Economics without a blind-spot on debt

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I’m being interviewed by Paul Mason for the BBC Radio 4 program Analysis on April 3rd, in front of an audience at the London School of Economics from 6.30-8pm. If you’d like to attend, you can book a place via this link (“Banks vs the Economy“). Bookings are free but essential, and will open on Monday March 26th at 10pm. More details are available for the public from; email for media enquiries.

The LSE asked me to write this entry for their blog British Politics and Policy at LSE. It’s reproduced here (along with the data) for Debtwatch readers.

 Click here for this post in PDF: Debtwatch Members; CfESI Members
Click here for the data in this post: Debtwatch Members; CfESI Members

As a car driver, you have surely had the experience of changing lanes and being beeped by a car with which you were about to collide—but which you didn’t see before the lane change. It’s because the car was clearly visible in your rear-view mirror, but that part of the image fell on your retina’s blind-spot—so you didn’t see it. Fortunately most of us learn that we have a blind spot, and so we check carefully to avoid being fooled by it again—and causing an avoidable accident.

If only economists could learn the same way, we might not now be in the accident of this never-ending economic crisis. “Neoclassical” economists (who dominate both academic economics and policy advice to governments) have a blind-spot about the role of private debt in macroeconomics, yet despite the economy crashing once before because of it during the Great Depression, they continue to argue that it’s irrelevant now—during this latest crash.

First, let’s establish that there was indeed a “car in the rear view mirror” in the 1930s and today. Data on long-term private debt levels is difficult to find, but I’ve located it for both the USA from 1920 till today, and for Australia from 1880 (see Figure 1). Clearly, there was a debt bubble before the Great Depression, and a plunge in debt levels during and after it (and Australian data also shows the same phenomenon during an earlier bubble and crash in the Depression of the 1890s; see Fisher and Kent 1999). The same process is clearly afoot again now.

Figure 1


Now for the blind-spot. Anyone not blessed—or rather cursed—by an economics education might think there was something in that coincidence of debt and Depressions. But it’s nothing to worry about, leading Neoclassical economists assure us—thus confirming that either they know something profound that proves that the coincidence is irrelevant, or that they have a blind-spot which means that their judgment can’t be trusted.

The profound insight they believe they have is that the level of debt doesn’t matter, and that only the distribution of debt can be important. Ben Bernanke rejected Irving Fisher’s “Debt Deflation” explanation for the Great Depression on this basis; after noting that Fisher did influence Roosevelt’s policies, Bernanke added that:

‘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)

One crisis later, leading Neoclassicals like Paul Krugman continue to argue that only the distribution of debt can matter:

People think of debt’s role in the economy as if it were the same as what debt means for an individual: there’s a lot of money you have to pay to someone else. But that’s all wrong; the debt we create is basically money we owe to ourselves, and the burden it imposes does not involve a real transfer of resources.

That’s not to say that high debt can’t cause problems — it certainly can. But these are problems of distribution and incentives, not the burden of debt as is commonly understood. (Krugman 2011)

So can we ignore the level of private debt? No—because this “profound insight” is in fact a blind-spot about the role of banks and debt in a capitalist economy. Neoclassical economists treat banks as irrelevant to macroeconomics—which is why banks are not explicitly included in their models—and regard a loan as merely a transfer from a saver (or “patient agent”) to a borrower (or “impatient agent”), as in Krugman’s “New Keynesian” model of our current crisis:

In what follows, we begin by setting out a flexible-price endowment model in which “impatient” agents borrow from “patient” agents, but are subject to a debt limit. (Krugman and Eggertsson 2010, p. 3)

With that model of lending, a change in the level of debt has no inherent macroeconomic impact: the lender’s spending power goes down, the borrower’s goes up, and the two changes roughly cancel each other out.

However, in the real world, banks lend to non-bank agents, giving them spending power without reducing the spending power of other non-bank agents. The difference between the neoclassical model of lending and the real world is easily illustrated using transaction tables. Figure 2 illustrates the neoclassical model (with an implicit banking sector): in this world, a change in the level of debt has no macroeconomic implications.

Figure 2: Neoclassical perspective on lending

Assets Deposits (Liabilities)
Action/Actor Patient Impatient
Make Loan +Lend -Lend


Figure 3 illustrates what actually happens: the bank creates a new deposit and a new loan simultaneously, adding to Impatient’s spending power without reducing Patient’s.

Figure 3: Real-world lending

Bank Assets Bank Deposits (Liabilities)
Action/Actor Patient Impatient
Make Loan +Lend -Lend


This case has been made theoretically and empirically by non-neoclassical economists for decades. Schumpeter argued it was the primary source of investment (Schumpeter 1934, p. 73), Basil Moore showed empirically that this endogenous creation of credit, and not the “money multiplier”, was the explanation for money growth (Moore 1979), and most succinctly, a Senior Vice-President of the New York Fed asserted it when arguing against the Monetarist experiment of the 1970s:

In the real world, banks extend credit, creating deposits in the process, and look for the reserves later. (Holmes 1969, p. 73)

Unfortunately, Neoclassicals continue to ignore it because it doesn’t fit their model. Well it’s time to ignore them—because their model doesn’t fit the real world. Once we take the endogenous creation of money by banks into account, rising debt has a macroeconomic impact because it adds to aggregate demand. It also is the primary way in which speculation on asset prices is financed, as Minsky emphasised (Minsky 1982, p. 24).

The crisis we are in suddenly becomes entirely explicable—and predictable before the event—when the blind-spot on debt is removed. Because the change in debt adds to aggregate demand (and is spent on assets as well as goods and services), there is a strong causal link between rising debt and both falling unemployment and rising asset prices. This is evident in the UK data: unemployment fell as the debt-financed component of aggregate demand rose, and unemployment is now rising as the growth in private debt subsides (see Figure 4, where unemployment is inverted to make the correlation more obvious).

Figure 4: Change in Debt & UK Unemployment

The reason that our economic crisis is a financial one as well is that changing debt drives not just demand for goods and services, but asset prices as well. And since changing debt is a major source of demand for share and property purchases, for asset prices to rise, the level of debt must not merely grow but accelerate. Accelerating household debt clearly drove the UK’s property bubble, and that bubble is now vulnerable as household debt decelerates (see Figure 5).

Figure 5: Relationship between accelerating household debt and change in house prices

Ignoring the role of private debt in the economy is thus as dangerous as driving a car while ignoring the fact that your vision has a blind-spot. It’s why neoclassical economics has to be consigned to the dustbin of history (Keen 2011), and a realistic, credit based economics must take its place.

Oh, and as passengers in the UK economic car, are you hoping that your economists are better drivers? Figure 6 shows the level of UK private debt compared to that of the USA and Australia. I suggest that you tighten your seat-belts.

Figure 6: Aggregate private debt level

Bernanke, B. S. (2000). Essays on the Great Depression. Princeton, Princeton University Press.

Fisher, C. and C. Kent (1999). Two Depressions, One Banking Collapse. Reserve Bank of Australia Research Discussion Papers. Sydney, NSW, Australia, Reserve Bank of Australia. 1999: 54.

Holmes, A. R. (1969). Operational Constraints on the Stabilization of Money Supply Growth. Controlling Monetary Aggregates. F. E. Morris. Nantucket Island, The Federal Reserve Bank of Boston: 65-77.

Keen, S. (2011). Debunking economics: The naked emperor dethroned? London, Zed Books.

Krugman, P. (2011). “Debt Is (Mostly) Money We Owe to Ourselves.” The Conscience of a Liberal 2012.

Krugman, P. and G. B. Eggertsson (2010). Debt, Deleveraging, and the Liquidity Trap: A Fisher-Minsky-Koo approach [2nd draft 2/14/2011]. New York, Federal Reserve Bank of New York & Princeton University.

Minsky, H. P. (1982). Can “it” happen again? : essays on instability and finance. Armonk, N.Y., M.E. Sharpe.

Moore, B. J. (1979). “The Endogenous Money Stock.” Journal of Post Keynesian Economics
2(1): 49-70.

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.



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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65 Responses to Economics without a blind-spot on debt

  1. RJ says:


    Do you realise how ridiculous your suggestion is. it would mean that we would all have to revert to just using notes and coins. And these notes and coins could not be banked (as when they are the banks create new bank money).

    It would also be costly and difficult to administer. And create dangers for the people distributing this money. And holding it.

    But can we agree that at present all money is created by banks. By a simple journal entry.

    DEBIT Bank loan (bank lending) or Central bank reserves (Govt spending)
    CREDIT Cheque account

    AS FOR THE NOTES. THEY ARE BACKED BY GOVT DEBT. No different to central bank reserves

  2. NeilW says:


    At that point the government becomes the bank – which if you recall circuitist theory is the trusted third party clearing the transaction between two other parties.

    Now you can tear up the tri-party model, but then you lose all the benefits of the model Steve has created.

  3. Derek R says:

    RJ, you stated that a government cannot create money without using a bank. I have just demonstrated how they can. So to then call the method ridiculous because it does not involve a bank seems a bit disingenuous to say the least. And if there is no bank then of course we would have to revert to notes and coins.

    But however ridiculous it may be, it is certainly not impractical. In fact the UK government carried out a similar scheme when it imposed rationing in the 1940s and 1950s. The ration books issued contained coupons which were just as valuable as coins. It appears that society was able to cope with the costliness, the danger, etc. then and I’m sure that it could now.

    Which is not to deny that it could all be implemented much more safely and efficiently if a bank was used.

    One final point about this type of government money is that it is not backed by debt. You will notice that there was no step involving the issue of a bond or promise by the government to provide a costly item in return. What gives the value to the notes is the promise by the government to provide a licence in exchange for the token, in the case of my examples, a licence giving the right to own land or to sell energy for a period of time. Once people own the licence it is up to them whether they make use of that licence or not. But issuing the licence costs the government next to nothing, and even if a licensee uses the licence, the government incurs no debt since the licence only allows the person to carry out certain types of transaction in an essential resource with other citizens.

    So this is money without debt.

  4. Derek R says:

    At that point the government becomes the bank – which if you recall circuitist theory is the trusted third party clearing the transaction between two other parties.

    I agree with that. The value of the notes depends upon the government enforcing the licence regime. If it doesn’t do that the notes become worthless.

    Now you can tear up the tri-party model, but then you lose all the benefits of the model Steve has created.

    I’m not so sure about tearing up the tri-party model because I don’t want to lose those benefits. As I see it there are several ways of creating money (credit/debt money based on banks, commodity money based on imperishable commodities like gold or silver, token money like the model I described, or status money like wampum or the Yap Islanders stone coins). Our modern economy overwhelmingly uses credit money and Steve’s model is essential to understand how credit money works, so there is no way we want to tear it up. However I don’t think it should blind us to the fact that other forms of money are possible and may operate in conjunction with the credit money system.

  5. Derek R says:

    RJ wrote:
    But can we agree that at present all money is created by banks. By a simple journal entry.
    DEBIT Bank loan (bank lending) or Central bank reserves (Govt spending)
    CREDIT Cheque account
    AS FOR THE NOTES. THEY ARE BACKED BY GOVT DEBT. No different to central bank reserves

    Absolutely agreed, RJ. That is how our current monetary system works.

  6. RJ says:

    “Absolutely agreed, RJ. That is how our current monetary system works.”

    Compared to

    “So this is money without debt.”

    Debt free money is impossible. It is a hoax that has taken hold. Money is a financial asset and must be backed by a financial liability (called debt).

    If they Govt would not accept notes and coins in exchange for bonds or tax. Then the money would have no value

  7. Derek R says:

    RJ wrote:

    “Absolutely agreed, RJ. That is how our current monetary system works.”

    Compared to

    “So this is money without debt.”

    There is no contradiction there. Our current system is totally debt-backed because current governments insist on issuing bonds to the value of any currency that they issue. So our current money is backed by debt, no question.

    However it doesn’t have to be like that. The MMTers provide an alternative vision of the economy where the value of the money is dependent on its being the sole allowable method of paying taxes. And that is also a valid way of giving value to money. Okay, it’s still dependent on debt, I’m not going to argue about that.

    But the money system that I described is not dependent on debt. It is dependent on people choosing to gain access to a government monopoly in the belief that they can turn a profit by doing so. In principle it would allow fiat money with value to exist in a society with no taxation or bonds.

    It is not our current monetary system but it is a form of money created without debt.

  8. NeilW says:

    “Debt free money is impossible”

    Depends what you understand by debt.

    Debt for most people involves having to give up something made of atoms or an amount of sweat to clear it.

    So when you hear the phrase ‘debt free money’ they are generally talking about fiat money which is of course just an accounting liability. Still debt in the technical sense, but not the SCARY DEBT that people worry about.

  9. RJ says:


    They are usually people who do not understand money and banking. Including what money is and even basic double entry book keeping

    if they did they would debt free money

  10. RJ says:

    the would not mention debt free money.

  11. gcjblack says:

    Based on data from Statistics Canada Report 378-0012, it appears that Canadians are in significantly better shape than its friends in Australia and USA. See attached graph.

  12. Steve Keen says:

    Can you provide a breakdown into Household, Business and Finance sector debt? That way I can double-check your aggregate total.

  13. Tom McAlone says:

    Steve K – I am still trying to get myself up to speed on the US data. In the data set attached to this article, I saw an entry for 2012 (2.512976228)
    which I assume was January 2012. Is that a interpolation or a calculation from data points? Do the debt/credit data points from the US come from the Flow of Funds Z.1 report? I took a quick look at the model section to try and run down some data definitions, but was unable to do so. Sorry to bog this discussion down with such mundane details……..Tom Mc

  14. foxbat101 says:

    I found this blog yesterday, there are some rude words it it so open at your own risk.
    Peter from Perth

  15. Steve; just looking at the UK/US/AUS comparison of household debt levels. How does the ‘Cost of Household Debt’ compare between the three, and is this particularly relevant?

    I suspect the differential between the three is quite reduced and that there is a strong corellation between reducing interst rates and increasing total borrowing.

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