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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  • alain­ton


    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.

  • 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?

  • 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.


  • Dan­ny­b2b


    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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  • RJ

    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.

  • RJ

    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).

  • Dan­ny­b2b

    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.

  • Dan­ny­b2b


    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.

  • 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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