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Debt-financed demand percent of aggregate demand 25 20 15 Percent 10 5 0 0 5 Great Depression including Government Great Recession including Government 10 15 20 25 0 1 2 3 4 5 6 7 8 9 10 11 12 13 Years since peak rate of growth of debt (mid-1928 & Dec. 2007 resp.) Neoclassical Economics: Dethroning the Naked Emperor of the Social Sciences Steve Keen University of Western Sydney Debunking Economics www.debtdeflation.com/blogs www.debunkingeconomics.com A paradoxical but transcendental truth… • Neoclassical economists don‟t understand neoclassical economics • Before the Crisis: founding editor of AER: Macro – “The state of macro is good… – “Dynamic Stochastic General Equilibrium‖ model is… – ―simple, analytically convenient, and has largely replaced the IS-LM model as the basic model of fluctuations in graduate courses… – Unlike the IS-LM model, it is formally, rather than informally, derived from optimization by firms and consumers.‖ (Blanchard 2009, pp.214-215) After the crisis… • ―The great moderation lulled macroeconomists and policymakers alike in the belief that we knew how to conduct macroeconomic policy. • The crisis clearly forces us to question that assessment… • It is important to start by stating the obvious, namely, that the baby should not be thrown out with the bathwater…‖ (Blanchard Dell'Ariccia et al. 2010; emphasis added) • Wrong: this baby should never have been conceived – Base of DSGE macro is Solow-Ramsey growth model • Yet Solow rejects DSGE models! – DSGE models commit fallacy of ―Strong Reductionism‖ • SMD conditions prove macro can‘t be applied micro Skip Solow‘s critique (in Debunking Economics II) Solow rejects DSGE • Robert Solow (2001 p. 19; emphases added) – ―The prototypical real-business-cycle model goes like this. There is a single, immortal household—a representative consumer—that earns wages from supplying labor. It also owns the single price-taking firm… – This is nothing but the neoclassical growth model… – [When I built it] … It was clear … what I thought it did not apply to, namely short-run fluctuations ... the business cycle... – Now ... an article today [on the] 'business cycle' … will be ... a slightly dressed up version of the neoclassical growth model. – The question I want to circle around is: how did that happen?” Solow: SMD conditions invalidate DSGE • ―Suppose you wanted to defend the use of the Ramsey model as the basis for a descriptive macroeconomics. What could you say? ... • You could claim that … there is no other tractable way to meet the claims of economic theory. • I think this claim is a delusion. • We know from the Sonnenschein-Mantel-Debreu theorems that…‖ (Solow 2008, p. 244; emphasis added) • Sonnenschein-Mantel-Debreu: demand curve for a single market can have any (polynomial) shape at all – Even study of a single market can‟t be reduced to study of a single utility-maximizing agent – Yet Neoclassical DSGE macro models the whole economy as a single utility-maximizing agent SMD: ―Anything goes‖ for market demand curves • SMD Conditions (Sonnenschein 1973; Shafer & Sonnenschein 1993;): – Market demand curves do not obey the „Law of Demand― – Even if summing „well behaved― individual demand curves P Crusoe P q Friday P q Market Q • Proof by contradiction: – Assume market demand curves do obey Law of Demand – Derive conditions under which this is true – Contradict initial assumption • Therefore they don„t obey the „Law“ of Demand Skip Logic (in Debunking Economics II) Logic: Price changes alter income distribution • Z X Coconuts B (1) Can vary Price without altering income • Pivot point does not move Y q1 q2 q3 II I III Bananas Price of Bananas • Logic: – ―Law of Demand‖ derived from Hicksian compensated demand curve procedure – Take individual with well-behaved utility function – Vary price of one commodity while keeping others constant and consumer income constant • Key assumptions: p1 p2 p3 q1 q2 q3 Bananas W Individual demand curve derivation q1 Price of Bananas • Outcome: Hicksiancompensated individual demand curve necessarily slopes down: the ―Law of Demand‖ • Motivation behind SMD research: Does this result survive aggregation to market demand? – Answer: No! X Coconuts • (2) Can change income and perfectly compensate for income effect of lower price (Hicksian-compensation) q2 q3 Bananas p1 p2 p3 q1 q2 q3 Bananas With more than one consumer… • Logic: ―individual demand curve‖ model ignores impact of price changes on income – But price changes will change income distribution • In 2 (or more) consumer model, each must have – Different income sources; and – Different tastes • Otherwise, there‘s only one consumer – Tastes must change with income • Otherwise, there‘s only one commodity • Consider 2-consumer, 2 commodity world – Crusoe and Friday; Coconuts and Bananas – Crusoe the Banana owner, Friday Coconut owner – Coconuts necessity, Bananas luxury – Friday higher preference for coconuts than Crusoe Change in relative price alters incomes • Start with arbitrary price ratio; • Keep aggregate income constant; • Consider lower price for bananas – Crusoe‟s (banana owner) income falls; Friday‟s rises Coconuts Coconuts Crusoe Bananas Friday Bananas • Market demand for bananas falls because of lower price – Crusoe‘s income fell – Friday‘s income rose – But his preferences for bananas less than Crusoe‘s Income growth alters distribution if tastes differ • Hicksian procedure – Keep relative prices constant – Increase income equally – Banana demand (luxury) rises more than Coconut – Crusoe‟s income rises more than Friday‟s Coconuts Coconuts Crusoe Bananas Friday Bananas • Cannot ―compensate‖ for income effect of price change: – ―Uniform‖ increase in income alters income distribution, because varying consumption as income rises favours luxury-producing agent over the other Market demand curve any polynomial at all • Outcome: market demand curve can have any (polynomial) shape at all – Need not obey ―Law of Demand‖ • Only way to avoid this: – Assume all consumers have identical tastes • So there is only one consumer! – Assume that tastes don‘t change with income • So there is only one commodity! • Contradicts starting assumption: – Two consumers with different tastes – Two different commodities • Proof by contradiction that ―Law of Demand‖ does not apply to market demand curve Skip quotes from Neoclassical Economists Should abandon methodological individualism… • How did Neoclassical economists react? – A very few reacted rationally: • Alan Kirman 1989 (p. 138) – ―If we are to progress further we may well be forced to theories in terms of groups who have collectively coherent behavior. – Thus demand and expenditure functions if they are to be set against reality must be defined at some reasonably high level of aggregation. – The idea that we should start at the level of the isolated individual is one which we may well have to abandon.‖ Skip quotes from Neoclassical Economists Should abandon methodological individualism… • Shafer & Sonnenschein 1993: – ―The importance of the above results is clear: • strong restrictions are needed in order to justify the hypothesis that a market demand function has the characteristics of a consumer demand function. • 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.‖ • But most reacted irrationally… Skip quotes from Neoclassical Economists Representative agent madness instead • Gorman 1953 (pp. 63-64) • ―we will show that there is just one community indifference locus through each point if, and only if, the Engel curves for different individuals at the same prices are parallel straight lines… • The necessary and sufficient condition quoted above is intuitively reasonable. – It says, in effect, that an extra unit of purchasing power should be spent in the same way no matter to whom it is given.‖ • Intuitively reasonable? – No, it‟s intuitively rubbish! • Textbooks reproduced the rubbish… Skip quotes from Neoclassical Economists Textbooks hide SMD results from undergrads • Samuelson and Nordhaus 2010 (p. 48) – ―The market demand curve is found by adding together the quantities demanded by all individuals at each price. – Does the market demand curve obey the law of downward-sloping demand? It certainly does…‖ • A provably false statement misleading undergraduates • Varian 1984 (p. 268) – ―it is sometimes convenient to think of the aggregate demand as the demand of some ‗representative consumer‘… – The conditions under which this can be done are rather stringent, but a discussion of this issue is beyond the scope of this book…‖ • A vague statement reassuring PhD students Macro an ―emergent property‖ • Real meaning of SMD conditions – Macroeconomic behavior an ―emergent property‖ of interaction of agents in a complex system • Cannot deduce behavior of macroeconomy from behavior of utility-maximizing individuals • Cannot reduce macroeconomics to ―applied microeconomics‖ • But that is what DSGE models do! • Fallacy of ―Strong Reductionism‖ – Believe ―macroeconomics is applied microeconomics‖ – But SMD conditions prove otherwise • ―macroeconomics cannot be applied microeconomics‖ Skip Strong Reductionism Fallacy (in Debunking Economics II) Fallacy of Strong Reductionism • Can‘t deduce even market behavior from model of individual behavior – Let alone deduce macro behavior from individual • Common knowledge in real sciences: Anderson, ―More is Different‖, Science (1972, Vol. 177, p. 393) – 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.‖ Fallacy of Strong Reductionism • ―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‖ X Solid state or many-body physics Chemistry Molecular biology Cell biology … Psychology Social sciences Y Elementary particle physics Many-body physics Chemistry Molecular biology … Physiology Psychology • 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.‖ Poor Scholarship basis of neoclassical economics • And ―macroeconomics is not applied microeconomics‖! • Neoclassical ―Strong Reductionism‖ maintained by: – Poor scholarship; – Poor technique; & – Ideology • Poor scholarship: – Most Neoclassical economists don‘t read their own literature but rely upon sanitized textbook version • Act as if theory vindicated • Don‘t know that theory contradicted – As with SMD conditions – Certainly don‘t know rival traditions they disparage (Keynes, Marx, Schumpeter) Skip quotes from Neoclassical Economists Poor Scholarship basis of neoclassical economics • Even Solow—critic of DSGE macro—shows poor scholarship. (Solow 2001, p. 21): – ―For a while the dominant framework for thinking about the short run was roughly ‗Keynesian'. – I use that label for convenience; I have absolutely no interest in 'what Keynes really meant'. – To be more specific, the framework I mean is what is sometimes called 'American Keynesianism' as taught to many thousands of students by Paul Samuelson's textbook and a long line of followers.‖ • Yet he wonders why his Growth Model misinterpreted! – Bad Scholarship—DSGE developers didn‘t heed his advice about limitations of Neoclassical growth model • Same poor scholarship he applies to Keynes! Skip quotes from Neoclassical Economists Poor Scholarship basis of neoclassical economics • Rabid Neoclassicals even worse—e.g., Lucas & Becker: • ―I thought when I was trying to prepare some notes for this talk that people attending the conference might be arguing about Axel Leijonhufvud‘s thesis that IS-LM was a distortion of Keynes, but I didn‘t really hear any of this in the discussions this afternoon. So I‘m going to think about IS-LM and Keynesian economics as being synonyms. • I remember when Leijonhufvud‘s book came out and I asked my colleague Gary Becker if he thought Hicks had got the General Theory right with his IS-LM diagram. Gary said, ―Well, I don‘t know, but I hope he did, because if it wasn‘t for Hicks I never would have made any sense out of that damn book.‖ That‘s kind of the way I feel, too, so I‘m hoping Hicks got it right. (Lucas 2004, pp. 1314; emphases added) Skip quotes from Neoclassical Economists Equilibrium fetish the core neoclassical weakness • But Hicks rejected IS-LM two decades earlier: – ―I accordingly conclude that the only way in which ISLM analysis usefully survives—as anything more than a classroom gadget, to be superseded, later on, by something better—is in application to a particular kind of causal analysis, where the use of equilibrium methods, even a drastic use of equilibrium methods, is not inappropriate…‖ (Hicks 1981, p. 151). • Poor technique: – Overwhelming problem the equilibrium fetish – Believe equilibrium must be assumed for modelling – Yet dynamic modelling commonplace in all real sciences Equilibrium fetish the core neoclassical weakness • E.g., today‘s dominant PhD textbook Mas-Colell: – ―A characteristic feature that distinguishes economics from other scientific fields is that, for us, the equations of equilibrium constitute the center of our discipline. – Other sciences, such as physics or even ecology, put comparatively more emphasis on the determination of dynamic laws of change. – In contrast, up to now, we have hardly mentioned dynamics. – The reason, informally speaking, is that economists are good (or so we hope) at recognizing a state of equilibrium but poor at predicting how an economy in disequilibrium will evolve.‖ (Mas-Colell, 1995, p. 620) Skip quotes from Neoclassical Economists Equilibrium fetish the core neoclassical weakness • 20th Century Neoclassicals fail their 19th century fathers – J.B. Clark‘s speculation on future economic theory: • ―The great coming development of economic theory is to take place, I venture to assert, through the statement and solution of dynamic problems. (p. 2) • A static state is imaginary. All actual societies are dynamic; and those that we have principally to study are highly so. • Heroically theoretical is the study that creates, in the imagination, a static society.‖ (p. 9) • Neoclassicals never stopped making ―heroic assumptions‖ • Why? Mainly because of ideology! – Wish to prove unregulated capitalism is ―perfect‖ Skip quotes from Neoclassical Economists Fallacies from Teleological approach to economics • Many fallacies in neoclassical economics arise from desire to reach given conclusions about capitalism. E.gs.: – Money neutrality – ―Rational‖ expectations • Both needed to reach conclusions that – Capitalism inherently stable – State cannot improve market outcomes • Beliefs maintained even though patently false assumptions needed… Fallacy of ―money neutrality‖ • ―Money neutrality‖: Friedman 1969 (p. 1) – it is a commonplace of monetary theory that nothing is so unimportant as the quantity of money expressed in terms of the nominal monetary unit… – let the number of dollars in existence be multiplied by 100; that, too, will have no other essential effect, – provided that all other nominal magnitudes (prices of goods and services, and quantities of other assets and liabilities that are expressed in nominal terms) are also multiplied by 100.‖ • Banks do not multiply debt by 10% when prices rise 10% – Therefore money is not neutral Fallacy of ―Rational‖ (= ―Prophetic‖) Expectations • ―Rational‖ expectations: Lucas 1972 (p. 54) • ―the hypothesis of adaptive expectations was rejected as a component of the natural rate hypothesis on the grounds that, under some policy [the gap between actual and expected inflation] is non-zero. • If the impossibility of a non-zero value … is taken as an essential feature of the natural rate theory, one is led simply to adding the assumption that [the gap between actual and expected inflation] is zero as an additional axiom… • or to assume that expectations are rational in the sense of Muth.‖ – ―Rational expectations‖ therefore means ―ability to predict the future‖ • Not rational but assumption of prophetic behavior! The Bankruptcy of Neoclassical Economics • Neoclassical theory wrong from first principles: – Treats complex monetary exchange as barter – Assumes macroeconomy is stable – Ignores social class • Treats entire economy a single agent • Despite SMD proof that this can‘t be done – Obliterates uncertainty • ―Rational‖ as capacity to foresee the future; – Uses empirically falsified ―money multiplier‖ model of money creation; and – Ignores credit and debt. A tentative, but not-bankrupt, alternative • A new macroeconomics must do the exact opposite: – Economy as inherently monetary; – Model the economy dynamically; – Social classes rather than isolated agents; – Rational but not prophetic behavior; – Endogenous creation of money by banking sector; and – Credit and Debt have pivotal roles • Foundation: Minsky‘s Financial Instability Hypothesis Skip Minsky quotes Modeling dynamics of debt • 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.‖ (p. 5) Skip Minsky quotes Modeling dynamics of debt • The neoclassical model is inadequate: – ―The abstract model of the neoclassical synthesis cannot generate instability. – When the neoclassical synthesis is constructed, capital assets, financing arrangements that center around banks and money creation, constraints imposed by liabilities, and the problems associated with knowledge about uncertain futures are all assumed away. – For economists and policy-makers to do better we have to abandon the neoclassical synthesis.‖ (Minsky 1982 , p. 5) Minsky‘s FIH: dynamic-disequilibrium-debt model 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 • • • • The Euphoric Economy • 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 Assets Boom and Bust • Ponzi financiers 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 – Empirical application: the ―Credit Accelerator‖ The ―Credit Accelerator‖ • Neoclassical belief: Walras‘ Law – ―Sum of excess demands is zero‖ • i.e., Aggregate Demand is Aggregate Supply – No role for credit • Empirical & endogenous money reality – Aggregate demand exceeds aggregate supply • AD AS + Change in Debt • Therefore – DAD DAS + Acceleration in Debt – “Credit Accelerator” = (Acceleration in Debt)/GDP – ―Walras‘ Law‖ false in credit-based economy • Core proposition in Marx, Schumpeter, Minsky Skip quotes from sensible Economists The ―Credit Accelerator‖ • Marx, Capital II, 1885, Chapter 4, Section "The Meeting of Demand and Supply" – ―The capitalist throws less value in the form of money into the circulation than he draws out of it … – Since he functions … as an industrial capitalist, his supply of commodity-value is always greater than his demand for it. – If his supply and demand in this respect covered each other it would mean that his capital had not produced any surplus-value … – His aim is not to equalize his supply and demand, but to make the inequality between them … as great as possible.‖ Skip quotes from sensible Economists The ―Credit Accelerator‖ • Schumpeter Theory of Economic Development, 1934 , pp. 95, 101 • ―THE fundamental notion that the essence of economic development consists in a different employment of existing services of labor and land … leads us to two heresies … that money … , and … other means of payment, perform an essential function, … • that processes in terms of means of payment are not merely reflexes of processes in terms of goods. • From this it follows, therefore, that in real life total credit must be greater than it could be if there were only fully covered credit. The credit structure projects not only beyond the existing gold basis, but also beyond the existing commodity basis.‖ Skip quotes from sensible Economists The ―Credit Accelerator‖ • Minsky 1963; Minsky 1982, p. 6; emphasis added • ―If income is to grow, the financial markets, where the various plans to save and invest are reconciled, must generate an aggregate demand that, aside from brief intervals, is ever rising. • For real aggregate demand to be increasing, . . . it is necessary that current spending plans, summed over all sectors, be greater than current received income and that some market technique exist by which aggregate spending in excess of aggregate anticipated income can be financed. • It follows that over a period during which economic growth takes place, at least some sectors finance a part of their spending by emitting debt or selling assets.‖ Empirical dynamics of the Credit Accelerator • In credit-driven economy, aggregate demand spent on both goods & services (GDP) and existing assets – AD = Income + DDebt = GDP + Net Asset Sales (NAS) • NAS = PA * fraction sold * QA= PA.sA.QA – D AD = D GDP + DDDebt = DGDP + D(PA.sA.QA) • Acceleration of debt ignored by neoclassical economists – ―the overall level of debt makes no difference … one person's liability is another person's asset.‖ (Krugman 2010, p. 3) • Neoclassicals wrong: Credit Accelerator correlated – With Change in output; – With Change in employment; and – With Change in asset prices – Drives them since finances investment & speculation Empirical dynamics of the Credit Accelerator • Private debt bubbles caused ―Roaring Twenties‖ & ―Noughty Nineties‖ US Private Debt to GDP 300 275 250 Percent of GDP 225 200 175 150 • Bursting of bubbles caused Great Depression & Great Recession 125 100 75 50 25 0 1920 1930 1940 1950 1960 1970 1980 1990 2000 2010 2020 Empirical dynamics of the Credit Accelerator • Change in Private Debt drives both booms and busts 0 14 0 12 2 12 2 10 8 4 6 10 8 4 6 6 4 2 0 8 10 12 0 14 6 4 2 0 8 10 12 0 14 2 4 6 16 18 20 2 4 6 16 18 20 8 22 Change in Debt 10 24 Unemployment 12 26 14 1920 1922 1924 1926 1928 1930 1932 1934 1936 1938 1940 1942 Year; Source Census, BLS, BEA Percent change in debt p.a. 14 Change in Debt 8 22 Unemployment 10 24 Unemployment (U6) 12 26 14 1990 1992 1994 1996 1998 2000 2002 2004 2006 2008 2010 2012 Year; Source Census, BLS, BEA • Differences Now vs Then – Bigger debt-driven boom Now than Then – Business less indebted now, households & finance more – Much bigger/faster Government response to crisis – Faster turnaround in fall in private debt Percent unemployment (inverted) Change in Private Debt and Unemployment Percent unemployment (inverted) Percent change in debt p.a. Change in Private Debt and Unemployment Empirical dynamics of the Credit Accelerator • Great Depression & Great Recession both commenced with collapse in Credit Accelerator 5 50 Percent p.a. 0 00 5 50 10 100 15 150 20 Credit Imp ulse Unemployment Change 200 Percent change in unemployment (inverted) Percent p.a. 100 10 100 5 50 0 00 5 50 10 100 15 150 20 Credit Imp ulse Unemployment Change 200 25 250 1920 1922 1924 1926 1928 1930 1932 1934 1936 1938 1940 1942 25 250 1990 1992 1994 1996 1998 2000 2002 2004 2006 2008 2010 2012 Year; Source Census, BLS, BEA Year; Source Census, BLS, BEA • Recent apparent recovery in US economy largely due to slowdown in rate of decline of private debt—a positive Credit Accelerator (CA) • Same true for sharemarket… Skip Sharemarket statistics Corr X1 X2 0.503 Percent change in unemployment (inverted) Credit Impulse and Change in Unemployment Credit Impulse and Change in Unemployment 10 Empirical dynamics of the Credit Accelerator • Credit Accelerator drives sharemarket performance… Credit Impulse and Change in Real Share Prices Credit Impulse and Change in Real Share Prices 30 120 30 120 24 96 24 96 18 72 18 72 12 48 12 48 6 24 6 24 00 0 00 0 6 24 6 24 12 48 12 48 18 24 Credit Imp ulse (Left Hand Scale) Change in DJIA (Right Hand) 72 18 96 24 Credit Imp ulse (Left Hand Scale) Change in DJIA (Right Hand) 72 96 120 30 120 30 1990 1992 1994 1996 1998 2000 2002 2004 2006 2008 2010 2012 1920 1922 1924 1926 1928 1930 1932 1934 1936 1938 1940 1942 Year; Source Census, BLS, BEA Year; Source Census, BLS, BEA • (Complex unstable lead/lag relationships between Credit & sharemarket…) • Recovery will fade because positive CA can‘t be sustained without resulting ultimately in rising debt—an unlikely outcome… Empirical dynamics of the Credit Accelerator • Private debt still falling GT R 30 • But rate of fall slowing down: positive Credit Accelerator Percent p.a. Debt Distanc e, Velocity & Ac celeration 3 00 30 2 50 20 2 00 10 1 50 0 0 1 00 10 50 0 1 97 0 Debt Rat io Change Acceleration 1 97 5 1 98 0 1 98 5 20 1 99 0 1 99 5 2 00 0 2 00 5 2 01 0 30 2 01 5 Percent of GDP • Sustained acceleration must ultimately cause debt ratio to rise again • Unlikely when debt ratio already crippling • Negative CA likely in next 6-12 months 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 • Physical side: Goodwin put into mathematical form Marx‘s ―growth cycle‖ model in Capital I, Ch. 25: – ―The mechanism of the process of capitalist production removes the very obstacles that it temporarily creates. The price of labor falls again to a level corresponding with the needs of the selfexpansion of capital, whether the level be below, the same as, or above the one which was normal before the rise of wages took place…‖ Keen 1995 Model Foundations: Nonlinear dynamics • Inherently cyclical growth (Goodwin 1967, Blatt 1983) • Capital K determines output Y via the accelerator: K 1/3 Accelerator K 1/3 Y Y Goodwin's cyclical growth model Accelerator 1.50 • Y determines employment L via productivity a: l / 1 a r Y l Labour Productivity / a 1 r l 1 / N r LabourPopulation Productivity .96 "NAIRU" + 10 * L l WageResponse / N 100 r 1 Population + Initial Wage 1/S + Integrator L Employment Wages 1.25 L l 1.00 • L determines employment rate l via population N: .75 PhillipsCurve dw/dt l .50 0 2 4 6 Time (Years) 8 10 • l determines rate of change of wages w via Phillips Curve + .96 "NAIRU" 10 WageResponse * Pi * W Goodwin's cyclical growth model 1.3 PhillipsCurve I dK/dt dw/dt 1.2 1.1 Wages + - Y w L • Integral of w determines W (given initial value) 1 3 Initial Capital Initial Wage dw/dt + 1/S + Integrator + 1.0 .9 w 1/S + Integrator L * W .8 .7 .9 • Y-W determines profits P and thus Investment I… Y W + - Pi I dK/dt • Closes the loop: .95 1 Employment 1 Initial Capital dK /dt 1/S + + 1.05 Monetary Circuit Theory • Basic process of endogenous money creation • Entrepreneur approaches bank for loan • Bank grants loan & creates deposit simultaneously • Alan Holmes, Senior Vice-President New York Fed, 1969: • ―In the real world, banks extend credit, creating deposits in the process, and look for the reserves later.‖ (1969, p. 73) • New loan puts additional spending power into circulation • Modeling this using strictly monetary framework: Explicitly Monetary Minsky Model • Input financial relations in Table: Assets Liabilities d ReservesReserve A Loan F Firm Deposit Worker Deposit dt Lend -A A d Record Loan Loan A F G A Interest B dt Pay Interest -B d Record FirmDeposit A -BB C D E F G dt Wages -C C Consumption D+E -D d WorkerDeposit C D -F Repay Loan F dt Record -F d Money NewBankEquity G BE dt Record G Equity Bank Equity B -E • System of dynamic equations derived automatically: Explicit Money Minsky Model • Strictly monetary macro model developed FL( t ) BV( t ) d BV( t ) •dt Linked via V r( tto ) production L r( t ) – nonlinear investment, BT( t) lending & debt repayment d BT( t ) rL FL( t ) rD FD( t) rD HD( t) B functions dt BV( t) FLpricing ( t) – Dynamic equation d FL( t) P( t ) YR( t ) Inv r( t) L r( t) V r( t) dt – Generalized (3 factor) ―Phillips curve‖ BV( t) FL( t) BT( t ) HD( t) W ( t) YR( t) d As Phillips papers but FD( t ) rD• FD ( t) in rL FLoriginal ( t) P(ignored t) YR( t) Inv rby ( t) L r( t) V r( t) B W a( t ) dt neoclassicals HD( t) W ( t) YR( t) d nonlinear dynamic system results… HD(– t) Complex rD HD( t) Financial Sector dt W a( t ) Physical output, labour and price systems Rate of change of capital stock Lev el of output d KR( t ) dt YR( t) KR( t ) g ( t) KR( t ) v YR( t) Explicitly Monetary Minsky Model • New monetary macroeconomics can explain the crisis Unemployment, Inflation & Debt Fac (smoothed) Minsky Fits the Stylized ts 25 15 35 Percent p.a. Percent 10 7.5 5 5 0 2.5 5 0 10 2.5 15 20 5 0 1980 3 2 0 2 0 1.5 1 Unemployment Unemployment Inflation Inflat ion Debt DebttotoGDP GDP 5 1985 10 15 199020 25 30 2000 35 1995 402005 45 10 50 60 2010 55 2015 Year Year Skip to Conclusion Ratio to GDP 4 2.5 15 10 Years to repay debt 20 12.5 Explicit Money Minsky Model • Modeled in new simulation program • Prototype QED ―Quesnay Economic Dynamics‖ freely available on my blog: – www.debtdeflation.com/blogs • More advanced, user-friendly versions being developed Explicit Monetary Minsky Model • Freely available at www.debtdeflation.com/blogs/qed • More advanced, user-friendly version being developed thanks to INET Grant Explicit Money Minsky Model • Scales to multiple sectors, input-output dynamics "T ype" 0 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 "Name" "BR" "LK1" "LK2" "LC1" "LC2" "LA1" "LA2" "LE1" "LE2" "DK1" "DK2" "DC1" "DC2" "DA1" "DA2" "DE1" "DE2" "Symbol" BR( t) FLK1( t) FLK2( t ) FLC1( t) FLC2( t) FLA1( t) FLA2( t) FLE1( t) FLE2( t ) FDK1( t) FDK2( t) FDC1( t) FDC2( t) FDA1( t ) FDA2( t) FDE1( t) FDE2( t ) 0 A1 A2 A3 A4 A5 A6 A7 A8 0 0 0 0 0 0 0 0 "Compound Interest" "Deposit Interest" 0 0 0 0 0 0 0 0 0 B1 B2 B3 B4 B5 B6 B7 B8 "W ages" 0 0 0 0 0 0 0 0 0 C1 C2 C3 C4 C5 C6 C7 C8 C1 C2 C3 "Household Interest" 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 "Investment Demand for K" 0 0 0 0 0 0 0 0 0 ( E1 E2) ( E3 E5 E7) ( E2 E1) ( E4 E6 E8) E3 E4 E5 E6 E7 E8 0 0 0 0 0 0 0 0 0 F1 F2 ( F3 F4) ( F1 F5 F7) ( F4 F3) ( F2 F6 F8) F5 F6 F7 F8 "Intersectoral Demand for C" "Intersectoral Demand for A" 0 0 0 0 0 0 0 0 0 G1 G2 G3 G4 ( G5 G6) ( G1 G3 G7) ( G6 G5) ( G2 G4 G8) G7 G8 "Intersectoral Demand for E" 0 0 0 0 0 0 0 0 0 H1 H2 H3 H4 H5 H6 ( H7 H8) ( H1 H3 H5) ( H8 H7) ( H2 H4 H6) S1 I9 I10 I9 I10 "Consumption K" 0 0 0 0 0 0 0 0 0 ( I1 I2) ( I3 I5 I7) ( I2 I1) ( I4 I6 I8) I3 I4 I5 I6 I7 I8 2 2 J9 J10 J9 J10 "Consumption C" 0 0 0 0 0 0 0 0 0 J1 J2 ( J3 J4) ( J1 J5 J7) ( J4 J3) ( J2 J6 J8) J5 J6 J7 J8 2 2 K9 K10 K9 K10 "Consumption A" 0 0 0 0 0 0 0 0 0 K1 K2 K3 K4 ( K5 K6) ( K1 K3 K7) ( K6 K5) ( K2 K4 K8) K7 K8 2 2 L9 L10 L9 L10 "Consumption E" 0 0 0 0 0 0 0 0 0 L1 L2 L3 L4 L5 L6 ( L7 L8) ( L1 L3 L5) ( L8 L7) ( L2 L4 L6) 2 2 "Pay Interest" 0 M1 M2 M3 M4 M5 M6 M7 M8 M1 M2 M3 M4 M5 M6 M7 M8 "Repay Loans" N1 N2 N3 N4 N5 N6 N7 N8 N1 N2 N3 N4 N5 N6 N7 N8 N1 N2 N3 N4 N5 N6 N7 N8 "Recycle Reserves" ( O1 O2 O3 O4 O5 O6 O7 O8) O1 O2 O3 O4 O5 O6 O7 O8 O1 O2 O3 O4 O5 O6 O7 O8 "New Money" 0 P1 P2 P3 P4 P5 P6 P7 P8 P1 P2 P3 P4 P5 P6 P7 P8 5 2 3 0 80 4 3 6 120 5 100 4 80 3 60 2 40 1 20 1 85 90 95 0 100 0 80 85 90 95 Years since start of simulation Years since start of simulation 0 100 Debt to GDP per cent 9 BI( t) Real GDP Change Debt to GDP (RHS) Percent change p.a. Profit Rate (Percent) 12 6 Growth Rate (Percent) Cap ital Goods Consumer Goods Agriculture Energy Growth Rate (RHS) 0 "BI" HD( t) Real GDP Growth and Debt/GDP Ratio The Rate of Profit in a Monetary Multisectoral Model of Produc tion 15 0 0 0 ( B1 B2 B3 B4 B5 B6 B7 B8) C4 C5 C6 C7 C8 0 D1 D1 0 0 0 0 0 0 0 0 I9 I10 J9 J10 K9 K10 L9 L10 0 M1 M2 M3 M4 M5 M6 M7 M8 0 0 0 0 0 0 1 "HD" Debunking Economics 2nd Edition… • For more details: References • • • • • • • • • • • • Anderson, P. W. (1972). "More Is Different." Science 177(4047): 393-396. Bezemer, D. J. (2009). ――No One Saw This Coming‖: Understanding Financial Crisis Through Accounting Models.‖ Groningen, The Netherlands, Faculty of Economics University of Groningen. Blatt, J. M. (1983). Dynamic economic systems : a post-Keynesian approach. Armonk, N.Y, M.E. Sharpe. Bezemer, D. J. (2010). "Understanding financial crisis through accounting models." Accounting, Organizations and Society 35(7): 676-688. Clark, J. B. (1898). 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