Does Debt Matter?

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A recent Twitter exchange…• “Nobel Prize” winner Paul Krugman: • Recent “Not the Nobel” finalist (me)

• Does it make a difference?

Do Banks matter?• Krugman (and mainstream “Neoclassical” economics in general): No…

• “As I (and I think many other economists) see it, banks are a clever but somewhat dangerous form of financial intermediary...

• in the end, banks don’t change the basic notion of interest rates as determined by liquidity preference and loanable funds...

• Banks don’t create demand out of thin air any more than anyone does by choosing to spend more; and banks are just one channel linking lenders to borrowers.” (March 27, 2012, “Banking Mysticism”, New York Times)

• Loanable Funds model as per economics textbooks:

• “Saving is the supply of loans – individuals lend their saving to investors or they deposit their saving in a bank that makes the loans for them.

• Investment is the demand for loans – investors borrow from the public directly by selling bonds or indirectly by borrowing from banks.” (Mankiw, Macroeconomics, p.65).

Assembling a long-term data series for USA Private Debt• Work initially

done for Richard Vague’s Debt-Economics Project

• Three different time series on loans and debt in USA Census, Federal Reserve…

1850 1900 1950 20000

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200Series X580 Census Bank LoansSeries X393-409 Census DebtFederal Reserve/BIS Data

Three different data series on private debt and loans

Census & BIS Data

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Panic 1837 GreatDepression

Assembling a long-term data series for USA Private Debt• Overlaps between 1916 and 1970…

1920 1940 1960

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Series X580 Census Bank LoansSeries X393-409 Census DebtFederal Reserve/BIS Data

Rates of change overlap almost perfectly

Census & BIS Data

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GreatDepression WWII End

Assembling a long-term data series for USA Private Debt• Long-term series normalized to current Federal Reserve private debt data…

1850 1900 1950 20000

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Composite series normalized to current Federal Reserve Data

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Panic 1837 GreatDepression

Current level still exceeds peak of Great Depression

• This is Debt (denominated in $)• I define Credit as the rate of change

of debt (denominated in $/Year)

• Derive credit from this debt data and we find…

Exposing “the smoking gun of credit”• Negative credit associated with the USA’s deepest downturns…

1820 1830 1840 1850 1860 1870 1880 1890 1900 1910 1920 1930 1940 1950 1960 1970 1980 1990 2000 2010 202010

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USA Credit (change in debt)/GDP since 1834Pe

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Panic 1837 GreatDepression

Panic of 1837

21%/ GDP fall

Great Depression

18%/GDP fall

GFC 21%/ GDP fall

The Debt and Credit Trap• Why don’t we talk (much) about private debt?• Same reason Medievals didn’t talk about gravity: their priests taught them a false theory

• “The idea of debt-deflation … 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)

• Banks as “Financial Intermediaries” in a “Loanable Funds” model

• “Think of it this way: when debt is rising, it’s not the economy as a whole borrowing more money.

• It is, rather, a case of less patient people—people who for whatever reason want to spend sooner rather than later—borrowing from more patient people.” (Krugman 2012, End this Depression Now!)

The Debt and Credit Trap• After the crisis, Central Banks reject Loanable Funds/Money Multiplier models:• Bank of England 2014: “Rather than banks receiving deposits when households save

and then lending them out, bank lending creates deposits.”• Bundesbank 2017: “It suffices to look at the creation of (book) money as a set of

straightforward accounting entries to grasp that money and credit are created as the result of complex interactions between banks, non- banks and the central bank.

• “this refutes a popular misconception that banks act simply as intermediaries at the time of lending – i.e. that banks can only grant credit using funds placed with them previously as deposits by other customers.”

• Bank of England 2014: “In normal times, the central bank does not fix the amount of money in circulation, nor is central bank money ‘multiplied up’ into more loans and deposits.”

• Bundesbank 2017: “And a bank’s ability to grant loans and create money has nothing to do with whether it already has excess reserves or deposits at its disposal.”

The Debt and Credit Trap• What’s the macroeconomic impact of credit?• A logical analysis: derive relative impact from identity of Aggregate Demand & Supply• Divide economy into 3 sectors, where each sector spends on the other two• 3x3 “Moore Table”: diagonal is expenditure (-), off-diagonal is income (+)• Each row must sum to zero: (Your) Expenditure IS (Someone Else’s) Income• Column sum can be non-zero: sectoral incomes can differ from expenditures• 3 monetary arrangements

• “Say’s Law”: no lending possible

• “Loanable Funds”: lending between two sectors (along diagonal)

• “Bank Originated Money & Debt”: Bank (4th sector) lends to one sector• Its Assets rise in tandem with new net lending

 ”Say’s Law” Sector 1 Sector 2 Sector 3 SumSector 1 -(A+B) A B 0Sector 2 C -(C+D) D 0Sector 3 E F -(E+F) 0Sum (C+E)-(A+B) (A+F)-(C+D) (B+D)-(E+F) 0

The Debt and Credit Trap• Firstly, “Say’s Law”: Expenditure only from existing money, no lending/borrowing

• Effectively Friedman’s “Quantity theory of money”• Aggregate Demand Aggregate Income = money times velocity of circulation

tr SL( )simplify

substitute A B C D E F V MM V

• Expenditure by sector 1• Income generated by sector 1’s expenditure• Income for sector 1

Aggregate Demand

  Sector 1 Sector 2 Sector 3 SumSector 1 -(A+B+Credit +Interest) A+Interest B+Credit 0Sector 2 C -(C+D-Credit) D-Credit 0Sector 3 E F -(E+F) 0Sum (C+E)-(A+B+Credit+Interest) (A+F+Interest)-(C+D-Credit) (B+D)-(E+F) 0

The Debt and Credit Trap• “Loanable Funds”

• Sector 2 lends to sector 1 (flow across diagonal of table)

• Sector 1 pays interest to sector 2

• Sector 1 spends on sector 3

Flow of credit

Expenditure of credit

• Credit cancels out• IF loanable funds were true, THEN banking could be ignored in macroeconomics

tr LF( )simplify

substitute A B C D E F VMInterest M V

The Debt and Credit Trap• “Bank Originated Money and Debt”: Bank lending (to sector 1) creates money• Sector 1 spends this money on sector 3

• Credit (increase in Bank Liabilities) created by increase in debt (Bank assets)

• Credit does not cancel out• SINCE BOMD is true, THEN banking cannot be ignored in macroeconomics• Credit is the most volatile component of aggregate demand and income

  Assets Liabilities (Change in Deposit Accounts) Equity    DDebt Sector 1 Sector 2 Sector 3 Bank SumSector 1 Credit -(A + B + Credit + Interest) A B+Credit Interest 0Sector 2   C -(C+D) D   0Sector 3   E F -(E+F)   0Bank   G H I -(G+H+I)  Sum   (C+E+G)-(A+B+Credit + Interest) (A+F+H)-(C+D) (B+D+I+Credit)-(E+F) Interest-

(G+H+I)0

tr BOMD( )simplify

substitute A B C D E F G H I VMCredit Interest M V

Creation of

credit

Expenditure of credit

The Debt and Credit Trap• Illustrating this this in

Minsky: system dynamics software supporting monetary modelling using double-entry bookkeeping…

• Krugman & Eggertsson (2012 supplement) had Loanable Funds model

• “Patient” Consumer goods producing agent lends to “Impatient” Investment goods producing agent

• Bank charges “Intermediation Fee”

• Huge changes in credit and debt• Trivial changes in GDP LoanableFunds.mky

The Debt and Credit Trap• Easily modify it to BOMD…

• Huge changes in credit and debt• Huge changes in GDP

BOMD.mky

The Debt and Credit Trap• Correlation of credit with unemployment in the USA since 1990 is minus 0.85

1990 1992 1994 1996 1998 2000 2002 2004 2006 2008 2010 2012 2014 2016 2018 20206

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CreditUnemployment

USA Credit and Unemployment

BIS, US Census & BEA Data

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GFC

• Causation runs from credit to aggregate demand (as shown in Moore Table)

• Similar results for all other countries in BIS database

• (Except Germany!• Huge trade

surplus plus government austerity

• Low/falling credit usage)

The Debt and Credit Trap• Correlation of change in household credit with real house price change is 0.71

1990 1992 1994 1996 1998 2000 2002 2004 2006 2008 2010 2012 2014 2016 2018 202010

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USA Household Credit Change & House Price Change

BIS, US Census & BEA Data

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GFC

• Causality test confirms causation from change in household credit (acceleration of household debt) to change in inflation-adjusted house price index

The Debt and Credit Trap• “Big Government” + Federal Reserve backstop caused dramatic change in economy

1820 1830 1840 1850 1860 1870 1880 1890 1900 1910 1920 1930 1940 1950 1960 1970 1980 1990 2000 2010 2020109876

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1112131415

USA Credit (change in debt/GDP) since 1834Pe

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Post_WWII_End

Pre_WWII_Start

Panic 1837 WWII End

Numerous negative credit events

One negative

credit event

Pre-1945 Credit average 1.9% p.a.

Post-1945 Credit average 7.5% p.a.

The Debt and Credit Trap• Decline in velocity of

circulation of money as inflation fell, debt levels rose

1960 1965 1970 1975 1980 1985 1990 1995 2000 2005 2010 2015 20201

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Money velocity

https://fred.stlouisfed.org/series/MZMV

GD

P/M

ZM

• Probable cause?• Increasing private

debt burden encourages individual “hoarding”

• Hoarding at individual level causes fall in velocity of money at aggregate level

The Debt and Credit Trap• Need policy to remove dangerous side-effects of Big Government + Fed backstop

• Too high credit-based demand

• Accumulation of too much private debt—see Vague “Brief History of Doom” (the new Mackay/Kindleberger)

• “Abolish private money creation” one option• Side-effects?

• “Modern Debt Jubilee” another• Per-capita “QE for the People”

• Debtor households get debt offset/reduce private debt

• Non-debtor households get cash injection• Spending? If aggregate demand boost needed• Purchase new corporate shares used to reduce corporate debt

• One-off to reduce private debt to ‘50s-60s “Golden Age of Capitalism” levels• Regular MDJs to stop accumulation of private debt past 75% of GDP

A new approach to economics: Minsky• Model economy as the monetary, dynamic, unstable complex system it actually is…

LinearDefinitionsModelSwitchNonlinear.mky

A new approach to economics: Minsky• General Dynamics: far more elaborate models can be built & simulated:• 5 sector model of Portuguese economy (Pratas, Portuguese Statistical Office)

PratasModelPortugal.mky

For more see https://www.patreon.com/ProfSteveKeen• Crowdfunding (from $1/month)

supports my work• Debunking Neoclassical

Economics• Monetary Non-Equilibrium

Macroeconomics• Energy-based real economy

analysis