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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  • RJ


    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

  • Derek,

    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.

  • Derek R

    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.

  • Derek R

    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.

  • Derek R

    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.

  • RJ

    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

  • Derek R

    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.

  • 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.

  • RJ


    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

  • RJ

    the would not men­tion debt free money.

  • gcjblack

    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.

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

  • Tom McAlone

    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

  • fox­bat101

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

  • 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.