Download Misunderstanding the Great Depression, making the next one worse

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.)
Why credit money doesn’t have to crash
And why it always does
Steve Keen
University of Western Sydney
Debunking Economics
www.debtdeflation.com/blogs
www.debunkingeconomics.com
13
The Great Moderation to The Great Recession
• Everything was going SO well…
The Great Moderation.. and Great Recession
15
2008.5
Percent
10
10
5
0
0
Unemployment
Inflation
5
1975
1980
1985
1990
1995
Year
2000
2005
2010
2015
What the hell happened?
• A debt bubble burst…
USA Private Debt to GDP
320
2008.5
300
280
260
Percent of GDP
240
220
• Should that
175
matter?
• Not according
to conventional
“neoclassical”
economics…
200
180
160
140
120
100
80
60
40
20
0
1920
1930
1940
1950
1960
1970
Year
1980
1990
2000
2010
2020
Credit Money Myths
• Neoclassical economics
– Debt not a problem because loans = savings
• “Fisher’s idea was less influential in academic
circles, though, because of the counterargument
that debt-deflation represented no more than a
redistribution from one group (debtors) to another
(creditors).” (Bernanke 2000, p. 24)
• Populist (& many non-neoclassical economists)
– Inevitable problem because interest can’t be paid
• “The existence of monetary profits at the
macroeconomic level has always been a conundrum …
not only are firms unable to create profits, they
also cannot raise sufficient funds to cover the
payment of interest.” (Rochon 2005, p. 125)
Neoclassical myth: “Deposits create loans”
• Creation process:
– Government creates Base Money (e.g., welfare cheque)
– Public puts BM in bank account
– Bank keeps fraction (RR%: “reserve requirement”)
– Lends rest: MB*(1-RR%)
– Borrower deposits loan in another bank…
– Iterative process generates BM/RR dollars
• Banks as
– Passive amplifiers of government money creation
– Mere intermediaries between savers & borrowers
• Loan transfers money from saver to borrower
– Private Debt has minimal macroeconomic effect
• Only if borrower has higher propensity to spend
Reality: Endogenous money
• Banks create credit money “out of nothing”
– “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)
• So credit money created “ab initio” by banks
• And that doesn’t have to be a problem…
Model of credit money
• Pure credit money system: bank issues own notes
– Like 19th century free banking in USA
– No Central Bank
• Private bank formed by elite
• Notes “backed” by own wealth
• Lends to local businesses…
• How did it work?
• Stylised model with 5 accounts
• “Vault”—where bank stores its wealth
• “Safe”—for spending, payment & receipt of interest
• “Loans”—ledger recording who owes bank how much
• “Firms”—deposit account for firms
• “Workers”—deposit account for workers
• System starts with Notes (say $1 million) in Vault
19th century free banking: Stage 1
•
•
•
•
•
•
•
•
$1 million in Vault, all other accounts zero…
Bank loans transfer notes from Vault to Firms
Bank records loans in its Loans ledger
Bank charges interest on loans
Firm pays interest which Bank deposits in its Safe
Bank records payment of interest on Loans ledger
Bank pays deposit interest to Firm
End result at this point:
• Over time, Vault emptied of Notes
• Notes pass via Firms back to Banks’ Safe:
19th century free banking: Stage 1
• Modelled using new software package QED
– “Quesnay Economic Dynamics”
QED
19th century free banking: Stage 2
•
•
•
•
•
Closing the system: workers, factories & consumption
Firms pay wages to Workers
Bank pays workers interest on deposits
Workers and Bankers consume
End result at this point: System sustainable
• Firms make profits
• Workers earn wages, Banks earn interest
Non-Neoclassical myth: “Interest can’t be repaid”
• Common belief in Post-Keynesian economics & populist
views of money: No it isn’t
– Interest can’t be repaid because loan less than loan +
interest; and firms can’t make monetary profits:
• “The existence of monetary profits at the
macroeconomic level has always been a conundrum
for theoreticians of the monetary circuit… not only
are firms unable to create profits, they also cannot
raise sufficient funds to cover the payment of
interest. In other words, how can M become M`?”
(Rochon 2005, p. 125)
– Wrong!
– Confusion of stock (size of loan in $) with flow
(turnover of economic activity in $/year)
Non-Neoclassical myth: “Interest can’t be repaid”
• System is stable if accounts can stabilise
• Vault empties over time: all bank assets Loans to Firms
• Accounts do stabilise
• What’s happening?
• After the vault
empties…
Non-Neoclassical myth: “Interest can’t be repaid”
Add up columns
• Long run dynamics in final 8 rows of table:
• System stable if sum of flows in each column equal zero
Flow conditions for stability of all accounts except Vault
Account
Outflows
Inflows
Loans
Interest charged
Interest paid
Firms
Interest on Loans + Wages
Deposit Interest + Consumption
Safe
Deposit interest + Consumption
Interest on Loans
Workers Consumption
Wages + Deposit Interest
• Vault stabilises too if loan repayment equals rate of loans:
19th century free banking: Stage 3
• Firm repays loan which Bank puts back in Vault
• Bank records repayment on Loan ledger
• Sustainable system
• Bank assets now unlent Notes in Vault plus Loans to Firms
• Incomes for all classes
• Wages $310.47 p.a.
• Net Interest $3.72
• Profit? 217.33 p.a.
(shown later)
• Final step: new money
QED
• In 19th century: notes
• In 20th century: credit
Money creation in pure credit economy
• 19th century: add new notes to vault
Money creation in pure credit economy
• 20th century: simultaneously issue loan and deposit
Money creation in pure credit economy
• System not inherently unstable
– Firms can pay interest & make a profit
– Debt can remain low & constant relative to GDP
– Rising debt also necessary for expanding economy…
• “If income is to grow, the financial markets … 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…
• 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.” (Minsky 1982, p. 6; emphasis added)
Money creation in pure credit economy
• Schumpeter on same issue: 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)
Money creation in pure credit economy
• But incentive to instability exists:
– Bank income rises if
• New money issued more rapidly
• Debt repaid more slowly (or not at all)
Money creation in pure credit economy
• Same result in modern banking; bank income rises if
– Bank reserves circulated more rapidly
– Loans paid off more slowly
– New loans created more rapidly
Money creation in our real economy
•
•
•
•
Banks have inherent bias to create debt
Borrowers control whether that bias is expressed
Income based borrowing—inherently limited
The “Solution”: lend to finance Ponzi Schemes
– Potential borrower expects asset price to rise
– Borrows money to buy asset
– Drives price of asset up
– Rise entices other borrowers into market
• Positive feedback from leverage to prices causes asset
price bubble
• Scheme “works until it fails”:
– Rising debt-financed spending boosts economy
– Requires acceleration in debt to continue forever…
The Facts on Debt
• 2 obvious US debt bubbles in last century
USA Private Debt to GDP
320
2008.5
300
280
260
Percent of GDP
240
220
200
180
175
160
140
120
100
80
60
40
20
0
1920
1930
1940
1950
1960
1970
Year
1980
1990
2000
2010
2020
Debt and Aggregate Demand
• Conventional “exogenous money” economics
– Debt has minor macroeconomic effects
• Redistributes money from lender to borrower
• “Absent implausibly large differences in marginal
spending propensities among the groups, it was
suggested, pure redistributions should have no
significant macroeconomic effects.” (Bernanke
2000, p. 24)
• Realistic “endogenous money” economics
– Increasing debt expands aggregate spending
– Aggregate demand equals GDP plus change in debt
• Spent on all markets—goods + existing assets
– Volatile “change in Debt” component dominates
economy as debt grows relative to income
Debt and Aggregate Demand
• Crisis manifestation of deleveraging
US Aggregate Demand GDP 1990-2010
7
210
7
1.810
7
1.610
$ million
7
1.410
GDP alone
GDP+Change in Debt
+ Government
18
Crisis by deleveraging
7
1.210
7
110
6
810
6
610
But notice recent
turnaround
6
410
0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21
Years since 1990
Debt and Aggregate Demand
• Correlation with unemployment
Correlation US debt-financed demand & unemployment
30
Percent change p.a.
24
18
Debt-financed
Inc. Gov
Unemployment
Crisis by deleveraging
0
1
2
3
12
4
6
5
0
06
6
7
 12
8
 18
9
But notice recent
turnaround
 24
 30
 36
1975
1979
1983
1987
1991
1995
Year
1999
2003
2007
10
11
2011
2015
Percent unemployed (inverted)
36
Acceleration in Debt & Change in Employment
• Since AD = GDP +DD
– DAD = DGDP +DDD
– Changes in aggregate demand
• & hence changes in employment
– Correlated not with change in debt (DD)
• But with acceleration/deceleration in debt (DDD)
• Defining “credit impulse” (Biggs, Meyer & Pick) as
ChangeInChangeInDebt
GDP
• Empirically, credit—ignored by neoclassical economics—is
the key driver of the economy...
Change in Debt & Change in Employment
• Correlation with change in employment
Acceleration of private debt & change in employment, USA
Crisis begins
10
2008
5
0
Percent p.a.
0
5
 10
 15
 20
USA stalled crisis by
slowdown in deleveraging
 25
 30
1955
Acceleration of private debt
Change in Private Employment
1960
1965
1970
1975
1980
1985
Year
1990
1995
2000
2005
2010
2015
Change in Debt & Change in Employment
• Summing up: Credit drives the economy
• Acceleration in debt precedes change in GDP
Credit Impulse Correlations in the USA
0.8
0
Employment
GDP
Correlation
0.6
0.4
0.2
0
 0.2
 20
 10
0
10
Lag in months
20
• Doesn’t have to
drive it “over the
cliff”
• But always does
• Why?
• The temptation
of Ponzi Finance
• Putting it all
together...
30
Finance and Economic Breakdown
• Economy is
– Inherently cyclical
• Waves of innovation/destruction (Schumpeter)
• Struggles over income distribution (Marx, Goodwin)
• Complex & aperiodic (Lorenz, Mandelbrot, Prigogine)
– Inherently monetary
• Moore, Graziani
– Inherently afflicted by uncertainty
• Keynes (not IS-LM!)
• Given nature of capital assets
– Banks’ desire to create debt leads to financial crises
• The Financial Instability Hypothesis: Minsky
Minsky’s “Financial Instability Hypothesis”
• Economy in historical time
– Both ignored by conventional “neoclassical” economics)
• 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
Modelling Minsky
• Modelled by
– Introducing nonlinear functions
• Capitalist desire to invest
• Debt repayment rate
• Money relending rate
– Endogenous money creation via “line of credit”
• Firm investment desire funded by increased deposit
• Simultaneous increase in debt
– Modelling production & price formation
• Also growth in population & labor productivity
Modelling Minsky: Financial side
• New Godley Table
“Line of
credit”:
money & debt
created at
same time
• Exponential functions for expectations under uncertainty:
• Given uncertain future, investors assume that “the
present is a much more serviceable guide to the future
than a candid examination of past experience would
show it to have been hitherto” (Keynes 1936, p. 214)
Modelling Minsky: behavioural components
• Functions for wage setting (workers), investment (firms),
loan repayment (firms) and money relending (banks)
20
50
20
Loan repayment
Money relending
40
10
5
15
30
Years
15
Percent of GDP
Percent change in money wages
Loan Repayment and Money relending
Investment & Profit Rate
Wages and Employment Rate
10
20
5
10
0
5
90
92
94
96
Employment Rate
98
100
0
5
0
Profit Rate %
5
10
0
 10
5
0
Rate of Profit
• Purpose of functions not to generate cycles
• System already inherently cyclical (Goodwin)
• But to constrain cycles to realistic levels
5
10
Modelling Minsky: Production Relations
• Capital K determines output Y via the accelerator:
K
1/3
Accelerator
Y
• Y determines employment L via productivity a:
Y
l
r
1
a
Labour Productivity
/
L
• L determines employment rate l via population N:
L
l
r
100
N
Population
/
l
• l determines rate of change of wages w via Phillips Curve
+
.96
"NAIRU" 10
WageResponse
*
PhillipsCurve
• (Linear Phillips curve for now)
dw/dt
• Integral
of w determines W (given initial value)
1
Initial Wage
dw/dt
+
1/S
+
Integrator
w
L
*
W
• Y-W determines profits P and thus Investment I…
Y
W
+
-
Pi
I
dK/dt
• Closes the loop:
1
Initial Capital
dK /dt
+
1/S
+
Integrator
Modelling Minsky: Inherent cycles
• Model generates cycles (but no growth since no
population growth or technical change yet)…:
K
1/3
Accelerator
l
r
1
a
Labour Productivity
1
Population
.96
"NAIRU"
+
10
WageResponse
L
/
• Cycles caused
by essential
nonlinearity:
• Wage rate
times
employment
Goodwin's cyclical growth model
1.50
/
Employment
Wages
1.25
l
1.00
.75
PhillipsCurve
*
dw/dt
.50
1
Initial Wage
Y
l
r
N
Y
w
L
+
1/S
+
Integrator
+
-
*
0
2
4
6
Time (Years)
W
Goodwin's cyclical growth model
1.3
Pi
I
1.2
dK/dt
+
1/S
+
Integrator
Wages
1.1
3
Initial Capital
8
1.0
.9
.8
.7
.9
.95
1
Employment
10
• Behavioural
nonlinearities
not needed for
cycles;
• Instead,
restrain values
1.05
to realistic
levels
Modelling Minsky: Wage dynamics
• Phillips curve much maligned in economics
– But used by almost all schools of thought
• Also misunderstood: three factors, not just one:
– 1. Level of unemployment (highly nonlinear relationship)
– 2. Rate of change of unemployment
– 3. Rate of change of retail prices “operating through
cost of living adjustments in wage rates.” (Phillips 1958
p. 283-4)
• All 3 factors included in this model:
Employ
Rate of
Rate of change of
Inflation
ment
employment
1change
d of
1 d
wages
W  Ph     g     
P
depends
W
dt on…
P dt
 
 

Modelling Minsky: Price dynamics
• Physical Output (Q) = Labor times L labor productivity a
• Labor = Money flow of wages divided by money wage W
• Flow of wages = worker share of output during turnover
period tS (time from outlays to receipts)
• Money Demand = Annual flow of wages plus profits
– = Money in Firms divided by turnover tS .
• Physical
Demand = Money
Physicaldemand divided by Price level
Physical
• In equilibrium,
of physical supply = physical demand
supply flowdemand
1  s FDe
1 FDe
Qe  a 

 De 

tS W
t S Pe
• Solving for equilibrium price: Pe 
1
W

1  s  a
Convergence over time
• As a dynamic process:
d
1 
1
W
P    P 

dt
tP 
1  s  a





Modelling Minsky: The full system
Financial Sector
• In scary equations…
d
BC( t)
dt
d
BPL( t)
dt
FL( t)

t RL  r( t)


BC( t)

t LC  r( t)

BC( 0)
rL FL( t)  rD FD( t)  rD W D( t ) 
BC( t)
FL( t)
BPL( t )
BPL( 0)
tB


d
FL( t)
dt
t 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) 
t LC  r( t )
t RL  r( t )
tB
tW
a( t )
d
W D( t)
dt




t RL  r( t )

 PC( t)  Yr( t)  Inv  r( t )

rD W D( t) 
W D( t)
tW


BC0




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
t Pc
 PC( t) 

W ( t)
W ( t)
 1  1 

 t  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
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 less scary QED format:
QED
Modelling Minsky: The outcome
• Model generates Great Moderation & Great Recession
– Not yet calibrated on data yet qualitatively similar…
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
Modelling Minsky: The outcome
• The full picture from QED
Modelling Minsky: The outcome
• The full picture from QED
Modelling Minsky: The insights
• Private debt causes both boom and crisis
• Workers pay for debt through reduced share of income:
Income Distribution
• Reduced volatility with
Workers
Capitalists rising debt a sign of
Bankers
• Not increased
stability (“The Great
Moderation”—
Bernanke 2004)
• But “Calm before the
storm” (Keen 1995)
110
100
90
Percent of GDP
80
70
60
50
40
30
20
10
0
 10
0
20
40
Year
60
How does “Now” compare to “Then”?
• Debt-financed proportion of aggregate
DDebt
demand:GDP  DDebt
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
Years since peak rate of growth of debt (mid-1928 & Dec. 2007 resp.)
13
Where to from here?
• 3 factors determine debt impact on economy
– Level (relative to GDP)
• Like distance between start and destination
• How long before journey is over
– Rate of change
• Like speed of travel to destination
• Affects aggregate demand
– Rate of change of rate of change
• Like acceleration/deceleration
• Whether you’re getting there more quickly or not
• Affects rate of change of aggregate demand
– Are things improving or getting worse right now?
Where to from here?: Level
• It’s a long way from the top if you’ve sold your soul...
USA Private Debt to GDP
320
300
280
260
The NBER thinks the
recession ended here!
Percent of GDP
240
220
200
180
160
140
120
100
80
60
40
20
0
1920
1930
1940
1950
1960
1970
Year
1980
• Almost 100% of
GDP reduction to
get to pre-Great
Depression level
• Speculative
175
debt still
present
• 200% to get back
to 50s level
75
• Only productive
debt
2010 2020
• Decade with
aggregate demand
below GDP
2009.5
1990
2000
Where to from here?: Rate of change
• Deleveraging impact equivalent to Great Depression level
Velocity of debt & unemployment
25
0
2009.5
Debt-financed demand
Unemployment (inverted)
Percent of aggregate demand
20
15
10
5
5
0
0
 5
 10
 15
 20
 25
 30
1980 1982 1984 1986 1988 1990 1992 1994 1996 1998 2000 2002 2004 2006 2008 2010 2012
Year
• Debt reducing at Great Depression rate
• Levelling out implies sustained slump
• “Turning Japanese”
U-3 measure of unemployment
30
Where to from here?: Acceleration
• We’re slowing down...
Acceleration of debt & change in employment
2009.5
10
Rate of change of new debt p.a.
5
0
 5
 10
 15
 20
0 0
The acceleration effect might
be why the NBER thinks the
recession ended here!
 25
 30
1955
 10
 20
Acceleration of debt
Rate of change of employment
1960
1965
1970
1975
1980
1985
Year
1990
1995
2000
2005
2010
Rate of change of private employment p.a.
10
 30
2015
• Less scary than accelerating fall (rising on quarterly data)
• But still not enough to increase employment
• Susceptible to future acceleration in fall
• Much of rise driven by return to Ponzi investing
Where to from here?
• 2 most persistent debt metrics
remain negative
– Level of debt to GDP
– Rate of change
• Most volatile currently positive
– Deceleration of deleveraging
has boosted economy
• Learning complicated dynamics of
debt the hard way
• History implies crisis has many
years to run…