Professional Documents
Culture Documents
Author: Steve Keen · March 26th, 2012 · Comments (18) Share This Print 2 1
My paper “Instability in Financial Markets: Sources and Remedies” for the INET conference
“Paradigm Lost: Rethinking Economics and Politics“, to be held in Berlin on April 12-14, is now
available via the INET website.
If you’d like to download it, you can get it either from my INET page, or from a link on the
conference program. For copyright reasons I can’t reproduce it here, but I can provide a quick
synopsis and some excerpts, so here goes.
A Primer on Minsky
The paper starts with a synopsis on Minsky, since his “Financial Instability Hypothesis” is one of
the key foundations of my approach to economics. He has come into vogue these days of
course, but to people who’ve known his work for several decades rather than ever since the
“Minsky Moment” of late 2007, a better expression would be that he’s “come into vague”. I
read papers like Krugman’s “Debt, Deleveraging, and the Liquidity Trap: A Fisher-Minsky-Koo
approach”, and for the life of me, I can’t see Minsky there. As I note in my paper:
Now, after the crisis that his theory anticipated, neoclassical economists are paying some
attention to his hypothesis, and there has been at least one attempt to build a New Keynesian
model of a key phenomenon in Minsky’s hypothesis, a debt-deflation (Krugman and Eggertsson
2010). However, to those of us who are not new to Minsky, it is hard to recognise any vestige of
the Financial Instability Hypothesis in Krugman’s work.
My good friend and long term fellow rebel in economics Professor Rod O’Donnell once
remarked that neoclassical economists are incapable of reading Keynes: they look at his words
and then spout Walras instead. A similar phenomenon applies here: neoclassicals like Krugman
read Minsky, and then proceed to build equilibrium models without banks, and think they’re
modelling Minsky.
No they’re not: they’re creating an equilibrium-obsessed Walrasian hand puppet and calling it
Minsky—just as they did to Keynes with DSGE modelling.
Disequilibrium
I used the word “equilibrium” twice above, because one clear methodological aspect of
Minsky’s thinking is that macroeconomics is about disequilibrium. Neoclassical economists
have the world precisely (to use an evocative piece of Australian slang) arse about tit. They
believe that if it’s not an equilibrium model it’s not economics.
Nonsense! The precise opposite is the case: if it isn’t disequilbrium, then it isn’t economics.
There’s nothing “radical” about this, which is often the way that neoclassical economists react
when I press this point: “assume disequilibrium? How dare you!?”. I dare because
“disequilibrium” is so common in real sciences that they don’t even call it that: they call it
dynamics. Any dynamic model of a process must start away from its equilibrium, because if you
start it in its equilibrium, nothing happens. It’s about time that economists woke up to the
need to model the economy dynamically—and to give Krugman his due here, he does admit at
the end of his paper that his dynamics are dreadful, and need to be improved:
The major limitation of this analysis, as we see it, is its reliance on strategically crude dynamics.
To simplify the analysis, we think of all the action as taking place within a single, aggregated
short run, with debt paid down to sustainable levels and prices returned to full ex ante
flexibility by the time the next period begins. This sidesteps the important question of just how
fast debtors are required to deleverage; it also rules out any consideration of the effects of
changes in inflation expectations during the period when the zero lower bound remains
binding, a major theme of recent work by Eggertsson (2010a), Christiano et. al. (2009), and
others. In future work we hope to get more realistic about the dynamics.
Hurry up Paul: you’re already eight decades behind Irving Fisher, who put the case for
dynamics even for those who assume that equilibrium is stable:
‘We may tentatively assume that, ordinarily and within wide limits, all, or almost all, economic
variables tend, in a general way, toward a stable equilibrium… But … New disturbances are,
humanly speaking, sure to occur, so that, in actual fact, any variable is almost always above or
below the ideal equilibrium…
Theoretically there may be—in fact, at most times there must be—over-or under-production,
over- or under-consumption, over- or under-spending, over- or under-saving, over- or under-
investment, and over or under everything else. It is as absurd to assume that, for any long
period of time, 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)
Endogenous Money
One key component of Minsky’s thought is the capacity for the banking sector to create
spending power “out of nothing”—to quote Schumpeter. As well as explaining endogenous
money, I show that Minsky’s analysis leads to the conclusion that aggregate demand is greater
than aggregate supply arising from the sale of goods and services alone—and therefore that
rising debt plays a crucial role in a capitalist economy:
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. (Minsky 1963;
Minsky 1982) (Minsky 1982, p. 6)
This aggregate demand is spent not just on goods and services, but also on buying financial
assets—hence economics and finance are inextricably linked, in opposition to the failed
neoclassical attempt to keep them separate in two hermetically sealed jars. This in turn
transcends Walras’ Law to give us what I call the Walras-Schumpeter-Minsky Law:
Aggregate demand is income plus the change in debt, and this is expended on both goods and
services and financial assets. Therefore in a credit-based economy, there are three sources of
aggregate demand, and three ways in which this demand is expended:
1. Demand from income earned by selling goods and services, which primarily finances
consumption of goods and services;
2. Demand from rising entrepreneurial debt, which primarily finances investment; and
3. Demand from rising Ponzi debt, which primarily finances the purchase of existing assets.
This is debt without banks—and without the endogenous creation of money—and it explains
why neoclassical economists don’t think that the level of private debt matters.
With that vision of debt, a change in the level of debt isn’t important, because the borrower’s
increase in spending power is counteracted by the lender’s fall in spending power. Here’s the
lending process as neoclassicals like Krugman see it:
Krugman therefore reassures his blog readers that there’s nothing to worry about when private
debt levels rise or fall:
People think of debt’s role in the economy as if it were the same as what debt means for an
individual: there’s a lot of money you have to pay to someone else. But that’s all wrong; the
debt we create is basically money we owe to ourselves, and the burden it imposes does not
involve a real transfer of resources.
That’s not to say that high debt can’t cause problems — it certainly can. But these are
problems of distribution and incentives, not the burden of debt as is commonly understood.
(Krugman 2011)
That would be reassuring if true, since we could then ignore data like this:
In the real world, a bank loan increases “Impatient”‘s spending power without reducing
“Patient”‘s, so that the level of private debt does matter.
In particular, the rate of change of debt matters because that tells us how much of demand is
debt financed. When you add the change in debt to GDP, you get total aggregate demand, and
that makes it exceedingly clear why the economic crisis occurred: the growth of debt collapsed,
and took the economy with it:
Since change in debt is part of aggregate demand, the acceleration of debt—the rate of change
of its rate of change—affects change in aggregate demand. This in turn has impacts on the
change in employment.
It also impacts on change in asset prices. The relationship between accelerating debt and rising
asset prices is clear even in the very volatile world of the stock market:
Remedies
Since asset market volatility is driven by the acceleration of private debt, the Minskian solution
to instability in finance markets is to somehow sever the link between debt and asset prices. I
put forward two ideas.
Jubilee Shares
Currently, shares last for the life of the issuing company, and 99% of the trade on the stock
market is in the secondary market. The Jubilee Shares proposal would allow shares to last
forever as now when purchased on the primary issue market, but would have them switch to a
defined life of (say) 50 years after a limited number of sales on the secondary market (say 7
sales). This would encourage primary share purchases, and also make it highly unlikely that
anyone would use borrow money to buy Jubilee shares on the secondary market.
Currently lending to buy property is allegedly based on the income of the borrower—which
gives borrowers an incentive to actually want higher leverage over time. “The PILL” would limit
the amount that can be lent to some multiple (say 10 times) of the income generating capacity
of the property itself.
End of Synopsis
There’s much more detail in the paper itself, and when the conference is held my talk on it will
also be available on the INET website.
Philip Pilkington: Nobel Laureate Paul Krugman Selectively Quotes Rival to Stitch Him Up After
Losing Argument « naked capitalism
[...] it went down. Post-Keynesian economist and sometimes Naked Capitalism contributor
Steve Keen wrote a cogent article critiquing a Paul Krugman paper on Minsky and debt
deflation. The key issue was that the so-called [...]
[...] debate between Paul Krugman and my friend Steve Keen regarding how banks work (see
here, here, here, and here) has caused me to revisit an old quote. Back in the 1990s I would
use [...]
[...] debate between Paul Krugman and my friend Steve Keen regarding how banks work (see
here, here, here, and here) has caused me to revisit an old quote. Back in the 1990s I would
use [...]
The Central Flaw in Krugman’s Argument Against Keen | Bear Market Investments
[...] 28, 2012 by admin The key failing in Krugman’s response to Steve Keen’s response to
Krugman’s paper (PDF) is here: If I decide to cut back on my spending and stash the funds [...]
[...] key failing in Krugman’s response to Steve Keen’s response to Krugman’s paper (PDF) is
here: If I decide to cut back on my spending and stash the funds [...]
[...] who is a beneficiary of George Soros’ Institute for New Economic Thinking, last
week published a summary of a paper he’s going to present at an INET conference next week,
which looks at why Hyman [...]
Philip Pilkington: Krugman Makes Accusations of Fundamentalism to Defend His Own Dogma «
naked capitalism
[...] Krugman has just done the intellectual equivalent on a blog ‘contesting’ Steve Keen’s
recent piece criticising his model of debt dynamics. Keen has raised these issues before and
Krugman has [...]
[...] Wonks How the behavioral economics idea of the “nudge” could improve public policy –
Economist A great primer on Minsky’s “Financial Instability Hypothesis” – Economonitor [...]
[...] My friend Steve Keen recently presented a “primer” on Hyman Minsky; you can read it
here. [...]
Krugman on Minsky – in danger of reinventing the wheel « Lars P Syll's Blog Docendo discimus
[...] Krugman has a post up today, responding to a new paper by Steve Keen on how some
people – like Krugman – gets it so wrong on the economics [...]
[...] and Methodology (Wonkish) Steve Keen has a new post up (with a link to a new paper)
about Minksyan (Minskyite?) economics, and how [...]
[...] Steve Keen explains: My good friend and long term fellow rebel in economics Professor Rod
O’Donnell once remarked that neoclassical economists are incapable of reading Keynes: they
look at his words and then spout Walras instead. A similar phenomenon applies here:
neoclassicals like Krugman read Minsky, and then proceed to build equilibrium models without
banks, and think they’re modelling Minsky. [...]
Reply
Reply
0 replies · active 1 week ago
Unfortunately five out of six embedded images cannot be seen. Can you please fix this issue?
Reply
Strikes me that you are picking an argument with Krugman that you don't need to have. Also
sounds to me that while there might be a correlation between debt delevaging and a collapse
in demand, that it's still about a collapse in demand at the end when it comes to explaining the
current problem with the economy in gdp & employment.
Reply
It's refreshing to see someone who actually reads Minsky advocate his ideas. Krugman is a
brilliant guy, and far more clued in than the monetarists whose obtuseness is unbounded, but
he doesn't grasp Minsky in the least.
Saying all that, your proposals seem quite out of the box to me, as differing from Minsky's
which were far more traditional. I wonder what your reaction would be to Norman Gall's
proposals that come at the end of this bit of vintage (and highly prescient) analysis. The whole
piece, written in 1998, is a brilliant read.
Reply
The quote of Minsky contains an ellision at a very key point "For real aggregate demand to be
increasing, . . . it is necessary " What was replaced by "..." ? Why was it so necessary to save
those pixels ?
Frankly, I don't see how to interpret the quoted passage from Minsky as other than a math
mistake.
Reply
Great stuff.
I'm fascinated by the idea of "jubilee shares". This seems to allign with Keynes's view of
"investing for prospective yield" vs "investing for expectations in the share price" - the latter
being speculation, which unfortunately dominates stock market behavior. I wonder what
potential adverse impacts this proposal could have? For instance, would it substantially raise
the cost of equity capital, due to investors now having less lucrative exit oppurtunities ? My
guess is that the critics would argue this point.
Reply
Fighting over the minutiate is to miss the point - both sides agree there is a lack of aggregate
demand, i.e. the economy needs stimulating.
Reply
Reply
Good article. Could be said that thanks to articles like this we are beginning to move out of the
the age of Neo-Liberalism into the age of Equi-Liberialism (or Equi-Liberalism take your pick) -
the attempt to put some balance as best we can into the real world of economic
disequilibrium.
Reply
Krugman assumes that people need to save in order for others to borrow.
Krugman explains that Keen is wrong by … assuming that people need to save in order for
others to borrow.
http://www.asymptosis.com/the-central-flaw-in-kru...
Reply
If the Chinese government has spent the last thirty odd years rolling over or cancelling non-
performing bank loans but still averaged 10% average annual GDP growth have they found a
way through using Modern Monetary Theory to successfully tackle Minsky's Financial
Instability Hypothesis?
Reply
Please forgive a beginner; I can't correlate the drop in public debt in your second figure with
any drop in the first figure, the way private debt has correlating drops?
Reply
I say so because the current instability resulted primarily from the fact that bank regulators
played dirty and without really informing anyone changed the ground zero of the financial
markets, by setting different capital/equity requirements for the banks based on the perceived
risks of default, mostly as perceived by the credit rating agencies.
Since the banks and the markets already cleared for these perceptions of risk by means of
interest rates, amount at exposure and other term, the market overdosed on perceived risks.
And now we are in a crisis because of obese exposures to what was or is officially perceived as
absolutely not risky, like triple-A rated or infallible sovereigns, and anorexic exposures to what
is officially perceived as risky, like small businesses and entrepreneurs. http://bit.ly/dFRiMs