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Financial Markets Instability: Sources & Remedies
A Minskian View
Steve Keen
University of Western Sydney
www.debtdeflation.com/blogs
A Primer on Minsky
• Firstly ignored by Neoclassical economists:
– “Minsky … argued for the inherent instability of the financial system
but … departed from the assumption of rational economic
behaviour…
– I do not deny the possible importance of irrationality in economic
life; however it seems that the best research strategy is to push the
rationality postulate as far as it will go.” (Bernanke 2000, p. 43)
• Now misinterpreted by them (Krugman & Eggertsson 2010)
– “A Fisher-Minsky-Koo approach”?
• Equilibrium DSGE model
• Without endogenous money or banks
• Where aggregate debt doesn’t matter (only distribution)
A Primer on Minsky
• In general rejection of Neoclassical model:
– “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)
A Primer on Minsky
• In particular (from Fisher & Schumpeter as well as Minsky):
– Disequilibrium
• “Theoretically there must be over or under everything…
• It is as absurd to assume that the variables in the economic
organization, or any part of them, will "stay put," in perfect
equilibrium, as to assume that the Atlantic Ocean can ever be
without a wave.” (Fisher 1933, p. 339)
• “Stable growth is inconsistent with an economy in which debt-financed
ownership of capital assets exists. 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)
A Primer on Endogenous money
• Endogenous money and banks (Schumpeter 1934, p. 73)
– “the conventional answer is not obviously absurd,
– yet there is another method of obtaining money…
– the creation of purchasing power by banks…
– It is not transforming purchasing power which already exists
– but the creation of new purchasing power out of nothing.”
• Debt—Investment link confirmed by Fama-French empirical work:
– “These correlations confirm the impression that debt plays a key
role in accommodating year-by-year variation in investment.” (Fama
and French 1999, p. 1954)
– “Debt seems to be the residual variable in financing decisions.
Investment increases debt, higher earnings tend to reduce debt.”
For Absent Friends…
”I’m all for including the banking sector in
stories where it’s relevant; but why is it so crucial
to a story about debt and leverage?”
• New York Fed Senior VP Alan Holmes (1969): Monetarism makes…
• “a naive assumption that the banking system only expands loans after
the System or market factors have put reserves in the banking system.
• In the real world, banks extend credit, creating deposits in the
process, and look for the reserves later.
• In any given statement week, the reserves required to be maintained by
the banking system are predetermined by the level of deposits existing
two weeks earlier.
• Since excess reserves in the banking system normally run at frictional
levels the level of total reserves in any given statement week is also
pretty well determined in advance.
• Since banks have to meet their reserve requirements each week … that
total amount of reserves has to be available to the banking system.”
For Absent Friends…
• “There is no evidence that either the monetary base or M1 leads the
cycle, although some economists still believe this monetary myth…
• The difference of M2-M1 leads the cycle by even more than M2, with the
lead being about three quarters…
• The fact that the transaction component of real cash balances (M1)
moves contemporaneously with the cycle while the much larger
nontransaction component (M2) leads the cycle suggests that credit
arrangements could play a significant role in future business cycle
theory.
• Introducing money and credit into growth theory in a way that accounts
for the cyclical behavior of monetary as well as real aggregates is an
important open problem in economics.” (Kydland and Prescott 1990)
A Primer on Minsky continued
• Minsky: growing aggregate private debt source of economic growth
– “If income is to grow, the financial markets must generate an
aggregate demand that is ever rising.
– For real aggregate demand to be increasing, it is necessary that
current spending plans 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.” (Minsky 1982)
• Rising debt also finances Ponzi behaviour & asset bubbles
A Primer on Minsky
• “Ponzi income falls short of interest payments on debt so that the
outstanding debt will grow due to interest on existing debt… Ponzi
units can fulfill their payment commitments on debts only by
borrowing… a Ponzi unit must increase its outstanding debts.’ (Minsky
1982, p. 24)
• Ponzi debt drives up asset prices:
• “During a period of tranquility, there will be a decline in the value of the
insurance that the holding of money bestows.
• This will lead to a rise in the price of capital assets so that a larger
admixture of Ponzi finance is accepted by bankers.
• In this way the financial system endogenously generates at least part of
the finance needed by the increased investment demand that follows a
rise in the price of capital assets.” (Minsky 1982, p. 107)
A strictly monetary view of aggregate demand
• Two sources of monetary demand
– Income (Wages + Profits)
– Borrowing (Change in Debt)
• Two categories of supply
– Goods & Services (Consumer + Investment Goods/Services)
– Net new financial assets
• Schumpeter:
– Incomes mainly spent on consumption
– Change in debt main source of funds for investment
• Minsky: Change in debt also finances Ponzi behavior
Wages  Profits 
d
D  Consumption  Investment  NetFIRE
dt
Walras-Schumpeter-Minsky Law
• Aggregate Demand = Income + Change in Debt
• Aggregate Supply = Good & Services + Net Asset Turnover
d
D  GDP  NetFIRE
dt
Implications for macro & finance: NetFIRE  PA  QA  TA
Y
•
– Change in debt a factor in level of employment, output
– Debt acceleration drives change in GDP & asset prices
d
d2
d
d
Y 2 D
GDP 
 PA  QA  TA 
dt
dt
dt
dt
• Change in debt explains crisis (& “Great Moderation” before it)
• Accelerating debt explains why asset bubbles must burst
Aggregate debt overview
• Private debt far more important than government debt:
US Debt to GDP
320
300
280
• Only the Great
Depression
compares to now
• & “Roaring
Twenties” to “The
Great Moderation”
Private
Public
260
Percent of GDP
240
220
200
180
160
140
120
100
80
60
40
20
0
1920
1930
1940
1950
1960
1970
1980
www.debtdeflation.com/blogs
1990
2000
2010
2020
Aggregate debt overview
• Higher level of debt today than now
• Different distribution part of why crisis less severe
Debt to GDP by Sector
Percent of GDP
170
160
150
Business
Finance
Household
140
130
120
110
100
90
80
70
60
50
• Dynamics of
aggregate
private debt
explain both
Depressions
40
30
20
10
0
1920
1930
1940
1950
1960
1970
1980
www.debtdeflation.com/blogs
1990
2000
2010
2020
Change in Debt & Aggregate Demand
• Great Depression:
US $ million p.a.
US Aggregate Demand 1920-1940
120000
115000
110000
105000
100000
95000
90000
85000
80000
75000
70000
65000
60000
55000
50000
45000
40000
35000
30000
1920
Nominal GDP
+Change in Private Debt
+Change in Public Debt
1922
1924
1926
1928
1930
1932
www.debtdeflation.com/blogs
1934
1936
1938
1940
Change in Debt & Aggregate Demand
• Today—compared to Then
US
USAggregate
Aggregate Demand
Demand 1920-1940
1980-2012
US $ million p.a.
US $ million p.a.
7
1.9
120000
10
7
115000
1.8
10
7
110000
1.7
10
7
105000
1.610
1000007
1.510
950007
1.410
900007
1.385000
10
7
1.280000
10
7
1.175000
10
7
170000
10
6
965000
10
600006
810
550006
710
500006
645000
10
6
540000
10
6
435000
10
Nominal GDP
+Change in Private Debt
+Change in Public Debt
Nominal GDP
+Change in Private Debt
+Change in Public Debt
6
330000
10
1980
1920
1982 1922
1984
1986
19241988
1990
1926 1992 1928
1994
199619301998
2000
1932 2002 1934
2004
www.debtdeflation.com/blogs
www.debtdeflation.com/blogs
20061936
2008
2010
1938 2012
1940
2014
Acceleration in Debt & Change in Employment
• Then…
20
10
15
7.5
10
5
5
2.5
0 0
0
-5
- 2.5
- 10
-5
- 15
- 7.5
- 20
- 10
- 25
- 30
1920
Credit Acceleration
Employment Change
1922
1924
1926
1928
- 12.5
1930
1932
1934
www.debtdeflation.com/blogs
1936
1938
- 15
1940
Change in 100 minus unemployment rate p.a.
Private Debt Acceleration p.a. as percent of GDP
Credit Acceleration & Employment Change (Corr=0.76)
Acceleration in Debt & Change in Employment
• Now (compared to then)
20
15
10
3
15
10
7.5
2
10
5
5
1
5
0
2.5
0 0
0 0
-1
- 2.5
0
-5
-5
- 10
- 10
-2
-5
- 15
- 15
-3
- 7.5
- 20
- 20
-4
- 10
- 25
Credit Acceleration
Employment Change
5
- 12.5
- 30
- 15
6
1920
1922
1924
192619921928
1930
193220021934
1936
1938
1980 1982
1984 1986
1988 1990
1994 1996
1998 2000
2004 2006
2008 2010
2012 1940
2014
www.debtdeflation.com/blogs
Change in 100 minus unemployment rate p.a.
Change in 100 minus unemployment rate p.a.
Private Debt Acceleration p.a. as percent of GDP
Credit Acceleration & Employment Change (Corr=0.76)
(Corr=0.69)
Share Prices—the long view
• Dow Jones deflated
by the CPI
DJIA deflated by the CPI
1200
1100
1000
Index (2012/02/01: 979)
Mean 1915-1995 (245)
Trend 1915-1995 (2012/02/01: 584)
Index 1915 = 100
900
800
700
600
500
400
300
200
100
0
1910 1920 1930 1940 1950 1960
1970 1980 1990 2000 2010
www.debtdeflation.com/blogs
2020
Share Prices—the long view
• Deviation from trend
CPI-deflated DJIA minus 1915-1995 Trend
Point deviation above or below trend, 1915=0
800
700
600
500
400
300
200
100
0
0
- 100
- 200
1910 1920 1930 1940 1950 1960
1970 1980 1990 2000 2010
www.debtdeflation.com/blogs
2020
Acceleration in Debt & Change in Dow Jones
• Then
20
200
15
150
10
100
5
50
0 0
0
-5
- 50
- 10
- 100
- 15
- 150
- 20
- 200
- 25
- 30
1920
Credit Acceleration
DJIA Change
1922
1924
1926
1928
- 250
1930
1932
1934
www.debtdeflation.com/blogs
1936
1938
1940
- 300
1942
Annual Change Deviation from Trend DJIA Percent
Credit Acceleration p.a. Percent of GDP (1 year lag)
Credit Accelerator & DJIA Deviation from Trend (Corr=0.65)
Acceleration in Debt & Change in Dow Jones
• Now (compared to then)
20
200
100
15
150
75
10
100
50
5
50
25
0 0
0
-5
50
- 25
- 10
- 50
100
- 15
150
- 75
- 20
200
- 100
- 25
Credit Acceleration
DJIA Change
- 30
1920 1988
19221990
1924
1928 1998
193020001932
1936 2008
1938
1986
1992 1926
1994 1996
2002 1934
2004 2006
2010 1940
2012
www.debtdeflation.com/blogs
250
- 125
300
- 150
1942
2014
Annual Change Deviation from Trend DJIA Percent
Acceleration
p.a. Percent
of (1
GDP
CreditCredit
Acceleration
p.a. Percent
of GDP
year lag)
(Corr=0.65)
Credit Accelerator & DJIA Deviation from Trend (Corr=0.34)
House Prices deflated by CPI—the long view
• NO trend; long term average 98
Real House Price Index
300
275
250
Index 1890 = 100
225
200
175
150
Greenspan
Index (2006/04: 262; 2012/01: 173)
Mean 1890-1997 (98)
• “a "bubble" in home prices does not appear likely
• home price declines, were they to occur, likely would not
have substantial macroeconomic implications.”
(Greenspan to Congress, August 2005)
125
100
75
50
25
0
1890
1900
1910
1920
1930
1940
1950
1960
1970
1980
www.debtdeflation.com/blogs; Case-Shiller Index
1990
2000
2010
2020
Acceleration in Mortgages & Change in House Prices
7
21
6
18
5
15
4
12
3
9
2
6
1
3
0
0 0
-1
-3
-2
-6
-3
-9
-4
- 12
-5
-6
-7
1986
- 15
Mortgage Accelerator
Change in Real House Prices
1988
1990
1992
1994
1996
1998
- 18
2000
2002
2004
2006
www.debtdeflation.com/blogs
2008
2010
2012
- 21
2014
Percent change in real Case-Shiller Index p.a.
Percent of GDP
Mortgage Acceleration & House Price Movements (Corr=0.78)
Sources & Remedies
• Accelerating debt THE source of asset price bubbles
• Breaking debt-asset price nexus essential to stop bubbles
• Two modest but fundamental proposals
– “Jubilee Shares”
• Last forever when purchased from firm
• Can be sold on secondary market 7 times
• After 7th sale, last 50 years then expire
– “The Pill”
• Property Income Limited Leverage
– Maximum mortgage (say) 1o times property income
• NO reliance on regulators, fine tuning, etc.
• Negative feedback loop between asset prices & change in debt
• Debt reserved for beneficial investment, not Ponzi Schemes
“Just one more thing…Remedy for today’s crisis”
• “Modern Debt Jubilee”
– “Quantitative easing for the public”
• Cancel irresponsibly created debt without penalizing savers
– Fiat money injection via private bank accounts
• First usage must be debt reduction
• Bank debt necessarily paid down
– Solvency maintained, liquidity challenged
• Bonds reduced in value
• But non-debtor bond-holders receive cash injection
– Minimal damage to aggregate demand, inflation/deflation