The Debtwatch Manifesto

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The fun­da­men­tal cause of the eco­nomic and finan­cial cri­sis that began in late 2007 was lend­ing by the finance sec­tor that pri­mar­ily financed spec­u­la­tion rather than invest­ment. The pri­vate debt bub­ble this caused is unprece­dented, prob­a­bly in human his­tory and cer­tainly in the last cen­tury (see Fig­ure 1). Its unwind­ing now is the pri­mary cause of the sus­tained slump in eco­nomic growth. The recent growth in sov­er­eign debt is a symp­tom of this under­ly­ing cri­sis, not the cause, and the cur­rent polit­i­cal obses­sion with reduc­ing sov­er­eign debt will exac­er­bate the root prob­lem of pri­vate sec­tor deleveraging.

Fig­ure 1

US pri­vate debt clearly rose faster than GDP from the end of World War II (when the debt to GDP ratio was 43%) until 2009 (when it peaked at 303%), but there is no intrin­sic rea­son why it (or the pub­lic sec­tor debt to GDP ratio) has to rise over time. I give a the­o­ret­i­cal expla­na­tion else­where (Keen 2010), but an empir­i­cal com­par­i­son will suf­fice here: 1945 till 1965 were the best years of the Aus­tralian economy—with unem­ploy­ment aver­ag­ing 2 percent—and dur­ing that time the pri­vate debt ratio remained rel­a­tively con­stant at 25% of GDP (see Fig­ure 2).

Fig­ure 2

America’s min­i­mum pri­vate debt ratio in 1945 may have been arti­fi­cially low in the after­math of both the Great Depres­sion and World War II (and there are good rea­sons why the US econ­omy should have a higher sus­tain­able debt ratio than does Aus­tralia), but at some time between 1945 and America’s first post-WWII finan­cial cri­sis in 1966 (Min­sky 1982, p. xiii), it passed this level.

The explo­sion in spec­u­la­tive debt drove asset prices to all-time highs—relative to con­sumer prices—from which they are now inex­orably col­laps­ing (see Fig­ure 3 and Fig­ure 4).

Fig­ure 3

Fig­ure 4

The debt and asset price bub­bles were ignored by con­ven­tional “Neo­clas­si­cal” econ­o­mists on the basis of a set of a pri­ori beliefs about the nature of a mar­ket econ­omy that are spu­ri­ous, but deeply entrenched. Under­stand­ing how this cri­sis came about will require a new, dynamic, mon­e­tary approach to eco­nomic the­ory that con­tra­dicts the neat, plau­si­ble and false Neo­clas­si­cal model that cur­rently dom­i­nates aca­d­e­mic eco­nom­ics and pop­u­lar polit­i­cal debate.

Escap­ing from the debt trap we are now in will require either a “Lost Gen­er­a­tion”, or poli­cies that run counter to con­ven­tional eco­nomic thought and the short-term inter­ests of the finan­cial sector.

Pre­vent­ing a future cri­sis will require a rede­f­i­n­i­tion of finan­cial claims upon the real econ­omy which elim­i­nates the appeal of lever­aged speculation.

These three obser­va­tions lead to the three pri­mary objec­tives of Debtwatch:

  1. To develop a real­is­tic, empir­i­cally based, dynamic mon­e­tary approach to eco­nomic the­ory and policy;
  2. To develop and pro­mote a “mod­ern Jubilee” by which pri­vate debt can be reduced while doing the min­i­mum pos­si­ble harm to aggre­gate demand and social equity; and
  3. To develop and pro­mote new def­i­n­i­tions of shares and prop­erty own­er­ship that will min­i­mize the destruc­tive insta­bil­i­ties of cap­i­tal­ism and pro­mote its cre­ative instabilities.

A realistic economics

The eco­nomic and finan­cial cri­sis has been caused by unen­light­ened self-interest and fraud­u­lent behav­iour on an unprece­dented scale. But this behav­iour could not have grown so large were it not for the cover given to this behav­iour by the dom­i­nant the­ory of eco­nom­ics, which is known as “Neo­clas­si­cal Economics”.

Though many com­men­ta­tors call this the­ory “Key­ne­sian”, one of Keynes’s objec­tives in the 1930s was to over­throw this the­ory, but instead, as the mem­ory of the Great Depres­sion receded, aca­d­e­mic econ­o­mists grad­u­ally con­structed an even more extreme ver­sion of Neo­clas­si­cal eco­nom­ics than that against which Keynes had fought. This began with Hicks’s “IS-LM” model, which is still accepted as rep­re­sent­ing “Key­ne­sian” eco­nom­ics today, but which was in fact a Neo­clas­si­cal model derived two years before the Gen­eral The­ory was pub­lished:

The IS-LM dia­gram, which is widely, but not uni­ver­sally, accepted as a con­ve­nient syn­op­sis of Key­ne­sian the­ory, is a thing for which I can­not deny that I have some respon­si­bil­ity… “Mr. Keynes and the Clas­sics” (Hicks 1937) was actu­ally the fourth of the rel­e­vant papers which I wrote dur­ing those years… But there were two oth­ers that I had writ­ten before I saw The Gen­eral The­ory… “Wages and Inter­est: the Dynamic Prob­lem” (Hicks 1935) was a first sketch of what was to become the “dynamic” model of Value and Cap­i­tal (Hicks 1939). It is impor­tant here, because it shows (I think quite con­clu­sively) that that [IS-LM] model was already in my mind before I wrote even the first of my papers on Keynes. (Hicks 1981, pp. 139–140; empha­sis added; see also Keen 2011)

As it grew more vir­u­lent, neo­clas­si­cal the­ory encour­aged politi­cians to remove the bar­ri­ers to fraud that were erected in the wake of the last great eco­nomic cri­sis, the Great Depres­sion, in the naïve belief that a dereg­u­lated econ­omy nec­es­sar­ily reaches a har­mo­nious equilibrium:

Macro­eco­nom­ics was born as a dis­tinct field in the 1940’s, as a part of the intel­lec­tual response to the Great Depres­sion. The term then referred to the body of knowl­edge and exper­tise that we hoped would pre­vent the recur­rence of that eco­nomic dis­as­ter. My the­sis in this lec­ture is that macro­eco­nom­ics in this orig­i­nal sense has suc­ceeded: Its cen­tral prob­lem of depres­sion pre­ven­tion has been solved, for all prac­ti­cal pur­poses, and has in fact been solved for many decades.’ (Lucas 2003 , p. 1 ; empha­sis added)

Reg­u­la­tors in its thrall—such as Greenspan and Bernanke—rescued the finan­cial sec­tor from a series of crises, with each one lead­ing to yet another until ulti­mately this one, from which no return to “busi­ness as usual” is possible.

Neo­clas­si­cal eco­nom­ics there­fore played an impor­tant role in mak­ing this cri­sis as extreme as it became. It is time to suc­ceed where Keynes failed, by both elim­i­nat­ing this the­ory and replac­ing it with a real­is­tic alternative.

Critiquing Neoclassical economics

Keynes was scathing about what he called “Clas­si­cal Eco­nom­ics”, and what we today call Neo­clas­si­cal Eco­nom­ics, lam­bast­ing its treat­ment of time, expec­ta­tions, uncer­tainty and money, and the sta­bil­ity or oth­er­wise of capitalism:

I accuse the clas­si­cal eco­nomic the­ory of being itself one of these pretty, polite tech­niques which tries to deal with the present by abstract­ing from the fact that we know very lit­tle about the future…. a clas­si­cal econ­o­mist … has over­looked the pre­cise nature of the dif­fer­ence which his abstrac­tion makes between the­ory and prac­tice … par­tic­u­larly the case in his treat­ment of Money…

This that I offer is, there­fore, a the­ory of why out­put and employ­ment are so liable to fluctuation.

The ortho­dox the­ory assumes that we have a knowl­edge of the future of a kind quite dif­fer­ent from that which we actu­ally pos­sess… The hypoth­e­sis of a cal­cu­la­ble future leads to a wrong inter­pre­ta­tion of the prin­ci­ples of behav­ior which the need for action com­pels us to adopt, and to an under­es­ti­ma­tion of the con­cealed fac­tors of utter doubt, pre­car­i­ous­ness, hope and fear (Keynes 1937, pp. 215–222)

Keynes’s fail­ure to over­throw Neo­clas­si­cal eco­nom­ics led instead to its recon­struc­tion after the Great Depres­sion in an even more extreme form. This process cul­mi­nated in “Ratio­nal Expec­ta­tions” macro­eco­nom­ics in which, rather than deal­ing with the present “by abstract­ing from the fact that we know very lit­tle about the future”, deals with it by assum­ing we can accu­rately pre­dict the future!:

I should like to sug­gest that expec­ta­tions, since they are informed pre­dic­tions of future events, are essen­tially the same as the pre­dic­tions of the rel­e­vant eco­nomic the­ory. (Muth 1961, p. 316)

In the pre­ced­ing sec­tion, the hypoth­e­sis of adap­tive expec­ta­tions was rejected as a com­po­nent of the nat­ural rate hypoth­e­sis on the grounds that, under some pol­icy [the gap between actual and expected infla­tion] is non-zero. If the impos­si­bil­ity of a non-zero value … is taken as an essen­tial fea­ture of the nat­ural rate the­ory, one is led sim­ply to adding the assump­tion that [the gap between actual and expected infla­tion] is zero as an addi­tional axiom… or to assume that expec­ta­tions are ratio­nal in the sense of Muth. (Lucas 1972, p. 54; empha­sis added)

I wrote Debunk­ing Eco­nom­ics (Keen 2001; Keen 2011) to help pre­vent a Neo­clas­si­cal revival recur­ring after our cur­rent cri­sis is over. Here I have the advan­tage of time over Keynes: when he wrote The Gen­eral The­ory, the flaws in neo­clas­si­cal eco­nom­ics were only vaguely specified—and Keynes him­self kept many of those con­cepts alive, such as the mar­ginal pro­duc­tiv­ity the­ory of income distribution:

For every value of [total employ­ment] there is a cor­re­spond­ing mar­ginal pro­duc­tiv­ity of labour in the wage-goods indus­tries; and it is this which deter­mines the real wage. (Keynes 1936, p. 27)

Since then, the flaws have been fully detailed, by crit­ics like Sraffa (Sraffa 1960) at one extreme to “own goals” like the Sonnenschein-Mantel-Debreu con­di­tions at the other (Son­nen­schein 1973; Shafer and Son­nen­schein 1993). The ambi­tion of Debunk­ing Eco­nom­ics was to make the many flaws in neo­clas­si­cal eco­nom­ics so well known that, should the econ­omy ever expe­ri­ence another Great Depres­sion, it would be that much harder for Neo­clas­si­cal eco­nom­ics to sur­vive (for more, see Debunk­ing Eco­nom­ics: the naked emperor dethroned?;or buy the book: Ama­zon USA; Ama­zon UK; Kin­dle USA; Kin­dle UK; Abbey’s Aus­tralia).

I also pro­vide cri­tiques of con­ven­tional eco­nomic the­ory in my lec­tures, which I make more broadly avail­able via Youtube videos.

Developing an alternative

The seeds of an alter­na­tive, real­is­tic the­ory were devel­oped by Hyman Min­sky in the Finan­cial Insta­bil­ity Hypoth­e­sis (FIH), which itself reflected the wis­dom of the great non-neoclassical econ­o­mists Marx, Veblen, Schum­peter, Fisher and Keynes, and the his­tor­i­cal record of cap­i­tal­ism that had included peri­odic Depres­sions (as well as the dra­matic tech­no­log­i­cal trans­for­ma­tion of pro­duc­tion). As Min­sky argued, an eco­nomic the­ory could not claim to rep­re­sent cap­i­tal­ism unless it could explain those peri­odic crises:

Can “It”—a Great Depression—happen again? And if “It” can hap­pen, why didn’t “It” occur in the 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 the­ory which makes great depres­sions one of the pos­si­ble states in which our type of cap­i­tal­ist econ­omy can find itself. (Min­sky 1982, p. 5)

Min­sky devel­oped a coher­ent ver­bal model of his hypoth­e­sis, but his own attempt to develop a math­e­mat­i­cal model in his PhD (Min­sky 1957) was unsuc­cess­ful (Keen 2000), and he sub­se­quently aban­doned that endeavour.

Using insights from com­plex­ity the­ory, I devel­oped mod­els on the FIH that cap­ture its fun­da­men­tal propo­si­tion, that a mar­ket econ­omy can expe­ri­ence a debt-deflation (Fisher 1933) after a series of debt-financed cycles (Keen 1995; Keen 1996; Keen 1997; Keen 2000). These mod­els gen­er­ated a period of declin­ing volatil­ity in employ­ment and wages with a ris­ing ration of debt to GDP, fol­lowed by a period of ris­ing volatil­ity before an even­tual debt-induced break­down. They led me to cau­tion that:

From the per­spec­tive of eco­nomic the­ory and pol­icy, this vision of a cap­i­tal­ist econ­omy with finance requires us to go beyond that habit of mind which Keynes described so well, the exces­sive reliance on the (sta­ble) recent past as a guide to the future. The chaotic dynam­ics explored in this paper 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; empha­sis added)

The empir­i­cal data and the impli­ca­tions of these mod­els led me to expect and warn of an impend­ing seri­ous eco­nomic cri­sis (Keen 2006; Keen 2007) at a time when Neo­clas­si­cal econ­o­mists were wax­ing lyri­cal about “The Great Mod­er­a­tion”(Bernanke 2004; Bernanke 2004; Sum­mers 2005; Camp­bell 2007; Benati 2008; D’Agostino and Whe­lan 2008; Gian­none, Lenza et al. 2008; Canova 2009; Gali and Gam­betti 2009; Wood­ford 2009; Bean 2010).

The cri­sis itself emphat­i­cally makes the point that a new the­ory of eco­nom­ics is needed, in which cap­i­tal­ism is seen as a dynamic, mon­e­tary sys­tem with both cre­ative and destruc­tive insta­bil­i­ties, where those destruc­tive insta­bil­i­ties emanate over­whelm­ingly from the finan­cial sector.

Specific projects

The Center for Economic Stability Incorporated

With the sup­port of blog mem­bers, I have formed the Cen­ter for Eco­nomic Sta­bil­ity Incor­po­rated. Our objec­tive is to develop CfESI into an empirically-oriented think-tank on eco­nom­ics that will develop real­is­tic analy­sis of cap­i­tal­ism, and pro­mote poli­cies based upon that analy­sis. The suc­cess of CfESI is depen­dent upon rais­ing suf­fi­cient fund­ing to enable staff to be hired who can take over the admin­is­tra­tive and web duties from me, and sup­ple­ment my research efforts.


Named in honor of Hyman Min­sky, this is a com­puter pro­gram that enables a com­plex mon­e­tary sys­tem to be mod­elled with rel­a­tive ease. The pro­gram imple­ments the tab­u­lar approach to mod­el­ling finan­cial flows devel­oped in (Keen 2008; Keen 2010; Keen 2011), and com­bines this with the “flow­chart” par­a­digm devel­oped by engi­neers to model phys­i­cal processes, and imple­mented in numer­ous soft­ware pro­grams (Simulink, Vis­sim, Ven­sim, Ithink, Stella, etc.). It will be both a ped­a­gogic tool to make dynamic mon­e­tary mod­el­ling easy and attrac­tive to new stu­dents, and a pow­er­ful research tool that will enable the con­struc­tion of real­is­tic, mon­e­tary mod­els of capitalism.

Fig­ure 5

  • A first ver­sion of Min­sky is already under devel­op­ment, with fund­ing pro­vided by a grant from the Insti­tute for New Eco­nomic Think­ing. This ver­sion, to be com­pleted in mid-2012, will enable the mod­el­ling of the econ­omy as a mon­e­tary dynamic sin­gle com­mod­ity sys­tem. A pro­to­type will be released in early 2012. A Source­forge page is now oper­at­ing, and we will shortly be open­ing it up for col­lab­o­ra­tion by Open Source developers.
  • Ver­sion 2.0 will enable multi-commodity input-output dynam­ics to be mod­elled, as well as a dis­ag­gre­gated bank­ing sec­tor. A seed­ing grant to help develop ver­sion 2.0 has been recently been received from the Insti­tute for New Eco­nomic Think­ing. This will be com­bined with grants from other pri­vate enti­ties to make an appli­ca­tion for sup­port under the Aus­tralian Research Council’s Link­age pro­gram for up to A$500,000 p.a. of fur­ther fund­ing. One Aus­tralian firm has already com­mit­ted to be an Indus­try Part­ner in this appli­ca­tion, and I wel­come addi­tional sup­port from other firms, whether Aus­tralian or oth­er­wise (a min­i­mum con­tri­bu­tion of A$50,000 over 3 years is required to qual­ify as an Indus­try Part­ner under ARC rules).
  • Ver­sion 3.0 will add the capa­bil­ity to model inter­na­tional trade and finan­cial flows.

The pro­gram will be plat­form inde­pen­dent, and freely avail­able under the GPL licence.

Integrating Minsky with biophysical data

Min­sky as it stands is purely a sim­u­la­tion tool. How­ever, as part of a United Nations Envi­ron­ment Pro­gram projectResource Effi­ciency: Eco­nom­ics and Out­look for Asia-Pacific“, a pre­cur­sor to Min­sky has been linked to a bio­phys­i­cal data­base known as ASFF (for “Aus­tralian Stocks and Flows Foun­da­tion”) devel­oped by the CSIRO (Turner, Hoff­man et al. 2011),. Our long term ambi­tion is to com­bine the two sys­tems seam­lessly, so that the phys­i­cal para­me­ters of Min­sky will be derived directly from empir­i­cal data (which can be derived for any national econ­omy) and so that Minsky’s fit to empir­i­cal data can be tested.



Fig­ure 6
The sec­ond stage of this process is part of the pro­posal for which I have just received fur­ther fund­ing from INET.

Finance and Economic Breakdown

This will be a book-length treat­ment of the Finan­cial Insta­bil­ity Hypoth­e­sis that I hope will form one of the foun­da­tions of a post-Neoclassical macro­eco­nom­ics. Writ­ing a book like this takes time and iso­la­tion, two things I have had very lit­tle of in the past six years since I first started warn­ing of an impend­ing eco­nomic cri­sis (Keen 2005). I have delayed the writ­ing of this “mag­num opus” for over a decade; in 2012–13 I intend devot­ing as much time as I can to writ­ing it, which neces­si­tates min­imis­ing time spent on other activ­i­ties such as the main­te­nance of this blog.


Cur­rently I pull in data from over 1500 dif­fer­ent sources into a Math­cad work­sheet on my PC. Math­cad, with a lit­tle help from my pro­gram­ming, does a won­der­ful job of analysing and dis­play­ing the data. But the nam­ing con­ven­tions in my pseudo-database are … a joke, there are none. Con­se­quently, only some­one inti­mately acquainted with the data can use my sys­tem, and at the moment that’s just me. I also have to man­u­ally down­load files when they are updated. Thanks to Mathcad’s vis­i­ble equa­tions, audit­ing the data is cer­tainly eas­ier than with a spread­sheet, but it is still dif­fi­cult com­pared to a well-structured rela­tional database.

A sup­porter has devel­oped an online sys­tem, cur­rently called Econ­o­data, to over­come these limitations:

  • The data is stored in a “Ruby on Rails” rela­tional database;
  • The sys­tem auto­mat­i­cally updates data when it is altered by providers;
  • The rela­tional data­base sys­tem and a 4GL for derived data series makes audit­ing straight­for­ward, and the sys­tem gen­er­ates a tinyURL so that a com­plex data series or chart can be eas­ily repli­cated by any­one; and
  • It will be eas­ily acces­si­ble and usable by sub­scribers to Debt­watch and CfESI.

Econ­o­data is cur­rently unavail­able since it is being ported to a new server, and the data­base is rel­a­tively unpop­u­lated. The data­base will also sup­port my book Finance and Eco­nomic Break­down, by mak­ing it pos­si­ble for read­ers to ver­ify any empir­i­cal charts for them­selves sim­ply by typ­ing its TinyURL into a browser.

Credit-aware Economic Indicators

My debt-aware per­spec­tive on eco­nom­ics makes it easy to explain what Bernanke has admit­ted is still inex­plic­a­ble to him: where the cri­sis came from, and why it is persisting:

Part of the slow­down is tem­po­rary, and part of it may be longer-lasting. We do believe that growth is going to pick up going into 2012 but at a some­what slower pace than we had antic­i­pated in April. We don’t have a pre­cise read on why this slower pace of growth is per­sist­ing… ” His admis­sion of igno­rance reflects gen­uine puz­zle­ment with the economy’s fail­ure to reach what he likes to call escape veloc­ity. (G.I. 2011)

In a nut­shell, the change in total pri­vate debt is a key deter­mi­nant of aggre­gate demand, and the turn­around from increas­ing debt boost­ing demand from incomes alone by 28% in 2008 to reduc­ing demand below this level by 20 per­cent in early 2010 was the cause of the crisis.

Fig­ure 7

Sim­i­larly, the slow­down in the rate of decline of debt from its max­i­mum rate of decline of almost US$3 tril­lion p.a. to a mere $340 bil­lion p.a. is—along with the growth in gov­ern­ment debt—the main rea­son why the cri­sis has atten­u­ated slightly, rather than plung­ing into Great Depres­sion depths of unemployment.

Fig­ure 8

One indi­ca­tor that has arisen out of my work—building on orig­i­nal work by Biggs, Mayer and Pick (Biggs and Mayer 2010; Biggs, Mayer et al. 2010)—is the “Credit Accel­er­a­tor” (Keen 2011, pp. 160–165), which was first called the “Credit Impulse”. Both the change in income and the accel­er­a­tion of credit deter­mine the rate of change of eco­nomic activ­ity, and these are cor­re­lated with each other (the R2 since 1980 is 0.56), but the eco­nom­ics col­lapse in late 2007 was clearly dri­ven pri­mar­ily by the rapid and unprece­dented decel­er­a­tion of debt.

Fig­ure 9

Debt accel­er­a­tion is the main fac­tor in deter­min­ing asset prices. Asset bub­bles there­fore have to burst, because debt accel­er­a­tion can­not remain pos­i­tive forever.

Fig­ure 10

This causal rela­tion­ship is much more obvi­ous with mort­gage debt and change in house prices (see Fig­ure 11).

Fig­ure 11

Fur­ther devel­op­ment of this indi­ca­tor is there­fore highly warranted—both as an indi­ca­tor of what trends can be expected in asset prices now, and as a means to iden­tify whether a bub­ble is devel­op­ing in future. At present, the Credit Accelerator’s def­i­n­i­tion is quite simple—the change in change in debt over a time period, divided by GDP at the mid­point of that period—and the nois­i­ness of finan­cial data makes it dif­fi­cult to use short time peri­ods, which would obvi­ously be supe­rior for fore­cast­ing. A sophis­ti­cated fil­ter­ing process and for­ward indi­ca­tors for credit would make the Credit Accel­er­a­tor a much more pow­er­ful tool.

A Modern Jubilee

Michael Hudson’s sim­ple phrase that “Debts that can’t be repaid, won’t be repaid” sums up the eco­nomic dilemma of our times. This does not involve sanc­tion­ing “moral haz­ard”, since the real moral haz­ard was in the behav­iour of the finance sec­tor in cre­at­ing this debt in the first place. Most of this debt should never have been cre­ated, since all it did was fund dis­guised Ponzi Schemes that inflated asset val­ues with­out adding to society’s pro­duc­tiv­ity. Here the irresponsibility—and Moral Hazard—clearly lay with the lenders rather than the borrowers.

The only real ques­tion we face is not whether we should or should not repay this debt, but how are we going to go about not repay­ing it?

The stan­dard means of reduc­ing debt—personal and cor­po­rate bank­rupt­cies for some, slow repay­ment of debt in depressed eco­nomic con­di­tions for others—could have us mired in delever­ag­ing for one and a half decades, given its cur­rent rate (see Fig­ure 12).

Fig­ure 12

That fate would in turn mean one and a half decades where the boost to demand that ris­ing debt should provide—when it finances invest­ment rather than speculation—will not be there. The econ­omy will tend to grow more slowly than is needed to absorb new entrants into the work­force, inno­va­tion will slow down, and jus­ti­fied polit­i­cal unrest will rise—with poten­tially unjus­ti­fied social consequences.

We don’t need to spec­u­late about the eco­nomic and social dam­age such a future his­tory will cause—all we have to do is remem­ber the last time.

We should, there­fore, find a means to reduce the pri­vate debt bur­den now, and reduce the length of time we spend in this dam­ag­ing process of delever­ag­ing. Pre-capitalist soci­eties insti­tuted the prac­tice of the Jubilee to escape from sim­i­lar traps (Hud­son 2000; Hud­son 2004), and debt defaults have been a reg­u­lar expe­ri­ence in the his­tory of cap­i­tal­ism too (Rein­hart and Rogoff 2008). So a prima facie alter­na­tive to 15 years of delever­ag­ing would be an old-fashioned debt Jubilee.

But a Jubilee in our mod­ern cap­i­tal­ist sys­tem faces two dilem­mas. Firstly, in any cap­i­tal­ist sys­tem, a debt Jubilee would paral­yse the finan­cial sec­tor by destroy­ing bank assets. Sec­ondly, in our era of secu­ri­tized finance, the own­er­ship of debt per­me­ates soci­ety in the form of asset based secu­ri­ties (ABS) that gen­er­ate income streams on which a mul­ti­tude of non-bank recip­i­ents depend, from indi­vid­u­als to coun­cils to pen­sion funds.

Debt abo­li­tion would inevitably also destroy both the assets and the income streams of own­ers of ABSs, most of whom are inno­cent bystanders to the delu­sion and fraud that gave us the Sub­prime Cri­sis, and the myr­iad fias­cos that Wall Street has per­pe­trated in the 2 decades since the 1987 Stock Mar­ket Crash.

We there­fore need a way to short-circuit the process of debt-deleveraging, while not destroy­ing the assets of both the bank­ing sec­tor and the mem­bers of the non-banking pub­lic who pur­chased ABSs. One fea­si­ble means to do this is a “Mod­ern Jubilee”, which could also be described as “Quan­ti­ta­tive Eas­ing for the public”.

Quan­ti­ta­tive Eas­ing was under­taken in the false belief that this would “kick start” the econ­omy by spurring bank lending.

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)

Instead, its main effect was to dra­mat­i­cally increase the idle reserves of the bank­ing sec­tor while the broad money sup­ply stag­nated or fell, (see Fig­ure 13), for the obvi­ous rea­sons that there is already too much pri­vate sec­tor debt, and nei­ther lenders nor the pub­lic want to take on more debt.

Fig­ure 13

A Mod­ern Jubilee would cre­ate fiat money in the same way as with Quan­ti­ta­tive Eas­ing, but would direct that money to the bank accounts of the pub­lic with the require­ment that the first use of this money would be to reduce debt. Debtors whose debt exceeded their injec­tion would have their debt reduced but not elim­i­nated, while at the other extreme, recip­i­ents with no debt would receive a cash injec­tion into their deposit accounts.

The broad effects of a Mod­ern Jubilee would be:

  1. Debtors would have their debt level reduced;
  2. Non-debtors would receive a cash injection;
  3. The value of bank assets would remain con­stant, but the dis­tri­b­u­tion would alter with debt-instruments declin­ing in value and cash assets rising;
  4. Bank income would fall, since debt is an income-earning asset for a bank while cash reserves are not;
  5. The income flows to asset-backed secu­ri­ties would fall, since a sub­stan­tial pro­por­tion of the debt back­ing such secu­ri­ties would be paid off; and
  6. Mem­bers of the pub­lic (both indi­vid­u­als and cor­po­ra­tions) who owned asset-backed-securities would have increased cash hold­ings out of which they could spend in lieu of the income stream from ABS’s on which they were pre­vi­ously dependent.

Clearly there are numer­ous com­plex issues to be con­sid­ered in such a pol­icy: the scale of money cre­ation needed to have a sig­nif­i­cant pos­i­tive impact (with­out exces­sive neg­a­tive effects—there will obvi­ously be such effects, but their impor­tance should be judged against the alter­na­tive of con­tin­ued delever­ag­ing); the mechan­ics of the money cre­ation process itself (which could repli­cate those of Quan­ti­ta­tive Eas­ing, but may also require changes to the legal pro­hi­bi­tion of Reserve Banks from buy­ing gov­ern­ment bonds directly from the Trea­sury); the basis on which the funds would be dis­trib­uted to the pub­lic; man­ag­ing bank liq­uid­ity prob­lems (since though banks would not be made insol­vent by such a pol­icy, they would suf­fer sig­nif­i­cant drops in their income streams); and ensur­ing that the pro­gram did not sim­ply start another asset bubble.

Taming the Finance Sector

Finance per­forms gen­uine, essen­tial ser­vices in a cap­i­tal­ist econ­omy when it lim­its itself to (a) pro­vid­ing work­ing cap­i­tal to non-financial cor­po­ra­tions; (b) fund­ing invest­ment and entre­pre­neur­ial activ­ity, whether directly or indi­rectly; © fund­ing hous­ing pur­chase for strictly res­i­den­tial pur­poses, whether to owner-occupiers for pur­chase or to investors for the pro­vi­sion of rental prop­er­ties; and (d) pro­vid­ing finance to house­holds for large expen­di­tures such as auto­mo­biles, home ren­o­va­tions, etc.

It is a destruc­tive force in cap­i­tal­ism when it pro­motes lever­aged spec­u­la­tion on asset or com­mod­ity prices, and funds activ­i­ties (like lev­ered buy­outs) that drive debt lev­els up and rely upon ris­ing asset prices for their suc­cess. Such activ­i­ties are the over­whelm­ing focus of the non-bank finan­cial sec­tor today, and are the pri­mary rea­son why finan­cial sec­tor debt has risen from triv­ial lev­els of below 10 per­cent of GDP before the 1970s to the peak of over 120 per­cent in early 2009.

Fig­ure 14

Return­ing cap­i­tal­ism to a finan­cially robust state must involve a dra­matic fall in the level of pri­vate debt—and the size of the finan­cial sec­tor— as well as poli­cies that return the finan­cial sec­tor to a ser­vice role to the real economy.

The size of the finan­cial sec­tor is directly related to the level of pri­vate debt, which in Amer­ica peaked at 303% of GDP in early 2009 (see Fig­ure 15). Using his­tory as our guide, Amer­ica will only return to being a finan­cially robust soci­ety when this ratio falls back to below 100% of GDP. Most other OECD coun­tries like­wise need to dras­ti­cally reduce their lev­els of pri­vate debt.

Fig­ure 15

The per­cent­age of total wages and prof­its earned by the FIRE sec­tor (as defined in the NIPA tables) gives another guide. America’s period of robust eco­nomic growth coin­cided with FIRE sec­tor prof­its being between 10 and 20 per­cent of total prof­its, and wages in the FIRE sec­tor being below 5 per­cent of total wages. Finance sec­tor prof­its peaked at over 50% of total prof­its in 2001, while wages in the FIRE sec­tor peaked at over 9 per­cent of total wages.

Fig­ure 16

Since finance sec­tor prof­its are pri­mar­ily a func­tion of the level of pri­vate debt, this implies that the level of debt needs to shrink by a fac­tor of 3–4, while employ­ment in the finance sec­tor needs to roughly halve. At the max­i­mum, the finance sec­tor should be no more than 50% of its cur­rent size.

Fig­ure 17

Such a large con­trac­tion in the size of the sec­tor means that the major­ity of those who cur­rently work there will need to find gain­ful employ­ment else­where. Indi­vid­u­als who can actu­ally eval­u­ate invest­ment proposals—generally speak­ing, engi­neers rather than finan­cial engineers—will need to be hired in their place. Many of the stan­dard prac­tices of that sec­tor today will have to be elim­i­nated or dras­ti­cally cur­tailed, while many prac­tices that have been largely aban­doned will have to be reinstated.

Taming the Credit Accelerator

Capitalism’s crises have always been a prod­uct of the finan­cial sec­tor fund­ing spec­u­la­tion on asset prices rather than fund­ing busi­ness and inno­va­tion. This allows finan­cial sec­tor prof­its to grow far larger than is war­ranted, on the foun­da­tion of a far larger level of pri­vate debt than soci­ety can sup­port. This lend­ing causes a pos­i­tive feed­back loop between accel­er­at­ing debt and ris­ing asset prices, lead­ing to both a debt and asset price bub­ble. The asset price bub­ble must burst—because it relies upon accel­er­at­ing debt for its maintenance—but once it bursts, soci­ety is still left with the debt.

The under­ly­ing cause is the rela­tion­ship between debt and asset prices in a credit-based econ­omy. As I explain in numer­ous places (“A much more neb­u­lous con­cep­tion“, “Debunk­ing Macro­eco­nom­ics“), aggre­gate demand is the sum of income (Y) plus the change in debt , and this is expended on both newly pro­duced goods and ser­vices and buy­ing finan­cial claims on exist­ing assets—which I call “Net Asset Turnover” . At a very gen­eral level, this implies the fol­low­ing relationship:

Net Asset Turnover can be bro­ken down into the price index for assets , times their quan­tity , times the turnover —expressed as a frac­tion of the num­ber of assets 

It there­fore fol­lows that there is a rela­tion­ship between the accel­er­a­tion of debt and change in asset prices.

Some accel­er­a­tion of debt is vital for a grow­ing econ­omy. As good empir­i­cal work by Fama and French has con­firmed (Fama and French 1999; Fama and French 2002), change in debt is the main source of funds for invest­ment, and as Schum­peter explains (Schum­peter 1934, pp. 95–107), the inter­play between invest­ment and the endoge­nous cre­ation of spend­ing power by the bank­ing sys­tem ensures that this will be a cycli­cal process. Debt accel­er­a­tion dur­ing a boom and decel­er­a­tion dur­ing a slump are thus essen­tial aspects of capitalism.

How­ever this rela­tion also implies that the accel­er­a­tion of debt is a fac­tor in the rate of change of asset prices (along with the change in income) and that when asset prices grow faster than incomes and con­sumer prices, the motive force behind it will be the accel­er­a­tion of debt. At the same time, the growth in asset prices is the major incen­tive to accel­er­at­ing debt: this is the pos­i­tive feed­back loop on which all asset bub­bles are based, and it is why they must ulti­mately burst (see Fig­ure 10 and Fig­ure 11). This is the foun­da­tion of Ponzi Finance (Min­sky 1982, p. 29), and it is this aspect of finance that has to be tamed to reduce the destruc­tive impact of finance on capitalism.

I do not believe that reg­u­la­tion alone will achieve this aim, for two reasons.

  • Minsky’s propo­si­tion that “sta­bil­ity is desta­bi­liz­ing” applies to reg­u­la­tors as well as to mar­kets. If reg­u­la­tions actu­ally suc­ceed in enforc­ing respon­si­ble finance, the rel­a­tive tran­quil­lity that results from that will lead to the belief that such tran­quil­lity is the norm, and the reg­u­la­tions will ulti­mately be abol­ished. After all, this is what hap­pened after the last Great Depression.
  • Banks profit by cre­at­ing debt, and they are always going to want to cre­ate more debt. This is sim­ply the nature of bank­ing. Reg­u­la­tions are always going to be attempt­ing to restrain this ten­dency, and in this strug­gle between an “immov­ably object” and an “irre­sistible force”, I have no doubt that the force will ulti­mately win.

If we rely on reg­u­la­tion alone to tame the finan­cial sec­tor, then it will be tamed while the mem­ory of the cri­sis it caused per­sists, only to be over­thrown by a resur­gent finan­cial sec­tor some decades hence (scep­tics on this point should take a close look at Fig­ure 2, show­ing the debt to GDP graph for Aus­tralia from 1860 till today).

There are thus only two options to limit capitalism’s ten­den­cies to finan­cial crises: to change the nature of either lenders or bor­row­ers in a fun­da­men­tal way. There are pro­pos­als for the for­mer, which I’ll dis­cuss later, but (for rea­sons I’ll dis­cuss now) my pref­er­ence is to address the lat­ter by reduc­ing the appeal of lever­aged spec­u­la­tion on asset prices.

There are, I believe, no prospects for fun­da­men­tally alter­ing the behav­iour of the finan­cial sec­tor because, as already noted, the key deter­mi­nant of prof­its in the finance sec­tor is the level of debt it can gen­er­ate. How­ever it is organ­ised and what­ever lim­its are put upon its behav­iour, it will want to cre­ate more debt.

There are prospects for alter­ing the behav­iour of the non-financial sec­tor towards debt because, fun­da­men­tally, debt is a bad thing for the bor­rower: the spend­ing power of debt now is an entice­ment, but with it comes the draw­back of ser­vic­ing debt in the future. For that rea­son, when either invest­ment or con­sump­tion is the rea­son for tak­ing on debt, bor­row­ers will be restrained in how much they will accept. Only when they suc­cumb to the entice­ment of lever­aged spec­u­la­tion will bor­row­ers take on a level of debt that can become sys­tem­i­cally dangerous.

This can eas­ily be illus­trated using dis­ag­gre­gated bor­row­ing data for Aus­tralia. At first glance, though per­sonal debt appears quite volatile, and strongly related to the busi­ness cycle—rising dur­ing booms and falling dur­ing slumps—there is clearly no trend across busi­ness cycles (see Fig­ure 18; “R90” refers to the start of the 1990s reces­sion, and “GFC” to the start of the cur­rent eco­nomic cri­sis for which Aus­tralians use the acronym “GFC”—or “Global Finan­cial Crisis”).

Fig­ure 18

How­ever there clearly is a trend in mort­gage debt across busi­ness cycles, and when rescaled by this trend, the volatil­ity of per­sonal debt is a non-event (see Fig­ure 19).

Fig­ure 19

The dif­fer­ence between the two series is obvi­ous. Regard­less of the end­less induce­ments from the finance sec­tor to enter into per­sonal debt, com­mit­ments by the pub­lic to per­sonal debt are gen­er­ally related to and reg­u­lated by income. Com­mit­ments to debt for the pur­chase of assets, on the other hand, are related not to income, but to expec­ta­tions of lever­aged prof­its on ris­ing asset prices—when the fac­tor most respon­si­ble for caus­ing growth in asset prices is accel­er­at­ing debt.

This rela­tion­ship between debt accel­er­a­tion and change in asset prices is espe­cially appar­ent for mort­gage debt. The R2 between mort­gage debt accel­er­a­tion and change in real house prices is 0.78 in the USA over 25 years, and 0.6 in Aus­tralia over 30 years (see Fig­ure 11 and Fig­ure 22). Though debt accel­er­a­tion can enable increased con­struc­tion or turnover , the far greater flex­i­bil­ity of prices, and the treat­ment of hous­ing as a vehi­cle for spec­u­la­tion rather than accom­mo­da­tion, means that the brunt of the accel­er­a­tion dri­ves house price appre­ci­a­tion. The same effect applies in the far more volatile share mar­ket: accel­er­at­ing debt leads to ris­ing asset prices, which encour­ages more debt acceleration.

Fig­ure 20

Fig­ure 21

The link between accel­er­at­ing debt lev­els and ris­ing asset prices is there­fore the basis of capitalism’s ten­dency to expe­ri­ence finan­cial crises. That link has to be bro­ken if finan­cial crises are to be made less likely—if not avoided entirely. This requires a rede­f­i­n­i­tion of finan­cial assets in such a way that the temp­ta­tions of Ponzi Finance can be eliminated.

Jubilee Shares

The key fac­tor that allows Ponzi Schemes to work in asset mar­kets is the “Greater Fool” promise that a share bought today for $1 can be sold tomor­row for $10. No inter­est rate, no reg­u­la­tion, can hold against the charge to insan­ity that such a fea­si­ble promise fer­ments, and on such a foun­da­tion the now almost for­got­ten folly of the Dot­Com Bub­ble was built. Both the promise and the folly are well illus­trated in Yahoo’s share price (see Fig­ure 22).

Fig­ure 22

I pro­pose the rede­f­i­n­i­tion of shares in such a way that the entice­ment of lim­it­less price appre­ci­a­tion can be removed, and the pri­mary mar­ket can take prece­dence over the sec­ondary mar­ket. A share bought in an IPO or rights offer would last for­ever (for as long as the com­pany exists) as now with all the rights it cur­rently con­fers. It could be sold once onto the sec­ondary mar­ket with all the same priv­i­leges. But on its next sale it would have a life span of 50 years, at which point it would terminate.

The objec­tive of this pro­posal is to elim­i­nate the appeal of using debt to buy exist­ing shares, while still mak­ing it attrac­tive to fund inno­v­a­tive firms or star­tups via the pri­mary mar­ket, and still mak­ing pur­chase of the share of an estab­lished com­pany on the sec­ondary mar­ket attrac­tive to those seek­ing an annu­ity income.

I can envis­age ways in which this basic pro­posal might be refined, while still main­tain­ing the pri­mary objec­tive of mak­ing lever­aged spec­u­la­tion on the price of exist­ing share unat­trac­tive. The ter­mi­na­tion date could be made a func­tion of how long a share was held; the num­ber of sales on the sec­ondary mar­ket before the Jubilee effect applied could be more than one. But the basic idea has to be to make bor­row­ing money to gam­ble on the prices of exist­ing shares a very unat­trac­tive proposition.

The Pill”

At present, if two indi­vid­u­als with the same sav­ings and income are com­pet­ing for a prop­erty, then the one who can secure a larger loan wins. This real­ity gives bor­row­ers an incen­tive to want to have the loan to val­u­a­tion ratio increased, which under­pins the finance sector’s abil­ity to expand debt for prop­erty purchases.

Since the accel­er­a­tion of debt dri­ves the rise in house prices, we get both the bub­ble and the bust. But since houses turn over much more slowly than do shares, this process can go on for a lot longer.

Fig­ure 23

The buildup of mort­gage debt there­fore also goes on for much longer (see Fig­ure 24 and Fig­ure 25).

Fig­ure 24

Fig­ure 25

Lim­its on bank lend­ing for mort­gage finance are obvi­ously nec­es­sary, but while those con­trols focus on the income of the bor­rower, both the lender and the bor­rower have an incen­tive to relax those lim­its over time. This relax­ation is in turn the fac­tor that enables a house price bub­ble to form while dri­ving up the level of mort­gage debt per head.

Fig­ure 26

I instead pro­pose bas­ing the max­i­mum debt that can be used to pur­chase a prop­erty on the income (actual or imputed) of the prop­erty itself. Lenders would only be able to lend up to a fixed mul­ti­ple of the income-earning capac­ity of the prop­erty being purchased—regardless of the income of the bor­rower. A use­ful mul­ti­ple would be 10, so that if a prop­erty rented for $30,000 p.a., the max­i­mum amount of money that could be bor­rowed to pur­chase it would be $300,000.

Under this regime, if two par­ties were vying for the same prop­erty, the one that raised more money via sav­ings would win. There would there­fore be a neg­a­tive feed­back rela­tion­ship between lever­age and house prices: an gen­eral increase in house prices would mean a gen­eral fall in leverage.

I call this pro­posal The Pill, for “Prop­erty Income Lim­ited Lever­age”. This pro­posal is a lot sim­pler than Jubilee Shares, and I think less in need of tin­ker­ing before it could be final­ized. Its real prob­lem is in the imple­men­ta­tion phase, since if it were intro­duced in a coun­try where the prop­erty bub­ble had not fully burst, it could cause a sharp fall in prices. It would there­fore need to be phased in slowly over time—except in a coun­try like Japan where the house price bub­ble is well and truly over (even though house prices are still falling).

There are many other pro­pos­als for reform­ing finance, most of which focus on chang­ing the nature of the mon­e­tary sys­tem itself. The best of these focus on insti­tut­ing a sys­tem that removes the capac­ity of the bank­ing sys­tem to cre­ate money via “Full Reserve Banking”.

Full Reserve Banking

The for­mer could be done by remov­ing the capac­ity of the pri­vate bank­ing sys­tem to cre­ate money. This is the sub­stance of the Amer­i­can Mon­e­tary Insti­tute‘s pro­pos­als, which are now embod­ied in the National Emer­gency Employ­ment Defense Act of 2011 (HR 2990), a Bill which was sub­mit­ted to Con­gress by Con­gress­man Den­nis Kucinich on Sep­tem­ber 21st 2011. This bill would remove the capac­ity of the bank­ing sec­tor to cre­ate money, along the lines the the 100% reserve pro­pos­als first cham­pi­oned by Irv­ing Fisher dur­ing the Great Depres­sion (Fisher 1936), and vest the capac­ity for money cre­ation in the gov­ern­ment alone.

A sim­i­lar sys­tem is pro­posed by the UK’s New Eco­nomic Foun­da­tion with its Pos­i­tive Money proposal.

Tech­ni­cally, both these pro­pos­als would work. I won’t go into great detail on them here, other than to note my reser­va­tion about them, which is that I don’t see the bank­ing system’s capac­ity to cre­ate money as the causa cau­sans of crises, so much as the uses to which that money is put. As Schum­peter explains so well, the endoge­nous cre­ation of money by the bank­ing sec­tor gives entre­pre­neurs spend­ing power that exceeds that com­ing out of “the cir­cu­lar flow” alone. When the money cre­ated is put to Schum­peter­ian uses, it is an inte­gral part of the inher­ent dynamic of cap­i­tal­ism. The prob­lem comes when that money is cre­ated instead for Ponzi Finance rea­sons, and inflates asset prices rather than enabling the cre­ation of new assets.

My cau­tion with respect to full reserve bank­ing sys­tems is that this endoge­nous expan­sion of spend­ing power would become the respon­si­bil­ity of the State alone. Here, though I am a pro­po­nent of gov­ern­ment counter-cyclical spend­ing, I am scep­ti­cal about the capac­ity of gov­ern­ment agen­cies to get the cre­ation of money right at all times. This is not to say that the pri­vate sec­tor has done a bet­ter job—far from it! But the pri­vate bank­ing sys­tem will always be there—even if changed in nature—ready to exploit any slipups in gov­ern­ment behav­iour that can be used to jus­tify a return to the sys­tem we are cur­rently in. Slipups will surely occur, espe­cially if the new sys­tem still enables spec­u­la­tion on asset prices to occur.

Since in the real world, peo­ple for­get and die, the mem­ory of the chaos we are liv­ing through now won’t be part of the mind­set when those slipups occur, espe­cially if the end of the Age of Delever­ag­ing ush­ers in a period of eco­nomic tran­quil­lity like the 1950s. We could well have 100% money reforms “reformed” out of exis­tence once more.

Schum­peter­ian bank­ing also inher­ently includes the capac­ity to make mis­takes: to fund a ven­ture that doesn’t suc­ceed, and yet to be will­ing to take that risk again in the hope of fund­ing one that suc­ceeds spec­tac­u­larly. I am wary of the capac­ity of that mind­set to co-exist with the bureau­cratic one that dom­i­nates government.

So though I am not opposed to the 100% Reserve Bank­ing pro­posal, I am not enthu­si­as­tic either. I believe they need curbs on the capac­ity to finance asset price spec­u­la­tion like Jubilee Shares and The Pill, and if they have them, these alone might achieve most of what mon­e­tary reform­ers hope to achieve with far more exten­sive change to the finan­cial system.

Other issues

As Dou­glas Adams once bril­liantly remarked, most of our solu­tions to human prob­lems involve move­ments of small green pieces of paper, and my solu­tions clearly fall into that camp:

This planet has—or rather had—a prob­lem, which was this: most of the peo­ple liv­ing on it were unhappy for pretty much of the time. Many solu­tions were sug­gested for this prob­lem, but most of these were largely con­cerned with the move­ments of small green pieces of paper, which is odd because on the whole it wasn’t the small green pieces of paper that were unhappy. (Adams 1988)

I have said noth­ing here about Global Warm­ing and Peak Oil. Clearly these fac­tors will shape the post-Great Con­trac­tion world far more pow­er­fully than would my reforms. The rea­sons for not men­tion­ing them include specialisation—I am an econ­o­mist after all, not a spe­cial­ist on the cli­mate or energy—and the fact that these issues will ulti­mately make the finan­cial cri­sis look triv­ial by com­par­i­son. Dis­cussing them while dis­cussing the finan­cial cri­sis would have swamped the lat­ter topic almost entirely.

End­ing the dom­i­nance of the FIRE sec­tor will also expose the extent to which Amer­ica and the UK in par­tic­u­lar have been de-industrialised in the last 30 years. Though the relo­ca­tion of pro­duc­tion from the West­ern OECD to devel­op­ing nations could have occurred inde­pen­dently of the growth of Ponzi Finance, Ponzi Finance enabled this trend to go on for much longer than it could have oth­er­wise done. It is highly likely that reforms to end Ponzi Finance will be blamed for caus­ing the cri­sis in unem­ploy­ment that has in fact existed for decades, and would merely be exposed by sud­denly reduc­ing the size of the FIRE sector.

On the bright side

All of the above makes for bleak read­ing. I cer­tainly do expect a bleak future his­tory for humankind in most of the rest of this cen­tury, which I believe will bear out the pre­dic­tions first made by the “Lim­its to Growth” report in 1972 (Mead­ows, Ran­ders et al. 1972; Mead­ows, Mead­ows et al. 2005; Turner 2008).

Fig­ure 27: From Turner 2008. 2 solid cir­cle series rep­re­sent upper and lower bound esti­mates respectively

Despite this, I am a long term opti­mist for human­ity. We have a depress­ing ten­dency to learn about the unsus­tain­abil­ity of cumu­la­tive processes only after a cri­sis (Dia­mond 2005), but we also have an extra­or­di­nary intel­li­gence, and a species nature that val­ues empathy—along with our equally obvi­ous ten­dency to let hier­ar­chy and per­sonal gain take the ascen­dancy in human affairs. Ulti­mately I believe we’ll work out a means to live sus­tain­ably on this planet and, in the very dis­tant future, to live beyond it as well. But to do so, we have to under­stand our cur­rent sit­u­a­tion prop­erly. There is no chance to move towards a bet­ter future if we mis­un­der­stand the sit­u­a­tion we are cur­rently in. That’s why I keep on going.

In this work, I find myself fol­low­ing the lead of the physi­cist and applied math­e­mati­cian Pro­fes­sor John Blatt—a fel­low Aus­tralian (a Syd­neysider even!) whom I never met, but whose writ­ings were the foun­da­tion of my first for­ays into eco­nomic dynam­ics and complexity:

We close this intro­duc­tion with a philo­soph­i­cal point. Karl Marx said: “The philoso­phers hith­erto have only inter­preted the world in var­i­ous ways; the thing, how­ever, is to change it.” There have been many changes in the world since this was writ­ten… But only the fool­hardy could claim that these changes have all, or even mostly, been for the better.

It is not the task of this book to change the world. Let us try to under­stand just a small part of it, namely the dynam­ics of com­pet­i­tive cap­i­tal­ism. It is by no means cer­tain that the human race has a future at all. But if it does, that future can not be harmed, and may even be aided, by an hon­est attempt to under­stand our past. (Blatt 1983, p. 15)


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90(3): 5–32.

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18(3): 397–411.

Turner, G. M., R. Hoff­man, et al. (2011). “A tool for strate­gic bio­phys­i­cal assess­ment of a national econ­omy – The Aus­tralian stocks and flows frame­work.” Envi­ron­men­tal Mod­el­ling & Software
In Press, Cor­rected Proof.

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1(1): 267–279.

Essential Readings from Debtwatch

Financial Instability

Rov­ing Cav­a­liers of Credit
Read Some Minsky
Mon­e­tary Prof­its Paradox
Are We “It” Yet?
Mon­e­tary Mul­ti­sec­toral Model

The New Depression

No-one saw this coming”?
Why the Cri­sis is not over
Delever­ag­ing with a twist
Bernanke doesn’t under­stand the Great Depression
The Case Against Bernanke

Australian Housing

Res­cu­ing the Bubble
Aus­tralian house prices
Com­pe­ti­tion No Panacea
House Prices & Banks I
House Prices & Banks II

Video overview

Lec­tures on Endoge­nous Money
Debt and Aus­tralian housing
HARDtalk inter­view
INET Inter­view on why I saw “It” coming

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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159 Responses to The Debtwatch Manifesto

  1. clive says:

    Sorry if this is a bit off topic. It prob­a­bly doesn’t come as a sur­prise to some of this blogs readers.

    APRA angry as West­pac reclas­si­fies mortgages 

    WESTPAC has infu­ri­ated the peak bank­ing reg­u­la­tor and the oppo­si­tion has called for an expla­na­tion after the bank revealed that it had incor­rectly clas­si­fied $28.8 bil­lion in prop­erty loans for up to three years.

    Australia’s second-largest bank had been record­ing the loans as belong­ing to owner-occupiers since Novem­ber 2008, when in fact they had been used for invest­ment purposes.’

  2. Pingback: Silver Eagle News » According to Steve Keen’s Debtwatch, the coming decade (or two) hinges on one thing: how quickly the U.S. can move through the damaging process of debt-deleveraging. (Manifesto alert – this one’s a doozy.)

  3. conal says:

    Great tour de force!
    But so many ref­er­ences… and so lit­tle time…
    I’ve still got a flagged ToDo from 2009 to check out John Blatt!

    Also want to have a good look at “A het­ero­dox growth and distribution
    model, Dun­can K. Foley and Lance Tay­lor in Eco­nomic Growth and Distribution
    On the Nature and Causes of the Wealth of Nations, Edited by Neri Sal­vadori 2006″
    (Any com­ments on that paper Andrew L?)

  4. Dannyb2b says:

    The fun­da­men­tal cause of the eco­nomic and finan­cial cri­sis that began in late 2007 was lend­ing by the finance sec­tor that pri­mar­ily financed spec­u­la­tion rather than investment.”

    I think one major rea­son for this is due to a herd men­tal­ity exis­tent at the exec­u­tive level of our major finan­cial insti­tu­tions. They all seem to for­mu­late sim­i­lar lend­ing poli­cies result­ing in these banks over­do­ing their lend­ing with only a short term focus on prof­itabil­ity and not tak­ing into account peo­ples long term abil­ity to repay. 

    If you look at the vot­ing records at the AGM’s of the big four banks you will notice that the 3 largest share­hold­ers account for at least 90% of all the votes. HSBC, JPMor­gan and National are the three biggest share­hold­ers in each of the big four Aussie banks.

  5. Matthew K says:

    Clive, great link there. I know a lot of peo­ple were buy­ing houses as owner occu­pied for the FHOG and stamp duty con­ces­sions then leas­ing them out asap (or sooner — asapos).

    Dannyb2b — very inter­est­ing that they are the largest and most active share­hold­ers, not sur­pris­ing though! My lim­ited expe­ri­ence in listed com­pa­nies is that the biggest share­hold­ers can get their way as and when they want to.

    Steve — I have fol­lowed full reserve bank­ing for a while and believe the stated ben­e­fits are not that it stops cri­sis but that it a) stops the sup­posed drag on the econ­omy of inter­est on the money sup­ply b) breaks the pos­i­tive feed­back loop from spec­u­la­tion to money cre­ation (and thereby lim­its poten­tial crises).

    Pos­i­tive money recently had an update that claimed UK lend­ing to busi­ness was 8% of their total lend­ing, con­sid­er­ing that spec­u­la­tive money cre­ation and the ensu­ing ‘make busy’ work has been ram­pant, i won­der if even at 8% full reserve bank­ing cant meet the pro­duc­tive lend­ing require­ments of the economy.

    But hav­ing said that, i am not 100% con­vinced full reserve bank­ing is the best way for­ward but will be sat­is­fied with the wider com­mu­nity under­stand­ing money cre­ation so as they can at least make an informed decision.

  6. cyrusp says:

    Michael Hudson’s sim­ple phrase that “Debts that can’t be repaid, can’t be repaid” ”

    Typo. Michael Hudson’s phrase is: “Debts that can’t be repaid, won’t be repaid”

  7. Mich says:

    polit­i­cal obses­sion with reduc­ing sov­er­eign debt”.
    Please don’t fall for the polit­i­cal the­ater. Gov­ern­ments are increas­ing debt as much as they can to sub­sidise the finan­cial sec­tor. They use the cri­sis for their polit­i­cal games.
    Same story with the ECB, they are NOT about low infla­tion, They have been and still are cre­at­ing mas­sive infla­tion. All to the ben­e­fit of finan­cial sec­tor. Again, its theater.

    The jubilee is inter­est­ing but I still pre­fer grand scale defaults, nation­al­is­ing the banks (NOT the debt, as it seems the mod­ern inter­pre­ta­tion of nation­al­is­ing), fire every­thing up from mid­dle man­age­ment, open the banks the very next day. No more casino banking.
    Tough luck for the (lim­ited per­cent­age of) peo­ple who bought a house they couldn’t pay for. They can buy again for half or less the price a year later.
    One can argue if pen­sion funds are the same as investors and should lose their gam­ble (I would) but same as the banks, they have a pub­lic func­tion, nation­alise them. Gov­ern­ments can “print” money when the value of money starts to rise above a cer­tain point, for exam­ple the value it had before bub­ble­co­nom­ics took off.

    Back to read­ing the manifesto.

  8. JoYohana says:

    Appre­ci­ate the inten­sive sum­mary that I can slowly work through!!

  9. glubilee says:

    Go Steve, Go!

  10. alainton says:


    Great wrap up

    Two com­ments

    Firstly should not RHS of the credit accel­er­a­tor for­mula have a depre­ci­a­tion term — if over any period invest­ment just keeps up with depre­ci­a­tion we have a steady state

    Sec­ondly there appears to be a hid­den assump­tion that all changes in debt have an even turnover, and remain within the circuit

    After Moore/Gechert I would add a v(1-lambda) term before delta debt — the veloc­ity mul­ti­plier — where where lambda is the mar­ginal propen­sity to con­sume — and which sub­tracts net debt set­tle­ment, net hoard­ing and (omit­ted by Gechert) net tax pay­ments (on consumption).

    I think this gives a much more pow­er­ful con­cept of the mon­e­tary cir­cuit and the rela­tion­ship between credit growth, debt dynam­ics, invest­ment and hoarding.

  11. Mich says:

    If reg­u­la­tions will be dis­man­tled through time it is not very use­ful to come up with new sys­tems any­way. Besides, in the past plenty of sound bank­ing and account­ing sys­tems have been fig­ured out. The fail­ure is a mat­ter of, to say it bluntly, crim­i­nals tak­ing over. Sep­a­ra­tion of pow­ers (Sep­a­ra­tion of Finance and State) and a func­tion­ing jus­tice sys­tem is, imho, what we need.

    But for now. Chang­ing the sys­tem slowly is con­tra­dic­tory with pre­vent­ing a lost gen­er­a­tion. Not only that, it gives the fail­ing sys­tem a chance to fight back. “Debts that can’t be repaid, can’t be repaid”, yep but they will sure try to make us all pay all we have now and in the future if they get the chance.

    Lend­ing for pur­chas­ing © hous­ing or (d) cars (both con­sumer goods) merely increases debt. As you write your­self, only lend­ing to pro­duc­tive eco­nomic activ­ity is ben­e­fi­cial in the long run.

    More and more I’m think­ing long term lend­ing (as in cre­at­ing PERMANENT money in the form of PERMANENT inter­est bear­ing DEBT) in an up and run­ning econ­omy isn’t nec­es­sary at all. Don’t we have plenty of sur­plus (how much of it goes to the finance sec­tor again?) to finance real eco­nomic activ­ity if there is no lend­ing to increase prices or consumption.
    Debt vs GDP should be con­stant and not too high? Ok why not (apart from very short term debt in trade finance etc) zero.

  12. NeilW says:

    My cau­tion with respect to full reserve bank­ing sys­tems is that this endoge­nous expan­sion of spend­ing power would become the respon­si­bil­ity of the State alone.”

    My reser­va­tion is more fun­da­men­tal than that. 

    Banks cheat .

    Which is how Frac­tional Reserve came into being in the first place.

    I think reg­u­la­tions based upon loans made out­side the rules being unen­force­able and unre­cov­er­able are the way to dis­ci­pline banks. ‘The Pill’ idea is an excel­lent one.

    The prob­lem is that the debate has been framed so that cred­i­tors are ‘good’ and debtors are evil. Only by refram­ing the debate can we get any trac­tion on the fast route to recovery.

  13. ChicagoSchoolPhysicist says:


    You started 2012 in full swing!
    I spent my hol­i­days fin­ish­ing your Beav­ioural Finance lec­tures and play­ing with QED.
    Speak­ing of QED, has any­one used QED to model the growth of a sin­gle busi­ness under dif­fer­ent circumstances/models? I was try­ing yes­ter­day to come up with a model that can be imple­mented in QED and it proved to be more dif­fi­cult than I thought because items in the Income State­ment (PnL) are not always clear flows between the items in the Bal­ance Sheet [It does not help that I am not an accoun­tant, I was look­ing up some books in Finan­cial Man­age­ment for ref­er­ence]. And the Cash Flow State­ment com­pli­cates things even more but for starters I will assume the cash is paid instantly and do with­out cash flow issues. 

    Thanks for the post and Happy New Year!

  14. Lyonwiss says:

    Post cri­sis, peo­ple are not spend­ing for very good rea­sons. For years, their wages have not really kept up with infla­tion. They have financed their spend­ing through debt and asset bub­ble spec­u­la­tion. Now that the asset bub­bles have burst, most peo­ple have lit­tle or no net equity left. They are forced to pay down debt to restore the house­hold bal­ance sheet. A period of under con­sump­tion has to fol­low a period of over consumption.

    Three decades of over con­sump­tion to be fol­lowed by 15 years of under con­sump­tion is not an unrea­son­able out­come. A debt jubilee merely “kicks the can down the road” and sends the mes­sage that over con­sump­tion has no harm­ful con­se­quences. The jubilee idea is in direct con­flict with the “Lim­its to Growth” the­sis which implies that there is such a thing as unsus­tain­able con­sump­tion. Try­ing to restore to pre­vi­ous con­stant growth (phoney econ­omy) con­tra­dicts the idea of long-term sustainability.

    If we accept a lower growth envi­ron­ment, then the prob­lem is not macro­eco­nomic (with more gov­ern­ment spend­ing and more fis­cal and mon­e­tary stim­u­lus), the prob­lem is mainly micro­eco­nomic, where the gov­ern­ment focuses its effort on help­ing the inno­cent vic­tims of the eco­nomic mis­man­age­ment of the last three decades. The gov­ern­ment needs to re-distribution the ill­got­ten gains of the finan­cial sec­tor to restore fair­ness and it also needs to do a proper job of regulation.

    Debunk­ing neo­clas­si­cal eco­nom­ics is fine and well-done. But the pub­lic policy
    rec­om­men­da­tions in the Man­i­festo have not been sup­ported by any seri­ous research and are inter­nally inconsistent.

  15. ChicagoSchoolPhysicist says:

    The “Finan­cial Cri­sis” sim­pli­fied model in the Behav­ioural Sci­ence course (using QED) pre­dicts that giv­ing the money to the con­sumers has a larger effect than giv­ing the money to the banks (will look up the link), this is why in this man­festo it is called “Quan­ti­ta­tive Eas­ing for the Public”. 

    I always asked myself why pub­lic pol­icy is not more “sci­en­tific” and does not make more use of eco­nom­ics. Also, why econ­o­mists dis­agree so much. After all nobody tries to make an Otto engine for cars with dis­re­gard to ther­mo­dy­nam­ics and every phsi­cist agrees on when clas­si­cal mechan­ics and when quan­tum mechan­ics should be used. But many politi­cians do dif­fer­ent things with no “the­ory” to guide them. While read­ing Debunk­ing Eco­nom­ics, I real­ized that the trou­ble is with too lit­tle “empir­i­cal eco­nom­ics” or with dis­re­gard­ing its results when they do not fit the theory. 

    I do not know whether you or Steve are right on the effects of Debt Jubilee, but I would like to see it imple­mented in at least one of the coun­tries with large pri­vate debt so that we have more empir­i­cal data to look at.

  16. Robert K says:

    Paul Krug­man has a recent post up, enti­tled “Nobody Under­stands Debt”. You
    almost need one of those white bags they (still??) give you on the air­lines nearby,
    but he DOES prove, at least, that HE is a mem­ber of the set of per­sons contained
    in that group. He even states that our debt is not really a prob­lem (USG debt) because we owe it mostly to OURSELVES. I think the cen­tral banks around the
    world which hold about $5.5 tril­lion of that debt as reserves might dis­agree?? A dis­heart­en­ing way to begin the new year, coun­ter­acted in part, thank goodness,
    by the lengthy post above.

  17. Pingback: Daily Reading on the Financial Markets: 1/3/12 « Playing the Ponzi

  18. Steve Keen says:

    Whoops! Thanks Cyrus, will fix when I prop­erly wake up. Up now for an inter­view on US radio pro­gram Frankie Boyer Lifestyle Show at 3am Syd­ney time!

  19. Steve Keen says:

    Thanks CSP,

    Given your back­ground, you’re one of the first peo­ple whom I’d like to check out “Min­sky” for me. It is vir­tu­ally ready for a first try-out. It can do things that are very dif­fi­cult in either QED or stan­dard flow­chart pro­grams, though its visual inter­face is very basic still com­pared to both QED and, for exam­ple, Vissim.

  20. sirius says:


    It takes a lot to get me onto “the stage” nowa­days but…

    I “Liked” all your post but I will note 2 points…

    The jubilee idea is in direct con­flict with the “Lim­its to Growth” the­sis which implies that there is such a thing as unsus­tain­able con­sump­tion. Try­ing to restore to pre­vi­ous con­stant growth (phoney econ­omy) con­tra­dicts the idea of long-term sustainability.


    I note also..

    help­ing the inno­cent vic­tims of the eco­nomic mis­man­age­ment of the last three decades.

    yes these “inno­cent vic­tims” are indeed spread (very) far and wide. Some­thing that many do not seem to appreciate.

    Maybe what you are search­ing for is an “Eco­nomic The­ory of Integrity”?

    I leave you with this…

  21. Matthew K says:

    CSP -‘I always asked myself why pub­lic pol­icy is not more “sci­en­tific” and does not make more use of economics’

    My own favourite the­ory is that eco­nom­ics is only ‘applied’ as a jus­ti­fi­ca­tion for a polit­i­cal view. Ie. It is the polit­i­cal agenda that is impor­tant, rather than the eco­nomic rea­son­ing. It is great to under­stand the eco­nom­ics of where we are and how we got here, but it is also impor­tant to bear in mind that the deci­sions that got us here were polit­i­cal, not economic.

  22. ChicagoSchoolPhysicist says:

    Sure, Steve,

    I would love to be one of the first peo­ple to give Min­sky a try. The pre­sen­ta­tion already made me curi­ous and I am wait­ing with eager antic­i­pa­tion to see how it works. There are a few things that I would like to try.
    Dur­ing my hol­i­day, I was think­ing about what could con­vince even more peo­ple that your mod­els are right. One thing could be get­ting stagfla­tion out of a dynamic model. Putting in a raw mate­r­ial prices “jump” in the model may take care of it. But then how would a highly delever­ag­ing econ­omy react to such a “price shock”? Would one get the so called “bifla­tion” out of the model? What is the cut-off point for the raw mate­ri­als jump in prices or the debt level to have a stagfla­tion, con­tin­u­ing debt defla­tion or “bifla­tion”? I do not think “bifla­tion” has been offi­cially observed yet there­fore if your flow mod­els pre­dict it and then it hap­pens, then that would be a smok­ing gun for your flow models.
    In con­clu­sion, I have a lot of inputs to give it!
    I will check the blog to see when it is avail­able for trial.

  23. Pingback: » Steve Keen: Dow To Drop 35%, Housing 40%?

  24. Pingback: The Cause and the Cure.The American Revolution of 2012 | justaluckyfool

  25. Frank says:


    I don’t post too often here and don’t have time to con­tribute much, but I fol­low the arti­cles and com­ments closely if I can. Also, I was until recently an IT Archi­tect at a Euro­pean bank and now am an IT Archi­tect at a bou­tique invest­ment bank (the change from big bank to lit­tle bank was vol­un­tary — as I expect the big banks to suf­fer in the com­ing years, while focused invest­ment banks pick up the pieces). As such, I have some thoughts about the tech­ni­cal direc­tion for Min­sky and other endeav­ours around the “Keen enter­prise,” that seems to be gath­er­ing momentum.

    My wife works in clin­i­cal tri­als for can­cer research. We were on hol­i­day in Crete about a year ago, and by com­plete coin­ci­dence met a cou­ple of Slo­vak sci­en­tists, one of whom was a senior fig­ure in the Acad­emy of Sci­ence there, and the other was head­ing a virol­ogy lab, both of whom are final­is­ing tri­als in a new tumour cure (tar­get­ting aggres­sive cells able to sur­vive in con­di­tions of hypoxia at tumour periph­eries). It was inter­est­ing to talk to them in such a relaxed envi­ron­ment, as we were able to cover all kinds of ground and cross-pollinate ideas. One of the things they men­tioned was that they were severely ham­pered by not hav­ing enough bioin­for­mat­ics resources — com­put­ing or people.

    I got really inter­ested in the bioin­for­mat­ics side of things for a while as a result, and quickly found that Microsoft was already address­ing part of this. Microsoft Research cre­ated a project called the Microsoft Bioin­for­mat­ics Foun­da­tion (not Foun­da­tion like ‘fund’ — MS have a series of core tech­nolo­gies that are con­sis­tently labelled X Foun­da­tion — eg: Win­dows Pre­sen­ta­tion Foun­da­tion for UI stuff, Win­dows Com­mu­ni­ca­tion Foun­da­tion for mes­sag­ing, etc). This was renamed to the MS Biol­ogy Ini­tia­tive, but the link to it is here:

    It is very inter­est­ing that through the ubiq­uity of Win­dows, a nar­row and spe­cialised suite of obscure tools for the sci­en­tific com­mu­nity, can become a stan­dard Win­dows tech­nol­ogy and poten­tially attract masses of devel­op­ers and bring IT resources to a resource-constrained aca­d­e­mic area.

    My thought is that MS Research can bring enor­mous resources to bear on this dynamic sys­tems approach to eco­nom­ics, and I think that it syn­er­gises well with many aspects of MS related tech­nolo­gies. Data Min­ing and etc. Not only are the MS tech­nolo­gies excel­lent in such areas, they are avail­able to a huge com­mu­nity of pro­fes­sional developers.

    MS Research does seem to be sniff­ing around in these areas, eg: , but they do not seem to have the full-fledged equiv­a­lent of the Bio Ini­tia­tive, for Economics.

    When Min­sky gets off the ground and begins to start show­ing inter­est­ing mod­els and results, the for­mats and tech­niques will be taken by MS and made into some­thing much more sexy and enhanced beyond any­thing this com­mu­nity can pro­duce. They will do empir­i­cal checks using huge cloud dat­a­cen­ters and they will have access to mas­sive data sets. 

    My thoughts are that the tech­ni­cal endeav­ours here could actu­ally work well with Microsoft’s sup­port, and could become the begin­ning of an MS Dynamic Eco­nom­ics Ini­tia­tive or some such, and that MS Research could, now that INET are assist­ing, bring much more pow­er­ful resources to bear on this project. 


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