Movement at the Station”: Canadian Central Bank Governor Carney on the Age of Deleveraging
There was movement at the station,
for the word had passed around
That the colt from old Regret had got away…
(“Banjo” Patterson, “The Man from Snowy River”)
Before I make any critical remarks, I’ll start by saying that I’m delighted to see the Governor of a Central Bank even refer to Hyman Minsky, let alone acknowledge that we are in a “Minsky Moment” (p. 4: “The global Minsky moment has arrived”—or should that be Millennium?), to acknowledge that we are now in an Age of Deleveraging (the speech’s title was “Growth in the age of deleveraging“), to focus upon the impact of changes in the aggregate level of debt rather than merely on its distribution (p. 1: “Accumulating the mountain of debt now weighing on advanced economies has been the work of a generation”), and to countenance that debt writeoffs may have a role to play in escaping from this never-ending crisis (Carney 2011, p. 6: “Whether we like it or not, debt restructuring may happen”).
By way of contrast, so far as I am aware, the word “Minsky” has yet to pass from Ben Bernanke’s lips since this crisis began, and his discussion of Minsky prior to this crisis was, to put it politely, asinine. Bernanke devoted precisely 2 sentences to Hyman Minsky in his Essays on the Great Depression (Bernanke 2000):
Hyman Minsky (1977) and Charles Kindleberger (1978) have in several places argued for the inherent instability of the financial system but in doing so have had to depart from the assumption of rational economic behavior.. [A footnote adds] I do not deny the possible importance of irrationality in economic life; however it seems that the best research strategy is to push the rationality postulate as far as it will go. (Bernanke 2000, p. 43)
I expect that sheer embarrassment may be one reason that Hyman’s name is taboo in Bernanke’s presence.
Figure 1: Result of search for “Minsky” in Federal Reserve Speeches
Similarly, the impact of deleveraging on aggregate demand doesn’t even fit in Bernanke’s doggedly Neoclassical mindset: from that point of view, only the distribution of debt matters, and not his aggregate level. Despite his popularly-believed status as an expert on the Great Depression, he simply refused to countenance any explanation of that event that didn’t fit into the Neoclassical basket—as evidenced by his dismissal of Irving Fisher’s “Debt Deflation Theory of Great Depressions” (Fisher 1933):
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… (Bernanke 2000, p. 24; emphasis added)
The highlighted section of the above quote also shows how little thought Bernanke gave to the actual process of debt-deflation: during such a crisis, many debtors can’t repay their debts and therefore there is no zero-sum “redistribution from debtors to creditors”, but widespread debt defaults. As Carney emphasises, defaults are inevitable and policy makers may make things worse if they simply try to avoid debt write-offs:
Whether we like it or not, debt restructuring may happen. If it is to be done, it is best done quickly. Policy-makers need to be careful about delaying the inevitable and merely funding the private exit. (p. 6)
So bravo to Governor Mark Carney for being probably the first OECD Central Bank Governor to acknowledge Minsky, deleveraging, and the inevitability of debt defaults (though not the first Central Bank Governor in the world; that honour almost certainly belongs to Mercedes Marcó del Pont, Governor of the Central Bank of Argentina).
That said, there are several points on which I’ll quibble with Carney’s analysis.
Private debt is different
Carney lumps private sector and public sector debt together, and excludes financial sector debt from his statistics—clearly in the belief that finance sector debt doesn’t matter, presumably (since he doesn’t provide his reasoning for doing so) in the belief that finance sector debt to the finance sector is a “zero sum game”.
Figure 2: Carney’s key debt to GDP ratio chart
From the perspectives of Minsky’s theory, the empirical record, and the process of private money and debt creation, both these decisions—lumping government and private sector debt together, and ignoring finance sector debt—are in error.
Minsky’s “Financial Instability Hypothesis” focused upon the dynamics of private debt, with the core concept being that leveraged speculation would rise during a period of tranquil growth in a capitalist economy because tranquillity was the exception rather than the rule:
Stability—or tranquillity—in a world with a cyclical past and capitalist financial institutions is destabilizing. (Minsky 1982, p. 101)
Minsky saw properly-managed public spending—and hence public debt—as a potential “homeostatic stabilizer” to this dynamic of private debt. Rising taxation and declining social security payments during a boom made a public sector surplus likely, which would take money out of circulation and reduce the scale of private speculation, while declining taxation and rising social security payments during a slump would give private businesses a cash flow they wouldn’t otherwise have, making it easier to repay debts. I modelled this aspect of his hypothesis in my first papers on Minsky (Keen 1995; Keen 1996; Keen 2000), and got the outcome that Minsky predicted: a private system that was prone to a debt-deflation could be stabilized by counter-cyclical government spending.
Figure 3: A Minsky model without government spending
Figure 4: A Minsky model with government spending
In my model, the government sector was “resolute”—increasing spending if unemployment exceeded 5% and reducing it below that level. In the real world, governments have accepted rising unemployment, and accumulated debt in pursuit of follies (like the war in Iraq) as well as in pursuit of economic stability. But even so, the counter-cyclical role of government debt can be seen when one compares private sector debt—including financial sector debt—to government (see Figure 5).
Figure 5: Separating out private sector and public sector debt in the USA
This is more apparent when we look just at the change in debt: private and public debt move in opposite directions.
Figure 6: Private and public debt move in opposite directions
Finance sector debt matters
Ignoring finance sector debt is a mistake. Firstly, it’s huge: by far the largest component of debt, private or public, in the USA (see Figure 7).
Secondly, finance sector debt is not a “zero sum game”. Though lending by a non-bank financial company to another entity doesn’t create money, it does create debt; and the initial lending by a bank to a non-bank creates both credit money and debt. Since the finance sector was the source of most of the speculative debt that fuelled the bubble, and it is by far the major force in deleveraging now, leaving it out of the analysis exempts a major causal factor in both the pre-2008 boom and the post-2008 debacle.
Thirdly, by lumping together private and government debt and ignoring finance sector debt, Carney’s aggregation obscures the comparison of today with the Great Depression, understates the growth of debt since the end of WWII, mis-identifies the start of the Age of Deleveraging, and understates the degree of deleveraging to date.
With Carney’s aggregation, “Peak Debt” during the Great Depression was 285% of GDP versus 254% today, the buildup in debt only began in 1980, “Peak Debt” occurred in August 2009, and deleveraging has been relatively mild since then.
However, considering just private sector debt and including the finance sector, Peak Debt in the Great Depression was 238% versus 303% today, the build-up in debt began right from 1945, “Peak Debt” occurred in February 2009, and deleveraging since then has been stark.
Considering all private and public debt together, the situation today is worse than the Great Depression (307% then versus 373% today), the debt build-up dates to 1950, “Peak Debt” was in March 2009, and deleveraging—despite a huge increase in government debt—has been marked.
Figure 8: Comparing debt ratios
Which aggregation is better? This is best answered by looking at why aggregate debt matters, which is the role of changing debt levels in aggregate demand.
Aggregate Demand is Income + Change in Debt
I’m beginning to feel a bit like Cato the Elder here, who ended every speech with “Furthermore, it is my opinion that Carthage must be destroyed“: in the credit-based economy in which we live, aggregate demand is the sum of incomes plus the change in debt. This monetary demand is then expended on both goods and services and claims on financial assets.
This is a case that is made well by both Schumpeter and Minsky, but has been ignored by neoclassical economics (and forgotten even by some modern non-neoclassical economists):
From this it follows, therefore, that in real life total credit must be greater than it could be if there were only fully covered credit. The credit structure projects not only beyond the existing gold basis, but also beyond the existing commodity basis. (Schumpeter 1934, p. 101)
If income is to grow, the financial markets, where the various plans to save and invest are reconciled, 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)
We can use this to show that Carney’s aggregation is misleading, because using his aggregation, there has been no deleveraging. The change in debt, on his measure, remained positive right through the crisis.
Figure 9: Change in debt in US$ million
But when the financial sector is included and government sector excluded, there has been a huge turnaround from rising debt adding almost 30% to aggregate demand at the peak of the bubble, and then subtracting 20% from aggregate demand at its trough.
Figure 10: Change in debt as percent of GDP
The final clincher is the correlation of these measures to unemployment. There is a strong negative correlation between change in debt and the level of unemployment, since increasing debt increases aggregate demand and reduces unemployment. Carney’s mixed private-public-minus-finance measure has a reasonable correlation to unemployment of -0.45, but the private-only-including-finance has a correlation of -0.94.
Figure 11: Far stronger correlation of change in Private debt to Unemployment
What’s “old Regret” got to do with it?
The three lines at the beginning of this post are from the famous poem/bush balled “The Man from Snowy River”. For two reasons, I couldn’t resist linking it to this story because it reminded me of the cliché “shutting the fence after the horse has bolted”.
Firstly, Carney’s measure makes it very hard to identify when the crisis began: the change in debt in his measure remains positive, and all that can be identified is a slight slowdown in the rate of growth of debt (from 14% of GDP p.a. to 7%, after which it “recovers” back to about 10%). Peak Debt occurs in August 2009—two years after the crisis began.
The private-including-finance measure however clearly identifies the end of 2007 as the beginning of the crisis—when the change in debt plunged from almost 30% of GDP p.a. down to minus 20% at its nadir in early 2010. So “the colt from old Regret” got away two years before the first Central Banker noticed.
Secondly, while I’m again very thankful that Governor Carney has put Minsky into the vocabulary of Western central bankers, we would have been far better off had Minsky’s wisdom been heeded decades ago, rather than after the event.
This was possible because knowledge of Minsky wasn’t limited to a few obscure non-orthodox economists like myself: the head of the BIS’s research department from 1995 till 2008 was another Canadian, Bill White, and he was an out and out Minsky fan whose warnings of a potential crisis were ignored.
That said, it’s good to see that sensible economics, rather than the fantasy that is neoclassical economics, is finally being considered in the realms of Central Banks.
I was doubly bemused to see the title of Governor Carney’s paper because I was working on a paper with almost exactly the same title:
Academic precedence being what it is, I’m happy to cede invention of the term “The Age of Deleveraging” to Governor Carney, and I’ll cite him whenever I refer to this term in future.
Bernanke, B. S. (2000). Essays on the Great Depression. Princeton, Princeton University Press.
Carney, M. (2011). Growth in the age of deleveraging. Empire Club of Canada/Canadian Club of Toronto. Toronto, Bank of International Settlements.
Fisher, I. (1933). “The Debt-Deflation Theory of Great Depressions.” Econometrica
Keen, S. (1995). “Finance and Economic Breakdown: Modeling Minsky’s ‘Financial Instability Hypothesis.’.” Journal of Post Keynesian Economics
Keen, S. (1996). “The Chaos of Finance: The Chaotic and Marxian Foundations of Minsky’s ‘Financial Instability Hypothesis.’.” Economies et Societes
Keen, S. (2000). The Nonlinear Economics of Debt Deflation. Commerce, complexity, and evolution: Topics in economics, finance, marketing, and management: Proceedings of the Twelfth International Symposium in Economic Theory and Econometrics. W. A. Barnett, C. Chiarella, S. Keen, R. Marks and H. Schnabl. New York, Cambridge University Press: 83-110.
Minsky, H. P. (1982). Can “it” happen again? : essays on instability and finance. Armonk, N.Y., M.E. Sharpe.
Schumpeter, J. A. (1934). The theory of economic development : an inquiry into profits, capital, credit, interest and the business cycle. Cambridge, Massachusetts, Harvard University Press.