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The Fiscal Cliff—Lessons from the 1930s

Steve Keen. www.debtdeflation.com/blogs. www.debunkingeconomics.com. Key insights. Understanding banks, debt & money key to understanding crisis. Economists didn’t see the . crisis coming because they ignore banks:.

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The Fiscal Cliff—Lessons from the 1930s

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The Fiscal Cliff—Lessons from the 1930s

Steve Keen



Key insightsUnderstanding banks, debt & money key to understanding crisisEconomists didn’t see the crisis coming because they ignore banks:“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

?” (Paul


, “


& Methodology


Banks crucial because lending increases cash flow in the economy

Effective demand is income plus the change in debt

Analysis of dynamics of debt

Explains the crisis

Gives guidance to what the future may hold…Slide3

Key data: Debt to GDP ratios since 1920Why now is comparable to The Great DepressionSlide4

The economic crisisA fall in GDP, but nothing like the Great Depression…Slide5

GDP and the levels of private & public debtPrivate debt far bigger than both GDP and public debt…Slide6

GDP and the change in private & public debtCrisis began when growth of private debt stopped…

2 years of heavy private

sector deleveragingSlide7

Effective demand as GDP plus change in debtNow the scale of the crisis is obvious…Slide8

Change in debt and unemploymentRising private debt causes falling unemployment;Rising unemployment causes rising public debtSlide9

Debt and asset pricesAccelerating debt causes rising asset pricesSlide10

The 1930s collapse in GDPMuch sharper falls in nominal and real GDP…Slide11

GDP and debt levelsMuch smaller debt bubble in the 1930s than today…Slide12

GDP and change in debtMuch longer period of private sector deleveragingMuch slower and smaller government deficit response

4 years of heavy private

sector deleveraging

2 more yearsSlide13

Effective demand: much longer plunge below incomeExtended deleveraging compared to todayRelatively minor government stimulus responseSlide14

The Fiscal Cliff of 1937Dip back into Depression as private sector deleveraging recommencedSlide15

Recovery in WWIIHuge increase in government stimulus drives GDP upPrivate sector delevers during WWII with minor impact on GDPSlide16

Private sector deleveraging during WWIIFall in private sector debt far greater during WWII than during Great Depression, but little impact on GDPStimulus, not austerity, ended Great DepressionSlide17

Private sector finishes deleveraging during WWIIPrivate debt 45% of GDP in 1945—down from 175% in 1930Slide18

Takeaway PointsPrivate debt and government debt are independentBut they affect each otherBoth boost demand in the economy when they



reduce it when they fall.

Private debt is more important than public

debt because


is so much larger, and


drives the economy whereas government debt reacts to it

The crisis was caused by the growth of private debt collapsing

Government debt rose because the economy



it reduced the severity of the crisis

A premature attempt to reduce government debt through “The Fiscal Cliff” could trigger a renewed bout of deleveraging by the private sector, which could push the economy back into a recession.

Main challenge of public policy is not reducing government debt

But managing the impact of the “Rock of Damocles” of private debt that hangs over the economy.