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.

Click here for this post in PDF

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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174 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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