Private debt to GDP ratios
200
175
150
125
100
75
300
275
250
225
USA
Australia
50
25
0
1870 1880 1890 1900 1910 1920 1930 1940 1950 1960 1970 1980 1990 2000 2010 2020
Flow of Funds Table L1+Census Data; RBA Table D02
Debt-financed demand percent of aggregate demand
25
20
15
10
5
0

5

10

15

20

25
0
Great Depression including Government
Great Recession including Government
1 2 3 4 5 6 7 8 9 10 11 12
Years since peak rate of growth of debt (mid-1928 & Dec. 2007 resp.)
0
13

• How did we go from this…
• To this?
• A Minskian explanation: debt-deflation
Great Moderation to Great Recession
15
U-6 Measure
10
5
0 Inflation 0
Unemployment
U-6 Measure

5
0 10 20 30 40 50 60 70 80 90 100 110
Year

• Debt has macroeconomic impact; contra Bernanke:
– “Fisher’s idea was less influential in academic circles, though, because of the counterargument that debtdeflation represented no more than a redistribution from one group (debtors) to another (creditors).”
(Bernanke 2000, p. 24)
• Minority of economists who predicted crisis displayed:
– “a further concern, that growth in financial wealth and the attendant growth in debt can become a determinant (instead of an outcome) of economic growth …” (Bezemer (2009, p. 10))
• Basic mechanisms:
– Debt expands aggregate demand
– Endogenous money creation
– Financial instability

• Schumpeter: growing debt adds demand beyond that generated by sales of goods & services
• Debt essential for entrepreneurial function
– Entrepreneur often has idea but no money
– Needs purchasing power before has goods to sell
– Gets purchasing power via loan from bank
– Entrepreneurial demand thus not financed by “circular flow of commodities” but by new bank credit
– Since entrepreneurial activities essential feature of growing economy, in real life “total credit must be greater than it could be if there were only fully covered credit. The credit structure projects not only beyond the existing gold basis, but also beyond the existing commodity basis.” (Schumpeter 1934, p. 101)

• “In the real world banks extend credit, creating deposits in the process, and look for the reserves later” (Moore
(1979, p. 539)—quoting Fed economist)
• “There is no evidence that … the monetary base … leads the cycle, although some economists still believe this monetary myth…, if anything, the monetary base lags the cycle slightly…
– The difference of M
2
-M
1 more than M
2 leads the cycle by even with the lead being about three
quarters." (Kydland & Prescott, 1990, p. 14)

• “Stable growth is inconsistent with the manner in which investment is determined in an economy in which debtfinanced 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)
• Current debt-assets price dual bubble biggest in history…

• Asset bubbles & rising debt to GDP
Asset price indices & Debt to GDP
50 300
45
40
35
30
25
20
15
120
90
10
5
60
30
0 0
1880 1890 1900 1910 1920 1930 1940 1950 1960 1970 1980 1990 2000 2010 2020
270
240
210
180
150
Year
Shiller Lagging 10 Year P/E Ratio
Case-Shiller Real House Price Index
US Private Debt to GDP

• Aggregate demand: Income + change in debt
• “Great Moderation” and “Great Recession” debt-driven
Debt financed demand and unemployment
30 12
20
10
10
8
0

10
6
4

20 2
Debt contribution to aggregate demand
Unemployment

30 0
1970 1975 1980 1985 1990 1995 2000 2005 2010 2015

• Change in AD: Change in GDP + acceleration in debt
Debt financed demand and unemployment
30
20
10
0 0
75
50
25
0
• Debt & disequilibriumaware model needed to capture these processes


10
20


25
50
• Minsky’s
Financial
Instability
Hypothesis

30

1970 1975 1980 1985 1990 1995 2000 2005 2010 2015
75
Year
Debt Acceleration
Change in Unemployment

• 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 rises
– Assets revalued upwards…
• “Stability is destabilising”
– Period of tranquility causes expectations to rise…
• Self-fulfilling expectations
– Decline in risk aversion causes increase in investment
– Investment expansion causes economy to grow faster

• Asset prices rise: speculation on assets profitable
• Increased willingness to lend increases money supply
– Money supply endogenous , not under RBA control
• Riskier investments enabled, asset speculation rises
• The emergence of “Ponzi” (Bond, Skase…) 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

• Ponzi financiers go bankrupt:
– Can no longer sell assets for a profit
– Debt servicing on assets far exceeds cash flows
• Asset prices collapse, increasing debt/equity ratios
• Endogenous expansion of money supply reverses
• Investment evaporates; economic growth slows
• Economy enters a debt-induced recession
– Back where we started...
• Process repeats once debt levels fall
– But starts from higher debt to GDP level
• Eventually final crisis where debt burden overwhelms economy

• Foundations
– Goodwin (1967) growth cycle model (Keen 1995)
– Pure credit economy model (Graziani 1989)
• Built using tabular system of ODEs (Keen 2008)
• See blog www.debtdeflation.com/blogs for details
• Especially Roving Cavaliers of Credit post

Financial Sector d d t d d t d d t d d t

RL


 

LC




LC


 

RL


 


B

Inv





LC


 

RL


 

B d d t


W

Physical output, labour and price systems
Level of output
Employment
Rate of Profit



 v


W






Inv






Rate of employment
Rate of real economic growth
Rate of change of wages
Rate of change of prices
Rate of change of capital stock d d t d d t
 t
 t

[ ( )

(
 
) ]
Inv



  v
W t
 

(
 t )
  
[ [ ( )

(
 
) ] ]
 


1

Pc
 


1
 a t

(
 s )
 d d t

1

Pc
  a t

(
 s ) d d t
Rates of growth of population and productivity d d t
  a t d d t
 
N t






N0
BC0
• Nonlinear
BPL0 functions for investment,
FL0
FD0
WD0 wage change, loan repayment, lending from capital
L0
 r 0
 r0

0

0 g0
Yr0
W0
• 3 factor
Phillips curve: employment, rate of change of employment, inflation a0
PC0
Kr0

QED

• Monetary factors

• Production, employment, wages and inflation

• Bernanke, B. S. (2000). Essays on the Great Depression. Princeton, Princeton
University Press.
• Bezemer, D. J. (2009). “No One Saw This Coming”: Understanding Financial
Crisis Through Accounting Models. Groningen, The Netherlands, Faculty of
Economics University of Groningen.
• Blatt, J.M., Dynamic Economic Systems: A Post Keynesian Approach, ME
Sharpe, Armonk.
• Goodwin, R. (1967). “A growth cycle” in C. H. Feinstein (ed.), Socialism,
Capitalism and Economic Growth. Cambridge, Cambridge University Press:
54-58.
• Graziani, A. (1989). "The Theory of the Monetary Circuit." Thames Papers in
Political Economy Spring: 1-26.
• Keen, S. (1995). "Finance and Economic Breakdown: Modeling Minsky's
'Financial Instability Hypothesis.'." Journal of Post Keynesian Economics
17(4): 607-635.
• Keen, S. (2008). Keynes’s ‘revolving fund of finance’ and transactions in the circuit. Keynes and Macroeconomics after 70 Years. R. Wray and M.
Forstater. Cheltenham, Edward Elgar: 259-278.

• Kydland, F. E. and E. C. Prescott (1990). "Business Cycles: Real Facts and a
Monetary Myth." Federal Reserve Bank of Minneapolis Quarterly Review
14(2): 3-18.
• 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.