My paper for INET’s Berlin 2012 Conference

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My paper “Insta­bil­i­ty in Finan­cial Mar­kets: Sources and Reme­dies” for the INET con­fer­ence “Par­a­digm Lost: Rethink­ing Eco­nom­ics and Pol­i­tics”, to be held in Berlin on April 12–14, is now avail­able via the INET web­site.

If you’d like to down­load it, you can get it either from my INET page, or from a link on the con­fer­ence pro­gram. For copy­right rea­sons I can’t repro­duce it here, but I can pro­vide a quick syn­op­sis and some excerpts, so here goes.

A Primer on Minsky

The paper starts with a syn­op­sis on Min­sky, since his “Finan­cial Insta­bil­i­ty Hypoth­e­sis” is one of the key foun­da­tions of my approach to eco­nom­ics. He has come into vogue these days of course, but to peo­ple who’ve known his work for sev­er­al decades rather than ever since the “Min­sky Moment” of late 2007, a bet­ter expres­sion would be that he’s “come into vague”. I read papers like Krug­man’s “Debt, Delever­ag­ing, and the Liq­uid­i­ty Trap: A Fish­er-Min­sky-Koo approach”, and for the life of me, I can’t see Min­sky there. As I note in my paper:

Now, after the cri­sis that his the­o­ry antic­i­pat­ed, neo­clas­si­cal econ­o­mists are pay­ing some atten­tion to his hypoth­e­sis, and there has been at least one attempt to build a New Key­ne­sian mod­el of a key phe­nom­e­non in Min­sky’s hypoth­e­sis, a debt-defla­tion (Krug­man and Eggerts­son 2010). How­ev­er, to those of us who are not new to Min­sky, it is hard to recog­nise any ves­tige of the Finan­cial Insta­bil­i­ty Hypoth­e­sis in Krug­man’s work.

My good friend and long term fel­low rebel in eco­nom­ics Pro­fes­sor Rod O’Don­nell once remarked that neo­clas­si­cal econ­o­mists are inca­pable of read­ing Keynes: they look at his words and then spout Wal­ras instead. A sim­i­lar phe­nom­e­non applies here: neo­clas­si­cals like Krug­man read Min­sky, and then pro­ceed to build equi­lib­ri­um mod­els with­out banks, and think they’re mod­el­ling Min­sky.

No they’re not: they’re cre­at­ing an equi­lib­ri­um-obsessed Wal­rasian hand pup­pet and call­ing it Minsky—just as they did to Keynes with DSGE mod­el­ling.


I used the word “equi­lib­ri­um” twice above, because one clear method­olog­i­cal aspect of Min­sky’s think­ing is that macro­eco­nom­ics is about dis­e­qui­lib­ri­um. Neo­clas­si­cal econ­o­mists have the world pre­cise­ly (to use an evoca­tive piece of Aus­tralian slang) arse about tit. They believe that if it’s not an equi­lib­ri­um mod­el it’s not eco­nom­ics.

Non­sense! The pre­cise oppo­site is the case: if it isn’t dis­e­qui­l­bri­um, then it isn’t eco­nom­ics.

There’s noth­ing “rad­i­cal” about this, which is often the way that neo­clas­si­cal econ­o­mists react when I press this point: “assume dis­e­qui­lib­ri­um? How dare you!?”. I dare because “dis­e­qui­lib­ri­um” is so com­mon in real sci­ences that they don’t even call it that: they call it dynam­ics. Any dynam­ic mod­el of a process must start away from its equi­lib­ri­um, because if you start it in its equi­lib­ri­um, noth­ing hap­pens. It’s about time that econ­o­mists woke up to the need to mod­el the econ­o­my dynamically—and to give Krug­man his due here, he does admit at the end of his paper that his dynam­ics are dread­ful, and need to be improved:

The major lim­i­ta­tion of this analy­sis, as we see it, is its reliance on strate­gi­cal­ly crude dynam­ics. To sim­pli­fy the analy­sis, we think of all the action as tak­ing place with­in a sin­gle, aggre­gat­ed short run, with debt paid down to sus­tain­able lev­els and prices returned to full ex ante flex­i­bil­i­ty by the time the next peri­od begins. This side­steps the impor­tant ques­tion of just how fast debtors are required to delever­age; it also rules out any con­sid­er­a­tion of the effects of changes in infla­tion expec­ta­tions dur­ing the peri­od when the zero low­er bound remains bind­ing, a major theme of recent work by Eggerts­son (2010a), Chris­tiano et. al. (2009), and oth­ers. In future work we hope to get more real­is­tic about the dynam­ics.

Hur­ry up Paul: you’re already eight decades behind Irv­ing Fish­er, who put the case for dynam­ics even for those who assume that equi­lib­ri­um is sta­ble:

We may ten­ta­tive­ly assume that, ordi­nar­i­ly and with­in wide lim­its, all, or almost all, eco­nom­ic vari­ables tend, in a gen­er­al way, toward a sta­ble equi­lib­ri­um… But … New dis­tur­bances are, human­ly speak­ing, sure to occur, so that, in actu­al fact, any vari­able is almost always above or below the ide­al equi­lib­ri­um…

The­o­ret­i­cal­ly there may be—in fact, at most times there must be—over-or under-pro­duc­tion, over- or under-con­sump­tion, over- or under-spend­ing, over- or under-sav­ing, over- or under-invest­ment, and over or under every­thing else. It is as absurd to assume that, for any long peri­od of time, the vari­ables in the eco­nom­ic orga­ni­za­tion, or any part of them, will “stay put,” in per­fect equi­lib­ri­um, as to assume that the Atlantic Ocean can ever be with­out a wave.’ (Fish­er 1933, p. 339)

Endogenous Money

One key com­po­nent of Min­sky’s thought is the capac­i­ty for the bank­ing sec­tor to cre­ate spend­ing pow­er “out of nothing”—to quote Schum­peter. As well as explain­ing endoge­nous mon­ey, I show that Min­sky’s analy­sis leads to the con­clu­sion that aggre­gate demand is greater than aggre­gate sup­ply aris­ing from the sale of goods and ser­vices alone—and there­fore that ris­ing debt plays a cru­cial role in a cap­i­tal­ist econ­o­my:

If income is to grow, the finan­cial mar­kets, where the var­i­ous plans to save and invest are rec­on­ciled, must gen­er­ate an aggre­gate demand that, aside from brief inter­vals, is ever ris­ing. For real aggre­gate demand to be increas­ing, … it is nec­es­sary that cur­rent spend­ing plans, summed over all sec­tors, be greater than cur­rent received income and that some mar­ket tech­nique exist by which aggre­gate spend­ing in excess of aggre­gate antic­i­pat­ed income can be financed. It fol­lows that over a peri­od dur­ing which eco­nom­ic growth takes place, at least some sec­tors finance a part of their spend­ing by emit­ting debt or sell­ing assets. (Min­sky 1963; Min­sky 1982) (Min­sky 1982, p. 6)

This aggre­gate demand is spent not just on goods and ser­vices, but also on buy­ing finan­cial assets—hence eco­nom­ics and finance are inex­tri­ca­bly linked, in oppo­si­tion to the failed neo­clas­si­cal attempt to keep them sep­a­rate in two her­met­i­cal­ly sealed jars. This in turn tran­scends Wal­ras’ Law to give us what I call the Wal­ras-Schum­peter-Min­sky Law:

Aggre­gate demand is income plus the change in debt, and this is expend­ed on both goods and ser­vices and finan­cial assets. There­fore in a cred­it-based econ­o­my, there are three sources of aggre­gate demand, and three ways in which this demand is expend­ed:

1.    Demand from income earned by sell­ing goods and ser­vices, which pri­mar­i­ly finances con­sump­tion of goods and ser­vices;

2.    Demand from ris­ing entre­pre­neur­ial debt, which pri­mar­i­ly finances invest­ment; and

3.    Demand from ris­ing Ponzi debt, which pri­mar­i­ly finances the pur­chase of exist­ing assets.

Neoclassical Misinterpretations of Fisher, Minsky & Banking

How do you mis­in­ter­pret me? Let me count the ways…”

There are so many ways in which neo­clas­si­cal econ­o­mists mis­in­ter­pret non-neo­clas­si­cal thinkers like Fish­er and Min­sky that I could write a book on the top­ic. This sec­tion focus­es on just one facet of how they get it wrong: by ignor­ing banks, and treat­ing loans as trans­fers from “savers” to “spenders” with no bank in between.

This is pre­cise­ly how Krug­man mod­els debt in his recent paper:

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. If this debt lim­it is, for some rea­son, sud­den­ly reduced, the impa­tient agents are forced to cut spend­ing… (Krug­man and Eggerts­son 2010, p. 3)

This is debt with­out banks—and with­out the endoge­nous cre­ation of money—and it explains why neo­clas­si­cal econ­o­mists don’t think that the lev­el of pri­vate debt mat­ters.

With that vision of debt, a change in the lev­el of debt isn’t impor­tant, because the bor­row­er’s increase in spend­ing pow­er is coun­ter­act­ed by the lender’s fall in spend­ing pow­er. Here’s the lend­ing process as neo­clas­si­cals like Krug­man see it:

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

Krug­man there­fore reas­sures his blog read­ers that there’s noth­ing to wor­ry about when pri­vate debt lev­els rise or fall:

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)

That would be reas­sur­ing if true, since we could then ignore data like this:

Unfor­tu­nate­ly, real lend­ing is bet­ter described by the next table:

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

In the real world, a bank loan increas­es “Impa­tient“ ‘s spend­ing pow­er with­out reduc­ing “Patient“ ‘s, so that the lev­el of pri­vate debt does mat­ter.

Applying Minsky to Macroeconomic Data

In par­tic­u­lar, the rate of change of debt mat­ters because that tells us how much of demand is debt financed. When you add the change in debt to GDP, you get total aggre­gate demand, and that makes it exceed­ing­ly clear why the eco­nom­ic cri­sis occurred: the growth of debt col­lapsed, and took the econ­o­my with it:

Since change in debt is part of aggre­gate demand, the accel­er­a­tion of debt—the rate of change of its rate of change—affects change in aggre­gate demand. This in turn has impacts on the change in employ­ment.

It also impacts on change in asset prices. The rela­tion­ship between accel­er­at­ing debt and ris­ing asset prices is clear even in the very volatile world of the stock mar­ket:

It is unde­ni­able in the prop­er­ty mar­ket:


Since asset mar­ket volatil­i­ty is dri­ven by the accel­er­a­tion of pri­vate debt, the Min­skian solu­tion to insta­bil­i­ty in finance mar­kets is to some­how sev­er the link between debt and asset prices. I put for­ward two ideas.

Jubilee Shares

Cur­rent­ly, shares last for the life of the issu­ing com­pa­ny, and 99% of the trade on the stock mar­ket is in the sec­ondary mar­ket. The Jubilee Shares pro­pos­al would allow shares to last for­ev­er as now when pur­chased on the pri­ma­ry issue mar­ket, but would have them switch to a defined life of (say) 50 years after a lim­it­ed num­ber of sales on the sec­ondary mar­ket (say 7 sales). This would encour­age pri­ma­ry share pur­chas­es, and also make it high­ly unlike­ly that any­one would use bor­row mon­ey to buy Jubilee shares on the sec­ondary mar­ket.

Property Income Limited Leverage

Cur­rent­ly lend­ing to buy prop­er­ty is alleged­ly based on the income of the borrower—which gives bor­row­ers an incen­tive to actu­al­ly want high­er lever­age over time. “The PILL” would lim­it the amount that can be lent to some mul­ti­ple (say 10 times) of the income gen­er­at­ing capac­i­ty of the prop­er­ty itself.

End of Synopsis

There’s much more detail in the paper itself, and when the con­fer­ence is held my talk on it will also be avail­able on the INET web­site.

Attending the conference

The con­fer­ence itself has only 300 invi­tees, and INET had over­whelm­ing demand from stu­dents for the 25 places they reserved for them. Rather than let­ting the over 500 oth­er appli­cants miss out, these oth­er appli­cants can watch the con­fer­ence live from a spe­cial live video broad­cast room at the Adlon Hotel, right next to the con­fer­ence venue itself in Berlin. Click here for details if you’re one of those 563 appli­cants.

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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.