the crisis in economics & economic theory steve keen university of western sydney debunking...
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The crisis in economics & economic theory
Steve KeenUniversity of Western Sydney
Debunking Economicswww.debtdeflation.com/blogs
www.debunkingeconomics.com
0 1 2 3 4 5 6 7 8 9 10 11 12 1325
20
15
10
5
0
5
10
15
20
25
Great Depressionincluding GovernmentGreat Recessionincluding Government
Debt-financed demand percent of aggregate demand
Years since peak rate of growth of debt (mid-1928 & Dec. 2007 resp.)
Per
cen
t
0
Macroeconomics Before the Crisis: Triumphalism• “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)
Macroeconomics Before the Crisis: Triumphalism• “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-to-quarter 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)
Macroeconomics Before the Crisis: Triumphalism• “there has been enormous progress and substantial
convergence…• Facts have a way of eventually forcing irrelevant
theory out (one wishes it happened faster), and good theory also has a way of eventually forcing bad theory out.
• The new tools developed by the New-Classicals came to dominate.
• The facts emphasized by the New-Keynesians forced imperfections back in the benchmark model. A largely common vision has emerged…
• The state of macro is good…” (Blanchard 2008, 2009)– Published as working paper 1 year after crisis
began!
And then there was an exogenous shock…• From “The Great
Moderation”…
1980 1985 1990 1995 2000 2005 2010 20155
2.5
0
2.5
5
7.5
10
12.5
15
UnemploymentInflation
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Per
cent
0
1980 1985 1990 1995 2000 2005 2010 20155
2.5
0
2.5
5
7.5
10
12.5
15
100
150
200
250
300
UnemploymentInflationDebt
0
• To “The Great Contraction”
1980 1985 1990 1995 2000 2005 2010 20155
2.5
0
2.5
5
7.5
10
12.5
15
100
150
200
250
300
UnemploymentInflationDebt
0
• & “The Jobless Recovery”
Macroeconomics After the Crisis: Evasion• “These models were designed to describe aggregate
economic fluctuations during normal times when markets can bring borrowers and lenders together in orderly ways, not during financial crises and market breakdowns.” (Sargent in Rolnick 2010)
• “Are … standard macroeconomic models … significantly flawed? I think the answer is a qualified no…
• Most of the time, including during recessions, serious financial instability is not an issue. The standard models were designed for these non-crisis periods, and they have proven quite useful in that context.” (Bernanke 2010)
• “It is important to start by stating the obvious, namely, that the baby should not be thrown out with the bathwater.” (Blanchard, Dell'Ariccia and Mauro 2010)
Macroeconomics After the Crisis: Evasion• Permanently negative random exogenous shocks?
…• “the Great Recession began in late 2007 and early
2008 with a series of adverse preference and technology shocks in roughly the same mix and of roughly the same magnitude as those that hit the United States at the onset of the previous two recessions…
• The string of adverse preference and technology shocks continued, however, throughout 2008 and into 2009. Moreover, these shocks grew larger in magnitude, adding substantially not just to the length but also to the severity of the great recession…” (Ireland 2011; see also McKibbin and Stoeckel 2009)
Monetary Macroeconomic Realism• Non-neoclassical economic realism:
– Endogenous crisis, not exogenous shock– Growth of private debt caused “Great Moderation”– Slowdown in growth of debt caused “Great
Recession”– Crisis will continue until deleveraging ends
• Neoclassical macro incapable of analysing these factors
• Key problem: blindsided by “exogenous money” fallacy…
The exogenous money fallacy• Individuals/companies have two sources of spending:
– Income– Increase in debt
• Neoclassical theory counts the first, ignores the second– Debt transfers money from saver to borrower– Only distribution of debt matters, not aggregate
level• Fisher's “Debt Deflation” theory ignored:• “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 … pure redistributions should have no significant macro-economic effects…” (Bernanke 2000)
The exogenous money fallacy• “Ignoring the foreign component, or looking at the
world as a whole, the overall level of debt makes no difference to aggregate net worth—one person's liability is another person's asset…
• In what follows, we begin by setting out a flexible-price endowment model in which “impatient” agents borrow from “patient” agents, but are subject to a debt limit.” (Krugman and Eggertsson 2010)
• “the debt we create is basically money we owe to ourselves, and the burden it imposes does not involve a real transfer of resources.
• That’s not to say that high debt can’t cause problems — it certainly can. But these are problems of distribution and incentives, not the burden of debt as is commonly understood.” (Krugman 2011)
The exogenous money fallacy• Patient lends to Impatient
• Patient’s spending power goes down• Impatient’s spending power goes up• No change in aggregate demand• Banks mere intermediaries (ignored in analysis)
The endogenous money reality• Logically & Empirically false
– Lending is not “transfer from saver to borrower”– But money creation “out of nothing”
• “Even though the conventional answer to our question is not obviously absurd, yet there is another method of obtaining money for this purpose, which … does not presuppose the existence of accumulated results of previous development…
• This method of obtaining money is the creation of purchasing power by banks…
• It is always a question, not of transforming purchasing power which already exists in someone's possession, but of the creation of new purchasing power out of nothing…” (Schumpeter, 1934)
• New debt net source of new investment & speculation
Actual “endogenous money” process• Entrepreneur approaches bank for loan
Assets Liabilities
• Bank grants loan & creates deposit simultaneously
• Alan Holmes, Senior V-P, New York Fed
• “In the real world, banks extend credit, creating deposits in the process, and look for the reserves later.” (1969)
• New loan puts additional spending power into circulation
• Aggregate demand exceeds demand from income alone
• Neoclassical macro wrong to ignore change in debt
“Endogenous money” changes everything• Explains why dynamics of debt caused boom and
bust• Aggregate demand = Income + Change in Debt
– Income (mainly) finances consumption– Change in debt (mainly) finances:
• Investment (new factories, innovation)• Speculation (gambling on asset prices)
• Spent on– New goods and services (the real economy)– Financial claims on existing assets (the FIRE
economy)• Call this Net Asset Turnover:
– Price of assets (DJIA, Case-Shiller Index)– Times quantity (Number of shares, houses)– Annual turnover (% sold each year)
“Endogenous money” changes everything• Aggregate accounting balance is not “Walras’ Law”
– “Aggregate Demand is Aggregate Supply”• But “Walras-Schumpeter-Minsky Law”
– Income + Change in Debt = GDP + NAT• Growth accounting balance is
– Change in Income;– Plus Acceleration in Debt (Change in the change…)– Equals– Change in GDP plus– Change in NAT
• Most of which is Change in Share & House Prices
“Endogenous money” changes everything• Basic Logic: d
Y D GDP NATdt
A A ANAT P Q T
2
2 A A A
d d d dY D GDP P Q T
dt dt dt dt
De
bt
accelerationdri
ves
change in ass
et pri
ces
“Endogenous money” changes everything
• Since accelerating debt causes asset price bubbles– Bubbles must burst, because acceleration must
end– Just like a car can’t accelerate forever
• At maximum velocity, acceleration is zero• Applying this to:
– Why the economy boomed from 1993-2007– Why it crashed in 2007– Why asset markets crashed as well
Boom & Bust: debt-charged growth & collapse• Rising private debt boosted demand by $4 trillion at
peak• Falling debt cut demand by $2.8 trillion at trough• From $18.3 to $11.5 trillion in just 2 years
1990 1992 1994 1996 1998 2000 2002 2004 2006 2008 2010 2012 20145 10
6
6 106
7 106
8 106
9 106
1 107
1.1 107
1.2 107
1.3 107
1.4 107
1.5 107
1.6 107
1.7 107
1.8 107
1.9 107
2 107
GDPPlus change in Private DebtPlus change in Government Debt
US Aggregate Demand
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US
$ m
illi
on
p.a
.
Partial Government Rescue• Government debt also creates money
– “Fiat” rather than Credit• Government deficit partially offset private
deleveraging• From $18.7 to $13 trillion in 2 years• Without government deficit, aggregate demand
would be– $1 trillion lower– $300 billion less than GDP
• Politicians obsess on government debt, but…
Partial Government Rescue• Rise in government debt 30% GDP• Dwarfed by 47% fall in private debt
1920 1930 1940 1950 1960 1970 1980 1990 2000 2010 20200
20
40
60
80
100
120
140
160
180
200
220
240
260
280
300
320
Private DebtPublic Debt
USA Debt to GDP Ratios
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Perc
en
t o
f G
DP
“The Great Recession”• Fall in debt-financed demand drove unemployment
1990 1992 1994 1996 1998 2000 2002 2004 2006 2008 2010 2012 201430
25
20
15
10
5
0
5
10
15
20
25
30 0
11
10
9
8
7
6
5
4
3
2
1
0
Debt ChangeUnemployment
USA Change in Debt & Unemployment (Corr=-0.92)
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Deb
t Cha
nge
p.a.
Per
cent
GD
P
Une
mpl
oym
ent (
Inve
rted
)
0
“The Great Recession”• Acceleration drives change in unemployment
1990 1992 1994 1996 1998 2000 2002 2004 2006 2008 2010 2012 201430
25
20
15
10
5
0
5
10
15
60
50
40
30
20
10
0
10
20
30
Debt ChangeUnemployment
Debt Acceleration & Unemployment Change (Corr=-0.74)
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Deb
t Acc
eler
atio
n p.
a. %
of
GD
P
Une
mpl
oym
ent (
Inve
rted
)
0
Stock market boom and bust• Debt acceleration drives asset prices—up and down
1990 1992 1994 1996 1998 2000 2002 2004 2006 2008 2010 2012 201430
25
20
15
10
5
0
5
10
15
90
75
60
45
30
15
0
15
30
45
Debt AccelerationAnnual change in DJIA
Debt acceleration & Share Price Change (Corr=.24)
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Deb
t acc
eler
atio
n p.
a. a
s %
of
GD
P
Ann
ual c
hang
e in
CP
I-de
flat
ed D
JIA
Housing bubble and bust• More obvious for mortgage debt & house prices:
1990 1992 1994 1996 1998 2000 2002 2004 2006 2008 2010 2012 20148
7
6
5
4
3
2
1
0
1
2
3
4
5
6
7
8
24
21
18
15
12
9
6
3
0
3
6
9
12
15
18
21
24
Mortgage AccelerationAnnual change in DJIA
Debt acceleration & House Price Change (Corr=.79)
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Mo
rtgag
e D
ebt
acce
lera
tion p
.a. as
% o
f G
DP
Ann
ual
chan
ge
in C
PI-
def
late
d C
ase-
Sh
ille
r In
dex
0
From facts to theory…• Neoclassical failure to foresee crisis inevitable:• “The preferred model has a single representative
consumer optimizing over infinite time with perfect foresight or rational expectations, in an environment that realizes the resulting plans more or less flawlessly through perfectly competitive forward-looking markets for goods and labor, and perfectly flexible prices and wages.
• How could anyone expect a sensible short-to-medium-run macroeconomics to come out of that set-up?...
• I start from the presumption that we want macroeconomics to account for the occasional aggregative pathologies that beset modern capitalist economies…
• A model that rules out pathologies by definition is unlikely to help.’” (Solow [Nobel Prize Winner!] in 2003)
Towards a monetary macroeconomics• All methodological choices of neoclassical macro
wrong:– Disequilibrium & dynamics, not equilibrium &
statics– Social classes, not isolated individuals– Money not barter
• Foundations: Marx, Schumpeter, Sraffa, Keynes, Fisher, Kalecki, Minsky, Goodwin, Graziani
• Integrated in Minsky’s Financial Instability Hypothesis• Focus: a model that can generate a Great
Depression:– Anything else isn’t a model of capitalism
The Financial Instability Hypothesis• Hyman Minsky, 1982:
– “Can “It”—a Great Depression—happen again?– And if “It” can happen, why didn’t “It” occur in the
years since World War II?– These are questions that naturally follow from
both the historical record and the comparative success of the past thirty-five years.
– To answer these questions it is necessary to have an economic theory which makes great depressions one of the possible states in which our type of capitalist economy can find itself.”
The Financial Instability Hypothesis
• Economy in historical time• Debt-induced recession in recent past• Firms and banks conservative re debt/equity, assets• Only conservative projects are funded
– Recovery means most projects succeed• Firms and banks revise risk premiums
– Accepted debt/equity ratio rises– Assets revalued upwards…
• “Stability is destabilising”– Period of tranquility causes expectations to rise…
• Self-fulfilling expectations– Decline in risk aversion causes increase in
investment– Investment expansion causes economy to grow
faster• Rising expectations leads to “The Euphoric
Economy”…
The Financial Instability Hypothesis
• Asset prices rise: speculation on assets profitable• Increased willingness to lend increases money supply
– Money supply endogenous, not controlled by CB• Riskier investments enabled, asset speculation
rises• The emergence of “Ponzi” financiers
– Cash flow less than debt servicing costs– Profit by selling assets on rising market– Interest-rate insensitive demand for finance
• Rising debt levels & interest rates lead to crisis– Rising rates make conservative projects
speculative– Non-Ponzi investors sell assets to service debts– Entry of new sellers floods asset markets– Rising trend of asset prices falters or reverses
The Financial Instability Hypothesis
• Boom turns to bust• Ponzi financiers first to go bankrupt
– Can no longer sell assets for a profit– Debt servicing on assets far exceeds cash flows
• Asset prices collapse, increasing debt/equity ratios• Endogenous expansion of money supply reverses• Investment evaporates; economic growth slows• Economy enters a debt-induced recession
– Back where we started...• Process repeats once debt levels fall
– But starts from higher debt to GDP level• Final crisis where debt burden overwhelms economy
– Modeling Minsky…
Keen 1995 Model Foundations: Nonlinear dynamics• Growth Cycle model (Goodwin 1967, Blatt 1983)
Y/
lr1
Labour Productivitya
L
dw/dt 1/SIntegrator
w++
1Initial Wage
*L
W
WY +
-Pi I dK/dt
• Closes the loop:
1Initial Capital +
+1/SIntegrator
dK/dt
K 1/3Accelerator
Y
L/
lr100
PopulationN
l
PhillipsCurve dw/dt+- *
10WageResponse
.96"NAIRU"
• Capital K determines output Y via the accelerator:
• Y determines employment L via productivity a:
• L determines employment rate l via population N:
• l determines rate of change of wages w via Phillips Curve
• Integral of w determines W (given initial value)
• Y-W determines profits P and thus Investment I…
K 1/3Accelerator
Y
/lr1
Labour Productivitya
L
/lr
1Population
Nl
PhillipsCurve dw/dt
1/SIntegrator
w++
1Initial Wage *
LW
Y +-
Pi I dK/dt
3Initial Capital +
+1/SIntegrator
+- *10
WageResponse
.96"NAIRU"
Goodwin's cyclical growth model
Time (Years)0 2 4 6 8 10
.50
.75
1.00
1.25
1.50Employment
Wages
Goodwin's cyclical growth model
Employment.9 .95 1 1.05
Wa
ge
s.7
.8
.9
1.0
1.1
1.2
1.3
Modelling Minsky & Endogenous Money…• Goodwin model:
dD I
dt
1 1
1
ddt vd
Pdt
• Debt essential element to introduce Minsky• For debt, essential that capitalists wish to invest
more than they earn– “Debt seems to be the residual variable in
financing decisions. Investment increases debt, and higher earnings tend to reduce debt.” (Fama & French 1997)
– “The source of financing most correlated with investment is long-term debt… These correlations confirm the impression that debt plays a key role in accommodating year-by-year variation in investment.” (Fama & French 1998)
Modelling Minsky & Endogenous Money…• Results in 3-dimensional system:
Wages share of output
Employment ratio
Debt to output ratio
dw
dt
kd
dt v
kdd k d
dt v
• Equilibrium of system locally stable but globally unstable– “Inverse tangent” route to chaos
Sensitive dependence on initial conditions..
• Outcome depends on initial conditions:– Close to equilibrium, convergence;– Far from equilibrium, divergence into debt-
induced depression:
0 20 40 60 80 1000.6
0.7
0.8
0.9
1
1.1
Employment Rate
Wages Share of Output
Employment Rate
Wages Share of Output
Basic Minsky Model: Convergence
Years
c t( )
c t( )
t
0 20 40 60 80 1000
0.5
1
1.5
2
2.5
3
Employment Rate
Wages Share of Output
Employment Rate
Wages Share of Output
Basic Minsky Model: Divergence
Years
d t( )
d t( )
t
Sensitive dependence on initial conditions..
• Debt dynamics behind very different outcomes:
• 1995 model included Government as “homeostatic stabilizer”
• Current work—converting to strictly monetary model
0 5 10 15 20 25 30 35 40 45 50 55 60 65 70 75 80 85 90 95 1004
2
0
2
4
6
8
10
12
14
16
18
20
Employment Rate
Wages Share of Output
Employment Rate
Wages Share of Output
Basic Minsky Model: Divergence
Years
19.131
3.313
d.c t( )
d.d t( )
T0 t
Theoretical dynamics of debt: Minsky + Circuit
• Monetary model of capitalism built from combination of:– Goodwin’s growth cycle– Minsky’s Financial Instability Hypothesis– Circuit theory of endogenous money creation
• Product: “Monetary Circuit Theory”—MCT• Graziani, Circuit Theory
– “any monetary payment must therefore be a triangular transaction, involving at least three agents, the payer, the payee, and the bank. Real money is therefore credit money.” (Graziani, 1989, p. 3)
• Strictly monetary model developed from double-entry bookkeeping
Explicitly Monetary Minsky Model• Input financial relations in Table:
Assets Liabilities Equity
Reserve Loan Firm Deposit
Worker Deposit
Bank Equity
Lend -A A
Record Loan
A
Interest B
Pay Interest -B B
Record -B
Wages -C C
Consumption
D+E -D -E
Repay Loan F -F
Record -F
New Money G
Record G
• System of dynamic equations derived automatically:
dReserves A F
dtd
Loan A F Gdtd
FirmDeposit A B C D E F GdtdWorkerDeposit C D
dtd
BankEquity B Edt
• Illustrating this in Mathcad…
Explicit Money Minsky Model
• Strictly monetary macro model developed• Linked to production via
– nonlinear investment, lending & debt repayment functions
– Dynamic pricing equation– Generalized (3 factor) “Phillips curve”
• As in original Phillips papers but ignored by neoclassicals
– Complex nonlinear dynamic system results…
Financial Sector
tBV t( )d
d
FL t( )
V r t( ) BV t( )
L r t( )
tBT t( )d
drL FL t( ) rD FD t( ) rD HD t( )
BT t( )
B
tFL t( )d
d
BV t( )
L r t( ) FL t( )
V r t( ) P t( ) YR t( ) Inv r t( )
tFD t( )d
drD FD t( ) rL FL t( )
BV t( )
L r t( ) FL t( )
V r t( ) BT t( )
B
HD t( )
W P t( ) YR t( ) Inv r t( )
W t( ) YR t( )
a t( )
tHD t( )d
drD HD t( )
HD t( )
W
W t( ) YR t( )
a t( )
Physical output, labour and price systems
Rate of change of capital stocktKR t( )d
dKR t( ) g t( )
Level of outputYR t( )
KR t( )
v
Employment L t( )YR t( )
a t( )
Rate of Profit r t( )P t( ) YR t( ) W t( ) L t( ) rL FL t( ) rD FD t( )
P t( ) KR t( )
Rate of employmentt t( )d
d t( ) g t( ) ( )[ ]
Rate of real economic growth g t( )Inv r t( )
v
tW t( )d
dW t( )( ) Ph t( )( )
1
t( )
t t( )d
d
1
P t( ) tP t( )d
d
Rate of change of wages
Rate of change of prices
tP t( )d
d
1P
P t( )W t( )
a t( ) 1 ( )
Rates of growth of population and productivityta t( )d
d a t( )
tN t( )d
d N t( ) N 0( ) N0
Full 11-equation ODE system in Mathcad…
Explicitly Monetary Minsky Model• New monetary macroeconomics can explain the
crisis
1980 1985 1990 1995 2000 2005 2010 20155
2.5
0
2.5
5
7.5
10
12.5
15
100
150
200
250
300
UnemploymentInflationDebt to GDP
Smoothed US Data
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Infl
atio
n &
Une
mpl
oym
ent
Deb
t to
GD
P
0
0 5 10 15 20 25 30 35 40 45 50 555
2.5
0
2.5
5
7.5
10
12.5
15
100
150
200
250
300
UnemploymentInflationDebt to GDP
Model output
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Infl
atio
n &
Une
mpl
oym
ent
Deb
t to
GD
P
0
Multi-sectoral extension• Extended to multiple sectors with
– Input-output relations in financial flows table– Replicated “Goodwin” cycle model of production
• Currently implemented as multiple columns in 2D matrix
S1
"Type"
"Name"
"Symbol"
"Compound Interest"
"Deposit Interest"
"Wages"
"Household Interest"
"Inv Dem K"
"Inv Dem C"
"Inv Dem A"
"Inv Dem E"
"IntSec Dema K"
"IntSec Dema C"
"IntSec Dem A"
"IntSec Dem E"
"Cons K"
"Cons C"
"Cons A"
"Cons E"
"Pay Int"
"Repay Loans"
"Recycle Res"
"New Money"
0
"BR"
BR t( )
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
N1 N2 N3 N4 N5 N6 N7 N8
O1 O2 O3 O4 O5 O6 O7 O8( )
0
1
"LK1"
FLK1 t( )
A1
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
M1
N1
O1
P1
1
"LK2"
FLK2 t( )
A2
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
M2
N2
O2
P2
1
"LC1"
FLC1 t( )
A3
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
M3
N3
O3
P3
1
"LC2"
FLC2 t( )
A4
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
M4
N4
O4
P4
1
"LA1"
FLA1 t( )
A5
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
M5
N5
O5
P5
1
"LA2"
FLA2 t( )
A6
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
M6
N6
O6
P6
1
"LE1"
FLE1 t( )
A7
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
M7
N7
O7
P7
1
"LE2"
FLE2 t( )
A8
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
M8
N8
O8
P8
1
"DK1"
FDK1 t( )
0
B1
C1
0
E1 E2( ) E3 E5 E7( )
0
0
0
0
F1
G1
H1
I1 I2( ) I3 I5 I7( )I9 I10
2
J1
K1
L1
M1
N1
O1
P1
1
"DK2"
FDK2 t( )
0
B2
C2
0
E2 E1( ) E4 E6 E8( )
0
0
0
0
F2
G2
H2
I2 I1( ) I4 I6 I8( )I9 I10
2
J2
K2
L2
M2
N2
O2
P2
1
"DC1"
FDC1 t( )
0
B3
C3
0
E3
0
0
0
0
F3 F4( ) F1 F5 F7( )
G3
H3
I3
J3 J4( ) J1 J5 J7( )J9 J10
2
K3
L3
M3
N3
O3
P3
1
"DC2"
FDC2 t( )
0
B4
C4
0
E4
0
0
0
0
F4 F3( ) F2 F6 F8( )
G4
H4
I4
J4 J3( ) J2 J6 J8( )J9 J10
2
K4
L4
M4
N4
O4
P4
1
"DA1"
FDA1 t( )
0
B5
C5
0
E5
0
0
0
0
F5
G5 G6( ) G1 G3 G7( )
H5
I5
J5
K5 K6( ) K1 K3 K7( )K9 K10
2
L5
M5
N5
O5
P5
1
"DA2"
FDA2 t( )
0
B6
C6
0
E6
0
0
0
0
F6
G6 G5( ) G2 G4 G8( )
H6
I6
J6
K6 K5( ) K2 K4 K8( )K9 K10
2
L6
M6
N6
O6
P6
1
"DE1"
FDE1 t( )
0
B7
C7
0
E7
0
0
0
0
F7
G7
H7 H8( ) H1 H3 H5( )
I7
J7
K7
L7 L8( ) L1 L3 L5( )L9 L10
2
M7
N7
O7
P7
1
"DE2"
FDE2 t( )
0
B8
C8
0
E8
0
0
0
0
F8
G8
H8 H7( ) H2 H4 H6( )
I8
J8
K8
L8 L7( ) L2 L4 L6( )L9 L10
2
M8
N8
O8
P8
1
"HD"
HD t( )
0
0
C1 C2 C3 C4 C5 C6 C7 C8
D1
0
0
0
0
0
0
0
0
I9
J9
K9
L9
0
0
0
0
0
"BI"
BI t( )
0
B1 B2 B3 B4 B5 B6 B7 B8( )
0
D1
0
0
0
0
0
0
0
0
I10
J10
K10
L10
M1 M2 M3 M4 M5 M6 M7 M8
0
0
0
• Objective: represent as multidimensional “hypercube”
Multi-sectoral extension• Generates multi-sectoral limit cycle
0 20 40 60 80 1005
0
5
10
15
Capital GoodsConsumer GoodsAgricultureEnergy
The Rate of Profit in a Monetary Multisectoral Model of Production
Years
Pro
fit/C
apita
(P
erce
nt)
0 20 40 60 80 1002
0
2
4
6
8
Real Rate of Economic Growth
Per
cent
p.a
.
100 GDPRealChange t( )
t
20 25 30 35 402
0
2
4
6
0
10
20
30
Real GDP GrowthDebt to GDP ratio
Real Rate of Economic Growth
Per
cent
p.a
.
Per
cent
of
GD
P
0
20 25 30 35 4010
20
30
40
50
0
10
20
30
40
GDPDebt
Change in Nominal Credit and Nominal GDP
Per
cent
cha
nge
p.a.
100 GDPNominalChange t( ) 100 DebtChange t( )
t
Multi-sectoral extension• Financial and income distribution dynamics:
20 25 30 351 10
5
1 106
1 107
1 108
10000
1 105
1 106
1 107
LoansDepositsBank Reserves (RHS)
Bank Assets & Liabilities
94 96 98 100 102 10455
60
65
70
75
80
85
90
95
100
15
10
5
0
5
10
15
20
25
30
WagesProfitInterest
Income Distribution Limit Cycles
Employment Rate
Wag
es S
hare
of
Out
put
Cap
italis
t & B
anke
r S
hare
s
• Reforming economics– Accessible monetary macroeconomics with Minsky
A new tool for dynamic macroeconomics
• Economists still practicing “comparative statics”– “[We] were doing comparative statics… there are
a variety of problems in economics … where you want to understand how some kind of shock will affect some equilibrating variable…
– It’s often helpful to do the analysis in two stages. First, you ask how some desired quantities would change holding the equilibrating variable constant; then you ask how that variable has to change to restore equilibrium…” (Paul Krugman 2012)
• Useless technique for non-equilibrating real world– Need to get new students to do dynamics instead– But current tools unsuitable for economics…
Minsky: dynamic monetary modelling• E.g., monetary flow model in
Vissim: • Same model in bookkeeping format:
• Enter “Minsky”• Melding systems
dynamics with accounting
Minsky: dynamic monetary modelling• Very early prototype (Tcl/Tk)• But can do flowchart
modelling…
• And accounting…
• Ambition: economic equivalent of meteorological modelling…
Minsky: dynamic monetary modelling• Table becomes Hypercube
– Twist one way—multiple sectors– Twist the other—multiple banks
• Multiple tables: trade & finance flows between national economies
• There’s just one more thing…
We need help!!!
Minsky: dynamic monetary modelling
• First INET Grant ($128K) runs out July 2012• Were going to apply for ARC Linkage Grant $500K
– INET agreed to pay $40K p.a. to this– Last year 2 rounds, 1st round funding by August– Jan 10th 2012 ARC says 1 round only funding July
2013!• We need $ to keep single programmer going till then
– INET will provide $40K if we get additional funding• Coding assistance in GPL project• Assistance in both respects needed
Deleveraging for … 2 decades?• At current rate, get to 1970 debt level by 2025
1920 1930 1940 1950 1960 1970 1980 1990 2000 2010 2020 20300
20
40
60
80
100
120
140
160
180
200
220
240
260
280
300
320
Debt to GDP ratio12.5% p.a. decline9% p.a. decline7.9% p.a.
USA Private Debt to GDP
www.debtdeflation.com/blogs
Per
cen
t of
GD
P
It won
’t be a sm
ooth rid
e
dow
n…
Volatility rules• It hasn’t been—and won’t be—a smooth ride
down…
2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 20122 10
7
2.25 107
2.5 107
2.75 107
3 107
3.25 107
3.5 107
3.75 107
4 107
4.25 107
4.5 107
5000000
4000000
3000000
2000000
1000000
0
1000000
2000000
3000000
4000000
5000000
LevelChangeAcceleration
Private US Debt: Level, Change, Acceleration
www.debtdeflation.com/blogs
$ m
illio
n
$ m
illio
n an
nual
ised
0
Acceleration Dynamics• Why asset markets
lead…
2 1.5 1 0.5 0 0.5 1 1.5 20
0.125
0.25
0.375
0.5
0.625
0.75
0.875
1
2
1.5
1
0.5
0
0.5
1
1.5
2
DistanceSpeedAcceleration
Why Asset Markets Are Leading Indicators
0
0.5
Assets Goods
Peak
Acc
ele
rati
on
Peak
Velo
city
• Why they’re weird…
Acc
eler
atio
n rise
s
As velocity falls
• Velocity: addition to aggregate demand
• Acceleration– Change in
aggregate demand
– Change in asset prices
What about Australia?• Same basic story: debt-driven boom/bust cycle
1860 1880 1900 1920 1940 1960 1980 2000 20200
30
60
90
120
150
180
210
240
270
300
Australia
Debt to GDP
1860 1880 1900 1920 1940 1960 1980 2000 20200
30
60
90
120
150
180
210
240
270
300
AustraliaUSA
Debt to GDP
• Higher level than ever before• But lower than
USA
Australia: Crisis? What Crisis?• We avoided crisis by delaying deleveraging:
2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012100
105
110
115
120
125
130
135
140
145
150
155
160
200
210
220
230
240
250
260
270
280
290
300
310
320
AustraliaUSA
Debt to GDP
www.debtdeflation.com/blogs
Aust
ralia
US
A
EndFHVB
Australia: Crisis? What Crisis?• We avoided crisis by delaying deleveraging:
2008 2008.5 2009 2009.5 2010 2010.5 2011 2011.5 201220
15
10
5
0
5
10
15
20
25
30
AustraliaUSA
Debt-financed Aggregate Demand
www.debtdeflation.com/blogs
Perc
en
t o
f G
DP
0
2008 2008.5 2009 2009.5 2010 2010.5 2011 2011.5 201220
15
10
5
0
5
10
15
20
25
30
AustraliaUSAplus Governmentplus Government
Debt-financed Aggregate Demand
www.debtdeflation.com/blogs
Perc
en
t o
f G
DP
0
• Plus Government stimulus…
Conclusion• We are in a different Great Depression
– Higher level of private debt, larger deleveraging– Different debt distribution—less deflation
1920 1930 1940 1950 1960 1970 1980 1990 2000 2010 20200
25
50
75
100
125
150
175
200
0
50
100
150
200
250
300
350
400
BusinessHouseholdFinanceTotal
US Private Debt to GDP
www.debtdeflation.com/blogs
Perc
en
t o
f G
DP
To
tal
Pri
vate
Deb
t
“Turning Japanese” rather than 1930 rerun
Conclusion• Larger Government significant reason for shallower
crisis
0 1 2 3 4 5 6 7 8 9 10 11 12 1325
20
15
10
5
0
5
10
15
20
25
Great Depressionincluding GovernmentGreat Recessionincluding Government
Debt-financed demand percent of aggregate demand
Years since 1928 & 2008 respectively
Per
cent
0
Conclusion• Policy
– Reduce private debt to reduce scale of crisis
• Theory– Consign neoclassical
economics to dustbin of history