SASE 2011 Presentation: The Failure of Neoclassical Macro & the Monetary Circuit Theory Alternative

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This is the presentation I gave at the 2011 conference of the Society for the Advancement of Socio-Economics (SASE) annual conference in Madrid last week:

It combines four themes that will be prominent in my public talks from now on:

  • Neoclassical economists don’t understand neoclassical economics;
  • Neoclassical “representative agent” macroeconomics (both the so-called New Classical and New Keynesian variants) violate fundamental research by neoclassical economists into the foundations of neoclassical theory;
  • The Credit Accelerator explains the Great Depression and the Great Recession (here my arguments are similar to those of Richard Koo, and the Credit Accelerator is the same concept initially derived by Biggs, Mayer and Pick that they called the Credit Impulse); and
  • The “Monetary Circuit Theory” model (my thanks to Mike Honeychurch for suggesting this name for my approach).

I had some software hassles–I changed the screen resolution after loading my screen capture program, which caused it to crash!–so I had to “dub” the talk later, and so there’s a bit of chatter about that at the start, and the sound levels are rather low. So my apologies, but it’s all I had time for when also coping with a brand new HP laptop that has been having BSOD events so regularly that I am now pining for Mephistopheles, my Dell laptop that I left back in Sydney.

In the 30 minutes I had, I only covered about half the material in the Powerpoint slides; a similar issue will apply when I present at the Central Bank of Argentina’s annual conference on Thursday. Hopefully one day I’ll get the chance to present this talk over an hour or so, which would be needed to cover all the information in it.

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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18 Responses to SASE 2011 Presentation: The Failure of Neoclassical Macro & the Monetary Circuit Theory Alternative

  1. TruthIsThereIsNoTruth says:

    hello Steve,

    Could you please explain slides 44 and 45. This is really confusing me, my understanding is that if you lag a variable, you are bringing past values forward, therefore the lagged variable is the explanotary variable. I am at pain to understand where my understanding is incorrect in this case.

  2. RickW says:

    How widely accepted is your modelling? Who is listening – apart from me of course!

    Have you tested what subtle changes can be made to restabilise the system once it is headed for collapse? Were you serious suggesting that there should be wage increases?

  3. Steve Keen says:

    Hi TININT,

    What I mean is that changes in the CA precede changes in stock and property prices. But as you know, my specialty is mathematical modeling rather than stats (let alone eCONometrics), so my language here can be sloppy, and I have used routines I’ve written in Mathcad to do the stats there rather than a standard econometric package.

    Given comments here that the timing looks the other way around on the images, I’ve sent the data to a colleague to check with standard statistical packages, in case I did make a mistake in my routines. Once I get word back–one way or the other–from that colleague, I’ll post the results and the original data here.

  4. Steve Keen says:

    Acceptance is pretty wide in the finance community these days Rick, and I am in Argentina right now as a guest of their Central Bank. Within the Post Keynesian camp there are disputes–the Chartalist-Circuitist issue–but my work is influential there as well, if decidedly unpopular with some individuals in that camp.

    On the wages issue, inflation would reduce the burden of outstanding private sector debt, and a wage rise would be a much more direct way to cause inflation than fiddling with Base Money, which is the current US Fed policy (combined with deflationary budget deficit reductions by the Federal Government). But there’s Buckley’s chance of that policy being followed in practice of course.

    And testing these models is a long way down the track. If I had a research team, or if there was an entire community of scholars (as the neoclassicals have with their misguided theories), then it would have already happened. But as a one man show, it simply hasn’t been possible for me to go beyond building them in the first instance.

  5. Nebbiolo71 says:

    Hi Steve,

    I’m continuously following your work since more than a year now but I still haven’t really figured out exactly what are the dispute between you and the chartalists (I suppose especially Bill Mitchell? 😉 …which I also follow continously) and the MMT.

    Another thing, back in Sweden I believe we have a similar situation as you’ve got in Australia regarding an asset bubble (even if the Swedish version has been fueled by other means, mainly tax cuts on salaries and properties). Have you ever had the opportunity to study this and apply your models?

  6. Steve Keen says:

    Welcome aboard Nebbiolo71,

    As for Sweden, I’m sorry but that hasn’t turned up on my radar; once we get an online database rolling, hopefully data will be available for easy comparison across countries, but I don’t have any for Sweden yet.

    On Chartalism versus Circuit Theory, I have been holding back from writing a critique for some time but will soon be embarking on one. I don’t dispute their accounting of how government financing works, or the need for a government deficit when the private sector is faltering. I do question their economics, which I see as being essentially static in nature (despite their arguments about stock-flow consistent modeling) and based on an erroneous conservation law, their relative non-consideration of the role of private sector credit creation–which as you know is my main analytic focus–and their tendency to treat the private sector as an aggregation, whereas I argue (from a Circuit perspective) that at least three classes must be distinguished to consider private sector dynamics properly: workers, capitalists and bankers.

    Those are preliminary remarks only. I won’t publish a detailed analysis and critique until I’m ready.

  7. Nebbiolo71 says:

    Hi Steve and thanks for your prompt reply (from down-under?)!

    My suspicion of the origin of the dispute, static versus dynamic modeling, was somewhat right then and I’m looking forward to read your coming publication of your more explicit critique of the MMT model/Chartalism.

    From an European perspective it’s extremely interesting and promising to see that so much new thinking is coming from down-under and I’m not only talking about your (and Bill Mitchell’s) work but also work from people like Geoff Davies.

    Regarding Sweden, it’s currently considered one of the European tiger economies but personally I think the economy is mostly fueled by the credit impulse injected by the still ongoing housing bubble. Of course, in addition, because of not being part of EURO, Swedish export industry has flourished when the currency has been floating/adapting but this doesn’t explain all.

    For years the increase in household debt has been in the range of 6-8 % of GDP and is now reaching 100% in total (of GDP), total private debt closing in on the 300% of GDP. The interesting is that this period of growth started by quite high unemployment (created during the last Swedish financial crisis in 1993 when the government tried to tie the currency to the EURO…) that hasn’t changed/improved despite the growth of GDP. The ratio between mean income and average debt is similar to the figures you’ve published on Australia, maybe even a bit worse.

    What worries me (an a whole bunch of others) is what happens once the increase in household debt declines or worse, if people starting to pay back loans instead of taking on new ones. Reading your work on the subject doesn’t really dispel these dark clouds… 😉 …when I think your analysis would point out a strong recession or even depression, given the magnitude of the debt (especially if the world is on a protectionism route, given the importance of export in Sweden) – am I right?

  8. sirius says:

    Maybe Ben Bernanke will start reading your blog ?

    Bernanke SwanSong ?

    a video with David Stockman – I am only 2 min 50 into viewing and it is scathing of Bernanke

  9. Frank says:

    Here is an interesting one:

    First hand experience of false economies.

  10. Steve Keen says:

    Those sound like crisis level figures to me Nebbiolo–similar to the USA which is much worse than Australia on debt to GDP. And your export vulnerability sounds like a replay of Japan, which slumped very badly when the Great Recession began since its exports plummeted.

  11. RickW says:

    This link gives the financial data for Sweden:
    I consider the net foreign investment position to be a good indicator of the health of an economy. I started looking at this a while back because it seems there is debt everywhere but there must be credit in the system to balance the debt.

    This data shows Sweden’s net position at Q1/2011 was -SEK628bn against a quarterly GDP of SEK853bn or say -18% of annual GDP. Even better news is that it improved from the previous quarter.

    The US is worse than this but not all investments are the same because US entities get favoured treatment and earn higher income on loans than do foreigners having assets in the US. However US is still going backwards at a blistering pace.

    Australia is much worse at around -88% of GDP but was making good gains up till end of 2010 then hit by bad weather giving poor BoP in Q1 2011. Some of the recent investment in Australia has been in productive assets but a lot of that investment comes from offshore – notably China. In 2009 Australia was worse than Ireland. Australians have a high proportion of their wealth tied up in the housing Ponzi scheme that the Federal Government encourages in various ways.

    I am baffled by the stupidity of economists who fail to factor in the significance of debt in an economic model. I have significant concern that the only way forward will be through inflation to devalue current debt and my savings with it. The incompetents who encouraged the debt get rewarded, those who enjoyed the benefits of the debt get forgiven and those who worked long and hard to save are proven stupid. What a mess!

  12. sirius says:

    News just come in…

    “Greece???” says “yes”…to…austerity and more raids from __________?

    I always “love” intimidation in our “democratic systems”…

    “One of those who voted against it – a deputy of the ruling party – was immediately expelled by the Greek prime minister George Papandreou. ”

    Whatever the real (physics) energy savings the private sector makes you can count on “government” to more than offset them…

    The government resorts to the old tried and tested favourite of “let’s build a road”.

    In this case a high speed rail link (dubbed “HS2”) for the “common good” estimated to cost a monetary 33 billion UK pounds.

    So what if we have to “destroy some GDP” in the form of houses, gardens and agricultural land that lay in the new path for this rail link?

    “Ah but ’tis for the ‘common good'” explains the barrister who will now be able to travel to the North of the UK from London on the same day rather than begin his journey the day before.

    (Do we really need barristers from London?).

    As I previously stated double the working speed of a mode of transport and you double the energy used (based upon the human view of what is the acceptable maximum time for a journey).

    All this in time of energy and resource constraints.

    We have to distinguish between “good governance” and “bad governance”.

    The clown car accelerates.

  13. sirius says:

    Clarity for prior post.

    The high speed rail link is to be built in the UK.

  14. alainton says:


    Hi, Im wondering about the lead-lag issue – it does seem an unresolved puzzle.

    Im wondering if a ‘tabletop’ model might resolve it – the idea come from growth of small businesses modelling.

    At any one time there are firms that are forming (coming onto the tabletop) firms growing, or declining (sliding off) and dying (falling off). I wish I could remember a reference.

    Same with debt, new loans arising, some growing and compounding, some defaulting and some being paid off and paid off completely.

    Investment comes from acceleration of credit for new loans.

    Existing loans compound, if debt restricts firm budget constraint too much then even acceleration of credit wont go to investment if go towards paying off interest and interest on interest.

    So at times of very high debt a credit acceleration can simply go towards restoring balance sheets, and when balance sheets are restored firms are safe to accelerate credit to expand – its a two way street – both lead and lag effects?

  15. Brian Hanley says:

    Saw on Kash Mansori’s blog that he says the USA’s banks have greater exposure to Greek debt than the european banks do. US Financials have been selling CDS’s on Greek debt to the Europeans. See:

    I have to ask the question, because it makes sense given the structure of the “too-big-to-fail” game. Have both USA and EU financiers/bankers been conspiring to stick the US taxpayer with the bill for the EU? One can model it as simply a rational response to the game’s structure. No player in the financial system loses in that scenario, and it could explain the huge (and I think otherwise utterly nonsensical) differential between EU and USA behavior relative to Greek debt.

    There is also the question as to exactly what the exposure really is, which is discussed on the blog without resolution.

    How much of CDS liability is collateralized? (i.e. Is there collateral, and to what degree does the collateral cover the position on paper?)
    And what, precisely, is the form of the collateral? (i.e. To what degree is each collateral posted liquid? Is the collateral itself an inflated asset? And if it is traced back, is the same collateral pledged multiple times over to cover different CDS’s?)

    Unless you know the answer to those questions, it is impossible to evaluate, and as far as I know, there is simply no source for such data.

  16. Steve Keen says:

    Hi Andrew,

    I’ve got that feedback from my more statistically capable colleague, and I did get my leads/lags wrong–relying on my own routines led me astray somewhat. There are lead/lag relationships which are unstable but the relationships are statistically significant. Once I’ve given the current post on Homelessness enough time for air, I’ll publish my colleague’s results and the original data for others to examine.

  17. A. Kadlcik says:

    Hello Steve,

    About neoclassical economists not reading their literature. I wouldn’t be surprised about that. Now my experience with “higher learning” is not on the research part of the equation but on the studying part (humanities, social sciences). I have been amazed time and again at the output of the so called research which has been empirically falsifiable, meaningless (without meaning and/or inconsequential), or internally inconsistent. (Not all has been bad, there have been also some true gems.)

    I have wondered about that and my conclusion is that there must be a silent “gentleman’s agreement” not to criticise each others’ works and thusly, keep the bulk of the academia in business. (Most likely the not reading one’s literature part is there as well because it is not at all unusual to read things claimed as new which, in the end, have been said before – several times – and more eloquently.)

    Now, onto economics. Although here my “expertise” is very limited, I have nonetheless been under the impression that quite a lot of economics – at least the kind which laymen and the like are likely to hear about, at least from the mainstream sources – is based on one strange premise: the ability to create a predictable model of essentially a chaotic system (economy).

    I mean, we have sophisticated mathematical models and formulas – which by the way completely surpass my competency to understand them – yet, it seems, in order for them to work, they must assume the chaotic element, or randomness, away. Such an act may indeed create a beautiful theory/model but if it is unfit to describe reality, why have it in the first place.

  18. alainton says:

    Hi Steve,

    Just a hunch but ive been wondering if the lead-lag issue might be closely related to a fundamental capital theory problem.

    That is the problem that you cant use the fisher stock-flow view of capital and, at the same time, use marginal productivity theory to determine the “optimal” level of capital, and then have marginal efficiency of investment theory determine the optimal level of investment – you no longer have a flow investment term, its overdetermined. You can have one but not both theories – and Fisher seems to be right.

    Now to avoid this problem neo-classicism developed Tobins-q, as much loved by Lucas.

    But it doesn’t work – neoclassical economics argues that the fluctuations in Tobin’s q are due to bubbles and crashes which can be forecasted by the market value of equities and bonds moving up faster that the cost of corporate fixed assets in a bubble, or dropping faster than the cost of corporate fixed assets in a crash.

    The trouble is that empirical work shows that exactly the opposite occurs (Nitzen and Bitchler 2010)

    This had already been predicted by Hennesy (2004)
    because of debt overhang. and Bolton, Chen and Wang (2009) who predict an inverse relation between marginal Tobin’s q and investment when the firm draws on its credit line.

    Just a hunch but i’m wondering what happens when you plug the acceleration of debt into these debt overhang equations, in macroeconomic terms. Can it explain the investment cycle in a way which knocks the final nail in the coffin of the marginal productivity theory of capital?

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