Debt-financed demand percent of aggregate demand
25
20
15
Percent
10
5
0
0
5
Great Depression
including Government
Great Recession
including Government
 10
 15
 20
 25
0
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.)
A Monetary Multisectoral (Minsky) Model
Steve Keen
University of Western Sydney
Debunking Economics
www.debtdeflation.com/blogs
www.debunkingeconomics.com
13
The Bankruptcy of Neoclassical Economics
• Before the crisis…
– The state of macro is good…” (Oliver Blanchard:
founding editor, AER: Macro)
• After the crisis…
– It is important to start by stating the obvious, namely,
that the baby should not be thrown out with the
bathwater…” (Blanchard Dell'Ariccia et al. 2010;
emphasis added)
• Reality
– Neoclassical macroeconomics is a baby that should
never have been conceived
The Bankruptcy of Neoclassical Economics
• Neoclassical theory wrong from first principles:
– Treats complex monetary exchange as barter
– Assumes macroeconomy is stable
– Ignores social class
• Treats entire economy a single agent
– Obliterates uncertainty
• “Rational” as capacity to foresee the future;
– Uses empirically falsified “money multiplier” model of
money creation; and
– Ignores credit and debt.
A tentative, but not-bankrupt, alternative
• A new macroeconomics must do the exact opposite:
– Economy as inherently monetary;
– Model the economy dynamically;
– Social classes rather than isolated agents;
– Rational but not prophetic behavior;
– Endogenous creation of money by banking sector; and
– Credit and Debt have pivotal roles
• Two instances
– Monetary Minsky Great Moderation/Recession model
– Dynamic Monetary Multisectoral model
• Base models:
– Monetary Circuit Theory (Graziani 1989; Keen 2008)
– Goodwin Growth Cycle (Goodwin 1967)
Monetary Circuit Theory
• Basic process of endogenous money creation
• Entrepreneur approaches bank for loan
• Bank grants loan & creates
deposit simultaneously
• Alan Holmes, Senior
Vice-President New
York Fed, 1969:
• “In the real world,
banks extend credit,
creating deposits in
the process, and look
for the reserves
later.” (1969, p. 73)
• New loan puts additional spending power into circulation
• Modeling this using strictly monetary framework:
Monetary Circuit Theory
• Input financial relations in matrix:
"Type"
0
0
1
1
1


"Account"
"Bank Capital" "Bank P/L (B.T)" "Firm Loan (FL)" "Firm Deposit (FD)" "Worker Deposit (WD)" 



"Symbol"
BV( t)
BT( t)
FL( t)
FD( t)
HD( t)


"Compound
Debt"
0
0
A
0
0




"Pay Debt"
0
B
0
B
0


"Record Payment"
0
0
B
0
0


"Debt-financed
Investment"
0
0
C
C
0

M 1  


"Wages"
0
0
0
D
D


"Interest"
0
( E  F)
0
E
F



"Consumption"
0
G
0
G H
H



"Debt repayment"
I
0
0
I
0


"Record
repayment"
0
0

I
0
0


 "Lend from capital"

J
0
0
J
0


"Record Loan"
0
0
J
0
0



d
BV( t ) I  J

dt


d
BT( t ) B  E  F  G

dt

d
FL( t) A  B  C  I  J
System M 1  

dt

 d FD( t) C  B  D  E  G  H  I 
 dt

d
HD( t) D  F  H

dt

• Symbolic derivation of system of
coupled ordinary differential equations









J




Monetary Circuit Theory
• Symbolic substitutions generate model







System M 1  


d
 d t FD( t)






 V  r( t)   L  r( t) 


BT( t)
d

BT( t) rL FL( t)  rD FD( t)  rD HD( t) 
B
dt


BV( t )
FL( t)
d

FL( t)

 P( t)  YR( t)  Inv   r( t) 
 L  r( t)   V  r( t ) 

dt

BV( t)
FL( t )
BT( t)
HD( t)
W ( t)  YR( t) 
rD FD( t )  rL FL( t) 



 P( t)  YR( t)  Inv   r( t)  

 L  r( t) 
 V  r( t) 
B
W
a( t )

HD( t)
W ( t)  YR( t)

d
HD( t) rD HD( t) 


W
a( t )
dt

d
BV( t)
dt
FL( t)

BV( t)
Goodwin Growth Cycle model
• Inherently cyclical growth (Goodwin 1967, Blatt 1983)
• Capital K determines output Y via the accelerator:
K
1/3
Accelerator
K
1/3
Y
Y
Goodwin's cyclical growth model
Accelerator
1.50
• Y determines employment L via productivity a:
l
/
1
a
r
Y
l
Labour Productivity
/
1
a
r
l
1
/
r
LabourPopulation
Productivity N
.96
"NAIRU"
+
10
*
L
l
WageResponse
/
100
N
r
1
Population
+
Initial Wage
1/S
+
Integrator
L
Employment
Wages
1.25
L
l
1.00
• L determines employment rate l via population N:
.75
PhillipsCurve
dw/dt
l
.50
0
2
4
6
Time (Years)
8
10
• l determines rate of change of wages w via Phillips Curve
+
.96
"NAIRU" 10
WageResponse
*
Pi
*
W
Goodwin's cyclical growth model
1.3
PhillipsCurve
I
dK/dt
dw/dt
1.2
1.1
Wages
+
- Y
w
L
• Integral
of w determines W (given initial value)
1
3
Initial Capital
Initial Wage
dw/dt
+
1/S
+
Integrator
+
1.0
.9
w
1/S
+
Integrator
L
*
W
.8
.7
.9
• Y-W determines profits P and thus Investment I…
Y
W
+
-
Pi
I
dK/dt
• Closes the loop:
.95
1
Employment
1
Initial Capital
dK /dt
1/S
+
+
1.05
Explicit Monetary Minsky Model
• Coupled with Goodwin
model to yield final
system
Financial Sector
FL( t)
BV( t)
d
BV( t)
dt
 V  r( t)
d
BT( t)
dt
BT( t)
rL FL( t)  rD FD( t)  rD HD( t) 
B
d
FL( t)
dt
 L  r( t)
d
FD( t)
dt
BV( t)
FL( t)
BT( t)
HD( t)
W ( t)  YR( t )
rD FD( t)  rL FL( t) 



 P( t)  YR( t)  Inv  r( t) 
 L  r( t)
 V  r( t)
B
W
a( t )
d
HD( t)
dt
HD( t)
W ( t )  YR( t)
rD HD( t) 

W
a( t )

BV( t)






 L  r( t)
FL( t)

 V  r( t )



 P( t)  YR( t)  Inv  r( t)







Physical output, labour and price systems
Rate of change of capital stock
Level of output
L( t )
YR( t)
a( t )

P( t)  YR( t)  W ( t)  L( t)  rL FL( t)  rD FD( t)
Rate of real economic growth
g( t)
d
W ( t)
dt
 ( t)  [ g( t)  (    ) ]

Inv  r( t)

v


W ( ( t) )   Ph (  ( t) )  
d
P( t)
dt
Rates of growth of population and productivity

P( t)  KR( t)
d
 ( t)
dt
Rate of employment
Rate of change of prices
v
 r( t)
Rate of Profit
KR( t)  g ( t )
KR( t)
YR( t)
Employment
Rate of change of wages
d
KR( t)
dt
1
P

1 d
1 d

  ( t) 
 P( t) 
 ( t) dt
P( t) d t

 P( t) 

d
a( t )
dt
W ( t)


a ( t )  ( 1  ) 
 a( t)
d
N ( t)
dt
  N ( t) N ( 0)
N0
Explicit Monetary Minsky Model
• Single sector model (not yet calibrated to data) can
generateReal“Great
Moderation and Great Recession”
Output
Inflation and Unemployment
110
4
20
$/Year
Percent
10
0
0
1000
 10
Inflation
Unemployment
 20
Debt to Output Ratio
5
0
20
40
60
Income Distribution
100
110
0
20
40
60
Workers
Capitalists
Bankers
100
90
80
3
Percent of GDP
Years to repay debt
4
2
70
60
50
40
30
1
20
10
0
0
0
20
40
Year
60
 10
0
20
40
Year
60
Multi-sectoral extension
• Stylized version of monetary flows table:
Account
Symbol
Compound Debt
Assets
Bank
Reserve
FD2(t)
Deposit Interest
B1
B2
Wages
Worker Interest
-C1
-C2
Investment K
Intersectoral C
Intersectoral A
Intersectoral E
Consumption K
E
-F
-G
-H
I
-E
F
G
H
-I
Consumption C
Consumption A
-J
-K
J
K
Consumption E
Pay Interest
Repay Loans
Recycle Reserves
L
O
-L
-M
-N
O
P
P
N
-O
FL1(t)
A1
FL1(t)
A2
Sector
Deposit
FD1(t)
New Money
BR(t)
Sector 1 Sector
Loan
2 Loan
Liabilities
1 Sector 2 Worker
Deposit
Deposit
Equity
Bank
Equity
WD(t)
BE(t)
C1+C2
-D
-D
M
Multi-sectoral extension
• Profit now net of intersectoral input purchases:
n
 K  t   PK  t   QK  t   W  t   LK  t     KS  W  t   LS  t     rL  K L  t   rD K D  t  
S K
PK  t   K K  t 
n
 C  t   PC  t   QC  t   W  t   LC  t     CS W  t   LS  t     rL  CL  t   rDCD  t  
S C
PK  t   KC  t 
• Each sector modeled as Goodwin cycle
FDK  t 
d
KC  t  
  KC  t 
dt
 PR  C  t    PK  t 
Capital Stock


1
  QC  t    K C  t  
vC


Output
d
1
LC  t   
dt
 LC


1
  LC  t  
 QC  t  
aC  t 


Labor
d
1
PC  t   
dt
 PC


W t 
  PC  t  

aC  t   1  sC  

Price Level
d
1
QC  t   
dt
 QC
d
aC  t     aC  t 
dt
Labor Productivity
• Financial flows matrix captures intersectoral dependencies
Multi-sectoral extension
• “Conjecture: The repeated development of an unstable
state of the economy is … an unavoidable consequence of,
the local instability of the state of balanced growth.”
The Rate of Profit in a Monetary Multisectoral Model of Production
(Blatt 1983, p. 161)
15
Profit/Capita (Percent)
10
5
0
Capital Goods
Consumer Goods
Agriculture
Energy
5
0
20
40
60
Years
80
100
Multi-sectoral extension
• “The usual image of the business cycle was of a wavelike
movement, and the waves of the sea were the accepted
metaphor… The reality in the nineteenth and early
twentieth centuries was, in fact, much closer to the teeth
of a ripsaw which go up on a gradual plane on one side and
drop precipitately on the other…” (Galbraith 1975, p. 104)
Debt Level and Economic Growth
6
120
Rate of Growth
Debt Ratio (RHS)
4
100
2
80
0
60
2
20
25
30
35
40
40
Multi-sectoral extension
• Model fundamentally monetary: physical cycles cause and
caused by cycles in finance
Bank Assets & Liabilities
110
8
7
110
Loans
Deposits
Bank Reserves (RHS)
110
7
110
6
110
6
110
110
5
5
20
25
30
35
10000
Addendum: Reforming economic education
• Making real dynamics sexy & accessible
• Free prototype QED “Quesnay Economic Dynamics”
• Inspired by Godley SAM approach
– Extended to continuous time
• Ideally suited to financial flows
Explicit Monetary Minsky Model
• Freely available at www.debtdeflation.com/blogs/qed
• Advanced
versions under
development
• Mathematica
version for
arbitrary number
of sectors
available soon
• New economic
dynamic monetary
modeling program
“Minsky” available
by early 2012
Conclusion: Kuznets was correct…
• According to … modern followers [of past economists],
static economics is a direct stepping stone to the
dynamic system…
• According to other economists, the body of economic
theory must be cardinally rebuilt, if dynamic problems
are to be discussed efficiently…
• … as long as static economics will remain a strictly unified
system based upon the concept of equilibrium, … its
analytic part will remain of little use to any system of
dynamic economics…
• the static scheme in its entirety, in the essence of its
approach, is neither a basis, nor a stepping stone towards
a proper discussion of dynamic problems. Kuznets, S.
(1930, pp. 422-428, 435-436; emphasis added)
References
•
•
•
•
•
•
•
•
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. (1983). Dynamic economic systems : a post-Keynesian approach. Armonk,
N.Y, M.E. Sharpe.
Bezemer, D. J. (2010). "Understanding financial crisis through accounting models."
Accounting, Organizations and Society 35(7): 676-688.
Biggs, M., T. Mayer, et al. (2010). "Credit and Economic Recovery: Demystifying
Phoenix Miracles." SSRN eLibrary.
Blanchard, O., G. Dell'Ariccia, et al. (2010). "Rethinking Macroeconomic Policy." Journal
of Money, Credit, and Banking 42: 199-215.
Goodwin, R. (1967). A growth cycle. Socialism, Capitalism and Economic Growth. C. H.
Feinstein. Cambridge, Cambridge University Press: 54-58.
Graziani, A. (1989). "The Theory of the Monetary Circuit." Thames Papers in Political
Economy Spring: 1-26.
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.
References
•
•
•
•
•
•
•
•
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.
Kuznets, S. (1930). "Static and Dynamic Economics." The American Economic Review
20(3): 426-441.
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.
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.
Solow, R. M. (2001) “From Neoclassical Growth Theory to New Classical
Macroeconomics”, in J. H. Drèze (ed.), Advances in Macroeconomic Theory. New York,
Palgrave
Solow, R. (2008). "The State of Macroeconomics." The Journal of Economic
Perspectives 22(1): 243-246.