Tran­scend­ing the Lucas Cri­tique & sim­ple dynamic mod­el­ling with Min­sky

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The Lucas Cri­tique has ruled eco­nom­ics for the last 40 years, and led it into a dead-end as well. In this talk to the Eco­nom­ics for Every­one con­fer­ence run by the Post Crash Eco­nom­ics Soci­ety in Man­ches­ter, I argue that micro-founded mod­els fail because of the emer­gent prop­er­ties that char­ac­terise com­plex sys­tems. An alter­na­tive approach that tran­scends Lucas’s well-founded objec­tion to ad-hoc model-build­ing is to build mod­els from strictly true macro­eco­nomic iden­ti­ties. I show that three sim­ple identities–the employ­ment rate, the wages share of income, and the pri­vate-debt-to-GDP ratio–are suf­fi­cient to build a sim­ple dynamic model that gen­er­ates the pos­si­bil­ity of a finan­cial cri­sis. I also give a high-speed but I think com­pre­hen­si­ble tuto­r­ial on using Min­sky, the Open Source mon­e­tary mod­el­ling pro­gram.

Are we fac­ing a global “Lost Decade”?

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This is an invited paper by the Pri­vate Debt Project, an ini­tia­tive of the phil­an­thropic orga­ni­za­tion the Governor’s Woods Foun­da­tion to raise aware­ness about the eco­nomic impor­tance and dan­gers of pri­vate debt.

The era of low growth known as Japan’s “Lost Decade” com­menced in 1990, and per­sists to this day.  While most authors acknowl­edge that the seeds for the Lost Decade were sown by exces­sive credit growth in the pre­ced­ing Bub­ble Econ­omy years, only Richard Koo (Koo, 2009, Koo, 2011, Koo, 2003, Koo, 2014) and Richard Werner (Voutsi­nas and Werner, 2011, Werner, 2002) have sys­tem­at­i­cally argued that insuf­fi­cient credit growth dur­ing the “Lost Decade” explains Japan’s now quar­ter-cen­tury long slump. Yet these argu­ments tell us more about the dilem­mas fac­ing today’s world econ­omy than many more com­monly accepted expla­na­tions of the cur­rent slow­down.

The Seven Coun­tries Most Vul­ner­a­ble To A Debt Cri­sis

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For decades, some of the most impor­tant data about mar­ket economies was sim­ply unavail­able: the level of pri­vate debt. You could get gov­ern­ment debt data eas­ily, but (with the out­stand­ing excep­tion of the USA—and also Aus­tralia) it was hard to come by.

That has been reme­died by the Bank of Inter­na­tional Set­tle­ments, which now pub­lishes a quar­terly series on debt—government & private—for over 40 coun­tries. This data lets me iden­tify the seven coun­tries that, on my analy­sis, are most likely to suf­fer a debt cri­sis in the next 1–3 years. They are, in order of likely sever­ity: China, Aus­tralia, Swe­den, Hong Kong (though it might deserve first billing), Korea, Canada, and Nor­way.

Cen­tral Bank­ing, Cli­mate Change and Envi­ron­men­tal Sus­tain­abil­ity

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The Coun­cil on Eco­nomic Poli­cies and the Bank of Eng­land are organ­is­ing a work­shop on this topic to be held at the Bank on Novem­ber 14–15 2016. A call for papers has just been put out, with a dead­line of June 30th.

Back­ground

Cli­mate change and other envi­ron­men­tal chal­lenges are mov­ing up pol­icy agen­das world­wide. Nonethe­less, the poten­tial impli­ca­tions of envi­ron­men­tal risks and scarci­ties for cen­tral bank­ing as well as the link­ages between finan­cial reg­u­la­tion, mon­e­tary pol­icy and envi­ron­men­tal sus­tain­abil­ity remain largely unex­plored.

Get ready for an Aus­tralian reces­sion by 2017

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For the last 25 years, Aus­tralian politi­cians of both Lib­eral and Labor hue have been able to brag that, under their stew­ard­ship, Aus­tralia has avoided a reces­sion. Those brag­ging rights are about to come to an end. Dur­ing the life of the next Par­lia­ment — and prob­a­bly by 2017 — Aus­tralia will fall into a pro­longed reces­sion.

Click here to read the rest of this post, and here to down­load the Excel file show­ing the link between a slow­down in the rate of growth of debt and a reces­sion.

Macro­eco­nom­ics of Loan­able Funds & Endoge­nous Money com­pared using Min­sky

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The main­stream eco­nomic idea that banks are just inter­me­di­aries between savers and investors is a fan­tasy, but given that fan­tasy, their argu­ment that the level and rate of change of pri­vate debt are not macro­eco­nom­i­cally sig­nif­i­cant (except at the “Zero Lower Bound”) is cor­rect. But in the real world, the role of the level and rate of change of pri­vate debt is cru­cial. I illus­trate this by build­ing a Min­sky model of Loan­able Funds and con­vert­ing it to the real world of Endoge­nous Money. Then I explain how credit growth plays an essen­tial role in aggre­gate demand and income, and how this is con­sis­tent with the tru­ism that Expen­di­ture equals Income.

Laughter–the Worst Med­i­cine

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Like many com­men­ta­tors, I regard August 9 2007 as the start of the “Global Finan­cial Cri­sis”. On that day, BNP Paribas declared that sev­eral of its funds were being closed because liq­uid­ity in those mar­kets had com­pletely evap­o­rated:

FinancialCrisisBNP20070809

So I was par­tic­u­larly amused–in a sick sort of way–to see this bril­liant info-graphic on The Fed on Twit­ter today: it plots the amount of laugh­ter in FOMC meet­ings between 2000 and 2012. “Peak Laugh­ter” occurred lit­er­ally days before the cri­sis began:

FederalReserveLaughterFOMC_PreBNP

Kingston Uni releases mon­e­tar­ily sound fore­cast model of US Econ­omy

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PERG econ­o­mists are devel­op­ing a macro­econo­met­ric model to track the evo­lu­tion of the US econ­omy over the medium term, which is 3–5 years:

The model belongs to the fam­ily of “finan­cial bal­ances mod­els”, an approach pio­neered by Wynne God­ley and col­lab­o­ra­tors at Cam­bridge Uni­ver­sity (UK) and then suc­cess­fully devel­oped by the macro­eco­nom­ics team of the Levy Insti­tute — led by God­ley him­self.

Graph

At its heart, the KFBM (Kingston Finan­cial Bal­ances Model) is char­ac­terised by a set of thor­ough account­ing matri­ces that gather the major stocks and flows of the US econ­omy as well as their links across insti­tu­tional sec­tors. This results in three key strengths of the KFBM:

Tilt­ing At Wind­mills: The Faus­t­ian Folly Of Quan­ti­ta­tive Eas­ing

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As I explained in my last post, banks can’t “lend out reserves” under any cir­cum­stances, which under­mines a major ratio­nale that Cen­tral Bank econ­o­mists gave for under­tak­ing Quan­ti­ta­tive Eas­ing in the first place. Con­se­quently, the hope that Bernanke expressed in 2009 is “To Dream The Impos­si­ble Dream”:

To dream the impos­si­ble dream
To fight the unbeat­able foe
To bear with unbear­able sor­row
To run where the brave dare not go

For­mer Chair of the Fed­eral Reserve Ben Bernanke lis­tens while US Sec­re­tary of the Trea­sury Jacob Lew speaks at the Brook­ings Insti­tu­tion July 8, 2015 in Wash­ing­ton, DC. AFP PHOTO/BRENDAN SMIALOWSKI (Photo credit should read BRENDAN SMIALOWSKI/AFP/Getty Images)