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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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