Download Debt, inequality and economic stability Steve Keen www.debtdeflation.com/blogs www.debunkingeconomics.com

Debt, inequality and economic stability
Steve Keen
www.debtdeflation.com/blogs
www.debunkingeconomics.com
Neoclassical economics ignores debt, banks & money
• “Keen … asserts that putting banks in the story is essential.
• Now, 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?...”
• (Krugman 2012)
• Ignorance of finance sector due to false model of money & lending
– “If I decide to cut back on my spending
– and stash the funds in a bank,
– which lends them out to someone else,
– this doesn’t have to represent a net increase in demand.”
• (Krugman 2012)
• “Loanable Funds” model of lending
– Fixed stock of money (amount controlled by Federal Reserve)
– Two types of agents (“patient” & “impatient”)
– Patient generally lenders—high interest rate encourages high
volume of Loanable Funds
– Impatient generally borrowers—demand rises as interest rate falls
Sustainable development & financial instability
• Sees lending as occurring between non-bank “agents”
• Banks mere intermediaries
• Money absent from analysis: lending effectively of commodities today
in return for more commodities in the future:
– “In what follows, we begin by setting out a flexible-price
endowment model in which “impatient” agents borrow from
“patient” agents, but are subject to a debt limit… (p. 3)
– “We assume initially that borrowing and lending take the form of
risk-free bonds denominated in the consumption good” (p. 5)
• Krugman & Eggertsson (2010)
• Ignore aggregate debt because of asset-liability balance
– “to a first approximation debt is money we owe to ourselves…
– looking at the world as a whole, the overall level of debt makes no
difference to aggregate net worth
• one person’s liability is another person’s asset.” (p. 3)
• Treat lending as “person to person”—not “bank to person”
– But real lending is bank to person…
Sustainable development & financial instability
• Aggregate debt can’t be ignored in a genuine monetary economy
– Money is a liability of bank sector to non-bank sectors of economy
• Debt an asset of banking sector that sets servicing/repayment
obligations on non-bank sectors
• Expansion of bank assets & liabilities therefore increases aggregate
demand
– Growth of assets & liabilities is not economic-growth-neutral
– If growth of debt results in debt servicing/repayment obligations
that exceed capacity of non-bank sectors, economic collapse
ensues.
• Banks, debt & money must play essential roles in economic models
• Illustrating difference between false Neoclassical vision of lending and
accurate “Post Keynesian” vision…
Sustainable development & financial instability
• Neoclassical vision of lending would ultimately appear to bank sector…
Assets
Liabilities (Deposits)
Equity Row Sum
Patient
Impatient
Nothing
+Loan
-Loan
0
over here…
No change in aggregate money supply
Increase in liabilities shown as minus in double-entry bookkeeping
• As lending ultimately appears in Post Keynesian model of lending…
Assets
Liabilities (Deposits) Equity Row Sum
Loans Reserves Patient Impatient
+Loan
-Loan
0
Money supply grows by size of the loan
Sustainable development & financial instability
• In Open Source simulation program “Minsky” (developers click here)
– Loanable Funds:
• Endogenous Money:
Sustainable development & financial instability
• Why does it matter?
• Neoclassical “Loanable
Funds” vision—no
change in aggregate
demand:
• Post Keynesian
“Endogenous Money”
vision—aggregate
demand grows as debt
grows
• Macroeconomic impact:
• Aggregate debt & change
in debt have extreme
impact on economic
growth
• Growing debt creates
additional demand
• Causes asset bubbles…
Sustainable development & financial instability
• How does change in debt feed into economic activity?
• 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
d
Wages + Profits +
=
D Consumption + Investment + NetAssetTurnover
dt
Sustainable development & financial instability
• Aggregate Demand = Income + Change in Debt
• Aggregate Supply = Good & Services + Net Asset Turnover
d
Y + D = GDP + NAT
dt
• Implications for macro & finance: NAT = PA ⋅ QA ⋅ TA
– Change in debt a factor in level of employment, output
– Debt acceleration drives change in GDP & asset prices
2
d
d
d
d
Y+ =
D
GDP + ( PA ⋅ QA ⋅ TA )
2
dt
dt
dt
dt
• Change in debt explains crisis (& “Great Moderation” before it)
• Accelerating debt explains why asset bubbles must burst
Sustainable development & financial instability
• Crisis can only be understood from dynamics of debt
– Decline in income relatively mild…
– But decline in debt change huge…
USA GDP
7
2×10
7
1.9×10
7
GDP
GDP + Debt Change
BNP
1.8×10
7
US $ Million
1.7×10
7
1.6×10
7
1.5×10
7
1.4×10
7
1.3×10
7
1.2×10
7
1.1×10
7
1×10
6
9×10
2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014
www.debunkingeconomics.com
Sustainable development & financial instability
• Change in debt & unemployment…
Debt contribution to demand & unemployment
30
Debt change
Unemployment Rate
0
1
20
2
15
3
10
4
5
5
0
0 6
−5
7
− 10
8
− 15
• Correlation -0.76
9
− 20
10
− 25
11
− 30
1980
1985
1990
1995
2000
2005
2010
Sources: As for Figure 3 plus BEA GDP
2015
Percent unemployed (inverted)
Percent of GDP p.a.
25
ZLB
Sustainable development & financial instability
• Acceleration of debt drives change in economic activity
15
3
10
2
5
1
0
00
−5
−1
− 10
−2
− 15
−3
− 20
−4
− 25
Credit Acceleration
Employment Change
−5
− 30
−6
1980198219841986 198819901992 1994199619982000 200220042006 200820102012 2014
www.debtdeflation.com/blogs
Change in 100 minus unemployment rate p.a.
Private Debt Acceleration p.a. as percent of GDP
Credit Acceleration & Employment Change (Corr=0.69)
Sustainable development & financial instability
7
21
6
18
5
15
4
12
3
9
2
6
1
3
0
00
−1
−3
−2
−6
−3
−9
−4
− 12
−5
−6
Mortgage Accelerator
Change in Real House Prices
− 15
− 18
−7
− 21
1986 1988 1990 1992 1994 1996 1998 2000 2002 2004 2006 2008 2010 2012 2014
www.debtdeflation.com/blogs
Percent change in real Case-Shiller Index p.a.
Percent of GDP
Mortgage Acceleration & House Price Movements (Corr=0.78)
Sustainable development & financial instability
• Accelerating debt drives change in stock market prices
2
40
1.5
30
1
20
0.5
10
00
0
− 0.5
− 10
−1
− 20
− 1.5
− 30
−2
− 40
− 2.5
−3
2001
Margin Acceleration
Share Index Change
2002
2003
2004
2005
− 50
2006
2007
2008
2009
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2010
2011
2012
− 60
2013
Percent real change p.a.
Percent of GDP p.a.
Margin Debt Acceleration & Share Price Change (Corr = 0.81)
The Financial Instability Hypothesis
• Minsky has best verbal model of debt & instability
– 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
– Rising expectations leads to “The Euphoric Economy”…
The Financial Instability Hypothesis
• 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 Financial Instability Hypothesis
• Boom turns to bust
• Ponzi financiers first to 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
– Modeling Minsky…
Keen 1995 Model Foundations: Nonlinear dynamics
• Growth Cycle model (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
1.50
Accelerator
• Y determines employment L via productivity a:
l
r
1
a
Y Productivity
l
Labour
a
1
1
LabourPopulation
Productivity
/
r
N
L
/
Employment
Wages
1.25
L
l
r
1.00
l
/
• L determines employment rate l via population N:
.96
"NAIRU"
+
10
L
WageResponse
100
N
1
Population
.75
*
l
r
PhillipsCurve
dw/dt
l
/
.50
2
0
6
4
Time (Years)
8
10
• l determines rate of change of wages w via Phillips Curve
+
- Y
w
L
+
1/S
+
Integrator
+
.96
"NAIRU" 10
WageResponse
*
W
*
Goodwin's cyclical growth model
1.3
Pi
dw/dt
PhillipsCurve
I
dK/dt
1.2
1.1
Wages
Initial Wage
•1 Integral of w determines W (given initial value)
3
Initial Capital
Initial Wage
dw/dt
+
1/S
+
Integrator
+
1.0
.9
w
L
1/S
+
Integrator
*
W
.8
.7
.9
• Y-W determines profits P and thus Investment I…
Y
W
+
-
Pi
I
dK/dt
• Closes the loop:
1
Initial Capital
dK/dt
.95
1
Employment
+
1/S
+
Integrator
1.05
Adding Ponzi Finance
• Realism: Capitalists invest more than profits
during boom
– Debt needed to finance excess
• Embellishment: Distinguish productive
from unproductive debt
• As systems dynamic model:
Capital
l
Output
Productivity
Equilibrium
r
Parameters
/
Employment
l
Population
r
/
Graphs Switches
Values
Wages
Output
Profit
Debt
+
Speculation
+
+
r
*
Interest
+
TotalDebt
d_ratio
tdratio
sratio
Debt/Output
7.5
Debt to GDP
5.0
Productive
Speculative
2.5
0
0
10
20
30
40
50
60
70
80
90
Time (Years)
E_rate
WageShare
Employment & Wages
1.00
Wage & Employment Dynamics
Employment Rate
Wages Share
.75
Wages Share
• Model predicts systemic breakdown as feasible
outcome
• But still only implicitly monetary
• Explicitly monetary model (Graziani): Capitalism
not barter (2-sided, 2 commodity exchange) but
monetary (3 sided—seller, buyer, bank—1
commodity), money a non-commodity token
.50
.25
0
0 10
30
50
70
1.00
.75
.50
.25
0
.3
90
.5
Time (Years)
g_rate
.7
.9
1.1
Employment Rate
dratio_g
sratio_g
Rate of Growth
Long Recovery/Boom, Short Slump
1.0
Change in Output
Change in Debt to GDP
Change in Speculative Debt to GDP
.5
0
0
10
20
30
40
50
Time (Years)
60
70
80
90
Explicitly Monetary Minsky Model
• Input financial relations in Table:
Assets
Liabilities
Equity
d
ReservesReserve
=− A +Loan
F
Firm Deposit Worker Deposit Bank Equity
dt
Lend
-AB
A
FL
d
V
=
−
BV
d
Record
Loan
τ L (=π rA
dt Loan
) −τ VF(π+r )G A
Interest
B
dt
BT
d
=
⋅
−
⋅
+
−
B
r
F
r
F
H
(
)
Pay Interest
B
ddt T L L D D D τ B -B
Record
FirmDeposit = A −-BB − C + D + E − F + G
BV
FL
d
dt
Wages
C
=
−
+ Y ⋅ Inv (π r ) -C
FL
τ V (π r ) τ L (π r )
Consumption
D+E
-D
-E
ddt
WorkerDeposit
= C − D B -F
d
Repay
Loan
F
dt FD = ( rD ⋅ FD − rL ⋅ FL ) − W ⋅ L +  V − FL  +  B T + H D  + Y ⋅ Inv (π r )
Record
-F
τ V (π r ) τ L (π r )   τ B τ H 
dt

d Money
New
G
−DE
d BankEquity= B H
H D = rD ⋅ H D + W ⋅ L −
dt
Record
τ G
dt
H
• System of dynamic equations derived automatically:
• Placeholders replaced by behavioural functions:
Explicitly Monetary Minsky Model
• Full system of 14 coupled differential equations
Financial Sector
d
d
d
d
d
FL( t)
(
)
−
BV( t)
(
)
BV( t)
dt
τ RL π r( t)
BT( t)
dt
BT( t)
rL⋅ FL( t) − rD⋅ FD( t) − rD⋅ HD( t) −
τB
BV( t)
(
)
−
τ LC π r( t)
FL( t)
(
)
(
+ P( t) ⋅ Yr( t) ⋅ Inv π r( t)
)
BV( 0)
BV0
BT( 0)
BT0
FL( 0)
FL0
FL( t)
dt
τ LC π r( t)
FD( t)
dt
FL( t)
BT( t)
HD( t)
W ( t) ⋅ Yr( t)
BV( t)
−
+
+
+ P( t) ⋅ Yr( t) ⋅ Inv π r( t) −
rD⋅ FD( t) − rL⋅ FL( t) +
τ RL π r( t)
τB
τW
a( t )
τ LC π r( t)
FD( 0)
FD0
HD( t)
dt
W ( t) ⋅ Yr( t)
HD( t)
+
rD⋅ HD( t) −
a( t )
τW
HD( 0)
HD0
τ RL π r( t)
(
)
(
(
)
)
Physical output, labour and price systems
Level of output
Employment
Rate of Profit
Rate of employment
Rate of real economic growth
Kr( t)
Yr( t)
L( t)
Yr( t)
L( 0)
a( t )
(
P( t) ⋅ Yr( t) − W ( t) ⋅ L( t) − rL⋅ FL( t) − rD⋅ FD( t)
v ⋅ P( t) ⋅ Yr( t)
λ ( t)
dt
g ( t)
Yr0
v
π r( t)
d
Yr( 0)
λ ( t) ⋅ [ g ( t) − ( α + β ) ]
(
Inv π r( t)
v
)
−δ
)
π r( 0)
L0
π r0
λ ( 0)
λ0
g ( 0)
g0
Explicitly Monetary Minsky Model
• Generates both “Great Moderation” & “Great Depression”
Inflation, Unemployment and Debt
25
500
Inflation
Unemployment
Debt to GDP
15
400
10
5
300
0
0
−5
200
− 10
− 15
100
− 20
− 25
0
10
20
30
40
50
0
60
Debt to GDP Ratio Percent
Inflation & Unemployment Percent
20
Explicitly Monetary Minsky Model
• Fits stylized facts of crisis
Unemployment, Inflation & Debt (smoothed)
3
15
12.5
Percent
7.5
2
5
2.5
0
− 2.5
−5
1980
0 1.5
Unemployment
Inflation
Debt to GDP
1985
1990
1995
2000
Year
2005
2010
1
2015
Ratio to GDP
2.5
10
Debt and Inequality
• Model fundamentally has 3 system states:
– Rate of Employment
– Debt to GDP ratio
– Workers’ share of output
• Equilibria of model involve
– Rate of Employment
– Debt to GDP ratio
– Capitalists’ share of output
• Workers income a residual after capitalists & bankers income
• Residual necessarily falls as debt ratio rises
• Workers pay for rising debt even if they have no debt
• Necessary link between rising debt & rising inequality…
Debt and Inequality
• If income distribution ignored, all appears well until catastrophe strikes
Income distribution & economic breakdown
100
Workers
Capitalists
Bankers
90
80
Percent of GDP
70
60
50
40
30
20
10
0
0
5
10
15
20
25
30
35
40
45
50
55
60
• Essential to restrain level of private debt to limit damaging inequality
References
• Grasselli, M. and B. Costa Lima (2013). “An analysis of the Keen model
for credit expansion, asset price bubbles and financial fragility.”
Mathematics and Financial Economics: 1-20.
• Keen, S. (2013). “Predicting the “Global Financial Crisis”—Post
Keynesian macroeconomics.” Economic Record
• Krugman, P. (2012). “Minsky and Methodology (Wonkish).” The
Conscience of a Liberal
– http://krugman.blogs.nytimes.com/2012/03/27/minksy-and-methodology-wonkish/
• Krugman, P. and G. B. Eggertsson (2010). “Debt, Deleveraging, and the
Liquidity Trap: A Fisher-Minsky-Koo approach” [2nd draft 2/14/2011].
New York, Federal Reserve Bank of New York & Princeton University.
Not “Double-counting”…
• Income is wages plus profits
• Divide profits into
– Distributed profits
– Retained profits
YI= W + Π
YI= W + Π= W + Π D + Π R
• Expenditure (ignoring asset markets & government for the moment)
– Is money spent buying either Consumer Goods or Capital Goods
YE= C + I
• Two sources of demand for Consumer Goods: Workers & Capitalists
d
CW= W + DWC
dt
d
CΠ =Π D + DΠC
dt
• Borrowing by workers for consumption
• Can be negative (=“savings”)
• Borrowing by capitalists for consumption
• Can also be negative (=“savings”)
Not “Double-counting”…
• Two sources of demand for Investment Goods
– Retained earnings
d
– New debt
I =Π + D
R
• Borrowing by firms for investment
• Can be negative (=“savings”)
dt
FI
• Comparing the two equations…
YE= C + I
d


Y=
( CW + CΠ ) +  Π R + DFI 
E
dt



d
d
d
 
 

Y=
E
  W + dt DWC  +  Π D + dt DΠC   +  Π R + dt DFI 
 
 


Not “Double-counting”…
• Rearranging…
d
d
d

Y=
W
D
D
D
+
Π
+
Π
+
+
+
(
)
E
D
R
WC
FI 
ΠC

dt
dt
 dt

• Subtract income from expenditure

d
d
d

YE −=
YI  (W + Π D + Π R ) +  DWC + DΠC + DFI   − (W + Π D + Π R )
dt
dt
 dt


• So expenditure equals income plus the change in debt
d
d
d
DWC + DΠC + DFI
dt
dt
dt
Still sounds like double-counting?
– Yes probably: because of “ex-ante” vs “ex-post” confusion…
Mathematical equality of recorded income & expenditure (“ex-post”)
– Even though differ “ex-ante” (before the event)
Debt injected at discrete points in time
Added to spending from income at that time
After that time, debt has boosted incomes
Recorded levels are the same…
YE =
YI +
•
•
•
•
•
•
Not “Double-counting”…
• In a picture…
Expenditure at time t
Change in debt
Income at time t
• Measured income at time t is “income looking back”
YI (t+) =lim+ YI ( s)
s →t
• This is identical to expenditure at time t
YE (t=
) YI (t+=
) YI (t) + ∆D(t)