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Transcending Lucas Critique & Modelling in
Minsky
Steve Keen
Kingston University London
IDEAeconomics
Minsky Open Source System Dynamics
www.debtdeflation.com/blogs
How to answer economic questions with models?
•
•
•
•
How should one do economics?
Work from microfoundations?
According to Lucas, yes:
Lucas 1976: “This essay has been devoted to an exposition
and elaboration of a single syllogism: given that the
structure of an econometric model consists of optimal
decision rules of economic agents…”
• Lucas 2003: “I also held on to Patinkin’s ambition
somehow, that the theory ought to be microeconomically
founded, unified with price theory. I think this was a very
common view.
• Nobody was satisfied with IS-LM as the end of
macroeconomic theorizing. The idea was we were going to
tie it together with microeconomics and that was the job of
our generation.”
How to answer economic questions with models?
A water molecule
• So macroeconomics must be derived from
microeconomics?
• Sure! Just like fluid scientists derive the properties
of water (macro) from micro (single molecule of
A steam molecule
H20)…
An ice molecule
A snowflake molecule
• Properties of water are emergent
• Can’t understand without considering
relationship between entities even when they
are identical
• Ditto economics: “microfoundations” a nonsequitur
How to answer economic questions with models?
• Realised by physicists half a century ago:
– “The behavior of large and complex aggregates of elementary
particles, it turns out, is not to be understood in terms of a simple
extrapolation of the properties of a few particles.
– Instead, at each level of complexity entirely new properties appear,
and the understanding of the new behaviors requires research
which I think is as fundamental in its nature as any other.
– One may array the sciences roughly linearly in a hierarchy, according
to the idea:
• The elementary entities of science X obey the laws of science Y
– But this hierarchy does not imply that science X is “just applied Y”.
At each stage entirely new laws, concepts, and generalizations are
necessary, requiring inspiration and creativity to just as great a
degree as in the previous one.
– Psychology is not applied biology, nor is biology applied chemistry.”
(Anderson 1972 , p. 393)
How to answer economic questions with models?
• Anderson explicitly rejected “constructionism”:
– “The main fallacy in this kind of thinking is that the reductionist
hypothesis does not by any means imply a “constructionist” one:
• The ability to reduce everything to simple fundamental laws
does not imply the ability to start from those laws and
reconstruct the universe.”
• Result discovered in economics by Sonnenschein-Mantel-Debreu:
– “market demand functions need not satisfy in any way the classical
restrictions which characterize consumer demand functions…
– Only in special cases can an economy be expected to act as an
‘idealized consumer’. The utility hypothesis tells us nothing about
market demand unless it is augmented by additional requirements.”
(Shafer & Sonnenschein 1993, p. 671)
• But ignored (and misunderstood) by Neoclassicals
• So we can’t “do” macro by extrapolating from micro
• How to do instead?...
How to answer economic questions with models?
• Classical tradition that structure of capitalism is
the main explicant of its behaviour
• Work from structure of capitalism:
– “Men make their own history,
– but they do not make it as they please;
– they do not make it under self-selected
circumstances,
– but under circumstances existing already,
given and transmitted from the past.” (Marx
1852)
• Consistent with Post Keynesian practice:
– Derive dynamics of capitalism from its social & physical structure
• Use this to pose the ultimate question about capitalism:
– “Is capitalism stable or unstable?”
Is Capitalism Stable or Unstable?
• The (Ultra)-Orthodox Perspective
– Edward Prescott (Nobel Prize 2004 for Real Business Cycle Theory)
• “Some Observations on the Great Depression” (1999)
– “The Marxian view is that capitalistic economies are
inherently unstable
– and that excessive accumulation of capital will lead to
increasingly severe economic crises.
– Growth theory, which has proved to be empirically
successful, says this is not true.
– The capitalistic economy is stable, and absent some change
in technology or the rules of the economic game,
– the economy converges to a constant growth path
– with the standard of living doubling every 40 years.”
Is Capitalism Stable or Unstable?
• The heterodox “Minskian” Alternative: Hyman Minsky (1969)
– “In this "Chicago" view there exists a financial system, different
from that which ruled at the time of crisis but nonetheless
consistent with capitalism, which would make serious financial
disturbances impossible
– The alternative polar view, which I call unreconstructed Keynesian,
– is that capitalism is inherently flawed, being prone to booms, crises
and depressions.
– This instability, in my view, is due to characteristics the financial
system must possess if it is to be consistent with full-blown
capitalism.
– Such a financial system will be capable of both generating signals
that induce an accelerating desire to invest and of financing that
accelerating investment.” (Minsky 1969 [1982, p. 224])
Different ideology, or better logic?
• A logically incontestable starting point: working from identities
EmploymentRate
Output
Employment 

LabourPr oductivity
Population
Wages
WagesShare 
Output • Can’t be disputed—just definitions
• Put them in dynamic form and you get…
Debt
DebtRatio 
Output
• The employment rate will rise if real economic growth exceeds the
sum of population growth and growth in labor productivity;
• The wages share of output will rise if money wage demands exceed the
sum of inflation and growth in labor productivity; and
• The private debt to GDP ratio will rise if the rate of growth of private
debt exceeds the sum of inflation plus the rate of economic growth.
Deriving the model from strict identities
• Deriving Goodwin model from strict identities:
– Employment rate  Employment/Population
d
d L
  
dt
dt  N 
L

N
d
1 1 d
Y 1 d 
 
Y
a     Nˆ
dt
N  a dt
a a dt 
d
1 d Y

   Nˆ
dt
N dt a
d
1L d

 
Y  L  aˆ     Nˆ
dt
N  Y dt


d
    Yˆ    aˆ  Nˆ
dt
d
1 d
L 1 d

L    N
dt
N dt
 N  N dt
Y
1 d
L
 N  Nˆ
a
N dt

1 d
a  aˆ
a dt
1 d
Y  Yˆ
Y dt

1 d
  ˆ  Yˆ  aˆ  Nˆ
 dt

• “Employment will rise if economic growth exceeds the sum of
population & labor productivity growth”
Deriving the model from strict identities
• Wages share of GDP  Wages/GDP

W
Y
d
d  W  d  w L  d  w 
     R   R 
dt
dt  Y  dt  L  a  dt  a 
w 1 d
d
1 d

wR  R   a
dt
a dt
a a dt
d
1 d
   wR    aˆ
dt
a dt
w
d
1 w d
1 d
   R  wR    aˆ  R 
 wR    aˆ
dt
a wR dt
a wR dt
d
    wˆ R    aˆ
dt
1
d
ˆ R  aˆ
   ˆ  w
 dt
• “Wages share of output will rise if wage rise exceeds growth in labor
productivity”
Deriving the model from strict identities
• Extending Goodwin to include (Hyman) Minsky
• Private Debt Ratio  Debt/GDP
d
D
Y
d
d D 1 d
D 1 d
d  
D    Y
dt
dt  Y  Y dt
 Y  Y dt
d
1D d
1 d
d
D d  Y
dt
Y D dt
Y dt
d
D 1 d
d
D  d  YˆR
dt
Y D dt
d
d  d  Dˆ  d  YˆR
dt
1 d
d  dˆ  Dˆ  YˆR
d dt
• “The private debt ratio will rise if private debt grows faster than GDP”
Turning identities into a simple model
• Simplest possible model of this:
– Output YR a linear function of capital KR
– Investment IR a linear function of profit rate r (& depreciation)
– Employment a linear function of output
– Wage change a linear function of employment rate
– Change in debt equal to investment minus profits


 1  r d





Z
 S 

v


   
      KR  
v






     S     N    
Some fundamental
nonlinearities apply…


 1  r d

S 
Z 



1



r

d

v




d   S 
  Z   1    r  d   d  
  KR 
v
v










A Classical theory of economic cycles
• Replicating this in Minsky (starting from basic Goodwin model)
• Simplest form of this model: linear relationships between variables
• So “Capital K determines Output Y” becomes K  Y
v
• Output determines Employment L becomes Y  L
a
L

N
• Employment rate  determines rate of change of wages wr…
Rate of change of wages
1 d
wr  fn   
wr dt
• Simplest “Phillips Curve” function linear
• Though Phillips insisted on nonlinear 3 factor
function—introduced in later lectures
How much wages change for a given
gap between actual employment 
and zero change rate 0
A function of
the rate of
employment
fn     S     0 
Rate at which
wage change
is zero
A Classical theory of economic cycles
• Minsky Interface:
• You develop a
model by
• Putting variables
and mathematical
operators on the
canvas
• Joining them
using “wires”
• For example, 2nd
equation in
Goodwin model is
Simulation controls
Toolkit of functions
• In Minsky
looks like…
“Canvas” where
modelthis
is drawn
Y
L
a
• Start entering this equation in Minsky by either
– Choosing “var” (“Variable”) from menu and naming it Y;
– Or simply type Y on canvas and press Enter key…
A Classical theory of economic cycles
• Key block in any system dynamics program is “Integral” block
• Used to relate flow (Investment) to a stock (Capital)
• Take equation like
dK
 I  K 
dt
• Integrate both sides
dK
 dt  K   I  K  
• In Minsky this looks like…
• Integration used rather than differentiation because it’s more stable
• Now let’s build whole model starting from definition of K…
A Classical theory of economic cycles
• Building model
in Minsky
• Using
parameter
values:
• v=3
• a=1
• s = 10
• Z = 0.9
•  = 0.1
• N = 120
• Initial conditions
• K(0) = 300
• wr(0)=0.8
• Equations…
K
• Enter these on the canvas like this:
v
Y
L
a
L

N
fn  S     Z 
Y
dwr
 fn  wr
dt
W  wr  L
Y W
I
dK
I  K
dt
• You should get something like the above…
• Now press Run…
• What you should see is sustained cycles in
employment rate  and wage rate wr—not
“equilibrium”…
A Classical theory of economic cycles
• Two basic ways to render model—closed form or full structure:
A Classical theory of economic cycles
• For now let’s add next level of realism: an investment function…
• Simple Goodwin model has capitalists investing all profits
– But they don’t
• Instead invest more during a boom, less during a slump
• Ignoring source of finance for this for now, add a linear
investment function to this model
– Linear only for simplicity—replaced later with more realistic
nonlinear function
• Have capitalists
– Invest on basis of investment function (Ifn) where they:
• Invest all of profits when profit rate = 3%
• Have reaction coefficient as big as that used in Phillips curve = 10
– Z = 0.03
– S = 10
• In Minsky this will look like:
A Classical theory of economic cycles
• A model of capitalism without “bankers behaving badly”:
– Pure free-market system: No government, Ponzi Finance, bankruptcy
– Nothing to “reform away” if there are problems
• Model has two main equilibria:
– “Good” equilibrium: Positive employment rate & wages share of
output; Finite debt ratio
– “Bad” equilibrium: Zero employment rate & wages share of output;
Infinite debt ratio
• Only the beginning of modelling cyclical dynamics of capitalism
– Multiple other sources of cyclicality (& possible systemic crises)
• Innovation cycles (Schumputer); inventory cycles (Meztler,
Kitchin); multi-sectoral cycles (Goodwin, dynamic versions of
Sraffa); ecological feedback (Limits to Growth, thermodynamics)
• Actual production & behaviour nonlinear
– But linear approximation (truncated Taylor series) dominates
behaviour in vicinity of equilibrium
– Model tells you deep characteristics of capitalism
Two possible outcomes
• (1) Convergence to “good” equilibrium
Stable system
(Linear
functions)
Wages
Employment
Private
Share
Debt
of Rate
Ratio
Output
Percent
of GDP
peremployed
year
Percent
of GDP
Percent
of population
100
66
80
64
90
60
62
80
40
60
70
20
58
60
0
56
54
50
20
00
0
50
50
50
100
100
100
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www.debtdeflation.com/blogs
Stable
150
150
150
200
200
200
Two possible outcomes
• (2) Convergence to “bad” equilibrium after apparent “moderation”
Unstable system (Linear functions)
Wages
Employment
Private
Share
Debt
of Rate
Ratio
Output
Percent
of GDP
Percent
of GDP
peremployed
year
Percent
of population
120
400
70
300
100
65
200
60
80
100
55
60
0
 100
50
40
000
Unstable
20
20
20
40
40
40
60
60
60
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www.debtdeflation.com/blogs
www.debtdeflation.com/blogs
80
80
80
100
100
100
We’ve seen this before—in complex systems
• Property of Lorenz “chaotic” model of fluid flow
• This
behaviour
cannot be
generated by
standard
equilibriumoriented
“linear”
model
• Inherent
nonlinearity
& nonequilibrium
dynamics are
essential
800
• Decreasing followed by
increasing turbulence
600
400
200
• Convergence to
laminar flow…
0
 200
0
5
10
15
20
Emergent Phenomena 1: Diminishing cycles then crisis
• Both had declining volatility before the crisis
1980-Now:
1920-40: Diminishing
Diminishingcycles,
cycles,then
thenBreakdown
Breakdown
16
30
Crisis
Crisis
14
25
12
20
Percent
Percent
10
15
8
10
6
5
4
0
2
0
5
0
0
10
2
Inflation
Unemployment
Inflation
Unemployment
15
4
1980
1920 19821922
1984 19861924
1988 1990
19261992 1994
19281996 1998
1930 20001932
2002 2004
1934
2006 2008
1936
2010 2012
19382014 1940
2016
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Emergent Phenomena 1: Diminishing cycles then crisis
• Both also had rising private debt, followed by deleveraging
1920-40: Rising
1980-Now:
RisingDebt,
Debt,then
thenDeleveraging
Deleveraging
Percent of GDP
140
160
Debt Ratio
Debt Change
Crisis
Crisis
80
80
70
70
130
150
60
60
120
140
50
50
110
130
40
40
100
120
30
30
90
110
20
20
80
100
10
10
70
90 0
00
60
80
10
 10
50
20
70
 20
1920
1926
19281996 1998
1930 2000 1932
1934
1936
19382014 2016
1940
1980 19821922
1984 19861924
1988 1990
1992 1994
2002 2004
2006 2008
2010 2012
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Percent of GDP change per year
150
170
Simple complex systems model…
• Slightly more complicated but still simple model (in equations)
s
 s  1    t   r  t   d  t  ; r 
v
Inflation-adjusted
r  t   if  inflagnominal
inflag  t  , rrate
 t   0, rb interest
b
1st
1 
1

inf
t


1



t




order time lag
determines
 inflation
 P  1  s

  Ifn  r 


1 d
   
  Kr       


 dt
v



1 d
   w fnaffects
 inf  t  share
Inflation
     wages
 dt
 Ifn  r  

 s
 debt

v affects
 Ifn  rgrowth


1 d Inflation


 d
 
  Kr   inf  t  


d dt
d

 v

inf  t  
1
d
1 
inflag  t  rate

1
Lagged interest
reaction
toinflation
inflag  t  dt
 inf  inflag  t  
Simple complex systems model…
• The same model in Open Source system dynamics program Minsky:
Rising inequality & crisis (full nonlinear price model)
• Falling workers’ share… • Offsets rising bankers’ share…
• Capitalist are
the last ones to
know that
capitalism is
coming to an
end…
Crisis because the mainstream ignores private debt
• Employment, inflation & profit give no warning of crisis:
• Private debt ratio is the key indicator of impending crisis
Crisis because The Left ignores private debt too
• There is no “tendency for the rate of profit to fall”
• There is a “tendency for private debt to grow exponentially”
Simple reason why credit slowdown causes crises
• Slowdown in credit growth causes crisis if Debt/GDP already high…
Where the next crisis will come from
• Candidates (1) : private debt > 175% of GDP (in rank order)
Private Debt to GDP Ratios
340
320
Percent of national GDP
300
280
260
240
220
200
180
160
140
120
100
80
1990
Spain
France
Finland
Korea
China
Portugal
Australia
Canada
Belgium
Switzerland
Norway
Denmark
Sweden
Netherlands
Ireland
1992 1994 1996
Hong Kong
GFC
1998
2000
2002
2004
2006
2008
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2010
2012
2014
2016
2018
Where the next crisis will come from
• Candidates (2) : Debt growth > 8% GDP per year since 2010 (rank order)
Percent of national GDP per year
Private Debt to GDP Growth Rates
50
48
46
44
42
40
38
36
34
32
30
28
26
24
22
20
18
16
14
12
10
8
6
4
2
0
2010
Hong Kong
China
Korea
Canada
Australia
Norway
Sweden
2011
2012
2013
2014
2015
www.debtdeflation.com/blogs
2016
2017
2018
Implications for economic pedagogy
• A Rethinking and Re-Learning of Economics is needed
• Learn Neoclassical economics well
– Warts and all (not the airbrushed textbook version)
• As a (hopefully passing) phase in the history of economic thought
• Learn other existing schools well too: none have complete alternative
– Austrian, Marxian, Post Keynesian, Evolutionary, Ecological, Feminist
• Learn complex systems approaches & thermodynamics
• But you won’t find that curriculum at Oxford or Cambridge!
• S0…