit­tle or no choice about accom­mo­dat­ing that demand; over time, its influ­ence can obvi­ously be felt. (Alan R. Holmes, 1969, p. 73; empha­sis added)

The empir­i­cal fact that “loans cre­ate deposits” means that the change in the level of pri­vate debt is matched by a change in the level of money, which boosts aggre­gate demand. The level of pri­vate debt there­fore can­not be ignored—and the fact that neo­clas­si­cal econ­o­mists did ignore it (and, with the likes of Greenspan run­ning the Fed, actively pro­moted its growth) is why this is no “gar­den vari­ety” downturn.

In all the post-WWII reces­sions on which Lazear’s regres­sion was based, the down­turn ended when the growth of pri­vate debt turned pos­i­tive again and boosted aggre­gate demand. This of itself is not a bad thing: as Schum­peter argued decades ago, in a well-functioning cap­i­tal­ist sys­tem, the main recip­i­ents of credit are entre­pre­neurs who have an idea, but not the money needed to put it into action:

[I]n so far as credit can­not be given out of the results of past enter­prise … it can only con­sist of credit means of pay­ment cre­ated ad hoc, which can be backed nei­ther by money in the strict sense nor by prod­ucts already in existence…

It pro­vides us with the con­nec­tion between lend­ing and credit means of pay­ment, and leads us to what I regard as the nature of the credit phe­nom­e­non… credit is essen­tially the cre­ation of pur­chas­ing power for the pur­pose of trans­fer­ring it to the entre­pre­neur, but not sim­ply the trans­fer of exist­ing pur­chas­ing power.” (Joseph Alois Schum­peter, 1934, pp. 106–107)

It becomes a bad thing when this addi­tional credit goes, not to entre­pre­neurs, but to Ponzi mer­chants in the finance sec­tor, who use it not to inno­vate or add to pro­duc­tive capac­ity, but to gam­ble on asset prices. This adds to debt lev­els with­out adding to the economy’s capac­ity to ser­vice them, lead­ing to a blowout in the ratio of pri­vate debt to GDP. Ulti­mately, this process leads to a cri­sis like the one we are now in, where so much debt has been taken on that the growth of debt comes to an end. The econ­omy then enters not a reces­sion, but a Depression.

For a while though, it looked like a recov­ery was afoot: growth did rebound from the depths of the Great Reces­sion, and very quickly com­pared to the Great Depres­sion (though slowly when com­pared to Post-WWII recessions).

Clearly the scale of gov­ern­ment spend­ing, and the enor­mous increase in Base Money by Bernanke, had some impact—but nowhere near as much as they were hop­ing for. How­ever the main fac­tor that caused the brief recovery—and will also cause the dreaded “dou­ble dip”—is the Credit Accelerator.

I’ve pre­vi­ously called this the “Credit Impulse” (using the name bestowed by Michael Biggs et al., 2010), but I think “Credit Accel­er­a­tor” is both move evoca­tive and more accu­rate. The Credit Accel­er­a­tor at any point in time is the change in the change in debt over pre­vi­ous year, divided by the GDP fig­ure for that point in time. From first prin­ci­ples, here is why it matters.

Firstly, and con­trary to the neo­clas­si­cal model, a cap­i­tal­ist econ­omy is char­ac­ter­ized by excess sup­ply at vir­tu­ally all times: there is nor­mally excess labor and excess pro­duc­tive capac­ity, even dur­ing booms. This is not per se a bad thing but merely an inher­ent char­ac­ter­is­tic of capitalism—and it is one of the rea­sons that cap­i­tal­ist economies gen­er­ate a much higher rate of inno­va­tion than did social­ist economies (Janos Kor­nai, 1980). The main con­straint fac­ing cap­i­tal­ist economies is there­fore not sup­ply, but demand.

Sec­ondly, all demand is mon­e­tary, and there are two sources of money: incomes, and the change in debt. The sec­ond fac­tor is ignored by neo­clas­si­cal eco­nom­ics, but is vital to under­stand­ing a cap­i­tal­ist econ­omy. Aggre­gate demand is there­fore equal to Aggre­gate Sup­ply plus the change in debt.

Thirdly, this Aggre­gate Demand is expended not merely on new goods and ser­vices, but also on net sales of exist­ing assets. Wal­ras’ Law, that main­stay of neo­clas­si­cal eco­nom­ics, is thus false in a credit-based economy—which hap­pens to be the type of econ­omy in which we live. Its replace­ment is the fol­low­ing expres­sion, where the left hand is mon­e­tary demand and the right hand is the mon­e­tary value of pro­duc­tion and asset sales:

Income + Change in Debt = Out­put + Net Asset Sales;

In sym­bols (where I’m using an arrow to indi­cate the direc­tion of cau­sa­tion rather than an equals sign), this is:


This means that it is impos­si­ble to sep­a­rate the study of “Finance”—largely, the behav­iour of asset markets—from the study of macro­eco­nom­ics. Income and new credit are expended on both newly pro­duced goods and ser­vices, and the two are as entwined as a scram­bled egg.

Net Asset Sales can be bro­ken down into three components:

  • The asset price Level; times
  • The frac­tion of assets sold; times
  • The quan­tity of assets

Putting this in symbols:


That cov­ers the lev­els of aggre­gate demand, aggre­gate sup­ply and net asset sales. To con­sider eco­nomic growth—and asset price change—we have to look at the rate of change. That leads to the expression:


There­fore the rate of change of asset prices is related to the accel­er­a­tion of debt. It’s not the only fac­tor obviously—change in incomes is also a fac­tor, and as Schum­peter argued, there will be a link between accel­er­at­ing debt and ris­ing income if that debt is used to finance entre­pre­neur­ial activ­ity. Our great mis­for­tune is that accel­er­at­ing debt hasn’t been pri­mar­ily used for that pur­pose, but has instead financed asset price bubbles.

There isn’t a one-to-one link between accel­er­at­ing debt and asset price rises: some of the bor­rowed money dri­ves up pro­duc­tion (think SUVs dur­ing the boom), con­sumer prices, the frac­tion of exist­ing assets sold, and the pro­duc­tion of new assets (think McMan­sions dur­ing the boom). But the more the econ­omy becomes a dis­guised Ponzi Scheme, the more the accel­er­a­tion of debt turns up in ris­ing asset prices.

As Schumpeter’s analy­sis shows, accel­er­at­ing debt should lead change in out­put in a well-functioning econ­omy; we unfor­tu­nately live in a Ponzi econ­omy where accel­er­at­ing debt leads to asset price bubbles.

In a well-functioning econ­omy, peri­ods of accel­er­a­tion of debt would be fol­lowed by peri­ods of decel­er­a­tion, so that the ratio of debt to GDP cycled but did not rise over time. In a Ponzi econ­omy, the accel­er­a­tion of debt remains pos­i­tive most of the time, lead­ing not merely to cycles in the debt to GDP ratio, but a sec­u­lar trend towards ris­ing debt. When that trend exhausts itself, a Depres­sion ensues—which is where we are now. Delever­ag­ing replaces ris­ing debt, the debt to GDP ratio falls, and debt starts to reduce aggre­gate demand rather than increase it as hap­pens dur­ing a boom.

Even in that sit­u­a­tion, how­ever, the accel­er­a­tion of debt can still give the econ­omy a tem­po­rary boost—as Biggs, Meyer and Pick pointed out. A slow­down in the rate of decline of debt means that debt is accel­er­at­ing: there­fore even when aggre­gate pri­vate debt is falling—as it has since 2009—a slow­down in that rate of decline can give the econ­omy a boost.

That’s the major fac­tor that gen­er­ated the appar­ent recov­ery from the Great Reces­sion: a slow­down in the rate of decline of pri­vate debt gave the econ­omy a tem­po­rary boost. The same force caused the appar­ent boom of the Great Mod­er­a­tion: it wasn’t “improved mon­e­tary pol­icy” that caused the Great Mod­er­a­tion, as Bernanke once argued (Ben S. Bernanke, 2004), but bad mon­e­tary pol­icy that wrongly ignored the impact of ris­ing pri­vate debt upon the economy.

Fig­ure 5

The fac­tor that makes the recent recov­ery phase dif­fer­ent to all pre­vi­ous ones—save the Great Depres­sion itself—is that this strong boost from the Credit Accel­er­a­tor has occurred while the change in pri­vate debt is still mas­sively neg­a­tive. I return to this point later when con­sid­er­ing why the recov­ery is now peter­ing out.

The last 20 years of eco­nomic data shows the impact that the Credit Accel­er­a­tor has on the econ­omy. The recent recov­ery in unem­ploy­ment was largely caused by the dra­matic rever­sal of the Credit Accelerator—from strongly neg­a­tive to strongly positive—since late 2009:

Fig­ure 6

The Credit Accel­er­a­tor also caused the tem­po­rary recov­ery in house prices:

Fig­ure 7

And it was the pri­mary fac­tor dri­ving the Bear Mar­ket rally in the stock market:

Fig­ure 8


Leads and Lags


I use the change in the change in debt over a year because the monthly and quar­terly data is sim­ply too volatile; the annual change data smooths out much of the noise. Con­se­quently the data shown for change in unem­ploy­ment, house prices and the stock mar­ket are also for the change the pre­vi­ous year.

How­ever the change in the change in debt oper­ates can impact rapidly on some markets—notably the Stock Mar­ket. So though the cor­re­la­tions in the above graphs are already high, they are higher still when we con­sider the causal role of the debt accel­er­a­tor in chang­ing the level of aggre­gate demand by lag­ging the data.

This shows that the annual Credit Accel­er­a­tor leads annual changes in unem­ploy­ment by roughly 5 months, and its max­i­mum cor­re­la­tion is a stag­ger­ing –0.85 (neg­a­tive because an accel­er­a­tion in debt causes a fall in unem­ploy­ment by boost­ing aggre­gate demand, while a decel­er­a­tion in debt causes a rise in unem­ploy­ment by reduc­ing aggre­gate demand).

Fig­ure 9

The cor­re­la­tion between the annual Credit Accel­er­a­tor and annual change in real house prices peaks at about 0.7 roughly 9 months ahead:

Fig­ure 10

And the Stock Mar­ket is also a crea­ture of the Credit Impulse, where the lead is about 10 months and the cor­re­la­tion peaks at just under 0.6:

Fig­ure 11

The causal rela­tion­ship between the accel­er­a­tion of debt and change in stock prices is more obvi­ous when the 10 month lag is taken into account:

Fig­ure 12

These cor­re­la­tions, which con­firm the causal argu­ment made between the accel­er­a­tion of debt and the change in asset prices, expose the dan­ger­ous pos­i­tive feed­back loop in which the econ­omy has been trapped. This is sim­i­lar to what George Soros calls a reflex­ive process: we bor­row money to gam­ble on ris­ing asset prices, and the accel­er­a­tion of debt causes asset prices to rise.

This is the basis of a Ponzi Scheme, and it is also why the Scheme must even­tu­ally fail. Because it relies not merely on grow­ing debt, but accel­er­at­ing debt, ulti­mately that accel­er­a­tion must end—because oth­er­wise debt would become infi­nite. When the accel­er­a­tion of debt ceases, asset prices collapse.

The annual Credit Accel­er­a­tor is still very strong right now—so why is unem­ploy­ment ris­ing and both hous­ing and stocks falling? Here we have to look at the more recent quar­terly changes in the Credit Accelerator—even though there is too much noise in the data to use it as a decent indi­ca­tor (the quar­terly lev­els show in Fig­ure 13 are from month to month—so that the bar for March 2011 indi­cates the accel­er­a­tion of debt between Jan­u­ary and March 2011). It’s appar­ent that the strong accel­er­a­tion of debt in mid to late 2010 is peter­ing out. Another quar­ter of that low a rate of accel­er­a­tion in debt—or a return to more deceleration—will drive the annual Credit Accel­er­a­tor down or even neg­a­tive again. The lead between the annual Credit Accel­er­a­tor and the annu­al­ized rates of change of unem­ploy­ment and asset prices means that this dimin­ished stim­u­lus from accel­er­at­ing debt is turn­ing up in the data now.

Fig­ure 13

This ten­dency for the Credit Accel­er­a­tor to turn neg­a­tive after a brief bout of being pos­i­tive is likely to be with us for some time. In a well-functioning econ­omy, the Credit Accel­er­a­tor would fluc­tu­ate around slightly above zero. It would be above zero when a Schum­peter­ian boom was in progress, below dur­ing a slump, and tend to exceed zero slightly over time because pos­i­tive credit growth is needed to sus­tain eco­nomic growth. This would result in a pri­vate debt to GDP level that fluc­tu­ated around a pos­i­tive level, as out­put grew cycli­cally in pro­por­tion to the ris­ing debt.

Instead, it has been kept pos­i­tive over an unprece­dented period by a Ponzi-oriented finan­cial sec­tor, which was allowed to get away with it by naïve neo­clas­si­cal econ­o­mists in posi­tions of author­ity. The con­se­quence was a sec­u­lar ten­dency for the debt to GDP ratio to rise. This was the dan­ger Min­sky tried to raise aware­ness of in his Finan­cial Insta­bil­ity Hypoth­e­sis (Hyman P. Min­sky, 1972)—which neo­clas­si­cal econ­o­mists like Bernanke ignored.

The false pros­per­ity this accel­er­at­ing debt caused led to the fan­tasy of “The Great Mod­er­a­tion” tak­ing hold amongst neo­clas­si­cal econ­o­mists. Ulti­mately, in 2008, this fan­tasy came crash­ing down when the impos­si­bil­ity of main­tain­ing a pos­i­tive accel­er­a­tion in debt for­ever hit—and the Great Reces­sion began.

Fig­ure 14

From now on, unless we do the sen­si­ble thing of abol­ish­ing debt that should never have been cre­ated in the first place, we are likely to be sub­ject to wild gyra­tions in the Credit Accel­er­a­tor, and a gen­eral ten­dency for it to be neg­a­tive rather than pos­i­tive. With debt still at lev­els that dwarf pre­vi­ous spec­u­la­tive peaks, the pos­i­tive feed­back between accel­er­at­ing debt and ris­ing asset prices can only last for a short time, since it if were to per­sist, debt lev­els would ulti­mately have to rise once more. Instead, what is likely to hap­pen is a a period of strong accel­er­a­tion in debt (caused by a slow­down in the rate of decline of debt) and ris­ing asset prices—followed by a decline in the accel­er­a­tion as the veloc­ity of debt approaches zero.

Fig­ure 15

Here Soros’s reflex­iv­ity starts to work in reverse. With the Credit Accel­er­a­tor going into reverse, asset prices plunge—which fur­ther reduces the public’s will­ing­ness to take on debt, which causes asset prices to fall even further.

The process even­tu­ally exhausts itself as the debt to GDP ratio falls. But given that the cur­rent pri­vate debt level is per­haps 170% of GDP above where it should be (the level that finances entre­pre­neur­ial invest­ment rather than Ponzi Schemes), the end game here will be many years in the future. The only sure road to recov­ery is debt abolition—but that will require defeat­ing the polit­i­cal power of the finance sec­tor, and end­ing the influ­ence of neo­clas­si­cal econ­o­mists on eco­nomic pol­icy. That day is still a long way off.

Fig­ure 16

Bernanke, Ben S. 2000. Essays on the Great Depres­sion. Prince­ton: Prince­ton Uni­ver­sity Press.

____. 2004. “The Great Mod­er­a­tion: Remarks by Gov­er­nor Ben S. Bernanke at the Meet­ings of the East­ern Eco­nomic Asso­ci­a­tion, Wash­ing­ton, Dc Feb­ru­ary 20, 2004,” East­ern Eco­nomic Asso­ci­a­tion. Wash­ing­ton, DC: Fed­eral Reserve Board,

Biggs, Michael; Thomas Mayer and Andreas Pick. 2010. “Credit and Eco­nomic Recov­ery: Demys­ti­fy­ing Phoenix Mir­a­cles.” SSRN eLi­brary.

Fisher, Irv­ing. 1933. “The Debt-Deflation The­ory of Great Depres­sions.” Econo­met­rica, 1(4), 337–57.

Holmes, Alan R. 1969. “Oper­a­tional Con­straints on the Sta­bi­liza­tion of Money Sup­ply Growth,” F. E. Mor­ris, Con­trol­ling Mon­e­tary Aggre­gates. Nan­tucket Island: The Fed­eral Reserve Bank of Boston, 65–77.

Kor­nai, Janos. 1980. “‘Hard’ and ‘Soft’ Bud­get Con­straint.” Acta Oeco­nom­ica, 25(3–4), 231–45.

Krug­man, Paul and Gauti B. Eggerts­son. 2010. “Debt, Delever­ag­ing, and the Liq­uid­ity Trap: A Fisher-Minsky-Koo Approach [2nd Draft 2/14/2011],” New York: Fed­eral Reserve Bank of New York & Prince­ton Uni­ver­sity,

Min­sky, Hyman P. 1972. “Finan­cial Insta­bil­ity Revis­ited: The Eco­nom­ics of Dis­as­ter,” Board of Gov­er­nors of the Fed­eral Reserve Sys­tem, Reap­praisal of the Fed­eral Reserve Dis­count Mech­a­nism. Wash­ing­ton, D.C.: Board of Gov­er­nors of the Fed­eral Reserve Sys­tem,

Schum­peter, Joseph Alois. 1934. The The­ory of Eco­nomic Devel­op­ment : An Inquiry into Prof­its, Cap­i­tal, Credit, Inter­est and the Busi­ness Cycle. Cam­bridge, Mass­a­chu­setts: Har­vard Uni­ver­sity Press.



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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266 Responses to Dude! Where’s My Recovery?

  1. kys says:

    It is the devel­op­ing nations with a fixed exchange rate regime that I was talk­ing about. I don’t think only cur­rency depre­ci­a­tion and high inter­est rates were observed in the events of cap­i­tal flight. Mass defaults, bank­rup­cies, riots… also inflicted tremen­dous pains. Of course every­thing will be calm but we the out­siders aren’t those who bear the brunt.

    Regard­ing CDS which I think is an insur­ance pre­mium, it should be taken as a cal­cu­lated risk for the finan­cial insti­tu­tions involved on the sell side, and shouldn’t be con­sid­ered as a prob­lem for the cred­i­tor nations.

    As to default by a large econ­omy with a float­ing exchange rate regime, we shall see.….who’s gonna hurt?

  2. Cahal says:

    Pro­fes­sor Keen,

    Great post. I have to say my head hurts a lit­tle when I con­sider exactly how the ‘money out of thin air’ mech­a­nism works.

    Let’s see if I have this right: firm 1 bor­rows £10 from the bank to pay firm 2. Firm 2s account is cred­ited £10, firm 1s goes into debt. How­ever, when firm 1 pays the money back it effec­tively disappears.

    Is this right?

  3. Steve Keen says:

    No Cabal: the money does not dis­ap­pear. It becomes part of the reserves of the bank­ing sys­tem. It dis­ap­pears from cir­cu­la­tion until relent, but it is not “destroyed” as some Post Key­ne­sians argue.

  4. Cahal says:

    If it isn’t destroyed then how is it true that credit exten­sion cre­ates money that wasn’t pre­vi­ously there?

    Sorry if I’m being dense I just want to make sure I under­stand it.

  5. Steve Keen says:

    This belief–that repay­ment of debt destroys money–has befud­dled a lot of non-neoclassical econ­o­mists as well. It’s double-entry book­keep­ing that cre­ates the money in the first place Cabal; double-entry book­keep­ing pre­serves it after that as well. A loan, when cre­ated, cre­ates a deposit as well; when the loan is repaid, the money becomes part of the bank’s reserves. I’ll be post­ing a paper on this in the next year or so, which I’m writ­ing with the ex-Chief Accoun­tant of a lead­ing bank.

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