debunking macroeconomics steve keen
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Economic AnAlysis & Policy, Vol. 41 no. 3, dEcEmbEr 2011
Debunking Macroeconomics
Steve Keen
School of Economics & Finance,
University of Western Sydney,
Locked Bag 1797,
Penrith 1797, NSW
Australia
(Email: [email protected])
Abstract: The ailre elassial mdels t war the emi risis has led t sme rare
sl searhig i a disiplie t kw r sh itrspeti. The dmiat reati
withi the pressi has ee t admit the ailre, t t arge that there is eed r
a drasti revisi emi thery. I rejet this mrtale lsi, ad arge
istead that this risis illstrates the pit made erehad y Rert Slw, that
mdels i whih maremi pathlgies are impssile are t adeate mdels
apitalism. Hikss ritie his w IS-LM mdel als idiates that, thgh
pathlgies a e impsed a IS-LM mdel, it is als iapprpriate r maremi
aalysis ease its alse impsiti eilirim ditis derived rm Walras
Law. I the s p what I see as the key weakess i the elassial apprah tmaremis whih applies t th DSGE ad IS-LM mdels: the alse assmpti
that the mey spply is exges. Ater tliig the alterative edges mey
perspetive, I shw that Walras Law mst e geeralized r a redit emy t what
I all the Walras-Shmpeter-Misky Law. The empirial data strgly spprts this
perspetive, emphasizig the eed r a rt ad rah rerm maremis.
I. InTRoDucTIon
The ailre elassial mdels t war the emi risis has led t sme rare slsearhig i a disiplie t kw r sh itrspeti. The dmiat reati withi the
pressi has ee t admit the ailre, t t arge that there is eed r a drasti revisi
emi thery.
I rejet this mrtale lsi, ad arge istead that this risis illstrates the pit
made erehad y Rert Slw, that mdels i whih maremi pathlgies are
impssile are t adeate mdels apitalism. Hikss ritie his w IS-LM mdel als
idiates that, thgh pathlgies a e impsed a IS-LM mdel, it is als iapprpriate
r maremi aalysis ease its alse impsiti eilirim ditis derived
rm Walras Law. I the s p what I see as the key weakess i the elassial appraht maremis whih applies t th DSGE ad IS-LM mdels: the alse assmpti that
the mey spply is exges. Ater tliig the alterative edges mey perspetive,
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I shw that Walras Law mst e geeralized r a redit emy t what I all the Walras-
Shmpeter-Misky Law. The empirial data strgly spprts this perspetive, emphasizig
the eed r a rt ad rah rerm maremis.
II. DEfEnDInG THE InDEfEnSIbLE
That mder elassial maremi mdels ailed t rewar the emi risis
that ega i 2007 is dispted. What is i dispte is the impliatis this shld have r
maremi thery.
Prmiet memers the disiplie have arged that there shld e seees.
be berake (berake 2010), reet nel Prize lareate Thmas Sarget (Rlik 2010)
ad the dig editr theAER: Macro olivier blahard (blahard et al. 2010) have all
asserted that elassial mdels helped gide pliy drig the gd times, ad shld t
e aaded simply ease they did t see the ad times mig. berakes argmet isrepresetative this perspetive:
the reet aial risis was mre a ailre emi egieerig ad emi maagemet
tha what I have alled emi siee
D these ailres stadard maremi mdels mea that they are irrelevat r at least
sigiatly awed? I thik the aswer is a alied . Emi mdels are sel ly i the
text r whih they are desiged.Most of the time, including during recessions, serious nancial
instability is not an issue. The standard models were designed for these non-crisis periods, and they
have proven quite useful in that context. ntaly, they were part the itelletal ramewrk that
helped deliver lw iati ad maremi staility i mst idstrial tries drig thetw deades that ega i the mid-1980s. (berake 2010, pp. 3, 17; emphasis added)
I make no apology for describing this argument as specious, on at least two grounds.firstly, this argmet wld ly e tleraly aeptale i elassial emis als had
well-develped mdels that were sitale r perids risis, t it des t.1 Sedly,
this las aeptae that there a e ad times sits ddly agaist the trimphalism that
haraterized elassial disrse maremis prir t this risis. This is est
exempliied y Lass Presidetial Address t theAmerican Economic Association i 2003,
i whih he asserted that elassial emis had seeded i elimiatig the pssiility
extremely ad times like thse we are w experieig:
Maremis was r as a distit eld i the 1940s, as a part the itelletal respse
t the Great Depressi. The term the reerred t the dy kwledge ad expertise that we
hped wld prevet the rerree that emi disaster. My thesis i this letre is that
maremis i this rigial sese has seeded:Its central problem of depression prevention
has been solved, for all practical purposes, and has in fact been solved for many decades. (Las,
Jr. 2003, p. 1 ; emphasis added)
The prpsiti that there a e separate mdels r gd ad ad times als implies that
there is asal lik etwee gd ad ad times, whih wld e tre i they were simply
1 It wld als have t e prvaly tre that there is asal lik etwee gd times ad ad times a pitI retr t elw.
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the prdt exges shks t the maremy. This is i at hw mst elassial
mdelers have reated: y retrspetively treatig the risis as eig de, t merely t
preedetedly large exges shks, t shks whih varied i magitde ver time
while still remaiig egative rather tha psitive:
the Great Reessi ega i late 2007 ad early 2008 with a series adverse preeree ad
tehlgy shks i rghly the same mix ad rghly the same magitde as thse that hit
the uited States at the set the previs tw reessis
The strig adverse preeree ad tehlgy shks tied, hwever, thrght 2008 ad
it 2009. Mrever, these shks grew larger i magitde, addig sstatially t jst t the
legth t als t the severity the great reessi (Irelad 2011, p. 48, see als MKii
ad Stekel 2009)
The at that these shks ame rm the iaial setrwhih the rdiary pli wld
ted t regard as eig part the emy, ad therere t e mre a edges
emi pheme tha a exges evethas ee treated as largely irrelevat y
leadig elassials:
The risis has shw that large adverse shks a ad d happe. I this risis, they ame rm
the aial setr, t they ld me rm elsewhere i the trethe eets a pademi
trism ad trade r the eets a majr terrrist attak a large emi eter. (blahard,
DellAriia ad Mar 2010, p. 207)
Give the severity ad persistee this risis, this is als speis reasig: i the risis was
merely de t a large exges egative shk, srely y w it wld e ver? Srely t,sie the shks emaated rm the iae setr, ad the stadard elassial dtrie
that permits a separati emis rm iae has w ee empirially rejeted (fama
ad freh 2004), the treatmet distraes i the iae setr as exges t the
emy shld als e rejeted?
These reatis elassial therists ad mdelers are therere mre tha a plea
that the re elassial visi the maremy as a stale system sjet t exges
shks shld e preserved, despite a preedeted empirial ailre. This prpsiti has
ee pt pely y blahard et al., amgst thers:
It is imprtat t start y statig the vis, amely, that the ay shld t e thrw t withthe athwater. (blahard, DellAriia ad Mar 2010, p. 204)
Hwever, lesser nelassials tha Jh Hiks (Hiks 1981) ad Rert Slw (Slw
2003, 2001, 2008) have pt the trary ase that these aies th tdays DSGE mdels
ad the IS-LM mdel that preeded themshld ever have ee eived i the irst plae.
Hikss diswig IS-LM appears t have disappeared witht trae i elassial
literatre. Slws vie was at least akwledged y blahard whe he plished his
exriatigly adly timed srvey mder maremis (blahard 2009, blahard
2008),2 i whih he stated that:
2 The risis is geerally dated rm Agst 6 2007, whe the bnP sht dw 3 its ds that were expsedt uS sprime ledig e year before blahards wrkig paper was irst psted.
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ater the explsi the eld i the 1970s, there has ee erms prgress ad sstatial
vergee.,, largely ease ats have a way t gig away, a largely shared visi th
tatis ad methdlgy has emerged... nt everythig is e bt e this is deadly.
The state of macro is good. (blahard 2009, p. 210; emphasis added).
I a tte, he added others, I kw, disagree with this ptimisti assessmet (r example,
Slw 2008), t he did t egage at all with Slws ritie. As the gle is w i its
ith year reletig emi trmil, it is time Slw was listeed t.
III. SoLoWS cRITIquE of DSGE
Slw eame a riti elassial maremis ease he was simply iredls
that the grwth mdel he develped ld e eve sidered as a asis r mdelig the
siess yle:
The prttypial real-siess-yle mdel is thig t the elassial grwth mdel
The pzzle I wat t disssat least it seems t me t e a pzzle, thgh part the pzzle is
why it des t seem t e a pzzle t may my yger lleagesis this. Mre tha rty
years ag, I ... wrked t ... elassial grwth thery... [I]t was lear rm the egiig what
I thght it did t apply t, amely shrt-r tatis i aggregate tpt ad emplymet
... the siess yle...
[n]w ... i y pik p a artile tday with the wrds siess yle i the title, there is a airly
high praility that its asi theretial rietati will e what is alled real siess yle
thery ad the derlyig mdel will e ... a slightly dressed p versi the elasssial grwth
mdel. The esti I wat t irle ard is: hw did that happe? (Slw 2001, pp. 23, 19)
Slw idetiied the searh r mirdatis r maremis as the taihead
DSGE mdelig, ad thgh he srmised that The rigial implse t lk r etter r
mre expliit mir datis was praly reasale (Slw 2003, p. 1), he dismissed
the deese that miremis jstiied DSGE maremi mdels as a delsi:
Sppse y wated t deed the se the Ramsey mdel as the asis r a desriptive
maremis. What ld y say?... (I take it r grated that realism is t a eligile deese.)
Y ld laim that it is t pssile t d etter at this level astrati; that there is thertratale way t meet the laims emi thery. I thik this laim is a delsi.
We kw rm the Seshei-Matel-Dere therems that the ly iversal empirial
aggregative impliatis geeral eilirim thery are that exess demad tis shld
e tis ad hmgees degree zer i pries, ad shld satisy Walras Law. Aye
is ree t impse rther restritis a mar mdel, t they have t e jstied r their w
sweet sake, t as eig reired y the priiples emi thery. (Slw 2008, pp. 244)
Slw rejeted th the Saltwater ad freshwater apprahes t maremis. The ase
mdel itsel, the freshwater real siess yle mdel, was sitale r maremis
ease it rled t the very ehavir that maremis is sppsed t explai:
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The preerred mdel has a sigle represetative smer ptimizig ver iite time with
peret resight r ratial expetatis, i a evirmet that realizes the resltig plas mre
r less awlessly thrgh peretly mpetitive rward-lkig markets r gds ad lar, ad
peretly exile pries ad wages.
How could anyone expect a sensible short-to-medium-run macroeconomics to come out of that
set-up?...
I start rm the presmpti that we wat maremis t at r the asial aggregative
pathlgies that eset mder apitalist emies, like reessis, itervals stagati, iati,
stagati, t t meti egative pathlgies like sally gd times. A model that rules
out pathologies by denition is unlikely to help. (Slw 2003, p. 1; emphasis added).
He dismissed the new Keyesia variat that ame t dmiate the pressi as mre
tha widw-dressig t imprve the apparet it a ad mdel t the data:
The simpler srt Rbc mdel that I have ee sig r expsitry prpses has had little r empirial sess, eve with a very demadig ti empirial sess. As a reslt, sme
the reer spirits i the Rbc shl have eg t lse p the asi ramewrk y allwig
r imperetis i the lar market, ad eve i the apital market
The mdel the sds etter ad ts the data etter. This is not surprising: these imperfections
were chosen by intelligent economists to make the models work better... (Slw 2001, p. 26;
emphasis added)
oe eed t wder hw Slw wld reat t elassial maremists, ater the risis,
addig t merely imperetis t adjstale exges shks t imprve the mdels
it t data that imperetis ale at explai, sie he gave his pii erehad:
It is always pssile t laim that thse pathlgies are delsis, ad the emy is merely
adjstig ptimally t sme exges shk. But why should reasonable people accept this?
(Slw, 2003, p. 1; emphasis added)
Thgh Slw saw the destiati that elassial maremis had reahed as a
impasse, he prvided alterate rte rward. Sme hark r a reversal direti ak t
IS-LM mdels (Mared Grter ad flria Jg, 2010), i whih pathlgies at least appear
easile. Hwever that rte was lked three deades ag y e Jh Hiks.
IV. HIcKSS cRITIquE of IS-LM
I 1981, Jh Hiks admitted that, thgh regarded as a mdel Keyes, IS-LM is elassial
mdel that predates Keyess General Theory (J. M. Keyes, 1936). Hiks ted that thgh
he irst spelled t the IS-LM mdel i detail i Mr. Keyes ad the classis (J. R. Hiks,
1937, his review The Geeral Thery), the mdel was irst develped i a less well-kw
paper, Wages ad Iterest: The Dyami Prlem (J. R. Hiks, 1935). Hiks was adamat
that this paper, ad t Mr. Keyes ad the classislet ale The General Theory itsel
was the real dati the IS-LM mdel:
The ther, mh less well kw, is eve mre relevat. Wages ad Iterest: the Dyami Prlem
was a rst sketh what was t eme the dyami mdel Vale ad capital (1939).It is
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important here, because it shows (I think quite conclusively) that that model was already in my
mind before I wrote even the rst of my papers on Keynes.(Hiks 1981, p. 140; emphasis added)
o rse, that IS-LM is i at a nelassial mdel ad t a Keyesia e is reas per
se t dismiss it: it ld still e a adeate mdel the mar emy. bt Hiks argedthat its w merits, it ailed.
The mdel i Wages ad Iterest had a ltra-shrt-r a week i a read emy
i whih pries were deided a Mday ad the applied r the remaider the week.
bt IS-LM, whih Hiks desried as a traslati Keyes lexprie mdel it my
terms, was a shrt-perid, we shall t g ar wrg i we thik it as a year (Jh
Hiks, 1981, p. 141). I Hikss mdel, evets drig the week were t allwed t aet
aythiga devie whih Hiks desried as a very artiiial devie, t (I wld thik
w) mh t e remmeded, t whih let him treat expetatis as stat. Therere,
eilirim applied:
That is t say (it is eivalet t sayig), we may airly rek that these markets, with respet t
these data, are i eilirim. (Hiks 1981, p. 146)
Hwever, this artiie ld t e exteded t a year, ad sed t derive a LM rve sie:
r the prpse geeratig a LM rve, whih is t represet liidity preeree, it will t d
witht amedmet. For there is no sense in liquidity, unless expectations are uncertain. (Hiks
1981, p. 152; emphasis added)
This i tr meat that markets had t e i diseilirimt IS-LM itsel was derived
rm eilirim aalysis, as Hiks als explaied:
the idea the IS-LM diagram ame t me as a reslt the wrk I had ee dig three-way
exhage, eived i a Walrasia maer. I had already d a way represetig three-way
exhage a tw-dimesial diagram (t appear i de rse i hapter 5 Vale ad capital).
As it appears there, it is a piee statis; t it was essetial t my apprah (as already appears
i Wages ad Iterest: the Dyami Prlem) that stati aalysis this srt ld e arried
ver t dyamis y redeiti terms. S it was atral r me t thik that a similar devie
ld e sed r the Keyes thery. (Hiks 1981, p. 141-142)
bt i at, extedig a eilirim mdel with a timerame a week t a timerame a
year i whih liidity preeree played a key rle led t a hpeless mddle whih Hiks,with hidsight, ld w appreiate. His ial jdgmet his w mdel was sathig:
I ardigly lde that the ly way i whih IS-LM aalysis selly srvivesas aythig
mre tha a lassrm gadget, t e sperseded, later , y smethig etteris i appliati
t a partilar kid asal aalysis, where the se eilirim methds, eve a drasti se
eilirim methds, is t iapprpriate
Whe e trs t estis pliy the se eilirim methds is still mre sspet.
There a e hage pliy i everythig is t g as expetedi the emy is t
remai i what (hwever apprximately) may e regarded as its existig eilirim. It may e
hped that, ater the hage i pliy, the emy will smehw, at sme time i the tre, settleit what may e regarded, i the same sese, as a ew eilirim; t there mst eessarily
e a stage ere that eilirim is reahed. There mst always e a prlem traverse. fr the
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stdy a traverse, e has t have rerse t seetial methds e kid r ather. (Hiks
1981, p. 152-153)
Hikss dametal lsi therere is that macroeconomic analysis must assume
disequilibrium rather tha eilirimad this des eve mre damage t IS-LM tha Hikshimsel appreiated. T rede maremis t the iterplay simply the gds ad mey
market,3 Hiks had sed the Walrasia assmpti that, in-1 markets are i eilirim, the
the nth market mst als e i eilirim, s that he ld igre the market r laale ds:
oe did t have t ther at the market r laale ds, sie it appeared, the Walras
aalgy, that i these tw markets were i eilirim, the third mst e als. S I lded
that the iterseti IS ad LM determied the eilirim the system as a whle. (Hiks
1981, p. 142)
bt this Walrasia lgi ts th ways: if disequilibrium applies in one market, then at least
one otherand probably all othersmust also be in disequilibrium. Therere, as s asdiseilrim is akwledged, markets whse very existee has ee igred i eilirim
aalysissh as, visly i IS-LM, the lar marketa lger e igred. Their
diseilrim dyamis mst w e sidered, ad the IS-LM mdel a give gidae
as t hw they will ehave.
V. An ALTERnATIVE MAcRoEconoMIcS
Slws key servati is that maremis shld seek t at r the asial
aggregative pathlgies that eset mder apitalist emies. Hikss key triti wasthat maremis mst e a stdy diseilrim dyamisa pit made deades earlier
still y Irvig fisher whe he peed The Det-Delati Thery Great Depressis:
We may tetatively assme that, rdiarily ad withi wide limits, all, r almst all, emi
variales ted, i a geeral way, tward a stale eilirim... bt new distraes are,
hmaly speakig, sre t r, s that, i atal at, ay variale is almst always ave r
elw the ideal eilirim...
Theretially there may ei at, at mst times there mst ever-r der-prdti, ver-
r der-smpti, ver- r der-spedig, ver- r der-savig, ver- r der-ivestmet,
ad ver r der everythig else.It is as absurd to assume that, for any long period of time, thevariables in the economic organization, or any part of them, will stay put, in perfect equilibrium,
as to assume that the Atlantic Ocean can ever be without a wave. (fisher 1933, p. 339; emphasis
added)
These priiples pit i the direti irst idiated y Hyma Misky, that sie apitalist
emies have experieed Depressis i the past, t adeately mdel apitalism:
it is eessary t have a emi thery whih makes great depressis e the pssile states
i whih r type apitalist emy a d itsel. (Misky 1982 , p. 5)
3 Have y ever wdered why the asi IS-LM mdel dest expliitly ilde the lar market, whe it wasprprted t e a mdel Keyess General Theory ofEmployment, Interest and Money?
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Miskys alterative was the fiaial Istaility Hypthesis, ad it was ased a expliit
rejeti the elassial paradigm:
The astrat mdel the elassial sythesis at geerate istaility. Whe the elassial
sythesis is strted, apital assets, aig arragemets that eter ard aks ad meyreati, straits impsed y liailities, ad the prlems assiated with kwledge at
ertai tres are all assmed away. fr emists ad pliy-makers t d etter we have t
aad the elassial sythesis. (Misky 1982 , p. 5)
I have develped mathematial mdels this hypthesis (Steve Kee, 1995, 2008, 2011,
2000) whih are ased a sidered rejeti virtally every preept elassial
thery. Explaiig all these methdlgial deisis reires a k rather tha a jral paper
(Steve Kee, 2011a), s here I will etrate what experiee has vied me is the
key reas why elassial emists ailed t resee the risis, ad why t this day they
at derstad why it remais s itratale. This is their visi hw mey is reated.
VI. EnDoGEnouS MonEY, EconoMIc GRoWTH
AnD DISEquILIbRIuM
n-emists might expet that emi mdels hw mey is reated wld e ased
empirial researh. There is sh a mdel, t it is the prvie the -elassial
shl thght kw as Pst Keyesia emis. nelassial emists have istead
persisted with the ratial reserve akig/mey mltiplier mdel, whih arges that
aks eed exess reserves ere they a led, that these are reated iitially y a expasi
gvermet-reated iat mey, ad that a seee ak depsits y reipiets iat
mey, ad las all t a rati this depsit y aks, reates redit mey that is a
mltiple the iitial ijeti iat mey.
This is i tr married t a visi aks as mere itermediaries, s that they a e
rmally igred i maremi mdelig. fially, the level private det is als igred
i elassial maremis, sie a la is regarded as simply a traser spedig
pwer rm a saver t a rrwer. With e perss spedig pwer gig dw ad athers
gig p y the same amt, ly the distriti det ld mattert its aggregate
level. As berake explaied, this is why fishers Det Delati explaati the Great
Depressi was igred y elassial emists:
fishers idea was less ietial i aademi irles, thgh, ease the terargmet
that det-deati represeted mre tha a redistriti rm e grp (detrs) t ather
(reditrs). Aset implasily large dierees i margial spedig prpesities amg the
grps, it was sggested, pre redistritis shld have sigiat mar-emi eets
(berake 2000, p. 24)
over rty years ag, the the Seir Vie-Presidet the new Yrk federal Reserve, Ala
Hlmes, pited t that this perspetive i whih the aggregate level det des t matter,
ad aks are mere itermediaries etwee savers ad leders, was erres. He arged that
the view that the akig system ly expads las ater the [federal Reserve] System (r
market atrs) have pt reserves i the akig system was ased a aive assmpti.
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Istead, he arged,
In the real world, banks extend credit, creating deposits in the process, and look for the reserves
later. The esti the emes e whether ad hw the federal Reserve will ammdate
the demad r reserves. I the very shrt r, the federal Reserve has little r hie at
ammdatig that demad; ver time, its iee a visly e elt. (Hlmes 1969, p. 73;
emphasis added)
Hlmes was ths argig that aks d t eed depsits i rder t ledthat i at the
at ledig simltaesly reates a mathig depsitad that aks a therere
edgesly reate ew spedig pwer (ew depsits) y issig a la, witht therey
redig the spedig pwer savers.
This experiee-ased jdgmet was sseetly irmed y empirial researh y the
Pst Keyesia emist basil Mre (basil J. Mre, 1979, 1983, 1988, 2001), ad eve y
the ders Real bsiess cyle thery (fi E. Kydlad ad Edward c. Prestt, 1990).
4
This led t the develpmet the mdel edges mey, i whih a la is regarded
t a traser spedig pwer rm a saver t a leder, t a reati spedig pwer r
the rrwer y the ak ab initio. This mder Pst Keyesia thery i at redisvered a
argmet irst pt y Shmpeter, that aks reate mey simply y a atig perati:
a la exteded t a rrwer reates th det ad spedig pwer t thig:
It is always a esti, t trasrmig prhasig pwer whih already exists i smees
pssessi, t the reati ew prhasig pwer t thig (Shmpeter 1934, p. 73)
This meas that the irease i det atally adds t aggregate demad, s that ttal spedig
is the sm th imes geerated i the irlar lw whih primarily iaessmptipls the grwth i detwhih primarily iaes ivestmet. Sie this ept
is s reig t elassial emists, it is wrth itig Shmpeter at legth it here:
the etrepreeri priiple ad as a rledes eed redit, i the sese a temprary traser
t him prhasig pwer, i rder t prde at all, t e ale t arry t his ew miatis,
t become a etrepreer. Ad this prhasig pwer des t w twards him atmatially,
as t the prder i the irlar w, y the sale what he prded i preedig perids. I
he des t happe t pssess it he mst rrw it He a ly eme a etrepreer y
previsly emig a detr his emig a detr arises rm the eessity the ase ad
is t smethig armal, a aidetal evet t e explaied y partilar irmstaes. Whathe rst wats is redit. bere he reires ay gds whatever, he reires prhasig pwer.
He is the typial detr i apitalist siety. (see als biggs ad Mayer 2010, biggs et al. 2010,
Shmpeter 1934, p. 102)
Shmpeter des t dey that some ivestmet is iaed y a traser existig ds rm
savershee resltig i a all i spedig y saver-smers ad a settig irease i
4 Thgh they made attempt t llw thrgh their lsi that The at that the trasati mpet real ash alaes (M1) mves tempraesly with the yle while the mh larger trasati
mpet (M2) leads the yle sggests that redit arragemets ld play a sigiiat rle i tresiess yle thery.Introducing money and credit into growth theory in a way that accounts for the cyclicalbehavior of monetary as well as real aggregates is an important open problem in economics. (Kydlad adPrestt 1990, p. 15; emphasis added)
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spedig y rrwer-ivestrs, with verall maremi impliatis. bt he isists
that the primary sre ivestr spedig mes rm the edges expasi the
mey spply, whih gives spedig pwer t etrepreers without sacrificing the existing
spending power of savers, s that risig det des have maremi eets:
Eve thgh the vetial aswer t r esti is t visly asrd, yet there is ather
methd taiig mey r this prpse, whih des t presppse the existee
amlated reslts previs develpmet, ad hee may e sidered as the ly e whih
is availale i strit lgi. This methd taiig mey is the reati prhasig pwer y
aks (Shmpeter 1934, p. 73)
This leads Shmpeter t what he happily desries as a heresy that presses i terms
meas paymet are t merely relexes presses i terms gds (Jseph Alis
Shmpeter, 1934, p. 95). Istead, i a grwig apitalist emy, aggregate demad is the
sm demad rm the sale gds ad serviesplus demad rm the grwth i redit-mey, where the latter is the primary sre ivestmet. fama ad freh irmed
this hypthesized relatiship etwee hage i det ad ivestmet i a empirial stdy:
These rrelatis rm the impressi that det plays a key rle i ammdatig year-y-
year variati i ivestmet. (fama ad freh 1999, p. 1954)5
This miati the edges expasi spedig pwer y ak ledig, pls the
se that y etrepreers t iae ivestmet, meas that the hage i the level private
det does have maremi sigiiaead it plays a etral rle i Shmpeters
thery the siess yle. Hwever it is t the ed the matter, ease etrepreers
are t the ly es wh rrw mey: s d key atrs i Miskys explaati r GreatDepressis, Pzi fiaiers.
These rrwers d t primarily ivest with rrwed mey, t y existig assets, ad
hpe t prit y sellig thse assets a risig market. ulike Shmpeters etrepreers,
whse dets tday a e repaid rm prits tmrrw, Pzi fiaiers always have det
serviig sts tha exeed the ash lws rm the assets they prhase with rrwed mey.
They therere mst expad their dets r sell assets t tie tiig:
A Pzi ae it is a spelative aig it r whih the ime mpet the ear
term ash ws alls shrt the ear term iterest paymets det s that r sme time i the
tre the tstadig det will grw de t iterest existig det Pzi its a lll theirpaymet mmitmets dets ly y rrwig (r dispsig assets) a Pzi it mst
irease its tstadig dets. (Misky 1982, p. 24)
Therere i a redit-ased emy, there are three sres aggregate demad, ad three
ways i whih this demad is expeded:
1. Demad rm ime eared y sellig gds ad servies, whih primarily iaes
smpti;
2. Demad rm risig etrepreerial det, whih primarily iaes ivestmet; ad
3. Demad rm risig Pzi det, whih primarily iaes the prhase existig
assets.
5 I a drat versi, they stated this eve mre learly: Det seems t e the residal variale i iaigdeisis. Ivestmet ireases det, ad higher earigs ted t rede det.
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Shmpeters ad Miskys perspetives ths eale s t itegrate redit, asset markets ad
diseilirim aalysis it a alterative maremis. I a redit emy, aggregate
demad is the sm ime pls the hage i det, ad this demad is expeded th
gds ad servies ad prhases existig assets. Det therere has th psitive ad
egative tatis r the emy: it iaes the expasi emi ativity via
ivati ad ivestmet, t it a als ase asset les ad evetally, a emi
risis i t mh this det is direted t Pzi fiae. This is preisely what rred i
the last tw deades.
VII. coMPARInG EnDoGEnouS MonEY To
THE MonEY MuLTIPLIER
As is well kw, berake lamed the fed r asig the Great Depressi:
there is w verwhelmig evidee that the mai atr depressig aggregate demad was a
wrldwide trati i wrld mey spplies. This metary llapse was itsel the reslt
a prly maaged ad tehially awed iteratial metary system (the gld stadard, as
restitted ater Wrld War I). (berake 2000, p. ix)
The mey mltiplier thery mey reati played a large rle i his argmet that the
Great Depressi was triggered y the federal Reserves redti the uS ase mey
spply etwee Je 1928 ad Je 1931:
the uited States is the ly try i whih the disretiary mpet pliy was argaly
sigiatly destailizig the rati metary ase t iteratial reserves ell sistetlyi the uited States rm 1928:II thrgh the sed arter 1931. As a reslt, u.S. mial
mey grwth was preisely zer etwee 1928:IV ad 1929:IV, despite th gld iws ad a
irease i the mey mltiplier.
The year 1930 was eve wrse i this respet: etwee 1929:IV ad 1930:IV, mial mey i the
uited States ell y almst 6 [peret] The prximate ase this delie i M1 was tied
trati i the rati ase t reserves, whih reired rather tha set delies i the mey
mltiplier. This tighteig lates mh the lame r the early (pre-1931) slwdw i wrld
metary aggregates with the federal Reserve. (be S. berake, 2000, p. 153)
berakes statistial evidee sed the relatiship etwee hage i M1 ad thelevel emplymet. usig a lger ad mre detailed series r M1 tha berake sed
(friedma ad Shwartz 1963, Tale A1), there is ideed a rst egative rrelati etwee
hage i M1 ad emplymet (see Figure 1; emplymet is iverted the right had
axis t shw the egative rrelati mre learly).6 The R2 is -0.33 r the whle perid,
-0.31 r 1920-1930 ad a strg -0.67 r 1930-1940.
Hwever M1 ildes mey reated y the aks, ad lamig the federal Reserve
r its llapse i the 1930s takes the mey mltiplier r grated as a valid explaati
mey reatiwhih the edges mey apprah disptes. oly M0 r base Mey
is stritly der the feds trl, ad (sig the St Louis FRED AMBSL data), the relatiship
6 uemplymet data rm 1920-1932 is smthed aal; rm 1932 it is mthly data, as is the data rM1 r the whle perid.
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etwee emplymet ad that part the mey spply ver whih the fed has dispted
trl is very dieret (see Figure 2). The rrelati r the whle time perid w has the
wrg sig (+0.44); mrever there is a reak i the relatiship. I the perid 1920-1930,
the rrelati is small with the rret sig (-0.22); i the perid 1930-1940, it is small with
the wrg sig (+0.28).
Figure 1: chage i M1 ad uemplymet, 1920-1940
Figure 2: chage i base Mey ad uemplymet, 1920-1940
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There is als a reak i the relatiship etwee hages i M0 ad hages i M1. I the
1920s, the rrelati was strg ad psitive (+0.89)i lie with the mey mltiplier
argmet. bt i the 1930s, while still psitive it was mh weaker (+0.34). frm the data
t, it is vis that the 1930s fed was tryig t st the mey spply rm 1931 till
1937. It the reded its stimls i 1937 whe it alsely elieved that the risis was ver as
emplymet ega t all, ly t see it start t rise e agai rm 11 ak t 20 peret.
Shked, it rapidly reversed direti, ireasig ase mey y mre tha 20 peret per
am rm mid-1938 . Argaly the direti asati was t that hages i M0
ad M1 drive emplymet, t that hages i emplymet drive federal Reserve pliy
ad hee hages i M0t with little impat the verall grwth the mey spply
ad hee little impat p emi ativity.
clearly the The fed Did It argmet is shaky grds with respet t the Great
Depressi, ad as berake is w idig t the hard way, it is a eve mre sspet
argmet tday. firstly the relatiship grwth i M3 t emplymet is eve strgertha the M1 t emplymet relati rm 1920-1940: the R2 is -0.7 r the whle perid.
Figure 3: M3 chage ad uemplymet are strgly egatively rrelated
(R^2 = -0.72)
Hwever the M0 t emplymet rrelati has the wrg sig, ad is eve strger
tha the wrg rrelati r the 1930s at +0.51 (see Figure 4). The iggest st t base
Mey i rerded histry did little t avert the llapse it the Great Reessi, ad repeated
sts are dig very little t ed it.
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Figure 4: The crrelati M0 chage ad uemplymet has the Wrg Sig
The Mey Mltiplier als has eve less eet the mey spply itsel w tha ak
i the Great Depressi: the rrelati etwee hages i M0 ad hages i M3 is eetively
zer r the whle perid sie 1990 (-0.07), strgly the wrg sig r the pre-risis peridrm 1990-2008 (-0.55), ad ly arely psitive r the pst-risis perid (+0.14).
I trast, the edges mey aalysis th the Great Depressi ad the Great
ctrati (http://www.project-syndicate.org/commentary/rogoff83/English) is sstatially mre
rst. T test the edges mey explaati, I pt the prpsiti that aggregate demad
is the sm ime pls the hage i det, ad that this is expeded th gds ad
servies ad prhases existig assets, i a eati where the let had side represets
metary lws ad the right had side represets the metary vale physial spplies
ad trver iaial laims physial assets:
dY D GDP NAT dt
+ = + (1)
NATstads r net Asset Trver, whih a e atred it the prie idex r assets
PA, times their atity QA, times the trver TA expressed as a rati the mer
assets (TA
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The rrelati etwee hage i det ad emplymet is ar strger tha the rrelati
etwee hage i M1 ad emplymet drig th perids (see figre 6):
Figure 5: chage i M0 has crrelati with chage i M3
Figure 6: chage i Det Drives Emi Perrmae
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Figure 7: chage i Det Drives Emi Perrmae
Similarly, there is a relatiship etwee the aelerati det ad th the rate hage
GDP (biggs ad Mayer 2010, biggs, Mayer ad Pik 2010) ad the hage i asset pries:
(3)This relati a e see as a geeralizati berakes fiaial Aeleratr (berake
et al. 1996) t th asset markets as well as gds markets, ad withoutthe alse nelassial
restriti that ly the distriti det, ad t its aggregate rate hage, has
maremi sigiiae.
The data strgly spprt the edges mey prpsiti that the aelerati det
has maremi sigiiae. The rrelati etwee redit aelerati ad hage i
emplymet i the 1920-40 perid is sigiiat ad has the rret sig (Figure 8).
The rrelati r the perid 1990-nw is strger still (-0.75) ad i at is larger tha
the rrelati hage i M3 with the level emplymetlet ale its rate hage
(Figure 9).7
The rrelati the aelerati det with hage i asset pries is als sstatial. I
strg trast t the w disredited Eiiet Markets Hypthesis laim that det plays rle
i determiig the vale eve a sigle rprati, the aelerati det has a sstatial
ilee p the hage i valati the etire asset market (Figure 10 ad Figure 11).
7 The rrelati the aelerati M3 with the hage i emplymet als has the right sig t it amh smaller mis 0.16.
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Figure 8: Det Aelerati ad uemplymet chage, 1920-1940
Figure 9: Det Aelerati ad uemplymet chage, 1990-2012
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Figure 10: credit Aelerati & the DJIA, 1922-1940
Figure 11: credit Aelerati ad the DJIA, 1990-nw
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This is espeially marked i the ase hsig, whe the aelerati mrtgage det
a e islated. The rrelati the aelerati mrtgage det with the hage i real
hse pries is 0.8 (Figure 12).
Figure 12: Mrtgage Aelerati ad chage i Real Hse Pries
Sie det at aelerate ideiitely, this is als why asset les, ltimately, have
t rashad therere als a reas why maremi pliy shld attempt t prevet
them i the irst plae.
VIII. concLuSIon: ToWARDS A nEW MAcRoEconoMIcS
The aalysis here is still ly prelimiary, t the data gives ar strger empirial spprt t the
edges mey, redit-drive perspetive tha t the elassial. fr th theretial ad
empirial reass, nelassial maremis des ideed deserve t e thrw t with
the athwater, ad a ew dyami, diseilirim maremis strted i its stead.
failre t hestly rt the theretial weakesses ad empirial ailres the
dmiat shl emis will t preserve it. Ideed, tiig t igre the gl
etwee the preditis elassial emi mdels ad the state the emy will
simply aelerate the steep delie i the pli respet arded t emists sie this
risis ega. ultimately, mplaey ad deial will lead emis ak t the psiti
disdai that Keyes desried s well drig the last Depressi:
bt althgh the dtrie itsel has remaied estied y rthdx emists p t a late date,
its sigal ailre r prpses sieti prediti has greatly impaired, i the rse time, the
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prestige its pratitiers. fr pressial emists, ater Malths, were apparetly mved
y the lak rrespdee etwee the reslts their thery ad the ats servati;
a disrepay whih the rdiary ma has t ailed t serve, with the reslt his grwig
willigess t ard t emists that measre respet whih he gives t ther grps
sietists whse theretial reslts are rmed y servati whe they are applied t the ats.(J. M. Keyes, 1936, p. 33)
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