Debt, Inequality and Crisis - PowerPoint Presentation

Slide1

Debt, Inequality and Crisis

Steve KeenKingston University LondonIDEAeconomicsMinsky Open Source System Dynamicswww.debtdeflation.com/blogsSlide2

When the economic history of our epoch is written…There will be at least 3 themes:Period of apparently increasing tranquillity (“Great Moderation”)Sudden transition crisis (“Great Recession”)

Rising inequalityThere should be (at least) a 4th:Rising private debtBecause all three go together and explain each otherMainstream (Neoclassical) macro omits both inequality & debtAccording to its indicatorsPeriod of stable growth a permanent improvement in economyPrivate debt

macroeconomically

irrelevant

Inequality simply a product of relative productivity

No longer maintained post-Piketty

But explanation limited to “r>g”

Statistical rather than causal explanation

“Great Moderation” a sign of policy success…Slide3

Mystery confluence: Great Moderation & Recession“the past two decades has seen not only significant improvements in economic growth and productivity but also a marked reduction in economic volatility… dubbed ‘the Great Moderation’.” (Bernanke 2004)

Unemployment

Deflation

Then “without warning”

Inflation &

Unemployment

FallingSlide4

Mystery confluence: Great Moderation & RecessionPost-crisis, see Moderation & Recession as 2 separate phenomena1st due to good economic policy, 2

nd to exogenous shock…“Standard macroeconomic models, such as the workhorse new-Keynesian model, did not predict the crisis, nor did they incorporate very easily the effects of financial instability.Do these failures of standard macroeconomic models mean that they are irrelevant or at least significantly flawed? I think the answer is a qualified no. Economic models are useful only in the context for which they are designed. Most of the time, including during recessions, serious financial instability is not an issue.The standard models were designed for these non-crisis periods, and they have proven quite useful in that context.Notably, they were part of the intellectual framework that helped deliver low inflation and macroeconomic stability in most industrial countries during the two decades that began in the mid-1980s

.”

Bernanke 2010 “

Implications of the Financial Crisis for Economics

”

What utter, self-serving, bollocks!Slide5

Behaviorism vs StructuralismNeoclassical DSGE models failed to anticipate crisisModels use “behavior of rational agents” as basis of modelingSince “Lucas Critique”, have asserted must capture “deep parameters” of individual behaviour for model to be valid

Post Keynesians have used “structure of economy” as basis“Behaviour under fundamental uncertainty” consideredBut behavioural concepts secondary to economic structureMy work combines this tradition with complex systems approachEssence of complex systems: “simple system, complex behavior”Sophisticated agent behaviour unnecessary to capture essential features of last 30 years of macroeconomics that Neoclassical models completely missed

Period of apparent diminishing cycles in employment & inflation

Rising private debt

Rising inequality as wages share falls, bankers’ share rises

Eventual crisisSlide6

Simple rules, complex

behaviour

My 1995 Minsky

model

can be stated as strict identities:

The

employment rate

will rise if

economic growth

exceeds the sum of

growth in

labor

productivity

and

population

growth

;

The

wages share of output

will rise if

wage demands

exceed the

growth in

labor

productivity

; and

The

private debt to GDP ratio

will rise if

private

debt

growth

exceeds

the

rate of economic

growthIn equations:Slide7

Simple rules, complex

behaviour

Equations are simply expansions of definitions

When put into simplest possible model

Generates

both “Great Moderation” & Great

Recession

Rising private debt

R

ising inequality

Simplest possible model:

Output Y

R

a linear function of capital K

R

Investment I

R

a linear function of profit rate

p

r

& depreciation

Employment a linear function of output

Wage change a linear function of employment rate

Change in debt equal to investment minus profitsNo government sector, no Ponzi

Finance, no bankruptcySlide8

Simple rules, complex

behaviour

Generates deceptively simple model:

3 variables

9 parameters (including

r

)

But complex behaviour…

Equilibria not the same as variables

Variables employment rate, debt ratio, wages share of output

Equilibria

employment rate, debt ratio,

profit

share of

output

Wages share a residual directly negatively related to debt service share (

r.d

)

Workers pay for rising debt via lower income share

Even without borrowing by workers in the model…Slide9

Simple rules, complex behaviour“Good” equilibrium is:

Two possible outcomes depending on parameter values

Equilibrium stable

Cyclical convergence to

positive employment rate, profit share, finite debt

ratio over time…

Lower growth means higher equilibrium debt level

And makes equilibrium more unstableSlide10

Simple rules, complex behaviourNot what we have experienced in the real worldSlide11

Simple rules, complex behaviourEquilibrium unstable: rising debt, rising inequality, moderation then breakdown:

Similar to what we have experienced in the real world…

Falling then rising cycles

Cyclically Rising Private Debt RatioSlide12

Simple rules, complex behaviourModel follows Pomeau-Manneville “inverse-tangent route to chaos”

First seen in transition from laminar to turbulent flow in fluidsModeled as Poincare Map in y-coordinate of Lorenz system where system bounces between a curve and a line:

Dynamics of system determined by whether line intersects

curve

For intersection

No

fluid

turbulence

Economic stability

For non-intersection

Turbulence

Instability

preceded by diminishing cyclesSlide13

Simple rules, complex behaviourDynamics of system determined by whether line intersects curveIf it does, stable equilibrium; cycles diminish to zero

If it doesn’t,

Unstable equilibrium

Cycles diminish at first and then increase

“Great Moderation” followed by “Great Recession”

N

ot 2 separate events but

two stages in the same process

…Slide14

Simple rules, complex behaviourWeakness of model: even-handed nature of crisis—booms & bustsReal world experience: apparent moderation then bust onlyGenerated by generalizing earlier identities to include inflation:

The employment rate will rise if real economic growth exceeds the sum of population growth and growth in labor productivity;The wages share of output will rise if money wage demands exceed the sum of inflation and growth in labor productivity; and

The private debt to GDP ratio will rise if the rate of growth of private debt exceeds the

sum of inflation plus the rate of economic growth

.

Additional equations needed for

Rate of inflation

Variable nominal interest rate

Simplest relationships used again:

Lagged convergence to equilibrium prices in monetary economyLagged inflation premium to base interest rate if inflation > 0Slide15

Simple rules, complex behaviourInflation formula derived from monetary flow logicDepends on wages share of output & firms’ markup

…

Inflation-adjusted nominal interest

rate

1

st

order time lag determines inflation

Inflation affects wages

share

Inflation affects debt growth

Lagged interest rate reaction

to inflationSlide16

Simple rules, complex behaviour4D model, so formal stability analysis much more challengingEmpirical appears to yield fundamental instability. Linear functions…Slide17

Simple rules, complex behaviourNonlinear functions:

Without recent financial crisis, model could be dismissed as “just a mathematical

curiousity

”

But real world actually followed pattern in this stylized, simple model

Apparent period of tranquillity “Great Moderation”

Then sudden crisis “Great Recession”…Slide18

Simple rules, complex behaviourIncome distribution dynamics of model:Profit share cycles around equilibrium level (before collapse)Declining workers share offsets rising bankers

shareFalling workers’ share signals approaching crisis (& causes deflation)

Average profit below equilibriu

m with nonlinear behaviour

Equilibriu

m profit rateSlide19

“no significant macro-economic effects”Simple non-equilibrium, nonlinear model with simple behavioural modelling captures what mainstream failed to anticipate

Why did mainstream economists ignore debt (& not see crisis coming)?Conventional macro: private debt is macroeconomically irrelevant:“The idea of debt-deflation goes back to Irving Fisher (1933).Fisher envisioned a dynamic process in which falling asset and commodity prices created pressure on nominal debtors, forcing them into distress sales of assets, which in turn led to further price declines and financial difficulties…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,

Essays on the Great Depression

, p. 24)Slide20

Bernanke’s view versus realityIn the data…

In my simulation of Minsky…

Crisis only inexplicable if you ignore “3

rd

dimension” of private debt

Private debt conspicuously absent from mainstream macro…Slide21

What is the mainstream missing?Role of banking sector in creating new money, demand and income“banking is where left and right meet.

Both Austrians … and Minskyites view banks as institutions that are somehow outside the rules that apply to the rest of the economy, as having unique powers for good and/or evil…I guess I don't see it that way.Banks don't create demand out of thin air any more than anyone does by choosing to spend more; and banks are just one channel linking lenders to borrowers…” (Krugman, “

Banking Mysticism

”)

Essence

of opposition is “Loanable Funds” model of

debt:

“Think of it this way:

when debt is rising, it’s not the economy as a whole borrowing more money

.It is, rather, a case of less patient people—people who for whatever reason want to spend sooner rather than later—borrowing from more patient people.” (Krugman 2012, End this Depression Now! , p 147)IF this model described reality, THEN debt would indeed not matter…Slide22

Analyzing this with system dynamic modellingMost Neoclassical models ignore banks, debt and moneyThose that do treat banks as “mere intermediaries” that arrange loans between savers and borrowersBanks themselves don’t lend in Neoclassical models

E.g., Eggertsson & Krugman 2012:Patient Consumer agent lends to impatient Investment agentInvestment agent pays interest to consumer agentBank charges “intermediation fee” for arranging loanBoth hire workersBuy output from each otherSell to workers & bankInvesting agent changes borrowing and repayment rates

Does debt matter? No…Slide23

The conventional “Loanable Funds” vision of lendingFull model: Bank arranges loan from Consumer sector (Patient) to investment (Impatient) sector & charges intermediation feeWorkers hired, output produced & sold, investment…

Bank Balance

Sheet

Assets

Liabilities

Equity

Flows\Stocks

Reserves

I

D

C

D

W

D

B

E

Initial Conditions

100

-20

-60

-15

-5

Lending

-Lend

Lend

Debt Repayment 

Repay-Repay 

 Interest Payments

 int-int

Bank Fee  

Fee

 -FeeHire Workers (C) 

 W

C-W

C

 Hire Workers (I) 

WI

-WI 

Purchases (I)

IC-I

C 

Purchases (C) 

-CI

C

I  

Workers Consumption

 -CW

CW

Bankers Consumption 

-C

B

C

B

Bankers Investment

-I

B

I

B

Debt doesn’t appear here: Asset of Consumer Sector…Slide24

The conventional “Loanable Funds” vision of lendingConsumer Sector “Godley Table”

Assets

Equity

Flows\Stocks

C

D

D

C

NW

Initial Conditions

60

10

-70

Lending

-Lend

Lend

Debt Repayment

Repay

-Repay

Interest Payments

int

-int

Bank Fee

-Fee

Fee

Hire Workers (C)-WC

 WC

Bankers ConsumptionCB

 -CBPurchases (I)

CI 

-C

IWorkers ConsumptionCW -C

WPurchases (C)

-IC

IC

Lending reduces Consumer Sector’s Asset of Cash at the Bank

Increases Consumer Sector’s Asset of Loan to Investment Sector

Consumer Sector’s does without Cash for duration of LoanSlide25

The conventional “Loanable Funds” vision of lending

Simulated, Krugman/Bernanke correct: debt doesn’t matter…

But a radical thought: what if—

just maybe

—banks lend money???Slide26

Varying lending & repayment in Endogenous MoneyChanging debt matters: change in money supply causes change in GDP

Logic behind this: aggregate demand

& income

include change in debtSlide27

Loanable Funds, aggregate demand & incomeConsider 3 sector model with sectors S1,

S2, S3Expenditure not debt-financed shown by CAPITAL LETTERSDebt financed expenditure shown by lowercase letters3 situations consideredBorrowing not possible

Borrowing from other sectors possible (“Loanable Funds”)

Borrowing from banks possible (“Endogenous Money”)

First case “Say’s Law” (actually “demand creates its own supply”)

Activity

Net Income

Sector

Sector

1

Sector 2

Sector 3

Expenditure

(Exp.)

Sector

1

-(A

+

B)

A

B

Sector

2

C

-(C+D)

D

Sector

3

E

F

-(E+F)

Negative sum of diagonal elements is aggregate demand

Sum of off-diagonal elements is aggregate incomeSlide28

Loanable Funds, aggregate demand & incomeClearly Expenditure  Income:

Loanable Funds: Sector 1 borrows

b

from Sector 2 to spend on Sector 3

Sector 1’s funds for spending increase by

b

Sector 2’s funds fall by

b

(split 50:50 between S1 & S3 for simplicity)

Activity

Net Income

Sector

Sector

1

Sector 2

Sector 3

Expenditure

(Exp.)

Sector

1

-(A

+

B+b

)

A

B+b

Sector

2

C-b/2

-(C+D-b)

D-b/2

Sector

3

EF

-(E+F)

Aggregate outcome clearly the same as without borrowing

But what if a bank lends to Sector 1?

Assets & liabilities of banking sector rise equally; and…Increased spending power for Sector 1 not offset by fall in Sector 2Slide29

Endogenous money, aggregate demand & incomeRise in Sector 1’s spending, and incomes of Sectors 2 & 3

Activity

Net Income

Sector

Sector

1

Sector 2

Sector 3

Expenditure

Sector

1

-(A

+

B+b

)

A

B+b

Sector

2

C

-(C+D)

D

Sector

3

E

F

-(E+F)

Aggregate outcome greater (if b>0) than without borrowing

Increase in debt causes equivalent increase in expenditure and income

Aggregate demand

and

income are

Demand¦Income

from turnover of existing money;Plus Demand¦Income from newly created moneyGeneralises to flow of new lending (

dD/dt: change in debt per year)Consider flow of expenditure from existing money stocks S1…S3 plus expenditure from flow of new debt-created money dD/dt…Slide30

Bank Accounts

New Debt

Turnover of existing

money

Gross finance

Endogenous money, aggregate demand & income

S

1

to S

3

now represent deposit account of relevant sector

Rate of spending per year by S

A

on S

B

shown as

v

AB

Bank equity account B

E

added

to record interest payments…

I.e.,

Both aggregate expenditure and aggregate income

are

Non-debt financed Expenditure (i.e. turnover of existing money)

Plus the change in debt (creation of new money & demand-income)

Plus gross financial transactionsSlide31

New Debt

Debt change & acceleration

Gross financial

Endogenous money, aggregate demand & income

Leads to dynamic, non-equilibrium, endogenous money Monetarism versus Friedman’s static, equilibrium, exogenous (“Helicopter Money”) Quantity Theory

So a monetary vision of capitalism is

essential

(with finance since most debt money created for asset purchases)

Private debt

a huge “omitted

variable error” in mainstream

economics

This is why they didn’t see the crisis coming

Not because unpredictable

B

ut because their models exclude the forces that caused the crisis:

Rate of change and acceleration of private

debt…

Static Friedman:

Dynamic monetary:

Change in GDP:Slide32

Level when

I began to warn of crisis (2006)

Level when

Godley began to warn of crisis (1998)

US Aggregate debt levels

Ignoring private debt has led us into biggest debt trap in history…Slide33

Global aggregate debt levelsTrend to excessive private debt common across the globeSlide34

Dramatic fall in credit growth post-crisisSlide35

Credit growth dictates economic growthSlide36

Whole world has “turned Japanese”Slide37

Debt dynamics dominate asset marketsAccording to Modigliani-Miller, these should be uncorrelated…

Correlation 0.96 (

unexpected

)Slide38

Debt dynamics dominate asset marketsAccording to Modigliani-Miller, these should be uncorrelated…

Correlation 0.69 (unexpected)Slide39

Debt dynamics dominate asset marketsAccording to Modigliani-Miller, these should be uncorrelated…

Correlation 0.53 (expected)Slide40

Debt dynamics dominate asset marketsAccording to Modigliani-Miller, these should be uncorrelated…

Correlation 0.77Slide41

Turning JapaneseJapan’s past 18 years gives us best case scenario projection for OECD…Slide42

China credit

growth now collapsing…

Dramatic fall in credit growth post-crisis

Decades of anaemic credit growth lie ahead…Slide43

The China CrisisChina has done in 6 years what took 17 in USA & Japan:Slide44

The China CrisisChina undergoing 2nd stock market crash, but first with high leverage

Margin debt 0.000014% of GDP

Margin debt >2% of GDPSlide45

The China CrisisAcceleration of margin debt key driver/indicator of market

Correlation 0.69 since 2014; 0.87 since 2015Slide46

Solution? Modern Debt JubileeOnly effective solution to debt-deflation is private debt reductionCould be done by “Quantitative Easing for the People”

CB direct injections into private bank accountsThose in debt must cancel debtThose not in debt get cash injectionRebase money system to more fiat, less credit-based moneyRestructure banking toReduce appeal of Ponzi lending (mortgages, margin loans)“PILL”: Property Income Limited LeverageMaximum loan factor (say 10 times) estimated income of property being bought

Meld venture capital with banking

“EEL”: Entrepreneurial Equity Loans

Banks get equity stake in loans to entrepreneurs

Alternative is continuous stagnation—as with Japan since 1990

Main barrier? Misplaced moral perception of debtSlide47

Solution? Modern Debt JubileeMoral responsibility of debtor product of interpersonal view of debtPerson to person loan—lender has to do without what he lends

Bank Balance

Sheet

Assets

Liabilities

Equity

Flows\Stocks

Reserves

I

D

C

D

W

D

B

E

Initial Conditions

100

-20

-60

-15

-5

Lending

-Lend

Lend

Debt Repayment 

Repay-Repay 

 Interest Payments

 int-

int  

But bank loans are creation of money & debt “out of nothing”

Bank Balance

Sheet

Assets

Liabilities

Equity

Flows\Stocks

Reserves

Loans

ID

C

DWDB

EInitial Conditions

100

-20

-60

-15

-5Lending 

Lend

-Lend

Debt Repayment

 -Repay

Repay

Interest Payments

int

-

int

Bank doesn’t lose pre-existing money if loan not repaid

Instead bank over-produced money & debt—should write them offSlide48

Solution? Modern Debt JubileeStop falsely thinking of banks as warehouses (“Loanable Fund” view)Start thinking of them as “money factories”Can over-produce money and debt

Write-off of excess production should be routineEspecially since recent production socially counterproductiveAsset bubbles caused by leverageMortgage acceleration drives house price changeMargin acceleration drives share price changeEffectively funding Ponzi Schemes…Slide49

ConclusionTheoretical: getting structure of economy (including finance) right more important than accurately modelling agent behaviourRevised realistic view of banking essential to understand where the crisis came from & work out how to escape it

Monetary complex systems macro needed in theory and policyPractical: current situation inevitably will give rise to political conflictModern politics dominated not by Eisenhower’s “military-industrial complex” but Minsky’s “politico-financial complex”Conventional “Ordo-Liberal” response to crisis (as in Greece) compounds basic weaknesses of capitalismModern Debt Jubilee needed to save capitalism from its own dynamics

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