Se 1 Pr 4 Steve Keen

8/11/2019 Se 1 Pr 4 Steve Keen

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Neoclassical economics ignores debt, banks & money

Keen asserts that putting banks in the story is essential.

Now, Im all for including the banking sector in stories where its relevant;

but why is it so crucial to a story about debt and leverage?... (Krugman 2012)

Ignorance of finance sector due to false model of money & lending

If I decide to cut back on my spending

and stash the funds in a bank, which lends them out to someone else,

this doesnt have to represent a net increase in demand.

(Krugman 2012)

Loanable Funds model of lending

Fixed stock of money (amount controlled by Federal Reserve) Two types of agents (patient & impatient)

Patient generally lendershigh interest rate encourages highvolume of Loanable Funds

Impatient generally borrowersdemand rises as interest rate falls
http://krugman.blogs.nytimes.com/2012/03/27/minksy-and-methodology-wonkish/http://krugman.blogs.nytimes.com/2012/03/27/minksy-and-methodology-wonkish/http://krugman.blogs.nytimes.com/2012/03/27/minksy-and-methodology-wonkish/http://krugman.blogs.nytimes.com/2012/03/27/minksy-and-methodology-wonkish/


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Sustainable development & financial instability

Aggregate debt cant be ignored in a genuine monetary economy

Money is a liability of bank sector to non-bank sectors of economy

Debt an asset of banking sector that sets servicing/repaymentobligations on non-bank sectors

Expansion of bank assets & liabilities therefore increases aggregatedemand

Growth of assets & liabilities is not economic-growth-neutral

If growth of debt results in debt servicing/repayment obligationsthat exceed capacity of non-bank sectors, economic collapseensues.

Banks, debt & money must play essential roles in economic models

Illustrating difference between false Neoclassical vision of lending andaccurate Post Keynesian vision


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Neoclassical vision of lending would ultimatelyappear to bank sector

Assets Liabilities (Deposits) Equity Row Sum

Nothingover here

Patient Impatient

+Loan -Loan 0

No change in aggregate money supply

As lending ultimatelyappears in Post Keynesian model of lending

Assets Liabilities (Deposits) Equity Row Sum

Loans Reserves Patient Impatient

+Loan -Loan 0

Money supply grows by size of the loan

Increase in liabilities shown as minus in double-entry bookkeeping


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In Open Source simulation program Minsky (developers click here)

Loanable Funds:

Endogenous Money:
http://www.debtdeflation.com/blogs/minsky/https://sourceforge.net/p/minsky/home/Home/https://sourceforge.net/p/minsky/home/Home/http://www.debtdeflation.com/blogs/minsky/


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Why does it matter? Neoclassical Loanable

Funds visionnochange in aggregatedemand:

Post KeynesianEndogenous Money

visionaggregatedemand grows as debt

grows

Macroeconomic impact:

Aggregate debt & change

in debt have extremeimpact on economicgrowth

Growing debt createsadditional demand

Causes asset bubbles


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Aggregate Demand = Income + Change in Debt

Aggregate Supply = Good & Services + Net Asset Turnover

dY D GDP NAT

dt+ = +

A A ANAT P Q T=

( )

2

2 A A A

d d d d

Y D GDP P Q T dt dt dt dt + = +

Implications for macro & finance:

Change in debt a factor in level of employment, output Debt acceleration drives change in GDP & asset prices

Change in debt explains crisis (& Great Moderation before it)

Accelerating debt explains why asset bubbles mustburst


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Crisis can only be understood from dynamics of debt

Decline in income relatively mild

20002001200220032004200520062007200820092010201120122013 20149 10

6

1 107

1.1 107

1.2 107

1.3 107

1.4 107

1.5 107

1.6 107

1.7 107

1.8 107

1.9 107

2 107

GDP

USA GDP

www.debunkingeconomics.com

US$Million

BNP

20002001200220032004200520062007200820092010201120122013 20149 10

6

1 107

1.1 107

1.2 107

1.3 107

1.4 107

1.5 107

1.6 107

1.7 107

1.8 107

1.9 107

2 107

GDP

GDP + Debt Change

USA GDP


US$Million

BNP

But decline in debt change huge


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Acceleration of debt drives change in economic activity

1980198219841986198819901992 1994199619982000200220042006200820102012 201430

25

20

15

10

5

0

5

10

15

6

5

4

3

2

1

0

1

2

3

Credit Acceleration

Employment Change

Credit Acceleration & Employment Change (Corr=0.69)

www.debtdeflation.com/blogs

PrivateDebt

Accelerationp.a.a

spercentofGDP

Changein

100minusunemploymentratep.a.

0


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1986 1988 1990 1992 1994 1996 1998 2000 2002 2004 2006 2008 2010 2012 20147

6

5

4

3

2

1

0

1

2

3

4

5

6

7

21

18

15

12

9

6

3

0

3

6

9

12

15

18

21

Mortgage Accelerator

Change in Real House Prices

Mortgage Acceleration & House Price Movements (Corr=0.78)

www.debtdeflation.com/blogs

PercentofG

DP

Percentch

angeinrealCase

-ShillerIndexp.a

.

0


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Accelerating debt drives change in stock market prices

2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 20133

2.5

2

1.5

1

0.5

0

0.5

1

1.5

2

60

50

40

30

20

10

0

10

20

30

40

Margin Acceleration

Share Index Change

Margin Debt Acceleration & Share Price Change (Corr = 0.81)


PercentofGDP

p.a.

Percentrealchan

gep.a.

0


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The Financial Instability Hypothesis

Minsky has best verbal model of debt & instability Economy in historical time

Debt-induced recession in recent past Firms and banks conservative re debt/equity, assets Only conservative projects are funded

Recovery means most projects succeed Firms and banks revise risk premiums

Accepted debt/equity ratio risesAssets revalued upwards

Stability is destabilisingPeriod of tranquility causes expectations to rise

Self-fulfilling expectations

Decline in risk aversion causes increase in investment

Investment expansion causes economy to grow faster

Rising expectations leads to The Euphoric Economy


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The Financial Instability Hypothesis

Asset prices rise: speculation on assets profitable

Increased willingness to lend increases money supply

Money supply endogenous, not controlled by CB

Riskier investments enabled, asset speculation rises

The emergence of Ponzi financiers

Cash flow less than debt servicing costs

Profit by selling assets on rising market Interest-rate insensitive demand for finance

Rising debt levels & interest rates lead to crisis

Rising rates make conservative projects speculative

Non-Ponzi investors sell assets to service debts

Entry of new sellers floods asset markets

Rising trend of asset prices falters or reverses


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Explicitly Monetary Minsky Model

Full system of 14 coupled differential equationsFinancial Sector

tBVt( )d

d

F

L

t( )

RL rt( )( )

B

V

t( )

LC rt( )( ) BV0( ) BV0

tBTt( )

d

drLFLt( ) rDFDt( ) rDHDt( )

BTt( )

B BT0( ) BT0

tFLt( )

d

d

BVt( )

LC rt( )( )

FLt( )

RL rt( )( ) P t( ) Yrt( ) Inv rt( )( )+ FL0( ) FL0

tFDt( )d

drDFDt( ) rLFLt( )

B

V

t( )

LC rt( )( )+

F

L

t( )

RL rt( )( )

B

T

t( )

B+

H

D

t( )

W+ P t( ) Yrt( ) Inv rt( )( )+

W t( ) Y

r

t( )

a t( ) FD0( ) FD0

tHDt( )

d

drDHDt( )

HDt( )

W

W t( ) Yrt( )

a t( )+ HD0( ) HD0

Physical output, labou r and price systems

Level of output Yr0( ) Yr0Yrt( )Krt( )

v

Employment L t( )Yrt( )

a t( )L 0( ) L0

Rate of Profit rt( )P t( ) Yrt( ) W t( ) L t( ) rLFLt( ) rDFDt( )( )

v P t( ) Yrt( ) r0( ) r0

Rate of employmentt t( )d

d t( ) g t( ) +( )[ ] 0( ) 0

Rate of real economi c growth g t( )Inv rt( )( )

v g 0( ) g0


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Generates both Great Moderation & Great Depression

0 10 20 30 40 50 6025

20

15

10

5

0

5

10

15

20

25

0

100

200

300

400

500

Inflation

Unemployment

Debt to GDP

Inflation, Unemployment and Debt

Inflatio

n&

UnemploymentPercent

De

bttoGDPRatioP

ercent

0


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Fits stylized facts of crisis

1980 1985 1990 1995 2000 2005 2010 20155

2.5

0

2.5

5

7.5

10

12.5

15

1

1.5

2

2.5

3

Unemployment

Inflation

Debt to GDP

Unemployment, Inflation & Debt (smoothed)

Year

Percent

RatiotoGD

P

0


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Debt and Inequality

Model fundamentally has 3 system states:

Rate of Employment

Debt to GDP ratio Workers share of output

Equilibria of model involve

Rate of Employment

Debt to GDP ratio

Capitalistsshare of output

Workers income a residual after capitalists & bankers income

Residual necessarilyfalls as debt ratio rises

Workers pay for rising debt even if they have nodebt

Necessarylink between rising debt & rising inequality


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Debt and Inequality

If income distribution ignored, all appears well until catastrophe strikes

0 5 10 15 20 25 30 35 40 45 50 55 600

10

20

30

40

50

60

70

80

90

100

WorkersCapitalists

Bankers

Income distribution & economic breakdown

PercentofGDP

Essential to restrain level of private debt to limit damaging inequality


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References

Grasselli, M. and B. Costa Lima (2013). An analysis of the Keen modelfor credit expansion, asset price bubbles and financial fragility.

Mathematics and Financial Economics: 1-20. Keen, S. (2013). Predicting the Global Financial CrisisPost

Keynesian macroeconomics. Economic Record

Krugman, P. (2012). Minsky and Methodology (Wonkish). TheConscience of a Liberal

http://krugman.blogs.nytimes.com/2012/03/27/minksy-and-methodology-wonkish/ 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.
http://krugman.blogs.nytimes.com/2012/03/27/minksy-and-methodology-wonkish/http://krugman.blogs.nytimes.com/2012/03/27/minksy-and-methodology-wonkish/


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Not Double-counting

Income is wages plus profitsI

Y W= + Divide profits into

Distributed profits Retained profits

I D RY W W= + = + + Expenditure (ignoring asset markets & government for the moment)

Is money spent buying either Consumer Goods or Capital Goods

= +W WC

dC W D

dt

Two sources of demand for Consumer Goods: Workers & CapitalistsEY C I= +

= +D Cd

C Ddt

Borrowing by workers for consumption Can be negative (=savings)

Borrowing by capitalists for consumption Can also be negative (=savings)


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Not Double-counting

Two sources of demand for Investment Goods

Retained earnings

New debt

Comparing the two equations

= +R FIdI Ddt

EY C I= +

( )

= + + +

E W R FI

dY C C D

dt

Borrowing by firms for investment Can be negative (=savings)

= + + + + +

E WC D C R FI

d d dY W D D D

dt dt dt


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Not Double-counting

Rearranging

( )

= + + + + +

E D R WC C FI

d d dY W D D D

dt dt dt Subtract income from expenditure

( ) ( )

= + + + + + + +

E I D R WC C FI D R

d d dY Y W D D D W

dt dt dt

So expenditure equals income plus the change in debt= + + +E I WC C FI

d d dY Y D D D

dt dt dt Stillsounds like double-counting?

Yes probably: because of ex-ante vs ex-post confusion

Mathematical equality of recordedincome & expenditure (ex-post) Even though differ ex-ante (before the event)

Debt injected at discrete points in time

Added to spending from income at that time

After that time, debt has boosted incomes Recorded levels are the same


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Not Double-counting

In a picture

Income at time tChange in debt

Expenditure at time t

Measured income at time t is income looking back( ) lim ( )

s tI I

Y t Y s+

+ =

This is identical toexpenditure at time t

( ) ( ) ( ) ( )E I IY t Y t Y t D t

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Se 1 Pr 4 Steve Keen