Krugman on (or maybe off) Keen

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Paul Krugman has just commented (twice) on my most recent blog about my paper for INET. In one sense, I’m delighted. The Neoclassical Establishment (yes Paul, you’re part of the Establishment) has ignored non-Neoclassical researchers like me for decades, so it’s good to see engagement rather than wilful (or more probably blind) ignorance of alternative approaches.

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Figure 1: Krugman’s first piece

There is a bizarre asymmetry in economics: critics of Neoclassical economics like myself read Neoclassical literature avidly, no because we agree with it—far from it—but because we feel obliged to understand why they hold to their counterfactual views on the economy.

Most Neoclassical economists, on the other hand, don’t even bother to consider critics within their own ranks—let alone critics from without. So to have a paper referred to is definitely a plus.

In another sense, I’m appalled, because Krugman’s comments put on display that very ignorance of Neoclassical literature—let alone of alternative economic thought.

For instance, Paul refers to many of the propositions in my blog (it’s clear that he hadn’t read the paper on which it is based) as “assertions about what is crucial, without much explanation of why these things are crucial.”

One of these “assertions” is the key role of the change in debt—rather than saving out of current income—in financing investment.

Well Paul, in that paper you will find references to the extensive theoretical and empirical literature from which that assertion was derived. I could start with non-Neoclassical authors like Schumpeter, but let’s lead with someone from within The Citadel (as Alan Kirman once called the Neoclassical orthodoxy: Alan Kirman, 1989, p. 126): Eugene Fama. The “assertion” that the change in debt was the main source of funding for investment was confirmed by Fama and French in a pair of empirical papers:

The source of financing most correlated with investment is long term debt. The correlation between I and dLTD is 0.79… These correlations confirm the impression … that debt plays a key role in accommodating year-by-year variation in investment.” (Eugene F. Fama and Kenneth R. French, 1999, p. 1954)

“Debt seems to be the residual variable in financing decisions. Investment increases debt, and higher earnings tend to reduce debt.” (in an unpublished draft of the same paper).

Or consider Alan Holmes’s crucial paper in 1969, in which he fought an unsuccessful campaign against the later experiment in Monetarism (far from being a “strict Monetarist”, as Paul jibes at one point, I and my Post-Keynesian colleagues and forebears take money seriously while simultaneously being trenchant critics of Friedman’s simplistic Monetarism—see for example Nicholas Kaldor, 1982). Holmes, then Senior Vice-President of the New York Federal Reserve, noted that the key Monetarist policy prescription of regulating the economy by “a regular injection of reserves” was based on “a naïve assumption” about the nature of the money creation process:

The idea of a regular injection of reserves—in some approaches at least—also suffers from a naïve assumption that the banking system only expands loans after the System (or market factors) have put reserves in the banking system. In the real world, banks extend credit, creating deposits in the process, and look for the reserves later. (Alan R. Holmes, 1969, p. 73)

Holmes would turn in his grave at Krugman’s naïve assertion, half a century later, that banks need deposits before they can lend:

If I decide to cut back on my spending and stash the funds in a bank, which lends them out to someone else, this doesn’t have to represent a net increase in demand. (Paul Krugman, 2012)

As Randy Wray observed, that is “the description of a loan shark, not a bank”—or of a hypothetical world in which banks need deposits before they can lend. In the real world, as Holmes points out above, bank lending creates deposits. That’s why banks matter in macroeconomics, and it’s not “Banking Mysticism” to point this out: it is “Banking Armchair Theorism” to ignore them in macroeconomics.

Neoclassical economists have ignored this point for decades, which is why you have to look to the non-Neoclassical literature to truly understand money creation and the crucial role of banks. Schumpeter put it clearly during the last Depression: he described the view that Krugman puts today, that investment (which is what the most important class of borrowers do) is financed by savings, as “not obviously absurd”, but clearly secondary to the main way that investment was financed, by the “creation of purchasing power by banks … out of nothing“. This is not “Banking Mysticism”: this is double-entry bookkeeping:

Even though the conventional answer to our question is not obviously absurd, yet there is another method of obtaining money for this purpose, which … does not presuppose the existence of accumulated results of previous development, and hence may be considered as the only one which is available in strict logic. This method of obtaining money is the creation of purchasing power by banks… It is always a question, not of transforming purchasing power which already exists in someone’s possession, but of the creation of new purchasing power out of nothing. (Joseph Alois Schumpeter, 1934, p. 73)

Figure 2: Krugman’s second piece

Why does it matter that “once you include banks, lending increases the money supply”? Simply, because the endogenous increase in the stock of money caused by the banking sector creating new money is a far larger determinant of changes in aggregate demand than changes in the velocity of an unchanging stock of money. And in reverse, the reduction in demand caused by borrowers repaying debt rather than spending is the cause of the downturn we are now in—and of the Great Depression too.

Figure 3 shows the ratios of private and public debt to GDP in America from 1920 till now. Non-neoclassical economists like myself, Michael Hudson, Ann Pettifor, the late Wynne Godley, Randy Wray and many others (see Dirk J Bezemer, 2009, and Edward Fullbrook, 2010 for fuller lists of those who warned of this crisis before it happened–including of course Nouriel Roubini, Dean Baker, Robert Shiller, and Peter Schiff) were shouting that the post-1993 explosion in private debt was unsustainable, and would necessarily lead to a crisis when its rate of growth slowed (let alone turned negative), for years before the crisis began (my first academic warning of the dangers of rising private debt is shown as SK1, and my first public warning that a crisis was imminent is shown as SK2 on Figure 3). We were ignored, in large part because only Neoclassical economists like Krugman, Bernanke and Greenspan had the ear of the public and politicians.

Now the crisis is the defining economic event of our times, and years after it began, the only period to which the recent boom and bust in the private debt to GDP ratio can be compared is the Great Depression.

Figure 3: Aggregate Private and Public Debt

Yet Neoclassical economists like Krugman continue to assert that the aggregate level of private debt, and changes in that level, are macroeconomically irrelevant, when even casual empiricism implies that changes in the aggregate level of private debt are associated with Depressions.

So while I welcome any Neoclassical economist at the forthcoming INET conference taking up Krugman’s call (“I hope someone in Berlin presses Keen on all this”), in reality Paul, empirically oriented non-Neoclassical economists like myself are the ones challenging the unsupported assertions of Neoclassical economics—not the other way round.

Bezemer, Dirk J. 2009. “”No One Saw This Coming”: Understanding Financial Crisis through Accounting Models,” Groningen, The Netherlands: Faculty of Economics University of Groningen,

Fama, Eugene F. and Kenneth R. French. 1999. “The Corporate Cost of Capital and the Return on Corporate Investment.” Journal of Finance, 54(6), 1939-67.

Fullbrook, Edward. 2010. “Keen, Roubini and Baker Win Revere Award for Economics,” E. Fullbrook, Real World Economics Review Blog. New York: Real World Economics Review,

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

Kaldor, Nicholas. 1982. The Scourge of Monetarism. Oxford: Oxford University Press.

Kirman, Alan. 1989. “The Intrinsic Limits of Modern Economic Theory: The Emperor Has No Clothes.” Economic Journal, 99(395), 126-39.

Krugman, Paul. 2012. “Minsky and Methodology (Wonkish),” The Conscience of a Liberal. New York: New York Times,

Schumpeter, Joseph Alois. 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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176 Responses to Krugman on (or maybe off) Keen

  1. alainton says:


    But why ever would any government rationally want to do that at a time of positive inflation and higher positive growth. In such periods inflation will erode debt so it makes sense to issue bonds – because it is CHEAPER.

    Surely this is the first principle of functional finance?

    I just cant see how MMT is compatible with functional finance on this point, not because the economics are wrong (at least on the sectoral balances issue) but because some of the policy measures are misconceived.

  2. joebhed says:

    To RJ at 1:58

    “People will not provide say labour or goods for a bond asset or bits of paper (called money) that has nothing whatsoever backing it.”

    There’s no bond asset – that involves a debt.
    What gives any ‘state-money’ issuance ‘value’, as you call it, is that it is issued in excahnge for a good or service that is provided to the government.
    Whomsoever provides the service has received payment from the government for the good or service provided.

    What backs the currency is the national economy.

    The money issued debt-free is serving as a means of exchange at issuance. When it is deposited in a bank account, it becomes an asset of the account holder and a liability of the bank.

    This being issuance of NEW money, it enters circulation – as circulating media – in accordance with that which DOES give money all value – it is not issued in excess of what is needed.

    I cited the 1939 Program for Monetary Reform.
    Shall I list Dr. Fisher’s co-authors?
    None of them is without an Academic Chair today.
    And 400 economists PUBLICLY supported the debt-free public money system proposal of the 1939 Program.

    What do you know that they did not?

  3. joebhed says:

    To Barry Thompson at 4:59

    It is true that ‘money’ can be created by monetizing a bond issuance – but it is totally unnecessary.
    The proposal of Congressman Kucinich provides – as did the 1939 Program – that the monetary authority determine the amount of new money needed and that this amount become the substitute for a bond issuance as part of the ‘revenue’ of the government.

    Budget is comprised of expenses on one side and taxation plus new money on the other side.

    Sorry to say that the real solution is NOT to provide ‘reserves’ to the system.

    Reserves are part of what Soddy called the ‘confidence trick’ of debt-based money.

    The future lies with non-reserve money systems.


  4. Dannyb2b says:


    The monetary authority can be structured similar to the central bank of today. It can be independant with a mandate relating to inflation. In a 21st century context we can have a system were all adult members of the public have acounts with the cb. No need for collateral like gov bonds to conduct policy. No outside lag when conducting policy with the general public because the effect will be instant. No transmission channel depending on private banks to create new loans.

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  7. RJ says:

    “The money issued debt-free is serving as a means of exchange at issuance. When it is deposited in a bank account, it becomes an asset of the account holder and a liability of the bank.”

    A liability = debt

    Its the banks debt. So it is not debt free.

    Don’t always trust so called authority figures. Sometimes they are misinformed or badly confused. Regardless of their titles. Even time can have an impact on a once sharp mind.

    Instead always use common sense. Would you hold something as an ASSET that is not backed by anything at all

    Of course not (hopefully). And what about notes and coins. Would they have any value if the Govt stopped accepting them in exchange for tax or bonds. Or if a Govt collapsed and the new Govt completely walked away from the old currency.

  8. RJ says:

    “Reserves are part of what Soddy called the ‘confidence trick’ of debt-based money.”

    Complete and utter nonsense. Reserves are what the Govt uses to pay their expenses through the central bank (via commercial banks).

    Reserves are the peoples freedom from financiers and banks. The people via the Govt can purchase goods and services in exchange for interest free or low interest reserves created from thin air (by journal entry).

    TAKE AWAY RESERVES (as Euro countries have done) and Govts must get their money from the markets (or banks) first. It will destroy these countries until a few super rich own everything.

    Whose side are you really on. (or the people you trust without you thinking it through).

  9. Dannyb2b says:

    A liability = debt
    “Its the banks debt. So it is not debt free.”

    Money shouldnt be created as a debt. After that if you lend money to a bank it becomes a debt. Thats fine.

  10. Dannyb2b says:


    The government doesnt need reserves for anything. Maybe your definition is different. The government needs money to pay for its expenditures which it can deposit with the central bank (maybe you call any money deposited with CB reserves).

    It seems to me as if you believe the current monetary arrangement is something fixed that cant be modified or improved. Maybe we just dont understand each other.

  11. joebhed says:

    To RJ at 4:57

    There is no problem that the money that is issued debt-free into the economy via government expenditure, where it becomes the permanent means of exchange for a growing economy, also BECOMES a liability or an asset or other D-E-B accounting entry. That’s how we COUNT it.

    The problem of the modern monetary economy today is the debt-saturated inability of ANY of the economies to generate aggregate demand, and in a debt-based money system, that aggregate demand cannot manifest without the issuance of more debt.

    As I said, the ‘backing’ of any properly issued national money is the national economy. It is the proper issuance that gives it national money value that remains stable.

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