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Lars Schall is a freelance financial journalist in the industrial heartland of Germany, the Ruhr Area, who focuses on oil, precious metals and the monetary system. Lars interviewed me several weeks ago for his podcast; click here for the MP3 file, or listen to the link below.
Steve Keen's Debtwatch Podcast
My paper “Instability in Financial Markets: Sources and Remedies” for the INET conference “Paradigm Lost: Rethinking Economics and Politics“, to be held in Berlin on April 12-14, is now available via the INET website.
If you’d like to download it, you can get it either from my INET page, or from a link on the conference program. For copyright reasons I can’t reproduce it here, but I can provide a quick synopsis and some excerpts, so here goes.
The paper starts with a synopsis on Minsky, since his “Financial Instability Hypothesis” is one of the key foundations of my approach to economics. He has come into vogue these days of course, but to people who’ve known his work for several decades rather than ever since the “Minsky Moment” of late 2007, a better expression would be that he’s “come into vague”. I read papers like Krugman’s “Debt, Deleveraging, and the Liquidity Trap: A Fisher-Minsky-Koo approach”, and for the life of me, I can’t see Minsky there. As I note in my paper:
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.
My good friend and long term fellow rebel in economics Professor Rod O’Donnell once remarked that neoclassical economists are incapable of reading Keynes: they look at his words and then spout Walras instead. A similar phenomenon applies here: neoclassicals like Krugman read Minsky, and then proceed to build equilibrium models without banks, and think they’re modelling Minsky.
No they’re not: they’re creating an equilibrium-obsessed Walrasian hand puppet and calling it Minsky—just as they did to Keynes with DSGE modelling.
I used the word “equilibrium” twice above, because one clear methodological aspect of Minsky’s thinking is that macroeconomics is about disequilibrium. Neoclassical economists have the world precisely (to use an evocative piece of Australian slang) arse about tit. They believe that if it’s not an equilibrium model it’s not economics.
Nonsense! The precise opposite is the case: if it isn’t disequilbrium, then it isn’t economics.
There’s nothing “radical” about this, which is often the way that neoclassical economists react when I press this point: “assume disequilibrium? How dare you!?”. I dare because “disequilibrium” is so common in real sciences that they don’t even call it that: they call it dynamics. Any dynamic model of a process must start away from its equilibrium, because if you start it in its equilibrium, nothing happens. It’s about time that economists woke up to the need to model the economy dynamically—and to give Krugman his due here, he does admit at the end of his paper that his dynamics are dreadful, and need to be improved:
The major limitation of this analysis, as we see it, is its reliance on strategically crude dynamics. To simplify the analysis, we think of all the action as taking place within a single, aggregated short run, with debt paid down to sustainable levels and prices returned to full ex ante flexibility by the time the next period begins. This sidesteps the important question of just how fast debtors are required to deleverage; it also rules out any consideration of the effects of changes in inflation expectations during the period when the zero lower bound remains binding, a major theme of recent work by Eggertsson (2010a), Christiano et. al. (2009), and others. In future work we hope to get more realistic about the dynamics.
Hurry up Paul: you’re already eight decades behind Irving Fisher, who put the case for dynamics even for those who assume that equilibrium is stable:
‘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)
One key component of Minsky’s thought is the capacity for the banking sector to create spending power “out of nothing”—to quote Schumpeter. As well as explaining endogenous money, I show that Minsky’s analysis leads to the conclusion that aggregate demand is greater than aggregate supply arising from the sale of goods and services alone—and therefore that rising debt plays a crucial role in a capitalist economy:
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)
This aggregate demand is spent not just on goods and services, but also on buying financial assets—hence economics and finance are inextricably linked, in opposition to the failed neoclassical attempt to keep them separate in two hermetically sealed jars. This in turn transcends Walras’ Law to give us what I call the Walras-Schumpeter-Minsky Law:
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.
“How do you misinterpret me? Let me count the ways…”
There are so many ways in which neoclassical economists misinterpret non-neoclassical thinkers like Fisher and Minsky that I could write a book on the topic. This section focuses on just one facet of how they get it wrong: by ignoring banks, and treating loans as transfers from “savers” to “spenders” with no bank in between.
This is precisely how Krugman models debt in his recent paper:
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)
This is debt without banks—and without the endogenous creation of money—and it explains why neoclassical economists don’t think that the level of private debt matters.
With that vision of debt, a change in the level of debt isn’t important, because the borrower’s increase in spending power is counteracted by the lender’s fall in spending power. Here’s the lending process as neoclassicals like Krugman see it:
| Assets | Deposits (Liabilities) | ||
| Action/Actor | Patient | Impatient | |
| Make Loan | +Lend | -Lend |
Krugman therefore reassures his blog readers that there’s nothing to worry about when private debt levels rise or fall:
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)
That would be reassuring if true, since we could then ignore data like this:
Unfortunately, real lending is better described by the next table:
| Bank Assets | Bank Deposits (Liabilities) | ||
| Action/Actor | Patient | Impatient | |
| Make Loan | +Lend | -Lend |
In the real world, a bank loan increases “Impatient”‘s spending power without reducing “Patient”‘s, so that the level of private debt does matter.
In particular, the rate of change of debt matters because that tells us how much of demand is debt financed. When you add the change in debt to GDP, you get total aggregate demand, and that makes it exceedingly clear why the economic crisis occurred: the growth of debt collapsed, and took the economy with it:
Since change in debt is part of aggregate demand, the acceleration of debt—the rate of change of its rate of change—affects change in aggregate demand. This in turn has impacts on the change in employment.
It also impacts on change in asset prices. The relationship between accelerating debt and rising asset prices is clear even in the very volatile world of the stock market:
It is undeniable in the property market:
Since asset market volatility is driven by the acceleration of private debt, the Minskian solution to instability in finance markets is to somehow sever the link between debt and asset prices. I put forward two ideas.
Currently, shares last for the life of the issuing company, and 99% of the trade on the stock market is in the secondary market. The Jubilee Shares proposal would allow shares to last forever as now when purchased on the primary issue market, but would have them switch to a defined life of (say) 50 years after a limited number of sales on the secondary market (say 7 sales). This would encourage primary share purchases, and also make it highly unlikely that anyone would use borrow money to buy Jubilee shares on the secondary market.
Currently lending to buy property is allegedly based on the income of the borrower—which gives borrowers an incentive to actually want higher leverage over time. “The PILL” would limit the amount that can be lent to some multiple (say 10 times) of the income generating capacity of the property itself.
There’s much more detail in the paper itself, and when the conference is held my talk on it will also be available on the INET website.
The conference itself has only 300 invitees, and INET had overwhelming demand from students for the 25 places they reserved for them. Rather than letting the over 500 other applicants miss out, these other applicants can watch the conference live from a special live video broadcast room at the Adlon Hotel, right next to the conference venue itself in Berlin. Click here for details if you’re one of those 563 applicants.
One of the many great ironies of American culture is that a society which lauds capitalism is also home to the fantasy of the selfless SuperHero: entities ranging from an ordinary but wealthy human (Batman) to an extraordinary but poor Extra-Terrestrial (Superman), who spend their days saving us mere mortals, for no obvious recompense.
Well bollocks to all that! Meet “Super Corporate Heroes“—superheroes who are more in line with the actual American Way. These superheroes are employed by a Fortune 500 company, charge for their services—”if you wanna get rescued, you gotta pay insurance”—and live lifestyles ranging from opulent to the top billers, to just above the breadline for the only slightly super amongst them.
Of course they have their own Super Villian—the Invisible Hand (“the world’s oldest and most mysterious super villain… It takes a few lifetimes to be a great capitalist”)—and many other challenges besides. This new eBook cartoon series is brilliantly conceived and drawn, and casts a welcome satiric light on our current economic predicament.
I highly recommend the series, and I’m happily forking out the 99 cents per digital issue (you can also buy a print copy for $3.99). If you want to sample before you buy, here’s the free preview.
It’s a brilliant sendup of capitalism, fantasy, and everything else we’ve come to love and loathe about modern society. Face it—we all need a laugh right now, and unlike the not-so-superheroes handling bailouts and austerity plans, these SuperHeroes actually deliver.
For a price
If your insurance is up to date
Oh, and if they aren’t distracted by a hangover, their own nagging bills, or some damn paternity suit.
Hey, I’m sort of trying to be one… Saving the world from Neoclassical economics ‘n’ all that… Maybe I should sign up? I wonder what the superannuation scheme is… And fringe benefits—how about a jaccuzi allowance?
These are the first two lectures of my Advanced Political Economy class at the University of Western Sydney. The class offers an in depth critique of the failures of neoclassical theories, as well as detailing my approach to a new economics. Click on the links to download the Powerpoint slides for the lectures.
Lecture 01: Part 1 – Introduction to subject/Failure of Neoclassical Macro
APE2012Lecture01A
APE2012Lecture01B
APE2012Lecture01C
Lecture 02: Failure of Neoclassical Macro (Demand and Supply)
APE2012Lecture02A
APE2012Lecture02B
I’m being interviewed by Paul Mason for the BBC Radio 4 program Analysis on April 3rd, in front of an audience at the London School of Economics from 6.30-8pm. If you’d like to attend, you can book a place via this link (“Banks vs the Economy“). Bookings are free but essential, and will open on Monday March 26th at 10pm. More details are available for the public from events@lse.ac.uk; email pressoffice@lse.ac.uk for media enquiries.
The LSE asked me to write this entry for their blog British Politics and Policy at LSE. It’s reproduced here (along with the data) for Debtwatch readers.
Click here for this post in PDF: Debtwatch Members; CfESI Members
Click here for the data in this post: Debtwatch Members; CfESI Members
As a car driver, you have surely had the experience of changing lanes and being beeped by a car with which you were about to collide—but which you didn’t see before the lane change. It’s because the car was clearly visible in your rear-view mirror, but that part of the image fell on your retina’s blind-spot—so you didn’t see it. Fortunately most of us learn that we have a blind spot, and so we check carefully to avoid being fooled by it again—and causing an avoidable accident.
If only economists could learn the same way, we might not now be in the accident of this never-ending economic crisis. “Neoclassical” economists (who dominate both academic economics and policy advice to governments) have a blind-spot about the role of private debt in macroeconomics, yet despite the economy crashing once before because of it during the Great Depression, they continue to argue that it’s irrelevant now—during this latest crash.
First, let’s establish that there was indeed a “car in the rear view mirror” in the 1930s and today. Data on long-term private debt levels is difficult to find, but I’ve located it for both the USA from 1920 till today, and for Australia from 1880 (see Figure 1). Clearly, there was a debt bubble before the Great Depression, and a plunge in debt levels during and after it (and Australian data also shows the same phenomenon during an earlier bubble and crash in the Depression of the 1890s; see Fisher and Kent 1999). The same process is clearly afoot again now.
Figure 1
Now for the blind-spot. Anyone not blessed—or rather cursed—by an economics education might think there was something in that coincidence of debt and Depressions. But it’s nothing to worry about, leading Neoclassical economists assure us—thus confirming that either they know something profound that proves that the coincidence is irrelevant, or that they have a blind-spot which means that their judgment can’t be trusted.
The profound insight they believe they have is that the level of debt doesn’t matter, and that only the distribution of debt can be important. Ben Bernanke rejected Irving Fisher’s “Debt Deflation” explanation for the Great Depression on this basis; after noting that Fisher did influence Roosevelt’s policies, Bernanke added that:
‘Fisher’s idea was less influential in academic circles, though, 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)
One crisis later, leading Neoclassicals like Paul Krugman continue to argue that only the distribution of debt can matter:
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)
So can we ignore the level of private debt? No—because this “profound insight” is in fact a blind-spot about the role of banks and debt in a capitalist economy. Neoclassical economists treat banks as irrelevant to macroeconomics—which is why banks are not explicitly included in their models—and regard a loan as merely a transfer from a saver (or “patient agent”) to a borrower (or “impatient agent”), as in Krugman’s “New Keynesian” model of our current crisis:
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. (Krugman and Eggertsson 2010, p. 3)
With that model of lending, a change in the level of debt has no inherent macroeconomic impact: the lender’s spending power goes down, the borrower’s goes up, and the two changes roughly cancel each other out.
However, in the real world, banks lend to non-bank agents, giving them spending power without reducing the spending power of other non-bank agents. The difference between the neoclassical model of lending and the real world is easily illustrated using transaction tables. Figure 2 illustrates the neoclassical model (with an implicit banking sector): in this world, a change in the level of debt has no macroeconomic implications.
Figure 2: Neoclassical perspective on lending
| Assets | Deposits (Liabilities) | ||
| Action/Actor | Patient | Impatient | |
| Make Loan | +Lend | -Lend | |
Figure 3 illustrates what actually happens: the bank creates a new deposit and a new loan simultaneously, adding to Impatient’s spending power without reducing Patient’s.
Figure 3: Real-world lending
| Bank Assets | Bank Deposits (Liabilities) | ||
| Action/Actor | Patient | Impatient | |
| Make Loan | +Lend | -Lend | |
This case has been made theoretically and empirically by non-neoclassical economists for decades. Schumpeter argued it was the primary source of investment (Schumpeter 1934, p. 73), Basil Moore showed empirically that this endogenous creation of credit, and not the “money multiplier”, was the explanation for money growth (Moore 1979), and most succinctly, a Senior Vice-President of the New York Fed asserted it when arguing against the Monetarist experiment of the 1970s:
In the real world, banks extend credit, creating deposits in the process, and look for the reserves later. (Holmes 1969, p. 73)
Unfortunately, Neoclassicals continue to ignore it because it doesn’t fit their model. Well it’s time to ignore them—because their model doesn’t fit the real world. Once we take the endogenous creation of money by banks into account, rising debt has a macroeconomic impact because it adds to aggregate demand. It also is the primary way in which speculation on asset prices is financed, as Minsky emphasised (Minsky 1982, p. 24).
The crisis we are in suddenly becomes entirely explicable—and predictable before the event—when the blind-spot on debt is removed. Because the change in debt adds to aggregate demand (and is spent on assets as well as goods and services), there is a strong causal link between rising debt and both falling unemployment and rising asset prices. This is evident in the UK data: unemployment fell as the debt-financed component of aggregate demand rose, and unemployment is now rising as the growth in private debt subsides (see Figure 4, where unemployment is inverted to make the correlation more obvious).
Figure 4: Change in Debt & UK Unemployment
The reason that our economic crisis is a financial one as well is that changing debt drives not just demand for goods and services, but asset prices as well. And since changing debt is a major source of demand for share and property purchases, for asset prices to rise, the level of debt must not merely grow but accelerate. Accelerating household debt clearly drove the UK’s property bubble, and that bubble is now vulnerable as household debt decelerates (see Figure 5).
Figure 5: Relationship between accelerating household debt and change in house prices
Ignoring the role of private debt in the economy is thus as dangerous as driving a car while ignoring the fact that your vision has a blind-spot. It’s why neoclassical economics has to be consigned to the dustbin of history (Keen 2011), and a realistic, credit based economics must take its place.
Oh, and as passengers in the UK economic car, are you hoping that your economists are better drivers? Figure 6 shows the level of UK private debt compared to that of the USA and Australia. I suggest that you tighten your seat-belts.
Figure 6: Aggregate private debt level
Bernanke, B. S. (2000). Essays on the Great Depression. Princeton, Princeton University Press.
Fisher, C. and C. Kent (1999). Two Depressions, One Banking Collapse. Reserve Bank of Australia Research Discussion Papers. Sydney, NSW, Australia, Reserve Bank of Australia. 1999: 54.
Holmes, A. R. (1969). Operational Constraints on the Stabilization of Money Supply Growth. Controlling Monetary Aggregates. F. E. Morris. Nantucket Island, The Federal Reserve Bank of Boston: 65-77.
Keen, S. (2011). Debunking economics: The naked emperor dethroned? London, Zed Books.
Krugman, P. (2011). “Debt Is (Mostly) Money We Owe to Ourselves.” The Conscience of a Liberal
http://krugman.blogs.nytimes.com/2011/12/28/debt-is-mostly-money-we-owe-to-ourselves/ 2012.
Krugman, P. and G. B. Eggertsson (2010). Debt, Deleveraging, and the Liquidity Trap: A Fisher-Minsky-Koo approach [2nd draft 2/14/2011]. New York, Federal Reserve Bank of New York & Princeton University.
Minsky, H. P. (1982). Can “it” happen again? : essays on instability and finance. Armonk, N.Y., M.E. Sharpe.
Moore, B. J. (1979). “The Endogenous Money Stock.” Journal of Post Keynesian Economics
2(1): 49-70.
Schumpeter, J. A. (1934). The theory of economic development : an inquiry into profits, capital, credit, interest and the business cycle. Cambridge, Massachusetts, Harvard University Press.
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