The overdue Copernican Revolution in Economics
Steve Keen
Kingston University London
IDEAeconomics
Minsky Open Source System Dynamics
www.debtdeflation.com/blogs
What does Economics have in common with Ptolemy?
• (1) The propensity to start from “a priori” beliefs rather than research
• (2) A plausible but false model of reality
• Ptolemy’s starting point: Aristotle’s vision of the universe…
– “the heavens were literally composed of 55 concentric, crystalline
spheres to which the celestial objects were attached and which
rotated at different velocities with the Earth at the center”
• Ptolemy’s puzzle: how to reconcile this
vision with the observable behaviour of
the planets (“wanderers” in Greek)?
• Answer: epicycles—spheres on spheres
• Literally any actual
path can be described
using epicycle
• So the model was
plausible—but wrong
What does Economics have in common with Ptolemy?
• Ditto economics on many topics—but especially money
• Economics’ starting point: Adam Smith & “The propensity
to truck & barter…”
• “THIS division of labour, from which so many advantages
are derived, is …the necessary …consequence of a certain
propensity in human nature …
• the propensity to truck, barter, and exchange one thing
for another…
• It is common to all men, and to be found in no other race
of animals, which seem to know neither this nor any other
species of contracts…
• Nobody ever saw a dog make a fair and deliberate
exchange of one bone for another with another dog…”
• Origin of Neoclassical vision of money as “veil over barter”
• Ensconsed in mainstream macroeconomics
– Banks, debt and money play no essential role…
What does Economics have in common with Ptolemy?
• What brought Ptolemaic astronomy to an end?
– More realistic (but incomplete!), simpler observation-based theory
– Anomalies: moons orbiting Jupiter, craters on the Moon
– Accurate predictions of extended Copernicus model
• Elliptic motion replaces circular, epicycles eliminated
• Newton’s theory of gravity
– Accurate prediction of Halley’s comet
• What could have brought Neoclassical economics to an end?
– The global financial crisis of 2007
• Not merely failure to predict an event
• But a complete anomaly in their equilibrium, non-monetary
vision of the economy
• Here economics differs from astronomy
– Laymen thought astronomers were experts on “the heavens”: True
– Laymen think economists are experts on money: False!
The conventional “veil over barter” vision of money
• Mainstream economics generally ignores banks, debt & money
– “self-proclaimed true Minskyites view banks as institutions that are
somehow outside the rules that apply to the rest of the economy, as
having unique powers for good and/or evil.
– I guess I don't see it that way.
– As I (and I think many other economists) see it, …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.
– I know I'll get the usual barrage of claims that I don't understand
banking; actually, I think I do, and it's the mystics who have it
wrong.” (Krugman 2012, “Banking Mysticism”)
• If Krugman’s model of banking were accurate, debt would have “no
significant macroeconomic effects” (except during a liquidity trap)
The conventional “veil over barter” vision of money
• “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, pp. 146-47)
• “The idea of debt-deflation goes back to Irving Fisher… 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 macroeconomic effects.” (Bernanke 200, p. 24)
• Let’s check this out:
• Modeling Eggertsson & Krugman’s 2012 model in Minsky…
– a system dynamics program tailored for monetary modeling
System dynamics
• Graphical method of building dynamic models
– Invented in 1950s
– “Bread & butter” in engineering & manufacturing process control
• Matlab’s Simulink (retail price about US$20,000), Vissim…
– Commonplace in sociology
• Vensim, Stella…
• Build equations using a flowchart…
• Program builds equations in the background…
Output  0
Productivity  0
Employment 
Output
Productivity
• Overkill for simple equations, essential for complex dynamic systems…
System dynamics
• Dynamics—systems with rates of change
• Integrals used for technical reasons…
• Model now an “Ordinary Differential Equation”
CO ratio  3
Productivity  1
Investment  30
Output 
Capital
CO ratio
Output
Employment 
Productivity
Capital(0)  300
dCapital
 Investment
dt
• “Ordinary”: involves time but not location
• “Differential”: rate of change modelled
– Dynamics & change
– Not “statics” & equilibrium
• Models get interesting with more “system
states” (variables) & nonlinearity
• Minsky adds ability to model money flows
using accounting “double entry
bookkeeping”…
System dynamics for monetary flows
• Flowchart paradigm works really well for physical flows
– Petrol in tank flowing into cylinder…
– One direction only
• Difficult to impossible for financial flows
– Every transaction has two “directions”
• Out of one account, into another
• Operation has to have opposite signs
– Easy to forget in flowchart, get signs wrong
• Solution: borrow idea from accountants
– Double-entry bookkeeping
– Record every transaction on one row
• Two entities (buyer and seller) recorded on one row
– Every row “sums to zero”
– For example, a simple “Buy and Sell” between two agents…
System dynamics for monetary flows
• From the banking sector’s point of view…
• From the buyer’s point of view…
• And the seller’s
The conventional “veil over barter” vision of money
• Using Minsky to model Krugman’s conventional vision of lending:
– “Patient people” lend to “impatient people”
– Banks just “intermediate” between the two groups
– Therefore lending doesn’t change demand…
• “Keen then goes on to assert that lending is, by definition (at least as I
understand it), an addition to aggregate demand. I guess I don’t get
that at all.
• If I decide to cut back on my spending and stash the funds in a bank,
– which lends them out to someone else,
– this doesn't have to represent a net increase in demand.
• Yes, in some (many) cases lending is associated with higher demand,
because resources are being transferred to people with a higher
propensity to spend;
• but Keen seems to be saying something else, and I'm not sure what.
• I think it has something to do with the notion that creating money =
creating demand, but again that isn’t right in any model I understand.”
The conventional “veil over barter” vision of money
• Modeling “patient lends to impatient” in Minsky
• Lending from one
deposit account
(“Patient”) to
another
(“Impatient)
• Shown as
“Crediting”
Patient &
“Debiting”
Impatient because
Deposits are
liabilities of bank
• Can also use + and
– (which I prefer)
The conventional “veil over barter” vision of money
• Full model: Bank arranges loan from Consumer sector (Patient) to
investment (Impatient) sector & charges intermediation fee
• Workers hired, output produced & sold, investment…
Bank Balance Sheet
Flows\Stocks
Initial Conditions
Lending
Debt Repayment
Interest Payments
Bank Fee
Hire Workers (C)
Hire Workers (I)
Purchases (I)
Purchases (C)
Workers Consumption
Bankers Consumption
Bankers Investment
Assets
Reserves
100
ID
-20
-Lend
Repay
int
WI
IC
-CI
Liabilities
CD
-60
Lend
-Repay
-int
Fee
WC
-IC
CI
-CW
-CB
WD
-15
Equity
BE
-5
-Fee
-WC
-WI
CW
-IB
• Debt doesn’t appear here: Asset of Consumer Sector…
CB
IB
The conventional “veil over barter” vision of money
• Consumer Sector “Godley Table”
Assets
Equity
CNW
-70
Flows\Stocks
CD
D
Initial Conditions
60
10
Lending
-Lend
Lend
Debt Repayment
Repay
-Repay
Interest Payments
int
-int
Bank Fee
-Fee
Fee
Hire Workers (C)
-WC
WC
Bankers Consumption
CB
-CB
Purchases (I)
CI
-CI
Workers Consumption
CW
-CW
Purchases (C)
-IC
IC
• Lending reduces Consumer Sector’s Asset of Cash at the Bank
• Increases Consumer Sector’s Asset of Loan to Investment Sector
• Consumer Sector’s does without Cash for duration of Loan
The conventional “commodity” vision of money
• Simulated, Krugman/Bernanke correct: debt doesn’t matter…
The conventional “commodity” vision of money
• But a “Mystical” thought: what if banks are actually the lenders???
The correct “Endogenous” view of money
• Bank lending does matter!
– Money created by it
– Demand created too
• Bank doesn’t “sacrifice” to
make loan
– Creates money by lending
• Nothing foregone by
bank to enable lending
– Benefits from growth in
level of debt
• Costless production of
money gives incentive to
over-produce
• Asked for $100,000.00 overdraft
– New Zealand petrol
• Bank clerk didn’t press decimal point
station owner story…
• One less keystroke…
• 100 times as much money created
Endogenous money & systemic crises
• Smith’s “Truck & barter” vision of origins of money a myth.
– Money originated in credit (Graeber 2011; Martin 2013)
– Demand-generating effect of bank lending causes booms & busts…
• Hyman Minsky on the unstable & monetary nature of capitalism
– “In this "Chicago" view there exists a financial system… which
would make serious financial disturbances impossible. It is the task
of monetary analysis to design such a financial system, and of
monetary policy to execute the design…
– The alternative polar view, which I call unreconstructed Keynesian,
is that capitalism is inherently flawed, being prone to booms, crises,
and depressions.
– This instability, in my view, is due to characteristics the financial
system must possess if it is to be consistent with full-blown
capitalism.
– Such a financial system will be capable of both generating signals
that induce an accelerating desire to invest and of financing that
accelerating investment.” (Minsky 1982, p. 279)
Minsky’s “Financial Instability Hypothesis”
• “The natural starting place for analyzing the relation between debt and
income is to take an economy with a cyclical past that is now doing
well…
• As the period over which the economy does well lengthens, two things
become evident in board rooms. Existing debts are easily validated and
units that were heavily in debt prospered; it paid to lever…
• Stable growth is inconsistent with the manner in which investment is
determined in an economy in which debt-financed 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, pp.
66-67)
• My contribution: modelling Minsky by extending nonlinear cyclical but
non-monetary Goodwin model
Goodwin’s cyclical growth model
• Goodwin’s simple cyclical growth model
fn     S     0 
K
– Capital determines output
Y
L
Y
v

L
– Output determines employment
N
a
d
– Employment rate determines rate of change of wages fn  wr  wr
dt
– Wages determine Profits wr  L  W Y  W  
– Profits determine Investment
I
– Investment is the rate of change of Capital I  K    dK  K
dt
– Generates cyclical growth…
• where
da
 a   and
dt
dN
 N   • Reduces to
dt
d
 1 
 • Generates sustained cycles even
   
       
with a linear “Phillips curve”
dt
 v

• Cycles caused by inherent
d
     fn      
nonlinearities…
dt
Minsky’s “Financial Instability Hypothesis”
• Goodwin’s non-monetary model…
Minsky’s “Financial Instability Hypothesis”
• Adding monetary realism…
– Investment exceeds profits during boom
– Investment less than profits during a slump
– Difference financed by change in debt
– Banks charge interest on debt…
• Endogenous money key here—debt financed spending boosts demand
• Crucial features of extended model
– Complexity: regular behaviour of base model replaced by potential
for complex behaviour
• “Stability leads to instability”
– Rising debt to GDP ratio: instability
– With rising ratio comes apparent “Great Moderation”
• Declining volatility in employment & inflation (proxy)
– Then subsequent breakdown
– Rising inequality with falling workers’ share of output
• Even though firms borrow, not workers…
Goodwin’s cyclical growth model
• Empirically realistic with nonlinear Phillips curve
– Forthcoming paper by Grasselli
• (Contra Harvie 2000—simple error in econometrics)
• Average of cycle conforms to average of 8/10 OECD countries
• My Minsky extension
– (Nonlinear) Investment function based on rate of profit
• Capitalists invest more than profits during boom
• Less than profits during slump
– Linear function used here for simplicity
– Investment minus profit gap financed by change in debt
– Profit net of interest on debt
r 
n Y W  r  D  n


K
K
v
I fn   r   E    S
I fn  Y  I
• Reduces to 3-dimensional system where “Period Three Implies
Chaos” (Li and Yorke 1975)…
dD
 I  n
dt
Goodwin + Minsky = Chaos
• Third system state is debt to output ratio d:
• Employment rises if growth exceeds d
  I fn  r 


   
        
population growth + technical


dt
v




change
• Wage share rises if wage demand d
     fn      
exceed productivity
• Debt rises if Investment>Profits or dt
 I fn  r 

Growth negative with positive debt d
d  I fn  r    n  d  
 
• Two non-trivial equilibria:
dt
 v

– “Good” (Grasselli & Costa Lima 2013)
• Positive wages share & employment rate, finite debt
– “Bad”
• Zero wages share & employment rate, infinite debt
– Bad equilibrium stable under some parameter & initial conditions
• Peculiar nature of cycles towards “Bad” equilibrium
– Debt to GDP rises
– Cycles in employment & wages diminish and then grow
– Wages share of output declines…
Goodwin + Minsky = Chaos
• Systemic behaviour applies even with linear behavioural functions…
• Initially diminishing
cycles
• Then increasing
volatility
• With cyclically rising
debt ratio
• And diminishing
wages share
• Inequality rises as
crisis approaches
• Workers pay for
higher debt in
lower wages share
• Even though they
do not borrow…
Emergent inequality
• Goodwin model’s equilibria involve 2 system states  and 
– With linear Phillips curve:
e  0 

S
e  1  v        
• Minsky model equilibria involve , d and profit share s
e  0 
s 
e
v2
S

0
S
        v   E  0
 S  v           S   E

de  v 
      S
 0
• Wages share a residual negative function of s and d:
e  1   s  r  d e
e
Emergent inequality
• Model dynamics involve
– Cycles around equilibrium values for  and S
– Falling wages share compensates for rising debt servicing costs
• Declining workers’ share lulls capitalists into false sense of
security as debt level rises
– Profits cyclical around equilibrium level…
– Until exponential debt relation overwhelms falling wages share
– Then collapse: zero employment, zero wages, infinite debt, infinitely
negative profit rate
– Fundamentally unstable dynamics of pure credit economy without
government or bankruptcy…
Minsky’s “Financial Instability Hypothesis”
• Minsky cycle in extended model
Minsky’s “Financial Instability Hypothesis”
• 1995 paper Conclusion (written in 1992 before end of 1990s recession):
– “From the perspective of economic theory and policy, this vision of
a capitalist economy with finance requires us to go beyond that
habit of mind which Keynes described so well, the excessive reliance
on the (stable) recent past as a guide to the future.
– The chaotic dynamics explored in this paper should warn us against
accepting a period of relative tranquility in a capitalist economy as
anything other than a lull before the storm.”
• Post 1992 economic history…
The “Great Moderation”?
• Declining levels of & volatility in employment and inflation
Unemployment and Inflation 1980-2008
15
Percent & Percent per year
Unemployment
Inflation
10
5
0
1980
1990
2000
www.debtdeflation.com/blogs
2010
The “Great Moderation”?
• Neoclassicals saw “The End of History”
– Lucas in 2003
• “Macroeconomics was born as a distinct field in the 1940's, as a
part of the intellectual response to the Great Depression.
• The term then referred to the body of knowledge and expertise
that we hoped would prevent the recurrence of that economic
disaster.
• My thesis in this lecture is that macroeconomics in this original
sense has succeeded:
• Its central problem of depression prevention has been solved, for
all practical purposes, and has in fact been solved for many
decades. (Lucas 2003 , p. 1 ; emphasis added)..
– Bernanke in 2004…
The “Great Moderation”?
– “As it turned out, the low-inflation era of the past two decades has
seen not only significant improvements in economic growth and
productivity but also a marked reduction in economic volatility, both
in the United States and abroad, a phenomenon that has been
dubbed "the Great Moderation."
– Recessions have become less frequent and milder, and quarter-toquarter volatility in output and employment has declined
significantly as well.
– The sources of the Great Moderation remain somewhat
controversial, but as I have argued elsewhere, there is evidence for
the view that improved control of inflation has contributed in
important measure to this welcome change in the economy.”
(Bernanke 2004; emphasis added)
• The OECD in June 2007…
The “Great Moderation”?
• “In its Economic Outlook last Autumn, the OECD took the view
that the US slowdown was not heralding a period of worldwide
economic weakness, unlike, for instance, in 2001.
• Rather, a “smooth” rebalancing was to be expected, with Europe
taking over the baton from the United States in driving OECD
growth.
• Recent developments have broadly confirmed this prognosis.
Indeed, the current economic situation is in many ways better than
what we have experienced in years. Against that background, we
have stuck to the rebalancing scenario.
• Our central forecast remains indeed quite benign: a soft landing in
the United States, a strong and sustained recovery in Europe, a
solid trajectory in Japan and buoyant activity in China and India.
In line with recent trends, sustained growth in OECD economies
would be underpinned by strong job creation and falling
unemployment.” (Cotis 2007 , p. 7)
The “Great Moderation”?
• Rising private debt: the factor ignored by Neoclassical economists
Private Debt to GDP 1980-2008
180
Percent of GDP
160
140
120
100
80
1980
1990
2000
www.debtdeflation.com/blogs
2010
Breakdown
• Crisis began when rate of growth of debt collapsed…
Private debt level & growth rate
Crisis
Percent of GDP
Level
Rate of Change
40
160
30
140
20
120
10
100 0
0
80
1980
1990
2000
www.debtdeflation.com/blogs
2010
 10
Percent of GDP p.a.
180
Breakdown
• Unemployment exploded, inflation became deflation (before rescue)
Unemployment and Inflation 1980-2010
Percent & Percent per year
15
Crisis
10
5
0
0
Unemployment
Inflation
5
1980
1990
2000
www.debtdeflation.com/blogs
2010
Debt & macroeconomic dynamics
• Change & acceleration of aggregate private debt drive economic cycle
Unemployment and Change in Debt 1990-Now
12
20
Crisis
Percent
10
8
6
0
0
4
Unemployment
Change in Debt
2
1990
Correlation -0.9
2000
www.debtdeflation.com/blogs
2010
 10
Percent of GDP per year
10
Debt & macroeconomic dynamics
• Change & acceleration of aggregate private debt drive economic cycle
Change in Unemployment and Debt Acceleration 1990-Now
5
Crisis
60
Percent per year
0
0
40
5
20
 10
0
Unemployment Change
Debt Acceleration
 20
1990
Correlation -0.89
2000
www.debtdeflation.com/blogs
2010
 15
Percent of GDP per year per year
80
Debt & macroeconomic dynamics
• Change & acceleration of aggregate private debt drive economic cycle
Real House Price and Change in Mortgage Debt 1990-Now
180
10
Crisis
Index
Mortgage Change
5
140
120
0
0
100
Correlation 0.61
80
1990
2000
www.debtdeflation.com/blogs
2010
5
Percent of GDP per year
Inflation Adjusted Index
160
Debt & macroeconomic dynamics
• Change & acceleration of aggregate private debt drive economic cycle
Change in House Prices and Mortgage Acceleration 1990-Now
4
Crisis
10
2
0 0
0
 10
2
 20
4
House Price Index Change
Mortgage Acceleration
 30
1990
Correlation 0.79
2000
www.debtdeflation.com/blogs
2010
6
Percent of GDP per year per year
Inflation-adjusted percent per year
20
Role of debt in aggregate demand & income
• Key aspect of Minsky model is change in debt boosts aggregate demand
• Shown to be stock-flow consistent by Grasselli & Costa Lima 2013
• But some Post Keynesians believe wrong in accounting:
– “Unless Keen (2014a) can explain how a purchase of a good or
service does not provide income for the seller, then he should
rethink his claim that debt extensions can force an inequality
between expenditure and income at the aggregate level” (Fiebiger
2014)
• Not inequality, but causal role for change in debt in both demand &
income…
Role of debt in aggregate demand & income
• Deriving role of change in debt in aggregate demand & income from an
expenditure table
– 3 sectors, 3 situations
• No borrowing is possible (“Say’s Law”)
• Borrowing from other agents is possible (“Loanable Funds”)
• Banks lend to non-banks (“Endogenous Money”)
– 2 types of expenditure:
• Financed out of existing money
– Exy: Expenditure by sector x to buy from sector y
• Financed by borrowing
– DD for single instance
– dD/dt for flow of debt in continuous time
Role of debt in aggregate demand & income
• Expenditure Table
– Rows show expenditure by each sector
– Columns show net income
– Negative sum of diagonal is aggregate demand
– Sum of off-diagonal elements is aggregate income
• Simplest “Say’s Law” (really “demand creates its own supply…”)
"S1"
"S2"
"S3"
"Activity\Sector"



E
E
 "Expenditure"  E1 2  E1 3
1 2
1 3

SL  

"Expenditure"
E
 E
E 
E
2 1
2 1
2 3
2 3


 "Expenditure" Aggregate
E
E
 E
 E 
income
3 1
3 2
3 1
3 2 

Aggregate income
• Aggregate demand AD( SL)  E1 2  E2 1  E1 3  E3 1  E2 3  E3 2
• Aggregate income
AY( SL)  E
1 2
E
2 1
E
1 3
E
3 1
E
2 3
E
3 2
Role of debt in aggregate demand & income
• Loanable Funds: Sector 1 borrows DD from Sector 2
– Sector 1 spends borrowed funds in proportion ,1- on 2 & 3
– Sector 2 spends that much less in proportions ,1- on 1 and 3
"S1"
"S2"
"S3"
"Activity\Sector"



"Expenditure"
 E
  DD   E
 ( 1  )  DD 
E
  DD
E
 ( 1  )  DD

1 2
1 3

 1 2
 1 3

LF  
"Expenditure"
E
   DD
 E
   DD   E
 ( 1   )  DD  E
 ( 1   )  DD 
2

1
2

1
2

3
2

3






 "Expenditure"

E
E
E
E
3 1
3 2

 3 1 ( 3 2) 
In Endogenous money, the ?D that increases Sector 1's expenditure emanates from a loan from the banking sector (not shown here)
ncreases the banking sector's assets and liabilities
AD( LFequally.
) collect DD  E
E
E
E
E
E
• Aggregate demand
• Aggregate income
1 2
AY( LF) collect DD  E
1 2
2 1
E
2 1
1 3
E
1 3
3 1
E
3 1
2 3
E
2 3
3 2
E
3 2
• Increase in spending power of borrower offset by decrease in
spending power of lender
• Neoclassicals logically correct that, if this accurately describes lending,
“pure redistributions should have no significant macroeconomic
effects”…
Role of debt in aggregate demand & income
• Endogenous Money: Sector 1 borrows DD from banking sector
– Sector 1 spends borrowed funds in proportion ,1- on 2 & 3
"S1"
"S2"
"S3"
"Activity\Sector"



"Expenditure"
 E
  DD   E
 ( 1  )  DD  E
  DD E
 ( 1  )  DD

1 3

 1 2
 1 3
 1 2
EM  

"Expenditure"
E
 E
E 
E
2 1
2 1
2 3
2 3


 "Expenditure"
E
E
 E
E  
3 1
3 2
3 1
3 2 

• Aggregate demand
AD( EM) collect DD  DD  E
1 2
E
2 1
E
1 3
E
3 1
E
2 3
E
3 2
AY( EM) equals
collect DD
 DD  E
E
E
E
E
E
expenditure
• Aggregate income Income
1 2
2 1
1 3
3 1
2 3
3 2
• Both Aggregate demand
and aggregate income include change in debt
Expenditure
• How to interpret?
– Aggregate demand & aggregate income include
• Expenditure/Income from currently existing money
• Plus expenditure/income from newly created debt-money
• Next, Loanable Funds & Endogenous Money in continuous time
Role of debt in aggregate demand & income
• Loanable funds: flow of lending from Sector 2 to Sector 1
• Sector 1 pays interest to Sector 2
S1
"Activity\Sector"

S1
 S1
d 

 D   rL D
 "Expenditure" 

  12  13 dt 

S2
d
 "Expenditure"
  D
 21
dt


S3
 "Expenditure"

 31

• Aggregate demand
 
AD LF2
simplify
S2
S1
d
  D  rL D
 12
dt
S2
 S2
d 


 D
  21  23 dt 
S3
 32


S1
d
 ( 1  )  D 
 13
dt 

S2
d 
 (1   ) D
 23
dt 

S3 
 S3





  31  32  
S3
• Interest is part of aggregate demand/income

collect S1S2S3
 1  1   S   1  1   S   1  1   S  D r

L
 13  1   21  23  2   31  32  3
12






• Aggregate income
 
AY LF2
simplify

collect S1S2S3
 1  1   S   1  1   S   1  1   S  D r

L
 13  1   21  23  2   31  32  3
12






Role of debt in aggregate demand & income
• Endogenous Money: Bank loans flow to Sector 1
• Sector 1 pays interest to Banking sector
• Banking sector pays deposit interest to non-bank sectors
S1
S2
S3
BE
"Activity\Sector"



S
S
S
S


 1
1
1
1
d 
d
d
rL D
 "Expenditure"      D   rL D    D   ( 1  )  D

dt 
dt
dt
12
13
12
13





S2
S2 
S2
 S2
 "Expenditure"



0

 21
 21  23
 23






S3
S3
S3 
 S3
 "Expenditure"



0


 31
 32

  31  32 


B
B
B
B
B
B









E
E
E
E
E
E

 rD S1
 rD S2
 rD S3

 rD S1   
 rD S2   
 rD S3 
 "Expenditure"

 B1
 B2
 B3

  B1
   B2
   B3
 
• Aggregate demand

simplify



 S1  S2  S3  rD 
collect rD S1S2S3BE
AD EM3
 1  1   S   1  1   S   1  1   S   1  1  1   B  dDdt  D r

 1 
 2 
 3 
 E
L
 12  13 
 21  23 
 31  32 
 B1  B2  B3 
• Aggregate income


AY EM3
simplify


 S1  S2  S3  rD 
collect rD S1S2S3 BE
 1  1   S   1  1   S   1  1   S   1  1  1   B  dDdt  D r

 1 
 2 
 3 
 E
L
 12  13 
 21  23 
 31  32 
 B1  B2  B3 
• Change in debt (+ deposit & loan interest) components of both
Role of debt in aggregate demand & income
• Corrected insights on role of debt in aggregate demand & income
– Expenditure/Income is
• That financed by existing money
• Plus that financed by the change in debt
– Plus gross financial transactions
ADEM
AYEM
 1
 1
 1
 1
1 
1 
1 
1
1 






  S1  
  S 2  
  S3  
  BE









1,3 
2,3 
3,2 
B ,2
B ,3 
 1,2
 2,1
 3,1
 B ,1
d
 rD   S1  S 2  S3   rL  D  D
dt
 1
 1
 1
 1
1 
1 
1 
1
1 



S



S



S



 1 
 2 
 3 
  BE

 1,2  1,3 
  2,1  2,3 
  3,1  3,2 
  B ,1  B ,2  B ,3 
d
 rD   S1  S 2  S3   rL  D  D
dt
• Which implies:
ADEM  AYEM
d
 V  M  D  rD  M  rL  D
dt
Role of debt in aggregate demand & income
• So the change in aggregate demand is…
d2
d
d
d
AD  M  V  V  D  2 D
dt
dt
dt
dt
d
d
d
d
 rL
D  Drule
 rD  D  M  rD  rL Product
dt
dt
dt
dt
expansion
• All there is in Loanable Funds macro
• Substituting that dM/dt=dD/dt
• Change & acceleration of debt affect change in aggregate demand
• Explanation for high correlations between change in debt & level of
unemployment, acceleration in debt & change in unemployment…
Debt & macroeconomic dynamics
• So rather than being an unpredictable “Black Swan”
• Crisis was a predictable consequence of lending-driven boom
• Is this all history? Will “It” never happen again?
Debt to GDP Ratios
200
180
Trivial
deleveraging
Private
Government
160
Percent of GDP
140
120
100
80
60
40
20
0
1800 1820 1840 1860 1880 1900
1920 1940 1960 1980 2000
www.debtdeflation.com/blogs
2020
Is this all history? Will “It” never happen again?
• Current revival beginning from highest level of private debt in history
Private debt level & growth rate
Percent of GDP
Level
Rate of Change
Crisis
• “It” will happen
again, & sooner
than last time (15
years 1992-2007)
40
30
160
20
10
140
0
120
2000
0
2005
2010
www.debtdeflation.com/blogs
2015
 10
Percent of GDP p.a.
180
The “Ptolemy” in mainstream economics
• Many other flaws of mainstream economics
– Sraffa’s critique of aggregation of capital
• Profit can’t be “marginal product” of capital
– McCombie’s critique of Cobb-Douglas production function
• A tautology that simply transforms Income=Wages + Profits
• Textbook teaching mendacious: teaches theory minus flaws
• You are shown Dorian Gray • The reality is more like his portrait…
• Some examples…
The “Ptolemy” in mainstream economics
• Equilibrium fixation. Yesterday CGE, today DSGE…
– “If I drop a ripe watermelon from this 15th-floor window, I suppose
the whole process from t0 to the mess on the sidewalk could
be described as some sort of dynamic equilibrium. But that may
not be the most fruitful—sorry—way to describe the fallingwatermelon phenomenon.” (Solow “Dumb & Dumber in Macro”)
• Modern dynamics is “far from equilibrium”… E.g., Lorenz’s “butterfly”
The “Ptolemy” in mainstream economics
• Theory: utility maximizing
• “the evidence for the utility
consumers choosing optimum
maximization hypothesis is at best
consumption bundles subject to
mixed.
income constraint
• While there are subjects who
appear to be optimizing, the
majority of them do not.
• The high power of our test might
explain why our conclusions differ
from those of other studies where
optimizing behavior was found to
be an almost universal principle
applying to humans and nonhumans as well.
• In contrast to this, we would like
to stress the diversity of individual
• Reality: Sippel’s 1997 realistic test of behavior and call the universality
of the maximizing principle into
revealed preference theory:
question…”
The “Ptolemy” in mainstream economics
• Theory: upward supply curve…
– Rising marginal cost as a
natural consequence of
fixed & variable inputs…
• Empirical observation: most
firms have declining or
constant marginal costs
• Alan Blinder 1999 survey:
The “Ptolemy” in mainstream economics
• “Another very common assumption of economic theory is that
marginal cost is rising. This notion is enshrined in every textbook and
employed in most economic models.
• It is the foundation of the upward-sloping supply curve.
• However, as we have noted already, Hall has used constant MC as the
basis for one family of models of price stickiness. What do business
people have to say about their own cost structures?”
• “Firms report having very high fixed costs—roughly 40 percent of total
costs on average.
• And many more companies state that they have falling, rather than
rising, marginal cost curves. While there are reasons to wonder whether
respondents interpreted these questions about costs correctly,
• their answers paint an image of the cost structure of the typical firm
that is very different from the one immortalized in textbooks.”
– Alan Blinder, ex-Vice President of American Economic Association
– (Click here for downloadable chapters—Chapter 4 the core)
The “Ptolemy” in mainstream economics
• “Can an arbitrary continuous function
• The “downward sloping
… be an excess demand function for
market demand curve”
some commodity in a general
• “The market demand curve is
equilibrium economy?...
found by adding together the
quantities demanded by all
• we prove that every polynomial … is
individuals at each price.
an excess demand function for a
specified commodity in some n
• Does the market demand curve
commodity economy…
obey the law of downwardsloping demand?
• every continuous real-valued function
is approximately an excess demand
• It certainly does.”
function.
– Samuelson and Nordhaus
– Sonnenschein 1972 , pp. 549-550
2010, p. 48
• Doesn’t assert that demand doesn’t normally fall with price
• Says Neoclassical theory can’t explain why
• Emergent phenomenon: aggregate individuals with
downward-sloping demand curves…
• Get any (polynomial) shaped demand curve at all
The “Ptolemy” in mainstream economics
• “Perfect” competition…
• So the demand curve P(q) for the
single firm is flat, so thatdP/dq=0?
• Not according to Stigler…
d
d
d
d
TR 
Pq  P q  q P
dq
dq
dq
dq
where
d
d
d
d
d
P
P Q 
P 1 
P0
dq
dQ dq
dQ
dQ
• So without strategic interaction (i.e.
Cournot or Bertrand competition)
• Demand curve for “competitive
firm” has same slope as market
demand curve
• Marshallian “Perfect competition” a
mathematical error
• Cournot equilibrium locally unstable
(mathematically, & not equilibrium in
repeated games)
• See Keen & Standish 2010
Conclusion
• We need an empirically realistic, logically sound, theory of economics
• Neoclassical equilibrium/barter model like Ptolemy’s theory of cosmos
– We need a Copernican replacement
• In the meantime, you should learn all theories, not just Neoclassical
– And if that doesn’t happen at your University, then…
References
•
•
•
•
•
•
•
•
•
•
Bernanke, B. S. (2004). Panel discussion: What Have We Learned Since October 1979? Conference
on Reflections on Monetary Policy 25 Years after October 1979, St. Louis, Missouri, Federal Reserve
Bank of St. Louis.
Bezemer, D. J. (2009). “No One Saw This Coming”: Understanding Financial Crisis Through
Accounting Models. Groningen, The Netherlands, Faculty of Economics University of Groningen.
Cotis, J.-P. (2007). Editorial: Achieving Further Rebalancing. OECD Economic Outlook. OECD. Paris,
OECD. 2007/1: 7-10.
Eggertsson, G. B. and P. Krugman (2012). "Debt, Deleveraging, and the Liquidity Trap: A FisherMinsky-Koo approach." Quarterly Journal of Economics 127: 1469–1513.
Eggertsson, G. B. and P. Krugman (2012). "Supplementary material to Debt, Deleveraging and the
Liquidity Trap." Quarterly Journal of Economics 127: Appendix.
Fama, E. F. and K. R. French (1999). "The Corporate Cost of Capital and the Return on Corporate
Investment." Journal of Finance 54(6): 1939-1967.
Fiebiger, B. (2014). "Bank credit, financial intermediation and the distribution of national
income all matter to macroeconomics." Review of Keynesian Economics 2(3): 292-311.
Godley, W. and L. R. Wray (2000). "Is Goldilocks Doomed?" Journal of Economic Issues 34(1): 201206.
Goodwin, R. M. (1967). A growth cycle. Socialism, Capitalism and Economic Growth. C. H. Feinstein.
Cambridge, Cambridge University Press: 54-58.
Keen, S. (1995). "Finance and Economic Breakdown: Modeling Minsky's 'Financial Instability
Hypothesis.'." Journal of Post Keynesian Economics 17(4): 607-635.
References
•
•
•
•
•
•
•
•
•
Keen, S. (2006). "The Recession We Can't Avoid?" Steve Keen's Debtwatch, from
http://debtdeflation.com/blogs/wpcontent/uploads/2007/03/SteveKeenDebtReportNovember2006.pdf.
Keen, S. (2007). Deeper in Debt: Australia's addiction to borrowed money. Occasional Papers.
Sydney, Centre for Policy Development.
Keen, S. (2014). “Endogenous money and effective demand.” Review of Keynesian Economics 2(3):
271–291.
Krugman, P. (2012). End this Depression Now! New York, W.W. Norton.
Lavoie, M. (2014). "A comment on ‘Endogenous money and effective demand’: a revolution or a
step backwards?" Review of Keynesian Economics 2(3): 321 - 332.
McLeay, M., A. Radia and R. Thomas (2014). "Money creation in the modern economy." Bank of
England Quarterly Bulletin 2014 Q1: 14-27.
Martin, F. (2013). Money: The Unauthorised Biography. London, The Bodley Head Ltd.
Minsky, H. P. (1982). Can "it" happen again? : essays on instability and finance. Armonk, N.Y., M.E.
Sharpe.
Wray, L. R. (2002). "What Happened to Goldilocks? A Minskian Framework." Journal of Economic
Issues 36(2): 383-391.
Data in presentation:
Date
1790
1790.083
1790.167
1790.25
1790.333
1790.417
1790.5
1790.583
1790.667
1790.75
1790.833
1790.917
1791
1791.083
1791.167
1791.25
1791.333
1791.417
1791.5
1791.583
1791.667
1791.75
1791.833
1791.917
1792
1792.083
1792.167
1792.25
1792.333
1792.417
1792.5
1792.583
1792.667
1792.75
1792.833
1792.917
1793
1793.083
1793.167
1793.25
1793.333
1793.417
1793.5
1793.583
1793.667
1793.75
1793.833
1793.917
1794
1794.083
1794.167
1794.25
1794.333
1794.417
1794.5
1794.583
1794.667
1794.75
1794.833
1794.917
1795
1795.083
1795.167
1795.25
Unemployment
Unemployment
Rate CPI change
Inflation
% p.a. p.a.
Private Debt
Government
Private
DebtDebt
Government
change p.a.
Private
DebtDebt
change
Government
acceleration
p.a. GDP
Debt
p.a.acceleration
Private debt
p.a.
Government
% GDP Private
debt Debt
% GDP
Government
change p.a
House
Debt
% GDP
Price
change
Change
Index
p.aCPI
House
%Mortgage
GDP
adjusted
Price Index
Debt
Mortgage
p.a. Debt change p.a.
187
76.6772
188.2925
40.72238
77.25289
189.6077
40.74355
77.79589
190.9453
40.74249
78.30621
192.3056
40.71967
78.78384
193.6884
40.67556
79.22878
195.0938
40.61061
79.64104
196.5217
40.52531
80.02061
197.9722
40.42012
80.3675
199.4453
40.2955
80.6817
200.941
40.15194
80.96321
202.4592
39.98989
81.21204
204
39.80982
81.42818
4.750983
205.5626
39.61235
2.311209
81.61272
4.359829
207.1435
39.39912
2.104739
81.77102
3.975133
208.7383
39.17395
1.904363
81.90956
3.603351
210.3426
38.94103
1.713087
82.03478
3.250941
211.9521
38.7044
1.53381
82.15314
2.92436
213.5624
38.46797
1.369323
82.2711
2.630065
215.1694
38.23551
1.222323
82.39512
2.374514
216.7685
38.01066
1.095415
82.53166
2.164163
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