Ptolemaic Economics in the Age of Einstein

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Jetlag has me up and at the keyboard at 5.54am here in London, 43 minutes before sunrise, which today is at 6.37am.

Only it's not "sunrise", is it? As we all know, it's really "Earth Axial Rotate" at the point in its 24 hour axial rotation when the Sun—around which the Earth rotates once each year—becomes visible from London.

Click here for this post in PDF

We still call it "sunrise" because it's a lot less awkward—and a lot more romantic—than saying "Earth Axial Rotate Earth-Sun Radial Alignment", which is what it really is. We all know that it's not really the Sun "rising" at all: that implies that the Earth is fixed while the Sun rotates around it, whereas ever since Copernicus we have known that, though it looks that way to a naïve observer on Earth, that's not what really happens.

However, not merely before Copernicus, but for a very long time after him, many people continued to believe that that was how it really is: that the Sun does rotate around the Earth, that the Earth is not merely fixed, but fixed at the Centre of the Universe, and not merely the Sun but all Celestial bodies rotate around it in perfect spheres.

What broke us from that belief was the empirical failure of the theory which encapsulated it and still made sense—as much as it could—of the anomalies between the predictions of that theory, and actual reality. Claudius Ptolemy's treatise the "Mathematike Syntaxis" (or Mathematical Composition), which became known as the Almagest (meaning "The Great Treatise"), was published in about 150 BC, and it provided a plausible model for earth-centric beliefs about the nature of the Universe that dated back millennia. It held sway not merely until Copernicus wrote his De revolutionibus orbium coelestium in 1543, but for many decades after, as not only the Church but also incensed Ptolemaic astronomers fought to suppress the new, more accurate, but to them heretical and false model of the Universe.

Why the brief discourse on Astronomy? Because reading what Paul Krugman is saying about banking feels like reading a Ptolemaic Astronomer describing sunrise today as if that's actually what's happening. He is dismissive of the view that banks can "create credit out of thin air"—so dismissive in fact, that anyone unacquainted with the empirical evidence might be fooled into believing that his case is so strongly supported by the facts that it's not even worth the bother of citing the empirical data that backs it up.

That is so NOT the case: the empirical evidence overwhelmingly supports the case Krugman is trying to dismiss out of hand, that banks can and do "create credit out of thin air", with the supposed regulatory controls over their capacity to do so being largely ineffective.

Figure 1: Krugman's 3rd post on banking and money creation

In fact the evidence is so strongly in favour of the case that Krugman blithely dismisses that it's difficult to decide where to begin in refuting his Ptolemaic fantasies to the contrary. I'll lead with his "gotcha!" argument in this post, but before that I'll return to the Ptolemaic Astronomy-Neoclassical Economics analogy—because it's quite a strong one that deserves further elucidation.

Ptolemy and Walras—Brothers in Arcs

The Geocentric models of the universe, of which Ptolemy's system was a variation, had 3 guiding principles, which Cardall describes as follows:

  1. All motion in the heavens is uniform circular motion.
  2. The objects in the heavens are made from perfect material, and cannot change their intrinsic properties (e.g., their brightness).
  3. The Earth is at the center of the Universe. (Cardall, 2000)

The key problem with this base theory is that it manifestly didn't fit the facts, because of the behaviour of celestial bodies that we now call Planets—which is the ancient Greek word for "wanderers". Far from obeying uniform circular motion, these Wanderers literally did wander all over the sky. We're generally not aware of this today because it's no big deal from our better-informed Heliocentric model of the solar system, but for the ancients it was a big deal. A simulation by David Colarusso indicates how much the apparent behaviour of the Wanderers violated the three core tenets of the Geocentric model.

Ptolemy's contribution was to provide "tweaks" to this core vision, which maintained its overall integrity while fitting it much more closely to the data. He stuck with most of proposition (1) and all of (2), but modified (3) to "The Earth is near the cen­ter of the Uni­verse”. With the Earth slightly off-center, the gen­er­ally ellip­ti­cal motion of The Wan­der­ers could now be explained by what was called The Eccen­tric. But their habit of “ret­ro­grade” motion—the fact that they would occa­sion­ally reverse direc­tion in the night sky—was still an anomaly.

To solve that, Ptolemy added cir­cu­lar motion on cir­cu­lar motion. All celes­tial bod­ies still fol­lowed a great circle—called the Deferent—but the plan­ets also did their own rota­tions on the Def­er­ent on mini-circles called Epicycles.

But even that wasn’t enough, because the plan­ets also appeared to speed up on part of their motion through the heav­ens, and slow down on oth­ers (today we know this is just because some­times they are closer to the earth on their ellip­ti­cal orbits around the earth, and there­fore appear to move more rapidly). So Ptolemy added “Equant” motion: the big “Def­er­ent” cir­cle each planet moved on was divided into seg­ments by lines through a point which was not its cen­ter, and the planet moved through each dif­fer­ently sized slice in the same time—thus speed­ing up in the big slices and slow­ing down in the small ones.

By these tweaks, a par­a­digm which was utterly unlike the real world was actu­ally able to mimic it to a tol­er­a­ble level of accu­racy. But the sys­tem was extremely com­pli­cated, and it took an enor­mous amount of brain power to be a Ptole­maic astronomer. Look­ing back on this once dom­i­nant the­ory, Cardall tellingly observes how the very com­plex­ity of this absolutely false men­tal con­struct helped pre­serve it despite mount­ing evi­dence that it did not describe reality:

That ancient astronomers could con­vince them­selves that this elab­o­rate scheme still cor­re­sponded to “uni­form cir­cu­lar motion” is tes­ta­ment to the power of three ideas that we now know to be com­pletely wrong, but that were so ingrained in the astronomers of an ear­lier age that they were essen­tially never ques­tioned. (Cardall, 2000)

Why am I reminded of Neo­clas­si­cal Eco­nom­ics? Let me count the ways…

Firstly, there are sim­i­lar under­ly­ing prin­ci­ples to the DSGE mod­els that now dom­i­nate Neo­clas­si­cal macro­eco­nom­ics, and as with Ptole­maic Astron­omy, these under­ly­ing prin­ci­ples clearly fail to describe the real world. They are:

  1. All mar­kets are barter sys­tems which are in equi­lib­rium at all times in the absence of exoge­nous shocks—even dur­ing recessions—and after a shock they will rapidly return to equi­lib­rium via instan­ta­neous adjust­ments to rel­a­tive prices;
  2. The pref­er­ences of con­sumers and the tech­nol­ogy employed by firms are the “deep para­me­ters” of the econ­omy, which are unal­tered by any poli­cies set by eco­nomic pol­icy mak­ers; and
  3. Per­fect com­pe­ti­tion is uni­ver­sal, ensur­ing that the equi­lib­rium described in (1) is socially optimal.

If that were actu­ally the real world, then not only would there not be a cri­sis now, there would never have been a Great Depres­sion either—and reces­sions would sim­ply be minor sta­tis­ti­cally unpre­dictable but inevitable events when the major­ity of shocks hit­ting the econ­omy were neg­a­tive, and they would rapidly be resolved by adjust­ments to rel­a­tive prices (wages included, of course).

So econ­o­mists like Krugman—who describe them­selves as “New Keynesians”—have tweaked the base case to derive mod­els that “ape” real-world data, with “sticky” prices rather than per­fectly flex­i­ble ones, “fric­tions” that slow down quan­tity adjust­ments, and imper­fect com­pe­ti­tion to gen­er­ate less-than-optimal social outcomes.

This is Ptole­maic Eco­nom­ics: take a model that is utterly unlike the real world, and which in its pure form can’t pos­si­bly fit real world data, and then add “imper­fec­tions” so that it can appear to do so.

Fig­ure 2: Krugman’s 3rd post on bank­ing and money cre­ation

Walk like a Ptolemain

Krugman’s rejec­tion of the propo­si­tion that banks can cre­ate money—in the sense that “their abil­ity to cre­ate money is not con­strained by the mon­e­tary base” as he puts it in an update—is also a vin­tage Ptole­main manoeu­vre. A sci­en­tific response to this propo­si­tion would be to dis­prove it via empir­i­cal evi­dence. Krug­man instead appeals to his own author­ity, relies on deduc­tive logic—which I’ll return to shortly—and derides those who believe that banks and credit growth mat­ter in macro­eco­nom­ics as “Bank­ing Mystics”.

What Krug­man dis­plays here is not greater insight but blind igno­rance. A recent addi­tion to the over­whelm­ing evi­dence that credit growth is a cru­cial fac­tor in macro­eco­nom­ics is an empir­i­cal paper by those well-known bas­tions of Bank­ing Mys­ti­cism, the National Bureau of Eco­nomic Research and the Fed­eral Reserve Bank of San Fran­cisco. The paper analy­ses 200 reces­sions in 14 coun­tries over 140 years, and sum­marises its results as follows:

This paper stud­ies the role of lever­age in the busi­ness cycle. Based on a study of nearly 200 reces­sion episodes in 14 advanced coun­tries between 1870 and 2008, we doc­u­ment a new styl­ized fact of the mod­ern busi­ness cycle: more credit-intensive booms tend to be fol­lowed by deeper reces­sions and slower recov­er­ies. We find a close rela­tion­ship between the rate of credit growth rel­a­tive to GDP in the expan­sion phase and the sever­ity of the sub­se­quent reces­sion. We use local pro­jec­tion meth­ods to study how lever­age impacts the behav­ior of key macro­eco­nomic vari­ables such as invest­ment, end­ing, inter­est rates, and infla­tion. The effects of lever­age are par­tic­u­larly pro­nounced in reces­sions that coin­cide with finan­cial crises, but are also dis­tinctly present in nor­mal cycles. The styl­ized facts we uncover lend sup­port to the idea that finan­cial fac­tors play an impor­tant role in the mod­ern busi­ness cycle. (Oscar Jorda et al., 2011a, Oscar Jorda et al., 2011b)

That emphat­i­cally decides the key empir­i­cal dispute—whether the level and rate of growth of aggre­gate pri­vate debt has macro­eco­nomic effects—in favour of the case I put.

Unre­served Lending

There is also a wealth of stud­ies to sup­port the con­tention that reserves don’t con­strain lending—that if any­thing, the causal link runs from lend­ing to reserves, and not the other way around. I referred to some of these in my last blog post, so I won’t repeat that issue here. Instead I’ll take up Paul’s “gotcha” argu­ment to the contrary:

Yes, a loan nor­mally gets deposited in another bank — but the recip­i­ent of the loan can and some­times does quickly with­draw the funds, not as a check, but in cur­rency. And cur­rency is in lim­ited sup­ply — with the limit set by Fed deci­sions. So there is in fact no auto­matic process by which an increase in bank loans pro­duces a suf­fi­cient rise in deposits to back those loans, and a key lim­it­ing fac­tor in the size of bank bal­ance sheets is the amount of mon­e­tary base the Fed cre­ates — even if banks hold no reserves.

Sigh. The level of cur­rency retrains lend­ing? So banks stop lend­ing as they approach the lim­its to cur­rency set by the Fed’s print­ing of notes?

I can’t improve on the com­ments of Neil Wil­son on Krugman’s argu­ment here:

Krug­man needs to start attend­ing the real world. The lat­est argu­ment is utter tosh. For there to be a con­straint in the real world, you have to have the actual power to stop another entity from doing something.

What Krug­man is sug­gest­ing is that the Fed has the power to limit the amount of cur­rency in issue. In other words he’s sug­gest that to con­trol the econ­omy the ATMs will be left to run dry and you will be told ‘no’ when you go and try and draw cash at the bank counter.

Sweep­stake on how many attosec­onds it would take to cause gen­eral pan­de­mo­nium if that every hap­pened. Here in the UK there has been a sug­ges­tion that the fuel pumps might be short of fuel if the tanker dri­vers did decide to go on strike. It has caused com­plete chaos even though noth­ing is dif­fer­ent this week­end than last. Krug­man is beyond grasp­ing at straws now.

And even if the Fed could do that—even if it did attempt to con­trol bank lend­ing by manip­u­lat­ing reserves (some­thing it gave up on doing about 30 years ago)—there are two fac­tors needed to make manip­u­lat­ing reserves a con­trol mech­a­nism over bank lending:

  1. Reserves them­selves; and
  2. A man­dated ratio between deposits at banks and reserves

Paul doesn’t seem to have caught up with the fact that this man­dated ratio no longer exists, for all prac­ti­cal pur­poses, in the USA and much of the rest of the OECD. Six coun­tries have no reserve require­ments what­so­ever; the USA still has one, but for house­hold deposits only. Fig­ure 3 shows the actual rules for reserves in the USA—taken from an OECD paper in 2007 (Yueh-Yun June C. O’Brien, 2007). The reserve ratio of 10% only applies to house­hold deposits; cor­po­rate deposits have no reserve require­ment. And the reserves are required with a 30 day lag after lend­ing has occurred—by which time the deposits cre­ated by the lend­ing are per­co­lat­ing through the bank­ing system.


Fig­ure 3: USA Reserve Require­ments

This, and the bank­ing cri­sis we are now in, finally inspired the Fed­eral Reserve’s research depart­ment to con­clude that, effec­tively, the “money mul­ti­plier” doesn’t exist. Car­pen­ter and Demi­ralp note that today reserve require­ments “are assessed on only about one-tenth of M2″, and con­clude that

the nar­row, text­book money mul­ti­plier does not appear to be a use­ful means of assess­ing the impli­ca­tions of mon­e­tary pol­icy for future money growth or bank lend­ing. (Seth B. Car­pen­ter and Selva Demi­ralp, 2010, p. 29)

So Paul’s “gotcha” lacks at least one of the blades needed to make it work—and if he cares to con­sult the exten­sive aca­d­e­mic lit­er­a­ture on the role of reserves post the failed Mon­e­tarist exper­i­ment of the 1970s, he will see that the other blade doesn’t exist either: Cen­tral Banks now sup­ply what­ever level of reserves is needed to main­tain their short-run inter­est rate target.

Who’s the Mys­tic then?

Krugman’s claim that those who argue banks play an essen­tial role in macro­eco­nom­ics are “Bank­ing Mys­tics” has a nat­ural riposte: Neo­clas­si­cal econ­o­mists like Krug­man who believe that cap­i­tal­ism can be mod­elled with­out either money or banks are Barter Mys­tics (David Grae­ber, 2011). How on earth can some­one believe that the man­i­fest real­ity that trans­ac­tions involve money being exchanged for goods can be ignored, and pre­tend instead that goods are exchanged for goods? How on earth can the insti­tu­tional real­ity of banks be ignored by those who claim to be macroeconomists?

How on earth indeed. It’s because they’re still liv­ing in a pre-Copernican uni­verse, deluded by the imag­ined per­fec­tion of the Spheres.


Cardall. 2000. “The Uni­verse of Aris­to­tle and Ptolemy,”

Car­pen­ter, Seth B. and Selva Demi­ralp. 2010. “Money, Reserves, and the Trans­mis­sion of Mon­e­tary Pol­icy: Does the Money Mul­ti­plier Exist?,” Finance and Eco­nom­ics Dis­cus­sion Series. Wash­ing­ton: Fed­eral Reserve Board,

Grae­ber, David. 2011. Debt: The First 5,000 Years. New York: Melville House.

Jorda, Oscar; Moritz H. P. Schu­lar­ick and Alan M. Tay­lor. 2011a. “When Credit Bites Back: Lever­age, Busi­ness Cycles, and Crises,” National Bureau of Eco­nomic Research, Inc, NBER Work­ing Papers: 17621,

Jorda, Oscar; Moritz Schu­lar­ick and Alan M. Tay­lor. 2011b. “When Credit Bites Back: Lever­age, Busi­ness Cycles, and Crises,” Fed­eral Reserve Bank of San Fran­cisco, Work­ing Paper Series: 2011–27,

O’Brien, Yueh-Yun June C. 2007. “Reserve Require­ment Sys­tems in Oecd Coun­tries.” SSRN eLi­brary.


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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50 Responses to Ptolemaic Economics in the Age of Einstein

  1. alainton says:

    Noooo ive bro­ken the inter­net with bad html code

  2. Derek R says:

    How could you?

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  5. Tom McAlone says:

    The Jorda et all paper seems like a big deal in that it con­firms Steve’s con­clu­sions using real cross coun­try data in math­e­mat­i­cal lan­guage that the neo-classical world should respect. While the authors do credit Min­sky directly for iden­ti­fy­ing rela­tion­ship between debt build up and the sever­ity of the fol­low­ing down­turn and other lever­age related impacts, they ignore the role that Steve and other het­ero­dox econ­o­mists played in dri­ving Minsky’s work for­ward even to the point of men­tion­ing the Eggerts­son and Krug­man 2010 paper as serv­ing to have “recently attracted renewed atten­tion” to these rela­tion­ships. What a sad com­men­tary on the state of dia­logue between dif­fer­ent aca­d­e­mic tra­di­tions in eco­nom­ics, but one that points to Steve K being on the money with his Ptolemy analogy.

  6. mahaish says:

    What you call money is just a lia­bil­ity with a large sphere of influ­ence – but ulti­mately you hand it back to the issuer to set­tle a debt.”


    and i think its bet­ter to dis­cuss in terms of finan­cial assetts and liabilities,

    rather than money.

    the term money con­fuses things

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  8. Bhaskara II says:

    Eco­nom­ics is dynamic. No pro­fes­sor would dis­agree. But what is pre­dom­i­nantly presented?

    ?Dynamic sto­chas­tic gen­eral equi­lib­rium?” is a con­tra­dic­tion in terms.
    Mod­el­ing some thing as if it was gen­er­ally in equi­lib­rium is not dynamic mod­el­ing. Every time you look at time series data the dynam­ics are cry­ing out to you! I’m dynamic!

    How can any one turn to their stu­dents and say, I, assume equi­lib­rium? They actu­ally say it, “We assume equi­lib­rium”, or just “Assum­ing equi­lib­rium …”, as if it was a fact. Why don’t they say, “I assume…”?

    Our expe­ri­ence and his­tory of eco­nom­ics is pre­dom­i­nantly dynamic, i.e. busi­ness cycles, infla­tion, employ­ment, bank­rupt­cies, rob­ber bar­rens, ris­ing indus­tries, and ris­ing companies.

    The assump­tion of equi­lib­rium in eco­nom­ics is obvi­ously a pre­sump­tu­ous, far­ci­cal, and igno­rant assumption.

    Cycles and expo­nen­tial growth (infla­tion), such as in an inter­est bar­ing sav­ings account, can­not be described or mod­eled as math­e­mat­i­cal equi­lib­rium. They are dynamic.

    In other fields dynam­ics are han­dled well. If not you would never fly in a plane or ride and ele­va­tor safely. Teach­ing and pre­sent­ing eco­nom­ics pre­do­mently this way is deceitful.

    Other fields know how to math­e­mat­i­cally describe and model dynam­ics. Dynamic things change over time. In the lan­guage of math, dynamic things expressed as func­tions of time, f(time,x,y,z), or in des­e­crate time, but usu­ally in con­tin­uos time. Data is usu­ally mea­sured in dis­crete time. Data mea­sured at a high enough fre­quency is close to con­tin­uos time.

    Dynamic laws are usu­ally described as rela­tions of rates of change, stated as equa­tions con­tain­ing deriv­a­tives of time. Most solu­tions of those rates of change equa­tions are aggre­gates those rates over time of change using sums, inte­grals, or “inte­grat­ing” dif­fer­en­tial equations.

    Specif­i­cally, in dynam­ics if the sec­ond time deriv­a­tive is not zero you have a dynamic sit­u­a­tion. That means any­thing involv­ing a net force or accel­er­a­tion is dynamic. The earth going around the sun is dynamic.

    Dynamic math­e­mat­i­cal descrip­tions or mod­els are impos­si­ble if every thing is mod­eled as con­stant in time. Things mod­eled in con­stant time have no time vari­able in the expres­sions. If time never shows up in the math expres­sion you are not describ­ing or mod­el­ing dynamically.

    The math of con­tin­u­ous dynam­ics is cal­cu­lus, (the math of curves) and dif­fer­en­tial equa­tions. Dynam­ics of more than one thing is a sys­tem, often mod­eled as mul­ti­ple equa­tions with shared variables.

    Dynamic equa­tions always have the vari­able time in them. Sim­ple as that. The data does doesn’t it?

  9. Bhaskara II says:

    Apt Note:

  10. Lyonwiss says:

    @ mahaish April 3, 2012 at 1:21 pm

    How could there be a ratio­nal dis­cus­sion, if what you mean by money is dif­fer­ent from what I mean by money? This lack of rig­or­our is symp­to­matic of much of the eco­nomic pro­fes­sion, lead­ing to lit­tle progress even in a com­mon under­stand­ing of the basics. The evi­dence of this bab­ble of Babel fills the cyber space.

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  13. seanbroseley says:

    Did I read Krug­man cor­rectly that he thinks peo­ple takes the pro­ceeds of loans advanced to them as phys­i­cal cash before they spend it? Or least that this is done to an extent that is eco­nom­i­cally significant?

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