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Private debt to GDP ratios Debt-financed demand percent of aggregate demand 300 275 USA Australia 20 15 225 200 10 175 5 Percent Years (percent of GDP) 250 25 150 125 100 0 0 5 Great Depression including Government Great Recession including Government 10 75 50 15 25 20 0 1870 1880 1890 1900 1910 1920 1930 1940 1950 1960 1970 1980 1990 2000 2010 2020 Flow of Funds Table L1+Census Data; RBA Table D02 25 0 1 2 3 4 5 6 7 8 9 10 11 12 Years since peak rate of growth of debt (mid-1928 & Dec. 2007 resp.) The Global Financial Crisis is far from over... Steve Keen University of Western Sydney Debunking Economics www.debtdeflation.com/blogs www.debunkingeconomics.com 13 The New Macroeconomic Puzzle • How did we go from this… • To this? • A Minskian explanation: debt-deflation Great Moderation to Great since Recession US Inflation and Unemployment 1970 16 15 Inflation Inflation Unemployment Unemployment 14 U-6 Measure 12 Percent Percent p.a. 10 10 8 5 6 4 0 2 0 Inflation Unemployment U-6 Measure 0 52 78 803082 84 92 94 70 96 9880 100 102 108 110 110 70 74 7620 0 72 10 4086 88 50 90 60 90104 106 100 Year Year First Principles • Debt has macroeconomic impact; contra Bernanke: – “Fisher’s idea was less influential in academic circles, though, because of the counterargument that debtdeflation represented no more than a redistribution from one group (debtors) to another (creditors).” (Bernanke 2000, p. 24) • Minority of economists who predicted crisis displayed: – “a further concern, that growth in financial wealth and the attendant growth in debt can become a determinant (instead of an outcome) of economic growth …” (Bezemer (2009, p. 10)) • Basic mechanisms: – Debt expands aggregate demand – Endogenous money creation – Financial instability Rising debt increases aggregate demand • Schumpeter: growing debt adds demand beyond that generated by sales of goods & services • Debt essential for entrepreneurial function – Entrepreneur often has idea but no money – Needs purchasing power before has goods to sell – Gets purchasing power via loan from bank – Entrepreneurial demand thus not financed by “circular flow of commodities” but by new bank credit – Since entrepreneurial activities essential feature of growing economy, 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.” (Schumpeter 1934, p. 101) Endogenous money: “Loans create deposits” • “In the real world banks extend credit, creating deposits in the process, and look for the reserves later” (Moore (1979, p. 539)—quoting Fed economist) • “There is no evidence that … the monetary base … leads the cycle, although some economists still believe this monetary myth…, if anything, the monetary base lags the cycle slightly… – The difference of M2-M1 leads the cycle by even more than M2 with the lead being about three quarters." (Kydland & Prescott, 1990, p. 14) Financial instability • “Stable growth is inconsistent with the manner in which investment is determined in an economy in which debtfinanced ownership of capital assets exists, and the extent to which such debt financing can be carried is market determined. • It follows that the fundamental instability of a capitalist economy is upward. • The tendency to transform doing well into a speculative investment boom is the basic instability in a capitalist economy.” (Minsky 1982, p. 67) • Current debt-assets price dual bubble biggest in history… Rising debt increases aggregate demand • Asset bubbles & rising debt to GDP 50 300 45 270 40 240 35 210 30 180 25 150 20 120 15 90 10 60 5 30 0 0 1880 1890 1900 1910 1920 1930 1940 1950 1960 1970 1980 1990 2000 2010 2020 Year Shiller Lagging 10 Year P/E Ratio Case-Shiller Real House Price Index US Private Debt to GDP Real house price index; Debt to GDP Price to 10 year lagged earnings ratio Asset price indices & Debt to GDP Rising debt increases aggregate demand • Aggregate demand: Income + change in debt • “Great Moderation” and “Great Recession” debt-driven 30 12 20 10 10 8 0 6 10 4 20 30 1970 2 Debt contribution to aggregate demand Unemployment 1975 1980 1985 1990 1995 Year 2000 • As is current apparent recovery… 2005 2010 0 2015 Unemployment Percent Change in Debt p.a./ (GDP+Change in Debt) Debt financed demand and unemployment Rising debt increases aggregate demand • Change in AD: Change in GDP + acceleration in debt 30 75 20 50 10 25 0 00 10 25 20 50 30 1970 1975 1980 1985 1990 1995 Year Debt Acceleration Change in Unemployment 2000 2005 2010 75 2015 • Debt & disequilibriumaware model needed to capture these processes • Minsky’s Financial Instability Hypothesis Change in Unemployment Percent p.a. Change in Change in Debt p.a./ GDP Debt financed demand and unemployment Minsky’s “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 The Euphoric Economy • Asset prices rise: speculation on assets profitable • Increased willingness to lend increases money supply – Money supply endogenous , not under RBA control • Riskier investments enabled, asset speculation rises • The emergence of “Ponzi” (Bond, Skase…) 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 • Eventually final crisis where debt burden overwhelms economy A Strictly Monetary Minsky Model • Foundations – Goodwin (1967) growth cycle model (Keen 1995) – Pure credit economy model (Graziani 1989) • Built using tabular system of ODEs (Keen 2008) Symbolic sum of columns • See blog www.debtdeflation.com/blogs for details • Especially Roving Cavaliers of Credit post Modelling Minsky: The full system Financial Sector • In equations… d BC( t) dt d BPL( t) dt FL( t) RL r( t) BC( t) LC r( t) BC( 0) rL FL( t) rD FD( t) rD W D( t ) BC( t) FL( t) BPL( t ) BPL( 0) B d FL( t) dt LC r( t) d FD( t) dt BC( t ) FL( t ) BPL( t) W D( t ) W ( t) Yr( t) rD FD( t) rL FL( t) PC( t) Yr( t ) Inv r( t) LC r( t ) RL r( t ) B W a( t ) d W D( t) dt RL r( t ) PC( t) Yr( t) Inv r( t ) rD W D( t) W D( t) W W ( t) Yr( t ) BPL0 FL( 0) FL0 FD( 0) FD0 W D( 0) a( t ) W D0 Physical output, labour and price systems Level of output Employment L( t ) Yr( t) Rate of real economic growth g( t) d W ( t) dt Rate of change of prices Rate of change of capital stock L( 0) a( t ) PC( t) Yr( t ) W ( t) L( t) rL FL( t) rD FD( t) r( 0) ( t) [ g( t) ( ) ] Inv r( t) v W ( ( t) ) Ph ( ( t ) ) [ [ g ( t) ( ) ] ] d PC( t) dt d Kr( t) dt Rates of growth of population and productivity v PC( t) Yr( t) d ( t) dt Rate of employment Yr( 0) Yr0 v r( t) Rate of Profit Rate of change of wages Kr( t) Yr( t) 1 Pc PC( t) W ( t) W ( t) 1 1 a( t) ( 1 s ) P ( t) C Pc a( t ) ( 1 s ) Kr( t) g ( t) d a( t ) dt a( t ) d N ( t) dt N ( t) N ( 0) N0 • Nonlinear functions for investment, wage change, loan repayment, lending from capital • 3 factor Phillips curve: employment, rate of change of employment, inflation BC0 L0 r0 ( 0) 0 g ( 0) g0 W ( 0) W0 PC( 0) PC0 Kr( 0) Kr0 a( 0) a0 Modelling Minsky: The full system • In new program QED QED Modelling Minsky: The outcome • Monetary factors Modelling Minsky: The outcome • Production, employment, wages and inflation References • • • • • • • Bernanke, B. S. (2000). Essays on the Great Depression. Princeton, Princeton University Press. 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., Dynamic Economic Systems: A Post Keynesian Approach, ME Sharpe, Armonk. Goodwin, R. (1967). “A growth cycle” in C. H. Feinstein (ed.), Socialism, Capitalism and Economic Growth. Cambridge, Cambridge University Press: 54-58. Graziani, A. (1989). "The Theory of the Monetary Circuit." Thames Papers in Political Economy Spring: 1-26. Keen, S. (1995). "Finance and Economic Breakdown: Modeling Minsky's 'Financial Instability Hypothesis.'." Journal of Post Keynesian Economics 17(4): 607-635. Keen, S. (2008). Keynes’s ‘revolving fund of finance’ and transactions in the circuit. Keynes and Macroeconomics after 70 Years. R. Wray and M. Forstater. Cheltenham, Edward Elgar: 259-278. References • • • • Kydland, F. E. and E. C. Prescott (1990). "Business Cycles: Real Facts and a Monetary Myth." Federal Reserve Bank of Minneapolis Quarterly Review 14(2): 3-18. Minsky, H. P. (1982). Can "it" happen again? : essays on instability and finance. Armonk, N.Y., M.E. Sharpe. Moore, B. J. (1979). "The Endogenous Money Stock." Journal of Post Keynesian Economics 2(1): 49-70. Schumpeter, J. A. (1934). The theory of economic development : an inquiry into profits, capital, credit, interest and the business cycle. Cambridge, Massachusetts, Harvard University Press.