INET Presentation: Minskian Perspective on Instability in Financial Markets

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Below is the video of my talk at INET's Berlin 2012 conference. The other videos for the conference are available from INET's website: Day 1; Day 2; Day 3.

Bearing in mind that I didn't see all presentations,  my favourite talks (in delivery order) were those by: George Soros; Gerd GigerenzerAxel Leijonhufvud; Michael HudsonYanis Varoufakis; Dirk Bezemer; and Moritz Schularick.

 INET will publish this paper on their website in due course. Click here for the Powerpoint file;
Click here for the data: Debtwatch members; (CfESI members link to come in Sydney morning)


In the seemingly never-ending aftermath to the economic crisis that began in 2007, there is little disagreement that financial markets are characterized by instability rather than stability. Even Eugene Fama, the most influential proponent of the Capital Assets Pricing Model (CAPM; Fama 1970), now acknowledges that CAPM is strongly contradicted by the data:

The attraction of the CAPM is that it offers powerful and intuitively pleasing predictions about how to measure risk and the relation between expected return and risk. Unfortunately, the empirical record of the model is poor—poor enough to invalidate the way it is used in applications… whether the model's problems reflect weaknesses in the theory or in its empirical implementation, the failure of the CAPM in empirical tests implies that most applications of the model are invalid. (Fama and French 2004, p. 25)

CAPM's empirical demise as a theory of finance has been accompanied by the rise of behavioural finance, which attributes much of the instability of finance markets to the limited and heuristically oriented cognitive capacities of actual traders (Kahneman and Tversky 1979; Kahneman 2003). While this is clearly an important aspect of instability, I will take a different tack and situate my explanation in the integrated macro-financial vision of Hyman Minsky's Financial Instability Hypothesis (FIH). Previous papers have applied Minsky's vision to macroeconomics (Keen 1995; Keen 1997; Keen 2000; Keen 2011); in this paper I will focus on the implications of Minsky's analysis for the behaviour of financial markets.

A lengthy prelude is necessary before I consider Minsky's analysis of financial markets, since past experience has shown that a neoclassical perspective on economics (which the vast majority of policy makers have, as well as most economists) obstructs comprehension of the link Minsky postulates between debt and asset prices.

A Primer on Minsky

Minsky enjoyed a strong following amongst Post Keynesian economists, but he was almost completely ignored by neoclassical economists before the crisis. Bernanke's treatment of him is not atypical:

Hyman Minsky (1977) and Charles Kindleberger (1978) have in several places argued for the inherent instability of the financial system but in doing so have had to depart from the assumption of rational economic behaviour… [A footnote adds] I do not deny the possible importance of irrationality in economic life; however it seems that the best research strategy is to push the rationality postulate as far as it will go. (Bernanke 2000, p. 43)

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. This reaction is based not merely on Minsky's explicit denial that his hypothesis could be modelled from a neoclassical perspective (Minsky 1982 , p. 5), but on ways in which it is strictly incompatible with New Keynesian methodology. There are many facets to this, but I will focus on two that are crucial to the link between the FIH and financial market instability: disequilibrium and endogenous money.


Minsky precursors Schumpeter and Fisher accepted that capitalism was always in disequilibrium. Schumpeter saw instability as intrinsic to capitalism, and regarded it as not a flaw, but as the source of capitalism's vitality (Schumpeter 1928). Fisher, as an apostate from neoclassical equilibrium modelling after the Great Depression ruined him, put the necessity for disequilibrium modelling very clearly—even for those who believe that capitalism is fundamentally stable. Fisher argued that, even if a tendency towards equilibrium is assumed, as a matter of fact, all economic variables will be in disequilibrium at all times in the real economy. Economics theory therefore must be disequilibrium in nature:

'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; emphasis added)

Minsky went further than Schumpeter and Fisher to argue that equilibrium itself was inherently unstable, and contained the seeds of disaster as well as of bounty. Because stability was the exception rather than the norm in a capitalist economy, any period of stability will have been preceded by a more turbulent time; and because the future was uncertain, a period of tranquillity would lead to capitalists revising their expectations upwards:

Stable growth is inconsistent with the manner in which investment is determined in an economy in which debt-financed ownership of capital assets exists, and the extent to which such debt financing can be carried is market determined. It follows that the fundamental instability of a capitalist economy is upward. The tendency to transform doing well into a speculative investment boom is the basic instability in a capitalist economy. (Minsky 1982, p. 67)

Minsky's classic phrase that "Stability … is destabilizing" (Minsky 1982, p. 101) encapsulates his cyclical vision of capitalism. Any attempt to shoehorn this into the comparative static, shifting equilibrium methodology of New Keynesian macroeconomics is certain to caricature his analysis rather than do it justice.

Endogenous Money

Banks play a crucial role in Minsky's analysis because they can endogenously expand the money supply in response to entrepreneurial or Ponzi Finance demands for funds. This emphasis upon the crucial role of banks can be traced back to Minsky's PhD advisor Schumpeter, who argued that investment is not financed by savings, but by the endogenous expansion of the money supply by banks:

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. (Schumpeter 1934, p. 73)

Schumpeter thus saw investment as being primarily financed not out of income, but out of the increase in the money supply caused by banks issuing loans to entrepreneurs—where this increase in the money supply was exactly matched by and caused by an increase in debt.

Schumpeter's entirely theoretical arguments on both the nature of banking and the ultimate source of finance for investment received subsequent support from empirical researchers. Basil Moore (Moore 1979; Minsky, Nell et al. 1991) overturned the "money multiplier" model of money creation with empirical research which showed that bank lending preceded reserve creation (see also Holmes 1969; Carpenter and Demiralp 2010). Fama and French concluded that correlations they found between investment and the change in corporate debt levels "confirm the impression that debt plays a key role in accommodating year-by-year variation in investment." (Fama and French 1999, p. 1954)

However, rising debt does not only finance investment: it also finances speculation. Enter Minsky, who extended Schumpeter by considering the demands of Ponzi Financiers as well. These borrowers do not invest, but buy existing assets and hope to profit by selling those assets on a rising market. Therefore, unlike Schumpeter's entrepreneurs, whose debts today can be serviced and repaid from profits tomorrow, Ponzi Financiers always have debt servicing costs that exceed the cash flows from the assets they purchased with borrowed money. They therefore must expand their debts or sell assets to continue functioning:

A Ponzi finance unit is a speculative financing unit for which the income component of the near term cash flows falls short of the near term interest payments on debt so that for some time in the future the outstanding debt will grow due to interest on existing debt… Ponzi units can fulfil their payment commitments on debts only by borrowing (or disposing of assets)… a Ponzi unit must increase its outstanding debts. (Minsky 1982, p. 24)

Schumpeter and Minsky both saw credit money created by the banking system as the source of the aggregate demand in excess of income. Minsky put this explicitly:

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; emphasis added)

This endogenous money perspective thus transcends Walras' Law, which plays such a key role in Neoclassical equilibrium modelling but is valid only in an economy without banks. In a credit economy, a dynamic disequilibrium "Walras-Schumpeter-Minsky's Law" applies instead: 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

The endogenous creation of money by banks means that the level and rate of change of private debt play crucial roles in Minsky's macroeconomics. In contrast, neoclassical theory treats banks as mere intermediaries between savers and borrowers, formally ignores them in DSGE modelling, and treats the level and rate of change of private debt as macroeconomically unimportant. Before the crisis, Bernanke dismissed Fisher's debt-deflation explanation for the Great Depression:

because of the counterargument that debt-deflation represented no more than a redistribution from one group (debtors) to another (creditors). Absent implausibly large differences in marginal spending propensities among the groups, it was suggested, pure redistributions should have no significant macro-economic effects. (Bernanke 2000, p. 24)

Even after the crisis, when private debt had to be acknowledged as a factor, neoclassical modellers insisted that the aggregate level of debt was unimportant—only its distribution could matter:

Ignoring the foreign component, or looking at the world as a whole, the overall level of debt makes no difference to aggregate net worth -- one person's liability is another person's asset…

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)

Krugman reasserted this analysis in a recent blog, arguing that the level of debt doesn't matter, because debt is "money we owe to ourselves":

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)

The flaw in this neo­clas­si­cal approach to debt and bank­ing is eas­ily illus­trated using book­keep­ing tables. In the fol­low­ing two tables, trans­ac­tions are shown from the bank’s point of view, so that cred­it­ing an account by an increase in deposits is shown as a neg­a­tive (since deposits are a lia­bil­ity for the bank) and deb­it­ing an account by an increase in debt is shown as a pos­i­tive (since loans are an asset). The neo­clas­si­cal vision of sav­ing as mod­elled by Krug­man (after insert­ing an implicit bank­ing sec­tor into Krugman’s bank-less model) is shown in Table 1. From this per­spec­tive, lend­ing makes no dif­fer­ence to the level of aggre­gate demand (unless the impa­tient agent has a markedly higher propen­sity to spend) because lend­ing does not change the amount of money in circulation—it only alters its distribution.

Table 1: Neo­clas­si­cal per­spec­tive on lending

Assets Deposits (Lia­bil­i­ties)
Action/Actor Patient Impa­tient
Make Loan +Lend –Lend


The endoge­nous money vision is shown in Table 2. From this per­spec­tive, lend­ing increases the amount of money in cir­cu­la­tion, and adds to the spend­ing power of the “Impa­tient agent” (in prac­tice, nor­mally either an investor or a Ponzi spec­u­la­tor) with­out sub­tract­ing from the spend­ing power of the “Patient agent”. Aggre­gate demand there­fore rises by the increase in debt.

Table 2: Endoge­nous money per­spec­tive on lending

Bank Assets Bank Deposits (Liabilities)
Action/Actor Patient Impa­tient
Make Loan +Lend –Lend


Table 2 is not only more faith­ful to Minsky’s vision: it is also more real­is­tic. Real world lend­ing is not a trans­fer of money from one depositor’s account to another’s, but a con­tract between a bank and a bor­rower in which the bank cred­its the borrower’s account (thus increas­ing the bank’s lia­bil­i­ties) in return for the bor­rower agree­ing to be in debt to the bank for the same amount (thus increas­ing the bank’s assets). This increases the aggre­gate amount of money in cir­cu­la­tion, increas­ing aggre­gate demand in the process—and pre­dom­i­nantly financ­ing invest­ment or spec­u­la­tion rather than con­sump­tion. Con­trary to neo­clas­si­cal a pri­ori logic, the level of pri­vate debt has seri­ous macro­eco­nomic effects, and plays a dom­i­nant role in set­ting asset prices.

The pri­mary focus of this paper is the lat­ter, but given the extent to which macro­eco­nom­ics and finance are inter­twined in Minsky’s work, I would be remiss not to cover his inte­grated vision of finan­cial macro­eco­nom­ics. The next sec­tion is an abridged extract from Keen (1995).

Min­sky on Debt-driven booms and busts

Minsky’s analy­sis of a finan­cial cycle begins at a time when the econ­omy is doing well, but firms are con­ser­v­a­tive in their port­fo­lio man­age­ment, and this con­ser­vatism is shared by banks. The cause of this high and uni­ver­sally prac­ticed risk aver­sion is the mem­ory of a not too dis­tant system-wide finan­cial fail­ure, when many invest­ment projects foundered, many firms could not finance their bor­row­ings, and many banks had to write off bad debts. Because of this recent expe­ri­ence, both sides of the bor­row­ing rela­tion­ship pre­fer extremely con­ser­v­a­tive esti­mates of prospec­tive cash flows: their risk pre­mi­ums are very high.

How­ever, the com­bi­na­tion of a grow­ing econ­omy and con­ser­v­a­tively financed invest­ments means that most projects suc­ceed. Two things grad­u­ally become evi­dent to man­agers and bankers: “Exist­ing debts are eas­ily val­i­dated and units that were heav­ily in debt pros­pered: it pays to lever” (Min­sky 1982, p. 65). As a result, both man­agers and bankers come to regard the pre­vi­ously accepted risk pre­mium as exces­sive. Invest­ment projects are eval­u­ated using less con­ser­v­a­tive esti­mates of prospec­tive cash flows, so that with these ris­ing expec­ta­tions go ris­ing invest­ment and asset prices. The gen­eral decline in risk aver­sion thus sets off both growth in invest­ment and expo­nen­tial growth in the price level of assets, which is the foun­da­tion of both the boom and its even­tual collapse.

More exter­nal finance is needed to fund the increased level of invest­ment and the spec­u­la­tive pur­chase of assets, and these exter­nal funds are forth­com­ing because the bank­ing sec­tor shares the increased opti­mism of investors. The accepted debt to equity ratio rises, liq­uid­ity decreases, and the growth of credit accelerates.

This marks the begin­ning of what Min­sky calls “the euphoric econ­omy” (Min­sky 1982, pp. 120–124), where both lenders and bor­row­ers believe that the future is assured, and there­fore that most invest­ments will suc­ceed. Asset prices are reval­ued upward and finan­cial insti­tu­tions now accept lia­bil­ity struc­tures for both them­selves and their cus­tomers “that, in a more sober expec­ta­tional cli­mate, they would have rejected” (Min­sky 1982, p. 123). The liq­uid­ity of firms is simul­ta­ne­ously reduced by the rise in debt to equity ratios, mak­ing firms more sus­cep­ti­ble to increased inter­est rates. The gen­eral decrease in liq­uid­ity and the rise in inter­est paid on highly liq­uid instru­ments trig­gers a market-based increase in the inter­est rate, even with­out any attempt by mon­e­tary author­i­ties to con­trol the boom. How­ever, the increased cost of credit does lit­tle to tem­per the boom, since antic­i­pated yields from spec­u­la­tive invest­ments nor­mally far exceed pre­vail­ing inter­est rates, lead­ing to a decline in the elas­tic­ity of demand for credit with respect to inter­est rates.

The con­di­tion of eupho­ria also per­mits the devel­op­ment of an impor­tant actor in Minsky’s drama, the Ponzi financier (Min­sky 1982, pp. 70, 115). These cap­i­tal­ists profit by trad­ing assets on a ris­ing mar­ket, and incur sig­nif­i­cant debt in the process. The ser­vic­ing costs for Ponzi debtors exceed the cash flows of the busi­nesses they own, but the cap­i­tal appre­ci­a­tion they antic­i­pate far exceeds the inter­est bill. They there­fore play an impor­tant role in push­ing up the mar­ket inter­est rate, and an equally impor­tant role in increas­ing the fragility of the sys­tem to a rever­sal in the growth of asset values.

Ris­ing inter­est rates and increas­ing debt to equity ratios even­tu­ally affect the via­bil­ity of many busi­ness activ­i­ties, reduc­ing the inter­est rate cover, turn­ing projects that were orig­i­nally con­ser­v­a­tively funded into spec­u­la­tive ones, and mak­ing ones that were spec­u­la­tive “Ponzi.” Such busi­nesses will find them­selves hav­ing to sell assets to finance their debt servicing—and this entry of new sell­ers into the mar­ket for assets pricks the expo­nen­tial growth of asset prices. With the price boom checked, Ponzi financiers now find them­selves with assets that can no longer be traded at a profit, and lev­els of debt that can­not be ser­viced from the cash flows of the busi­nesses they now con­trol. Banks that financed these assets pur­chases now find that their lead­ing cus­tomers can no longer pay their debts—and this real­iza­tion leads ini­tially to a fur­ther bank-driven increase in inter­est rates. Liq­uid­ity is sud­denly much more highly prized; hold­ers of illiq­uid assets attempt to sell them in return for liq­uid­ity. The asset mar­ket becomes flooded and the eupho­ria becomes a panic, the boom becomes a slump.

As the boom col­lapses, the fun­da­men­tal prob­lem fac­ing the econ­omy is one of exces­sive diver­gence between the debts incurred to pur­chase assets, and the cash flows gen­er­ated by them—with those cash flows depend­ing upon both the level of invest­ment and the rate of inflation.

The level of invest­ment has col­lapsed in the after­math of the boom, leav­ing only two forces that can bring asset prices and cash flows back into har­mony: asset price defla­tion, or cur­rent price infla­tion. This dilemma is the foun­da­tion of Minsky’s icon­o­clas­tic per­cep­tion of the role of infla­tion, and his expla­na­tion for the stagfla­tion of the 1970s and early 1980s.

Min­sky argues that if the rate of infla­tion is high at the time of the cri­sis or the debt level is rel­a­tively low, then though the col­lapse of the boom causes invest­ment to slump and eco­nomic growth to fal­ter, ris­ing cash flows rapidly enable the repay­ment of debt incurred dur­ing the boom. The econ­omy can thus emerge from the cri­sis with dimin­ished growth and high infla­tion, but few bank­rupt­cies and a sus­tained decrease in liq­uid­ity. Thus, though this course involves the twin “bads” of infla­tion and ini­tially low growth, it is a self-correcting mech­a­nism in that a pro­longed slump is avoided.

How­ever, the con­di­tions are soon re-established for the cycle to repeat itself, and the avoid­ance of a true calamity is likely to lead to a sec­u­lar decrease in liq­uid­ity pref­er­ence. A sec­u­lar trend toward ris­ing debt to equity ratios devel­ops, as each new cycle begins before all debt accu­mu­lated in the last cycle had been repaid. Col­lo­qui­ally, firms bor­row dur­ing a boom and repay dur­ing a slump, which gives the debt to income ratio a ten­dency to ratchet up over time, mak­ing the sys­tem more fragile.

If the rate of infla­tion is low at the time of the cri­sis and debt lev­els are very high, then cash flows will remain inad­e­quate rel­a­tive to the debt struc­tures in place. Firms whose inter­est bills exceed their cash flows will be forced to under­take extreme mea­sures: they will have to sell assets, attempt to increase their cash flows (at the expense of their com­peti­tors) by cut­ting their mar­gins, or go bank­rupt. In con­trast to the infla­tion­ary course, all three classes of action tend to fur­ther depress the cur­rent price level, thus at least par­tially exac­er­bat­ing the orig­i­nal imbal­ance. The asset price defla­tion route is, there­fore, not self-correcting but rather self-reinforcing, and is Minsky’s expla­na­tion of a depression.

The above basi­cally describes Minsky’s per­cep­tion of an econ­omy in the absence of a gov­ern­ment sec­tor. With big gov­ern­ment, the pic­ture changes in two ways, because of fis­cal deficits and Reserve Bank inter­ven­tions. The col­lapse in cash flows that occurs when a boom becomes a panic is at least partly ame­lio­rated by a rise in gov­ern­ment spending—the clas­sic “auto­matic sta­bi­liz­ers,” though this time seen in a more mon­e­tary light. (Keen 1995, pp. 611–614)

That’s the the­ory: how well does it stack up against the data? Firstly, the level of pri­vate debt has cer­tainly dis­played the sec­u­lar trend that Min­sky iden­ti­fied (see Fig­ure 1).

Fig­ure 1: Aggre­gate Pri­vate and Pub­lic Debt

Sec­ondly, Minsky’s ver­bal model of the cycle also focused pri­mar­ily on the bor­row­ing behav­iour of the non-financial busi­ness sec­tor, and here the cycli­cal­ity he pre­dicted is also obvi­ous. But over­laid on top of it is an expo­nen­tial rise in finance sec­tor debt, as Ponzi Finance became the dis­eased back­bone of the US economy.

Fig­ure 2: Pri­vate Debt by Sec­tor

Finally, the Min­skian dynam­ics of debt also explain what neo­clas­si­cal analy­sis will always find per­plex­ing: the sud­den tran­si­tion from The Great Mod­er­a­tion to The Great Con­trac­tion (Rogoff 2011).

Apply­ing Min­sky to Macro­eco­nomic Data

The Walras-Schumpeter-Minsky propo­si­tion that aggre­gate demand is income plus the change in debt, and that this is expended on both goods and ser­vices and pur­chases of finan­cial claims on exist­ing assets, can be put into a sim­ple equa­tion (with Y and D stand­ing for nom­i­nal income and debt lev­els, GDP for the nom­i­nal value of out­put and NAT stand­ing for “Net Asset Turnover”):

Net Asset Turnover can be fac­tored into the price index for assets PA, times their quan­tity QA, times the annual turnover TA expressed as a frac­tion of the num­ber of assets :

There will thus be a rela­tion­ship between change in debt and the level of both eco­nomic activ­ity and asset prices.

Focus­ing on the for­mer for now, it is eas­ily shown that the Great Mod­er­a­tion was dri­ven by a sub­stan­tial rise in debt-financed aggre­gate demand, while the Great Con­trac­tion coin­cided with a dra­matic rever­sal from ris­ing to falling debt.

Fig­ure 3: Aggre­gate demand as income plus change in debt

Sim­i­larly, when the rate of change of aggre­gate demand is con­sid­ered, there is a rela­tion­ship between the accel­er­a­tion of debt and both the rate of change of GDP (Biggs and Mayer 2010; Biggs, Mayer et al. 2010) and the change in asset prices:

The rela­tion­ship between the “Credit Accelerator”—defined, fol­low­ing (Biggs and Mayer 2010; Biggs, Mayer et al. 2010) as the rate of change of the rate of change in debt per annum, divided by GDP at the midpoint—and change in the employ­ment rate is shown in Fig­ure 2. Far from aggre­gate debt not being macro­eco­nom­i­cally impor­tant, change in employ­ment is strongly cor­re­lated with the accel­er­a­tion of debt.

Fig­ure 4: Credit Accel­er­a­tion and change in employ­ment

The scale and tim­ing of the down­turn is much eas­ier to com­pre­hend from Minsky’s credit-based per­spec­tive than the income-only per­spec­tive of neo­clas­si­cal eco­nom­ics. The down­turn in GDP was rel­a­tively minor—from $14.4 tril­lion at its peak to $13.9 tril­lion at its low­point, a fall of just over half a tril­lion or 4% of nom­i­nal GDP—and it com­menced late (in July 2008) and fin­ished early (in May 2009) com­pared to the cri­sis itself, which is gen­er­ally regarded as hav­ing started in August 2007 and con­tin­ued get­ting worse in macro­eco­nomic terms until late 2009.

The down­turn in pri­vate aggre­gate demand was much more severe: from $18.4 tril­lion at its peak in Novem­ber 2007 to $11.4 tril­lion in Feb­ru­ary 2010, a fall of $6.9 tril­lion or 38% over 2.3 years. The decel­er­a­tion of debt was 5 times greater than any other decel­er­a­tion in the entire post-WWII period, and even stronger than in the Great Depres­sion itself, when the max­i­mum neg­a­tive value of the Credit Accel­er­a­tor was –18% of GDP.

The pro­found effect of the cri­sis not only on employ­ment and GDP, but also on asset mar­kets, is now far eas­ier to comprehend.

This now brings us to Minsky’s dis­tinc­tive argu­ment that there are (at least) two price lev­els in capitalism—one for com­modi­ties and the other for cap­i­tal assets—and his analy­sis of the finan­cial dynam­ics that can wedge them apart dur­ing spec­u­la­tive bubbles.

Min­sky on Finance: Two Price Levels

As a Post Key­ne­sian, Min­sky argued that the prices of most end-consumer com­modi­ties are set by a markup on prime cost (Reynolds 1987; Blinder 1998; Lee 1998). He por­trayed changes in the price level for “cur­rent goods” as mainly a con­se­quence of cost pres­sures (largely from wages and raw mate­ri­als) and changes to markups. The largely inde­pen­dent price level of assets is based, not on the orig­i­nal cost of pro­duc­tion of the assets, but on the net present value of antic­i­pated cash flows. These in turn depend on the gen­eral state of expec­ta­tions, which vary sys­tem­at­i­cally over the finan­cial cycle, lag­ging behind cur­rent prices in a slump, run­ning ahead of them in a recov­ery and boom, and are financed largely by Ponzi bor­row­ing. This per­spec­tive allows for sig­nif­i­cant diver­gence between the two price lev­els as expec­ta­tions rise and fall over the medium term, and as the growth of debt that finances Ponzi activ­ity in asset mar­kets rises and falls with them. How­ever over the very long term, asset prices must even­tu­ally return to some kind of har­mony with cur­rent prices, since the only sus­tain­able sup­port for asset prices is the sales of the com­modi­ties they pro­duce. The price sys­tem thus dis­plays far-from-equilibrium dynam­ics, accord­ing to Min­sky, in con­trast to the neo­clas­si­cal argu­ment that the price sys­tem is a sta­bil­is­ing force in a cap­i­tal­ist economy.

This implies that a sim­ple com­par­i­son of asset prices to con­sumer prices can iden­tify bub­bles, since Min­sky saw no rea­son for a long-term trend for the asset to con­sumer price ratio to rise over time—the only basis for this would be the cap­i­tal­iza­tion of income streams gen­er­ated by assets into asset prices. This is fea­si­ble with share prices, given retained earn­ings and in par­tic­u­lar the zero-dividend poli­cies of firms like Berkshire-Hathaway, but not with house prices.

Even given the exis­tence of a trend to the real share price, the com­mence­ment of the “Great Mod­er­a­tion” share price bub­ble in 1995 is obvi­ous (see Fig­ure 3).

Fig­ure 5: Two price lev­els (shares)

Fig­ure 4 sub­tracts the trend from 1915 till 1995 from the data.

Fig­ure 6: DJIA minus expo­nen­tial trend 1915–1995

The role of the accel­er­a­tion of debt in dri­ving these asset price bub­bles is evi­dent. Equa­tion casts the role of spec­u­la­tion on asset prices in a far dif­fer­ent light than does neo­clas­si­cal eco­nom­ics, which sees spec­u­la­tion as aid­ing in price dis­cov­ery (Schwartz, Wolf et al. 2010). Instead, lever­aged spec­u­la­tion plays a dom­i­nant role in price formation—leading to the devel­op­ment of debt-financed bub­bles in asset prices.

The equa­tion as stated ignores the feed­back rela­tions between income and out­put and change in debt, but even then it indi­cates that the impact of the accel­er­a­tion in debt will be dis­persed through at least five highly aggre­gated vari­ables. Clearly behav­ioural sen­ti­ment issues will also affect how much debt is lev­ered into asset mar­kets ver­sus parked else­where. Nonethe­less sig­nif­i­cant cor­re­la­tions exist between debt accel­er­a­tion and real share prices (see Fig­ure 7 and Fig­ure 8), and espe­cially between accel­er­a­tion of mort­gage debt and change in real house prices (see Fig­ure 10).

Fig­ure 5 shows the cor­re­la­tion of the devi­a­tions from trend with the accel­er­a­tion of pri­vate credit dur­ing the Roar­ing Twen­ties and the Great Depres­sion (lagged one year since the pre-1950 debt data is end-of-year annual only).


Fig­ure 7: Credit Accel­er­a­tion and share price move­ments 1922–1942

Fig­ure 6 shows the same rela­tion­ship from 1986 till today.

Fig­ure 8: Credit Accel­er­a­tion and share price move­ments 1986-Now

The rela­tion­ship between the change in house prices and the accel­er­a­tion of debt since 1990 are more eas­ily iden­ti­fied, for three rea­sons. Firstly, there is no need to sub­tract any trend in real house prices prior to the bub­ble, since there is no rea­son to expect a trend, and the empir­i­cal data con­firms that there was none. Sec­ondly, there is a spe­cific sub­set of debt—mortgage debt—whose accel­er­a­tion can be directly be com­pared to change in real house prices. While some mort­gage debt bleeds into expen­di­ture on other items (espe­cially with “mort­gage equity with­drawal” loans) and into expand­ing the stock of hous­ing, the major­ity of mort­gage debt goes into pur­chas­ing exist­ing housing.

Thirdly, this was the first truly major house price bub­ble in America’s his­tory. Minor bub­bles are evi­dent in 1895, 1979 and 1990, but they are mere Catskills com­pared to the Ever­est of the 2006 bub­ble. The Sub­prime Bub­ble clearly began in 1997 (see Fig­ure 7), and burst nine years later. With this data read­ily avail­able since 2000 (Shiller 2000), it beg­gars belief that, just 10 months before the peak, Greenspan could assert to Con­gress that there was no national hous­ing bub­ble, and that any house price declines would “not have sub­stan­tial macro­eco­nomic implications”:

That said, there can be lit­tle doubt that excep­tion­ally low inter­est rates on ten-year Trea­sury notes, and hence on home mort­gages, have been a major fac­tor in the recent surge of home­build­ing and home turnover, and espe­cially in the steep climb in home prices. Although a “bub­ble” in home prices for the nation as a whole does not appear likely, there do appear to be, at a min­i­mum, signs of froth in some local mar­kets where home prices seem to have risen to unsus­tain­able lev­els… Although we cer­tainly can­not rule out home price declines, espe­cially in some local mar­kets, these declines, were they to occur, likely would not have sub­stan­tial macro­eco­nomic impli­ca­tions. (Greenspan 2005)

At the time of Greenspan’s tes­ti­mony, the real house price index was 240, a mere 8 per cent below the even­tual peak and almost 2.5 times the long term average.

Fig­ure 9: Two price lev­els (prop­erty)


The propul­sion for this bub­ble was clearly pro­vided by accel­er­at­ing mort­gage debt, and the rapid decel­er­a­tion of debt drove it back down (see Fig­ure 8). Pos­i­tive feed­back loops work in both directions—up and down.

Fig­ure 10: Mort­gage Accel­er­a­tion & Change in Real House Price Index

This “Min­skian” per­spec­tive on the role of accel­er­at­ing debt in dri­ving asset price bub­bles leads to sev­eral obvi­ous conclusions:

  1. The cri­sis will not be over until pri­vate debt has been reduced substantially—to the order of 100% of GDP or less;
  1. Asset prices will fall with the reduc­tion of debt. Even with the 33% decline by Novem­ber 2011, the real house price Index remains 77% above the 1890–1995 aver­age (and 50% above the mini-peak of 1990), while shares are still 67% above the long term trend from 1915–1995;
  2. Ponzi Lend­ing is the key cause of asset price bubbles;
  3. Since debt can­not per­ma­nently accel­er­ate, all asset bub­bles will ulti­mately burst; and
  4. To avoid asset price bub­bles in the first place, we have to break the pos­i­tive feed­back loop between lever­age and asset prices.


If we are to really end the destruc­tive insta­bil­ity of the finan­cial sys­tem, we have to address the cause of this insta­bil­ity, and from a Min­skian per­spec­tive, that cause is the pos­i­tive feed­back loop between ris­ing debt and asset prices.

This can­not be done sim­ply by rely­ing upon banks learn­ing from the cri­sis and behav­ing more respon­si­bly after it, since they have an innate desire to extend as much debt as they can per­suade the non-bank sec­tors to take on. The rea­son is sim­ple: bank prof­its are dri­ven pri­mar­ily by the vol­ume of debt. There is no mys­tery behind why the prof­its and wages of the FIRE econ­omy have grown rel­a­tive to the rest of the econ­omy, nor behind the coin­ci­dence that neg­a­tive FIRE prof­its have occurred only dur­ing the Great Depres­sion and our cur­rent cri­sis (see Fig­ure 11).

Fig­ure 11: The FIRE Econ­omy vs the Real Econ­omy

But lend­ing is a two-sided activ­ity: the non-bank pub­lic has to be a will­ing par­tic­i­pant if debt lev­els are to rise faster than income, and ulti­mately reach lev­els that can cause a finan­cial crisis.

This always requires the prospect of gain from lever­aged spec­u­la­tion on asset prices, since the public—both house­holds and firms—rarely bor­row exces­sively on the basis of income alone. A break­down of house­hold debt makes this point: as Fig­ure 12 illus­trates, despite all the entice­ments to per­sonal debt, it changed very lit­tle rel­a­tive to income, whereas mort­gage debt has risen dra­mat­i­cally over time.

Fig­ure 12: Only Mort­gage Debt has risen sub­stan­tially

To pre­vent bub­bles, we there­fore have to reduce the appeal of lever­aged spec­u­la­tion on asset prices, with­out at the same time chok­ing off demand for debt for either legit­i­mate invest­ment or unavoid­able bor­row­ing. I pro­pose two mech­a­nisms: “Jubilee Shares” and “Prop­erty Income Lim­ited Lever­age” (“The PILL”):

  1. Jubilee Shares: To rede­fine shares so that, if pur­chased from a com­pany directly, they last for­ever, but after a min­i­mal num­ber of sales (say seven), they become Jubilee Shares that last another 50 years before they expire; and
  2. Prop­erty Income Lim­ited Lever­age: To limit the debt that can be secured against a prop­erty to ten times the annual rental of that property.

Jubilee Shares

Cur­rently, 99% of all trad­ing on the stock mar­ket involves spec­u­la­tors sell­ing pre-existing shares to other spec­u­la­tors. This is under­taken with bor­rowed money in the hope of exploit­ing price bub­bles like that set by Yahoo! in the Dot­Com Bub­ble (see Fig­ure 13), when that the lend­ing itself largely causes the price bubbles.

If instead shares on the sec­ondary mar­ket lasted only 50 years, then even the Greater Fool couldn’t be enticed to buy them with bor­rowed money–since their ter­mi­nal value would be zero. Instead a buyer would only pur­chase a share on the sec­ondary mar­ket in order to secure a flow of div­i­dends for 50 years (or less). One of the two great sources of ris­ing unpro­duc­tive debt would be eliminated.

The objec­tive of this pro­posal is to make lever­aged spec­u­la­tion on exist­ing shares unat­trac­tive, while still mak­ing fund­ing IPOs and share issues attrac­tive, and enabling gen­uine price discovery.


Fig­ure 13: Yahoo’s share price bub­bles and bursts

Prop­erty Income Lim­ited Leverage

Some debt is needed to pur­chase a house, since the cost of build­ing a new house far exceeds the aver­age wage. But debt greater than per­haps 3 times aver­age annual wages dri­ves not house con­struc­tion, but house price bubbles.

Prop­erty Income Lim­ited Lever­age (“the PILL”) would break this pos­i­tive feed­back loop by bas­ing the max­i­mum that can be lent for a prop­erty pur­chase, not on the income of the bor­rower, but on a mul­ti­ple of the income-earning poten­tial of the prop­erty itself.

With this reform, all would-be pur­chasers would be on equal foot­ing with respect to their level of debt-financed spend­ing, and the only way to trump another buyer would be to put more non-debt-financed money into pur­chas­ing a property.

It would still be possible–indeed necessary–to pay more than ten times a property’s annual rental to pur­chase it. But then the excess of the price over the loan would be gen­uinely the sav­ings of the buyer, and an increase in the price of a house would mean a fall in lever­age, rather than an increase in lever­age as now. There would be a neg­a­tive feed­back loop between house prices and lever­age. That hope­fully would stop house price bub­bles devel­op­ing in the first place, and take dwellings out of the realm of spec­u­la­tion back into the realm of hous­ing, where they belong.


I hope that my Minsky-inspired analy­sis of the source of finan­cial mar­ket insta­bil­ity is com­pelling; I expect that my reform pro­pos­als are less so. But they are not so much rad­i­cal as born from a real­is­tic assess­ment, not only of the cause of finan­cial insta­bil­ity, but the his­tor­i­cal record of our past attempts to tame it.

We can­not rely upon laws or reg­u­la­tors to per­ma­nently pre­vent the fol­lies of finance. After every great eco­nomic cri­sis come great new insti­tu­tions like the Fed­eral Reserve, and new reg­u­la­tions like those embod­ied in the Glass-Steagall Act. Then there comes great sta­bil­ity, due largely to the decline in debt, but also due to these new insti­tu­tions and reg­u­la­tions; and from that sta­bil­ity arises a new hubris that “this time is different”—as the debt that causes crises rises once more. Reg­u­la­tory insti­tu­tions become cap­tured by the finan­cial sys­tem they are sup­posed to reg­u­late, while laws are abol­ished because they are seen to rep­re­sent a bygone age. Then a new cri­sis erupts, and the process repeats. Minsky’s apho­rism that “sta­bil­ity is desta­bi­liz­ing” applies not just to cor­po­rate behav­iour, but to leg­is­la­tors and reg­u­la­tors as well.

Jubilee Shares and the PILL are an attempt to write restraints on Ponzi Finance into the fab­ric of our soci­ety, so that bub­bles do not form in the first instance, so that the pos­i­tive feed­back loop that turns ris­ing asset prices into accel­er­at­ing debt does not hap­pen, and so that another finan­cial cri­sis like the one we are now in never occurs again.

Appen­dix: Double-entry ver­sions of tables


Table 3: Double-entry ver­sion of Neo­clas­si­cal vision of lending

Bank Assets

Deposits (Lia­bil­i­ties)

Action/Actor Patient Impa­tient
Assets Lia­bil­i­ties Assets Lia­bil­i­ties
Make Loan +Lend –Lend
Record Loan –Lend +Lend



Table 4: Double-entry ver­sion of actual lending

Bank Assets Deposits (Bank Liabilities)
Action/Actor Lend­ing Licence Loan Ledger Patient Impa­tient
Assets Lia­bil­i­ties
Make Loan +Lend –Lend
Record Loan –Lend +Lend


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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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66 Responses to INET Presentation: Minskian Perspective on Instability in Financial Markets

  1. centerline says:

    Mr. Steve Keen —

    I do not know if what I have to offer today is of any value. But, I will toss it out here.

    I hear you talk of debt in terms of accel­er­a­tion. Most folks in the pro­fes­sion of eco­nom­ics prob­a­bly don’t relate so well to calculus.

    As an anal­ogy, I offer some­thing from engi­neer­ing. The con­cept herein is that we design for veloc­ity and accel­er­a­tion in terms of say a building’s move­ment at upper floors, or a trans­porta­tion sys­tem, road­way design, etc. The most impor­tant fac­tor in cases where dynam­ics and/or human expe­ri­ence comes to bear is accel­er­a­tion. Why? Well, mainly because this is what is “felt” more than any­thing else. For exam­ple, the upper floor of a build­ing may sway sev­eral feet in a high wind, but no one will really notice unless it moves too quickly. Or say in a trans­porta­tion sys­tem wherein speed is not a prob­lem and dis­place­ment is the goal — but peo­ple will not tol­er­ate so well the accel­er­a­tion (or neg­a­tive accel­er­a­tion). Etc. Lots of good exam­ples illus­trat­ing the need for for­ward move­ment, but not at the expense of being able to main­tain solid standing.

    While I would step­ping out on a very pre­car­i­ous limb here as a non-economist, I would maybe try to con­nect debt with the notion that it’s rel­a­tive increase or even amount (rel­a­tive dis­place­ment) does not mat­ter quite so much as the accel­er­a­tion. And that socially, for­ward move­ment is just part of human nature… a require­ment for progress.

    Yeah, this might cross over right here to a social sci­ence I think. But, I under­stand that math is a trump card. Hard to refute the likes of physics, while Plato and oth­ers can always be argued.

    Thank you for the per­mis­sion to post on this site. If you are ever in Cen­tral Florida, let me know. Din­ner is on me and my fam­ily (wife and 2 kids who put up with me! — LOL).

  2. RickW says:

    My view is that the sys­tem is eas­ier to change than most believe. How­ever it does require lead­er­ship and there is not much of that vis­i­ble. Sadly the polies in devel­oped economies are directed by banks or are ex-bankers.

    There is a widely held view that reces­sions are bad but I will gladly take defla­tion over infla­tion. It means less pres­sure on resources. Maybe reduced pop­u­la­tion growth — cer­tainly in devel­oped economies.

    I see the pub­lic QE idea gain­ing momen­tum. Steve made some solid points in the Tonight pro­gram. The woman in the panel is yet another exam­ple of how lit­tle under­stand­ing there is of money — sadly Steve’s point on money cre­ation was drowned out.

    My view is that infla­tion­ary pres­sure comes about through scarce energy — or maybe, more pre­cisely, scarce “clean” energy. Beyond energy iron ore and cokng coal are tight but pro­duc­tion of these can be ramped up. There are steel mak­ing plants idle. We have huge excess capac­ity in car man­u­fac­ture right now. There is high unem­ploy­ment in con­struc­tion sec­tors. There are ups and down with farm­ing but lots of oppor­tu­nity to use resources better.

    So if we can move beyond finan­cial­i­sa­tion bleed­ing life out of economies and focus on the tech­ni­cal chal­lenges of improv­ing pro­duc­tive effi­ciency then there are no chal­lenges that are dif­fi­cult to manage.

  3. RickW says:

    Steve’s done it again — the off-the-cuff response to Irish debt prob­lem by issu­ing their own money again. It could be a sound idea but to even men­tion it in the cir­cum­stances reduces credibility.

    It may be an hon­est response to what seems a good idea but it is not rea­son­able for some­one to be taken seri­ously on global issues when pro­mot­ing an idea that came from an unknown dur­ing a casual tele­phone con­ver­sa­tion unless the idea has been thor­oughly thought through.

    Topic change — other scarce resources — I expect grow­ing pres­sure on health care due to aging pop­u­la­tions, poor plan­ning for this and poor health habits and atti­tudes across a large pro­por­tion of the world’s pop­u­la­tion. So this area is likely to see infla­tion­ary pressure.

  4. Steve Hummel says:

    The mon­e­tary sys­tem is cred­i­tary in nature. Plusses and minuses. A debt accel­er­a­tion that got out of hand can be dealt with by an accel­er­ated debt reduc­tion. The only prob­lem (and the REAL prob­lem is only for the minor­ity that ben­e­fits from their con­trol and access to credit really) is that this time almost EVERYONE got infected and involved. And the oligarchy’s only refuge this time was pick­ing the pocket of every­one else via sov­er­eign debt while they skated in still wildly prof­itable ways. Well, you can’t fool all of the peo­ple all of the time.

    We have to raise ques­tions which have rarely if ever been asked in economics.

    What is the value of tech­no­log­i­cal progress, and who should ben­e­fit from it?

    Were sys­tems made for Man or Man for systems?

    What is the actual psy­chol­ogy of cur­rent eco­nom­ics and money sys­tems, and how can it be made more healthy?

  5. Dannyb2b says:


    the solu­tion for ire­land is to cir­cum­vent the bank­ing sys­tem. instead of the cb con­duct­ing mon­e­tary pol­icy through banks that dont lend onwards the cb should deal directy with the pub­lic. Thereby the liq­uid­ity cant get trapped.

  6. Steve Hummel says:

    I’m as agnos­tic as you can get, but the Bible is so incred­i­bly preg­nant with valid human psychological/spiritual insight that you can open it just about to any page, take the advice there and trust its correct.

    For Ire­land, Spain, Por­tu­gal and Italy here’s Deuteron­omy 30:19

    .….I have set before you life and death, bless­ing and curs­ing: there­fore choose life, that both you and your descen­dants may live”

  7. Derek R says:

    Here is a link to Steve’s pre­sen­ta­tion at the Just Bank­ing con­fer­ence in Edin­burgh. It’s not to easy to find but once you have gone to the web­site, look for the videos tab and select the video cap­tioned “Just bank­ing morn­ing day 2″, Steve’s talk starts at the 03:14:30 point. Ann Pettifor’s talk was also pretty good and started at 02:47:45. I haven’t watched the other speak­ers yet.

    Video qual­ity isn’t that great. In par­tic­u­lar it’s a lot­tery whether you get to see the speaker’s slides and graphs or not. Still a lot bet­ter than not get­ting to see the pre­sen­ta­tion at all. So kudos to the Just Bank­ing con­fer­ence organ­is­ers for putting this online.

  8. mahaish says:

    Steve’s done it again – the off-the-cuff response to Irish debt prob­lem by issu­ing their own money again. It could be a sound idea but to even men­tion it in the cir­cum­stances reduces credibility.

    It may be an hon­est response to what seems a good idea but it is not rea­son­able for some­one to be taken seri­ously on global issues when pro­mot­ing an idea that came from an unknown dur­ing a casual tele­phone con­ver­sa­tion unless the idea has been thor­oughly thought through”

    seems an emi­nently rea­son­ble idea that steves pro­motng rickw,

    blind paddy with his shay­laylee knows hang­ing onto the euro is about a good an idea as invest­ing in irish potato farm­ing in 1845(not)

  9. mahaish says:

    the solu­tion for ire­land is to cir­cum­vent the bank­ing sys­tem. instead of the cb con­duct­ing mon­e­tary pol­icy through banks that dont lend onwards the cb should deal directy with the pub­lic. Thereby the liq­uid­ity cant get trapped.”

    trea­sury does the spend­ing danny,

    they need to punt the euro, and go back to the punt, and trea­sury can use its agent the cen­tral bank to cre­ate deposits and net assetts ‚and improve the net worth posi­tion of non bank bal­ance sheets.

    but yes agree with your sen­ti­ment, they just cant do it under maas­tre­icht and riechs fuhrer merkel 😉

  10. Dannyb2b says:

    “trea­sury does the spend­ing danny,”

    Im not refer­ring to fis­cal pol­icy. Im refer­ring to cre­at­ing stim­u­lus through mon­e­tary pol­icy. The rea­son mon­e­tary stim­u­lus is inef­fec­tive is becuase the mon­e­tary trans­mis­sion chan­nel is bro­ken. There­fore the cen­tral bank should deal directly with the public.

    Heres a bet­ter expla­na­tion:

  11. While this does not detract from your main points, I am puz­zled by the state­ment that “debt can­not accel­er­ate forever.”

    Why not?

    Cen­tral bank pol­icy is to tar­get a con­stant infla­tion rate. If debt is money, does not this infla­tion pol­icy imply indef­i­nite accel­er­a­tion in debt?

  12. Pingback: P2P Foundation » Blog Archive » Steve Keen: Two proposals to eliminate the unproductive debt burden

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  14. Kozak says:

    Steve. See

    A guy called Buddy Rojek has sug­gested the use of elec­tronic Gov­ern­ment issued Debit Cards, loaded with money from a sur­plus bud­get har­vested dur­ing boom times to increase aggre­gate demand dur­ing defla­tionery times. Basi­cally it is not printed cash it is cash the gov­ern­ment har­vested from the peo­ple dur­ing a boom time to reduce infla­tionery pres­sures. Very switched on guys see specifically

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