should/could economics have predicted the crisis? dr. steve keen
TRANSCRIPT
Should/Could economics have predicted the crisis?
Dr. Steve Keenwww.debtdeflation.com/blogs
https://sourceforge.net/p/minsky/
The crash of 2007/08• An “unexpected” macroeconomic downturn…
– “the current economic situation is in many ways better than what we have experienced in years” (OECD, June 2007)
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A "Black Swan"?
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A "Black Swan"?
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A "Black Swan"?
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Correlation coefficient = 0.98Correlation coefficient = 0.91
Debt-driven asset markets too• Credit acceleration drives economy and asset markets…
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Margin acceleration & SP500 Change
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Hubris before the crisis…• “The Marxian view is that capitalistic economies are
inherently unstable and that excessive accumulation of capital will lead to increasingly severe economic crises.
• Growth theory, which has proved to be empirically successful, says this is not true.
• The capitalistic economy is stable, and absent some change in technology or the rules of the economic game, the economy converges to a constant growth path with the standard of living doubling every 40 years.” (Prescott 1999, p. 4)
• “Macroeconomics was born as a distinct field in the 1940’s, as a part of the intellectual response to the Great Depression. The term then referred to the body of knowledge and expertise that we hoped would prevent the recurrence of that economic disaster.
• My thesis in this lecture is that macroeconomics in this original sense has succeeded: Its central problem of depression prevention has been solved, for all practical purposes, and has in fact been solved for many decades. (Lucas 2003 , p. 1 ; emphasis added)
Turning Nelson’s Eye to what really matters
• “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).
• Absent implausibly large differences in marginal spending propensities among the groups, it was suggested, pure redistributions should have no significant macro-economic effects…” (Bernanke 2000, p. 24)
• “Hyman Minsky (1977) and Charles Kindleberger (1978) have in several places argued for the inherent instability of the financial system
• but in doing so have had to depart from the assumption of rational economic behavior.. – 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)
• What Minsky actually did was develop a model in which Depressions can occur—because they had done so in the past…
Minsky & economic realism• “Can “It”—a Great Depression—happen again?• And if “It” can happen, why didn’t “It” occur in the years
since World War II?• These are questions that naturally follow from both the
historical record and the comparative success of the past thirty-five years.
• To answer these questions it is necessary to have an economic theory which makes great depressions one of the possible states in which our type of capitalist economy can find itself. (Minsky 1982, p. xii)
• Upshot: a historical-causal model in which private debt has macroeconomic significance– Contra Neoclassical mainstream which ignores banks,
debt & money
Financial Instability Hypothesis
• “The natural starting place for analyzing the relation between debt and income is to take an economy with a cyclical past that is now doing well.
• The inherited debt reflects the history of the economy, which includes a period in the not too distant past in which the economy did not do well.
• Acceptable liability structures are based upon some margin of safety so that expected cash flows, even in periods when the economy is not doing well, will cover contractual debt payments.
• As the period over which the economy does well lengthens, two things become evident in board rooms. Existing debts are easily validated and units that were heavily in debt prospered; it paid to lever.” (65)
Financial Instability Hypothesis
• “After the event it becomes apparent that the margins of safety built into debt structures were too great.
• As a result, over a period in which the economy does well, views about acceptable debt structure change. In the deal making that goes on between banks, investment bankers, and businessmen, the acceptable amount of debt to use in financing various types of activity and positions increases.
• This increase in the weight of debt financing raises the market price of capital assets and increases investment. As this continues the economy is transformed into a boom economy…” (65)
• This transforms a period of tranquil growth into a period of speculative excess:
Financial Instability Hypothesis
• “Stable growth is inconsistent with the manner in which investment is determined in an economy in which debt-financed 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.” (65)
• My model of this (circa 1992) added debt financed investment to Goodwin cyclical growth model. 3 system states:– Employment rate– Income distribution (Workers’ share of output)– Debt to GDP ratio…
My 1992 Minsky model• Apparent tranquility precedes breakdown• Cause is rising debt to
GDP
• “The chaotic dynamics explored in this paper should warn us against accepting a period of relative tranquility in a capitalist economy as anything other than a lull before the storm.” (Keen 1995, p. 634)
Why ignore banks, debt & money in macroeconomics?
• “the overall level of debt makes no difference to aggregate net worth—one person’s liability is another person’s asset.
• “It follows that the level of debt matters only if the distribution of net worth matters, if highly indebted players face different constraints from players with low debt.”
• So we can ignore this trend…
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• Versus predictions that a crisis would begin when the rate of growth of private debt declined…
• A realistic macroeconomics must be monetary and genuinely dynamic
• And transcend the myth of “Loanable Funds”…
Not foreseeing it: Ignorance about money & debt
• The conventional and false vision of banks: “Loanable Funds”
Assets Liabilities
• The unconventional and accurate vision: “Endogenous Money”
• Simply acknowledging that bank loans appear on asset side of bank ledger completely transforms vision of macroeconomics– Loanable Funds: Banks, debt & money irrelevant– Endogenous Money: Banks, debt & money crucial
Not foreseeing it: Ignorance about money & debt
• Loanable Funds: debt irrelevant
LoanableFunds.mky
• Endogenous money: debt crucial
EndogenousMoney.mky
Debt-driven Crises• Incorporating debt into economics—Minsky crises…
DebtDeflationPresentation.mky
• Beginnings of a monetary dynamic macroeconomics• Reformed education also needed for a realistic economics
…
A mendacious approach to education• Standard micro tuition—downward sloping market demand
(Mankiw)
• “Unfortunately . . . The aggregate demand function will in general possess no interesting properties . . . But…
• Suppose that all individual consumers’ indirect utility functions take the Gorman form … This demand function can in fact be generated by a representative consumer.” (Varian 1992, pp. 153-154)
• “The necessary and sufficient condition quoted above is intuitively reasonable. It says, in effect, that an extra unit of purchasing power should be spent in the same way no matter to whom it is given.”. (Gorman 1953 , p. 64)
Versus what advanced research has concluded
• Sonnenschein-Mantel-Debreu Theorem:– “Can an arbitrary continuous function … be an excess
demand function for some commodity in a general equilibrium economy?...
– we prove that every polynomial … is an excess demand function for a specified commodity in some n commodity economy…
– every continuous real-valued function is approximately an excess demand function.” (Sonnenschein 1972 , pp. 549-550)
• I.e., The “Law” of Demand does not survive aggregation even for micro, let alone macro
• A sensible reaction to this general theorem:– “If we are to progress further we may well be forced to
theories in terms of groups who have collectively coherent behavior. Thus demand and expenditure functions if they are to be set against reality must be defined at some reasonably high level of aggregation.
– The idea that we should start at the level of the isolated individual is one which we may well have to abandon.” (Kirman 1989 , p. 138)