The Future of Economics

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I was approached by Bloomberg to write an 800-word fea­ture on “The Future of Eco­nom­ics” for the World Eco­nomic Forum, which starts today in Davos. Here is the  Bloomberg newslet­ter, with my com­men­tary on page 5.

For its entire his­tory, macro­eco­nom­ics has been dom­i­nated by math­e­mat­i­cal mod­els that ignore the exis­tence of money, debt and bank­ing, and that per­ceive the economy’s move­ment through time as tran­si­tions from one state of equi­lib­rium to another.

At any point in his­tory, these would be heroic assump­tions. Could it really be true that mod­els with­out either money or insta­bil­ity are prov­ably supe­rior at pre­dict­ing the economy’s future course than mod­els in which money and bank­ing exist, and in which the model econ­omy can be out of equi­lib­rium? If not, is it the case then that such mod­els are sim­ply too dif­fi­cult to construct—that the best we can do is pre­tend that the econ­omy doesn’t have banks or money, and that it’s always in equi­lib­rium, even if we know these assump­tions are false?

Before the cri­sis of 2007, few non-economists even asked those ques­tions, because there seemed to be no need to chal­lenge what econ­o­mists did. The econ­omy, after all, was going gang­busters. Pro­fes­sional econ­o­mists, using the very lat­est math­e­mat­i­cal mod­els of the econ­omy, took credit for its ster­ling per­for­mance, and pre­dicted more of the same for the fore­see­able future.

Robert Lucas, the father of “Ratio­nal Expec­ta­tions Macro­eco­nom­ics”, asserted that the “macro­eco­nom­ics … has suc­ceeded. Its cen­tral prob­lem of depres­sion pre­ven­tion has been solved, for all prac­ti­cal pur­poses, and has in fact been solved for many decades.“[1]  Ben Bernanke lauded “improved con­trol of infla­tion” as the cause of “the Great Mod­er­a­tion”, which he described as “this wel­come change in the econ­omy.” [2] In June 2007, the OECD, guided by its macro­eco­nomic model, opined that “the cur­rent eco­nomic sit­u­a­tion is in many ways bet­ter than what we have expe­ri­enced in years… Our cen­tral fore­cast remains indeed quite benign”. [3]

Then all hell broke loose, and almost five years later, it shows no signs of abat­ing. Now non-economists are chal­leng­ing what econ­o­mists do, and finally real­iz­ing what a minor­ity of dis­si­dents within eco­nom­ics have long known: these assump­tions are not merely heroic, they are both false and unnec­es­sary. Money, debt and dis­e­qui­lib­rium dynam­ics play cru­cial roles in the actual behav­iour of the econ­omy, and it is rel­a­tively easy to develop math­e­mat­i­cal mod­els which include money and banks, and in which the econ­omy is always in dis­e­qui­lib­rium. I should know: it’s what I do, and it’s why I was one of two math­e­mat­i­cal econ­o­mists who saw this cri­sis com­ing, and warned of it pub­licly before it hap­pened (the other was the late Wynne God­ley). [4]

For eco­nom­ics to have a future, it has to aban­don the obses­sion with equi­lib­rium mod­el­ling, and real­is­ti­cally incor­po­rate money, bank­ing and finance into macro­eco­nom­ics. Both things are, as I’ve said, not hard to do.

The start­ing point for mod­el­ling any process in a true sci­ence is a posi­tion of disequilibrium—Newton, after all, mod­elled grav­ity by con­sid­er­ing a falling apple, not one at rest! Econ­o­mists have to aban­don their fetish with “com­par­a­tive sta­t­ics” and instead model processes of change. Dynam­ics has to be the core of eco­nomic analy­sis, not equilibrium.

Money is also eas­ily mod­elled by bor­row­ing the basic tool of the accoun­tant, double-entry book­keep­ing. [5] Money and debt are cre­ated by book­keep­ing entries, and the same par­a­digm can be used to derive dynamic mod­els of the flow of money in one direc­tion, pro­pelling the move­ment of goods and finan­cial assets in the other.

The dif­fi­culty in devel­op­ing a mon­e­tary dynamic macro­eco­nom­ics comes not from the tools them­selves, but from the beliefs that have to be aban­doned to employ them sensibly—from other assump­tions that Neo­clas­si­cal econ­o­mists have made to “sim­plify” analy­sis that instead have made it almost impos­si­ble to under­stand the real world. There are enough of these to lit­er­ally fill a book—to whit, my Debunk­ing Eco­nom­ics [6]—but I’ll sin­gle out just three:

  • Ratio­nal” expectations—which really means assum­ing that every­one can accu­rately pre­dict the future (and there­fore avoid any calami­ties like the one we are in right now);
  • Rep­re­sen­ta­tive agents—which really means assum­ing that there’s only one per­son in the econ­omy, who pro­duces and con­sumes just one com­mod­ity; and
  • Per­ceiv­ing macro­eco­nom­ics as applied microeconomics

This last false belief, and not a quest for greater real­ism, was the dri­ving force behind the devel­op­ment of macro­eco­nom­ics since WWII. It was a fool’s errand, since as physi­cists real­ized decades ago, “More Is Different”—to quote the title of a famous paper from Physics Nobel Lau­re­ate Philip Ander­son. [7] Biol­ogy can­not be treated as merely applied chem­istry, even though the ele­men­tary build­ing blocks of liv­ing enti­ties are chem­i­cals, because prop­er­ties emerge from the inter­ac­tions of these chem­i­cals that can’t be explained from the chem­i­cals alone.

We call one of these emer­gent prop­er­ties “Life”. We know a great deal about chem­istry, but no chemist has as yet cre­ated life. The attempt to reduce macro­eco­nom­ics to applied micro­eco­nom­ics was as futile a quest.


[1] Robert E. Lucas, Jr, “Macro­eco­nomic Pri­or­i­ties”, his 2003 Pres­i­den­tial Address to the Amer­i­can Eco­nomic Asso­ci­a­tion, Jan­u­ary 10, 2003.

[2] Bernanke, B. S. (2004). Panel dis­cus­sion: What Have We Learned Since Octo­ber 1979? Con­fer­ence on Reflec­tions on Mon­e­tary Pol­icy 25 Years after Octo­ber 1979, St. Louis, Mis­souri, Fed­eral Reserve Bank of St. Louis.

[3] Cotis, J.-P. (2007). Edi­to­r­ial: Achiev­ing Fur­ther Rebal­anc­ing. OECD Eco­nomic Out­look. OECD. Paris, OECD. 2007/1: 7–10.

[4] For­tu­nately God­ley (, has many young fol­low­ers car­ry­ing on his work. For the list of econ­o­mists who warned of the cri­sis, see Beze­mer, D. J. (2009). “No One Saw This Com­ing”: Under­stand­ing Finan­cial Cri­sis Through Account­ing Mod­els. Gronin­gen, The Nether­lands, Fac­ulty of Eco­nom­ics Uni­ver­sity of Gronin­gen.

[5] For an exam­ple of mod­el­ling a sim­ple 19th cen­tury paper money sys­tem, see–31.

[6] Steve Keen (2011), Debunk­ing Eco­nom­ics: the naked emperor dethroned?, Pluto Press, Lon­don.–1

[7] Ander­son, P. W. (1972). “More Is Dif­fer­ent.” Sci­ence 177(4047): 393–396.

About Steve Keen

I am a professional economist 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 debts accumulated in Australia, and our very low rate of inflation.
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50 Responses to The Future of Economics

  1. koonyeow says:

    Title: koonyeow’s Wish

    I think that epis­te­mol­ogy (the­ory of knowl­edge) should be taught at every school. Bribe our chil­dren to learn it if we have to.

  2. cyrusp says:

    The best argu­ment against the “print money will cause hyper­in­fla­tion” case is the data. US Bank reserves are through the roof, and lend­ing hasn’t taken off, and nei­ther has inflation.”

    Pro­fes­sor Keen, there seems to be grow­ing evi­dence that excess reserves from QE are not idle. The claim is that they are being used to sup­port equity and com­mod­ity prices:

    If that is true then Pres­i­dent Barack Obama’s claim of a “mul­ti­plier effect” is sort of cor­rect. Since share prices are set on the mar­gin then a few high bids at low vol­ume is enough to keep the share mar­ket high. Con­spir­acy types have dubbed this the “plunge pro­tec­tion team”.

    Infla­tion hasn’t taken off, but nei­ther has deflation.

  3. RJ says:


    But how much more has QE pushed down inter­est rates

    The Fed­eral Reserve knows full well that sol­vency is not an issue for the gov­ern­ment of the United States, short term or long term.

    It knows as oper­a­tional fact there is no such thing as the U.S. gov­ern­ment ‘run­ning out of money’ or ‘being depen­dent on China’ for fund­ing. Or ‘leav­ing the tab to our grand children.’

    The Fed knows debt man­age­ment is noth­ing more than shift­ing dol­lar bal­ances between reserve accounts at the fed to secu­ri­ties accounts at the Fed, and that pay­ing off the debt is noth­ing more than shift­ing dol­lar bal­ances from secu­ri­ties accounts at the Fed to reserve accounts at the Fed, with no grand chil­dren involved.

    And the Fed knows that they, and not mar­kets, nec­es­sar­ily set inter­est rates by vot­ing on them, as the fed is the monop­oly sup­plier of clear­ing bal­ances (reserves) for the bank­ing sys­tem and there­fore what’s called ‘price set­ter’ in eco­nom­ics 101.

  4. Steve Keen says:

    Yes, I’ve seen that argu­ment Cyrusp, and I’m wait­ing on a more ana­lytic paper by Dirk Beze­mer on the issue. The funds haven’t boosted activ­ity or lend­ing in the indus­trial sec­tor, but they may well have financed a spec­u­la­tive bub­ble in com­mod­ity prices, as this arti­cle claims.

    And yes, defla­tion has been minor com­pared to the GD. One fea­si­ble rea­son for the difference–in addi­tion to the rel­a­tive impact of Gov­ern­ment spending–is the com­po­si­tion of debt, which was much more in non-financial busi­ness debt back in the GD com­pared to this time round.

  5. RJ says:

    And who mainly exchange reserves for other assets

    Isn’t it the banks. So in effect it makes no dif­fer­ence. Except for very mar­gin­ally lower inter­est rates

    The key MAYBE is the low inter­est rates no QE

  6. RJ says:

    but they may well have financed a spec­u­la­tive bub­ble in com­mod­ity prices, as this arti­cle claims”

    How can this be correct?

    QE exchange one bank asset like a govt bonds for another one (reserves). So the banks asset posi­tion does not change. Except the assets earn lower interest.

    Are you say­ing the bank is more likely to loan money at lower inter­est rates because of this which then encour­age more lend­ing that flows into commodities

    But note that even if they do the total bank reserve hold­ing do not change. They just flow from one bank to another one.

  7. Steve Keen says:

    Utterly agree Frank! Unfor­tu­nately he’s not attend­ing the INET con­fer­ence in Berlin, but I hope to meet up with him when I’m there since his is in Berlin.

  8. Steve Keen says:

    Read the arti­cle RJ.

  9. RJ says:


    I have. But isn’t this arti­cle mostly total garbage. For the rea­sons I have given above

  10. cja says:

    RJ, there was also this arti­cle on Naked Cap­i­tal­ism a cou­ple of weeks ago regard­ing the infla­tion of com­modi­ties — well worth look.

  11. LCTesla says:

    One thing that I’ve heard about the trans­mis­sion mech­a­nism between asset spec­u­la­tion and QE is that hedge funds have been bor­row­ing money directly from con­ser­v­a­tive insti­tu­tions that used to hold US trea­suries in order to spec­u­late with the money on a highly lever­aged basis. In other words, the lend­ing occurred via the shadow bank­ing sys­tem, with con­ser­v­a­tive insti­tu­tions act­ing as the shadow lender and hedge­funds act­ing as the shadow borrower:

    It has been my the­ory that this is the market’s way of get­ting around the arti­fi­cial bar­rier raised by the fact that the deci­sion was made not to char­ter new, well cap­i­tal­ized banks in the wake of the cri­sis. If the gov­ern­ment won’t cre­ate well cap­i­tal­ized “banks”, the shadow sec­tor will. The effect of this is that the prob­lem of a lack of cap­i­tal in the bank­ing sys­tem is cir­cum­vented some­what, but the exist­ing banks are under more com­pe­ti­tion than the gov­ern­ment ini­tially wanted them to be exposed to (i.e. why it did not allow new char­ter­ing). A nasty side effect is that the shadow bank­ing sys­tem has grown to pro­por­tions that exceed those of reg­u­lar bank­ing in the US (Lew Spellman’s videos in the same series as the one I post above explain a lot of this).

    Now, does this mean that the excess reserves that banks are reported to hold are being used actively? I don’t imme­di­ately see how. I would expect the money being lent out by these insi­tu­tions not to appear as “excess reserves” any­more. Maybe I’m wrong. I’m out on a limb on most of this.

  12. Steve Hummel says:

    This kind of hyper­fi­nan­cial­iza­tion is nuts. Its the ulti­mate “Eat, drink and be merry for tomor­row we die philosophy.

  13. Steve Hummel says:


    The last para­graph in that Naked Cap­i­tal­ism arti­cle is a scream­ing jus­ti­fi­ca­tion for a Dis­trib­utist econ­omy with strict reg­u­la­tion of speculation.

  14. alainton says:

    The fal­lacy of expan­sion­ary fis­cal consolidation

    Crack­ing paper from Simon Tilford

    Euro­zone policy-makers – from Pres­i­dent Sarkozy and Wolf­gang Schäu­ble to the for­mer Pres­i­dent of the ECB, Jean-Claude Trichet – advo­cate that Italy and Spain should emu­late the Baltic states and Ire­land. These four coun­tries, they argue, demon­strate that fis­cal aus­ter­ity, struc­tural reforms and wage cuts can restore economies to growth and debt sus­tain­abil­ity.
    Latvia, Esto­nia, Lithua­nia and Ire­land prove that so-called “expan­sion­ary fis­cal con­sol­i­da­tion” works and that economies can regain exter­nal trade com­pet­i­tive­ness (and close their trade deficits) with­out the help of cur­rency deval­u­a­tion. Such claims are highly mis­lead­ing. Were Italy and Spain to take their advice, the impli­ca­tions for the Euro­pean econ­omy and the future of the euro would be dev­as­tat­ing.…
    What have the three Baltic economies and Ire­land done to draw such acclaim? All four have expe­ri­enced eco­nomic depres­sions. From peak to trough, the loss of out­put ranged from 13 per cent in Ire­land to 20 per cent in Esto­nia, 24 per cent in Latvia and 17 per cent in Lithua­nia. Since the trough of the reces­sion, the Eston­ian and Lat­vian economies have recov­ered about half of the lost out­put and the Lithuan­ian about one third. For its part, the Irish econ­omy has barely recov­ered at all and now faces the prospect of renewed reces­sion.
    Domes­tic demand in each of these four economies has fallen even fur­ther than GDP. In 2011 domes­tic demand in Lithua­nia was 20 per cent lower than in 2007. In Esto­nia the short­fall was 23 per cent, and in Latvia a scarcely believ­able 28 per cent. Over the same period, Irish domes­tic demand slumped by a quar­ter (and is still falling). In each case, the decline in GDP has been much shal­lower than the fall in domes­tic demand because of large shift in the bal­ance of trade.
    The improve­ment in exter­nal bal­ances does not reflect export mir­a­cles, but a steep fall in imports in the face of the col­lapse in domes­tic demand. ..
    Spain and Italy could close their trade deficits if they engi­neered eco­nomic slumps of the order expe­ri­enced by the Baltic coun­tries and Ire­land. But a col­lapse in demand in the EU’s two big South­ern Euro­pean economies com­pa­ra­ble to that expe­ri­enced in the Baltic coun­tries and Ire­land would impose a huge demand shock on the
    Euro­pean econ­omy. Taken together, Italy and Spain account for around 30 per cent of the euro­zone econ­omy, so a 25 per cent fall in domes­tic demand in these two economies would trans­late into an 8 per cent fall in demand across the euro­zone. The result­ing slump across Europe would have a far-reaching impact on pub­lic finances, the region’s bank­ing sec­tor and hence on investor con­fi­dence in both gov­ern­ment finances and the banks. The impact on sov­er­eign sol­vency in Spain and Italy and on the two coun­tries’ bank­ing sec­tors would be devastating.’

  15. NeilW says:

    Any men­tion in that paper that the ‘mir­a­cle’ in those coun­tries involves vast num­bers of their pop­u­la­tion leav­ing the country?

    Which goes to my sug­ges­tion that neo-classical eco­nom­ics is actu­ally a form of elim­i­na­tion­ism. The ‘sur­plus’ pop­u­la­tion is expected to die qui­etly or leave the coun­try and become some­body else’s problem.

  16. RJ says:



    The Guardian artilce is utter garbage

    This one is much bet­ter (infla­tion FEARS etc not directly due to QE )

    This bub­ble, Cook argues, was inflated due to infla­tion fears after the QE pro­grams under­taken by the Fed­eral Reserve and the Bank of Eng­land. With the mar­kets awash with dol­lar and ster­ling liq­uid­ity, banks and investors piled into com­modi­ties to escape what they saw to be a loom­ing inflation.”

  17. centerline says:

    RJ, oth­ers — per­haps some time spent read­ing arti­cles on Zero­hedge might help. The work done by authors is usu­ally spot-on and pro­vides insight only gained from those who truly know how the sys­tem works (and does not) at the level where greed and power come to bear on the world eco­nom­ics (and con­se­quently use the tools of mod­ern eco­nom­ics to pull the wool over peo­ples eyes).

  18. centerline says:

    LCTesla —

    In my opin­ion you are right into the heart of the mat­ter, the shadow bank­ing system.

    One the key dif­fer­ence between now and any other item is how the finan­cial sec­tor has man­aged to cre­ate such incred­i­ble instru­ments of lever­age — and do so vir­tu­ally com­pletely out­side of reg­u­lated space.

    The kicker here is how firms have uti­lized bilat­eral net­ting as a means of keep­ing the essen­tial double-entry books in bal­ance. Real­ity how­ever is that net expo­sure becomes gross expo­sure the moment liq­uid­ity seizes up. AIG was clearly an exam­ple of this.

    Like­wise, we all the know the mechan­ics here depend on per­pet­ual growth. Lack­ing organic eco­nomic growth, there has only been syn­thetic (recur­sive) gains keep­ing the cur­rent sys­tem out­side of sys­temic default. Mean­while, ZIRP has forced pen­sion funds and other sim­i­lar funds des­per­ate for yield into riskier and riskier classes of invest­ment (yeah, that will end well… LOL).

    Check out arti­cles on “rehy­poth­e­ca­tion” if you want to really frighten yourself.

  19. RJ says:

    Cen­tre line

    You are kid­ding about zero­hedge I hope

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  22. conal says:

    As the econ­o­mist Steve Keen puts it: “Most econ­o­mists are deluded.“‘

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