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.

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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  • alain­ton


    From How to Win at Monop­oly (and this is a seri­ous point)

    Debt can be either good or bad. As a fuel to buy­ing more prop­er­ties, early in the game, it is a good thing. But later in the game when rents begin to sky-rocket it becomes the road to ruin. 

    Very Homer Hoyt — for me he is just as impor­tant as Min­sky in explain­ing credit cycles because he is more spe­cific on land as a fac­tor

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  • Black­Box

    I apol­o­gize if this has been explained before, but I am hav­ing trou­ble under­stand­ing the NAT term in equa­tion 1.1. Shouldn’t there be a match­ing term on the left (income) side because the sale of an exist­ing asset pro­vides an income to the seller which bal­ances the expen­di­ture by the pur­chaser?

    If there is no such off­set, then the turnover in the stock­mar­ket alone would pro­duce a term of the same order as the GDP, leav­ing the equa­tion seri­ously unbal­anced.

  • It says “Net” Black­Box for that rea­son; but it might be more accu­rate to actu­ally include asset sales on the left hand side as a source of mon­e­tary demand; but even that is prob­lem­atic when you have sales by one spec­u­la­tor to another–that is truly an exchange that alters the own­er­ship of $ with­out chang­ing the gross level of mon­e­tary demand.

  • Black­Box

    Thank you Steve — I thought that might be what “Net” meant, but I still have a prob­lem under­stand­ing why the net amount is not zero. (For most trans­ac­tions there are fees and com­mis­sions, of course, but those should already be included in GDP as finan­cial ser­vices.)

    Asset prices are crit­i­cal in another way, I sup­pose, because much inflated debt is only pos­si­ble when inflated assets are used as col­lat­eral.