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Monetary Complex Systems Macroeconomics Steve Keen Monetary Complex Systems Macroeconomics Steve Keen Kingston University London IDEAeconomics Minsky Open Source System Dynamics www.debtdeflation.com/blogs The crisis in economic theory • 2008 economic crisis a crisis for theory as well as economy •Crisis completely unanticipated by mainstream DSGE models –Predicted “benign” medium term future, not crisis • Post‐crisis defence: –“Crises can’t be predicted” –“Nonlinear models are too complicated” – “Linear models OK if we can ‘stay away from dark corners’” •Response – Failure to anticipate crisis due to false priors in mainstream theory –“Simple complex models” give insights missing from mainstream –We are still in that dark corner but mainstream doesn’t know it! False prior (1) money doesn’t matter • Neoclassical Prior re money: should not cause real disturbances •Non‐monetary perspective built into mainstream thinking –Micro: “the money illusion” budget‐line/prices analysis – Embedded in micro‐founded macroeconomics from the outset: •“It is natural (to an economist) to view the cyclical correlation between real output and prices as arising from a volatile aggre‐gate dddemand schdlhedule that traces out a relilative ly stable, upward‐sloping supply curve.‘ •This point of departure leads to something of a paradox, since the absence of money illusion on the part of firms and consumers appears to imply a vertical aggre‐gate supply schedule, • which in turn implies that aggreg ate demand fluctuations of a purely nominal nature should lead to price fluctuations only…” (Lucas 1972 “Econometric Testing of the Natural Rate Hypothesis”; emphasis added) False prior (2) private debt doesn’t matter • Neoclassical Prior re debt: redistribution with limited macro impact • Bernanke dismisses Fisher’s debt‐deflation theory of Great Depressions: –“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 redistr ibuti on from one group (de btors ) 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) False prior (2) private debt doesn’t matter • Argument maintained today after obvious role of debt in financial crisis • Essence of opposition is “Loanable Funds” model of what debt means: – “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 peopl”le.” (Kru gman 2012, EdEnd this DiDepression N!Now! , p 147) •Spending power fall for one offset by increase for the other –“Maybe part of the problem is that Koo envisages an economy in which everyone is balance‐sheet constrained, as opposed to one in which lots of people are balance‐sheet constrained. –I’d say that his vision makes no sense: –where there are debtors, there must also be creditors, so there have to be at least some pppeople who can respond to lower real interest rates even in a balance‐sheet recession.” (Krugman 2013 “Abenomics and Interest Rates: A Finger Exercise (Wonkish)” Analyzing priors with system dynamic modelling • Analysing these false priors in Minsky: – Following Eggertsson & Krugman 2012: •Patient Consumer agent lends to impatient Investment agent – Investment agent pays interest to consumer agent –Bank charges “intermediation fee” for arranging loan •Both hire workers •Buy output from each other •Sell to workers & bank • Investing agent changes borrowing and repypayment rates •Does debt matter? No… The conventional “Loanable Funds” vision of lending • Full model: Bank arranges loan from Consumer sector (Patient) to investment (Impatient) sector & charges intermediation fee •Workers hired, output produced & sold, investment… Bank Balance Sheet Assets Liabilities Equity Flows\Stocks Reserves ID CD WD BE Initial Conditions 100 ‐20 ‐60 ‐15 ‐5 Lending ‐Lend Lend Debt Repayment Repay ‐Repay Interest Payments int ‐int Bank Fee Fee ‐Fee Hire Workers (C) WC ‐WC Hire Workers (I) WI ‐WI Purchases (I) IC ‐IC Purchases (C) ‐CI CI Workers Consumption ‐CW CW Bankers Consumption ‐CB CB Bankers Investment ‐IB IB •Debt doesn’t appear here: Asset of Consumer Sector… The conventional “Loanable Funds” vision of lending • Consumer Sector “Godley Table” Assets Equity Flows\Stocks CD DCNW IiilInitial CdiiConditions 6010 ‐70 Lending ‐Lend Lend Debt Repayment Repay ‐Repay Interest Payments int ‐int Bank Fee ‐Fee Fee Hire Workers (C) ‐WC WC Bankers Consumption CB ‐CB Purchases (I) CI ‐CI Workers Consumption CW ‐CW Purchases (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 Loan The conventional “Loanable Funds” vision of lending • Simulated, Krugman/Bernanke correct: debt doesn’t matter… LoanableFunds.mky •Why does debt not matter in this model?... Loanable Funds, aggregate demand & income • Consider 3 sector model with sectors S1, S2, S3 • Expenditure not debt‐financed shown by CAPITAL LETTERS •Debt financed expenditure shown by lowercase letters • 3 situations considered – Borrowing 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 1Sector 2Sector 3 Sector 1 ‐(A + B) A B Expenditure Sector 2C ‐(C+D) D (Exp.) Sector 3 EF‐(()E+F) •Negative sum of diagonal elements is aggregate demand •Sum of off‐diagonal elements is aggregate income Loanable Funds, aggregate demand & income • Clearly Expenditure Income: ADABCDEFSL AYSL A B C D E F •Loanable Funds: Sector 1 borrows a+b from Sector 2 –Sector 1’s funds for spending increase by a+b – StSector 2’s fdfunds fllfall by a+b Activity Net Income Sector Sector 1Sector 2Sector 3 Sector 1 ‐(A + B+a+b) A+a B+b Expenditure Sector 2C‐a ‐(C+D)‐(a+b) D‐b ((p)Exp.) StSector 3 E F ‐(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 2 Endogenous money, aggregate demand & income • Rise in Sector 11s’s spending, and incomes of Sectors 2 & 3 Activity Net Income Sector Sector 1Sector 2Sector 3 Sector 1 ‐(A + B+a+b) A+a B+b Expenditure Sector 2C ‐(C+D) D ((p)Exp.) Sector 3 E F ‐(E+F) ADABabCDEFEM AYAaBbCDEFEM • Aggregate outcome greater (if a+b>0) than without borrowing • Increase in debt causes equivalent increase in expenditure and income The “Endogenous money” vision of money • Modify Loanable Funds model to show bank lending •Model currently shows Loans as asset of “patient” Consumer Agent… • Let’s make it an Asset of the Bank instead… Varying lending & repayment in Endogenous Money • Changing debt matters: change in money supply causes change in GDP EndogenousMoney.mky Equations • Loanable Funds model • Endogenous money model dReserves dReserves 0 0 dt dt dD dD Lend Repay Lend Repay dt dt dC dCD D Repay intCC C Lend Fee W I CCCBIW WI CC dt I WB CC dt dI D dID LendI IWC Reppyay int LendICBIWC Reppyay int I I dt CB I I dt dW dW D WWC D WWC dt CIW dt CIW dBE dBE Fee CI int CIBB dt BB dt dCNW dCNW intCCC Fee WI CCCBIW WI CC dt BIW CC dt dI dI NW IIint WC NW IIint WC dt BC I I dt BC I I dW dW NW WWC NW WWC dt CIW dt CIW • Differences • Tiny changes in model but major changes in –These terms disappear from CD macroeconomic dynamics –This term moves to BE Endogenous money, aggregate demand & income • Result generalizes to a flow of new lending dD/dt: "Activity\Sector" S S S B 1 Bank Accounts2 3 E S S S S 1 1 d 1 d 1 d "Expenditure" D rLD D ()1 D rLD 12 13 dt 12 dt 13 dt S2 S2 S2 S2 "Expenditure" 0 21 21 23 23 S3 S3 S3 S3 "Expenditure" 0 31 32 31 32 BE BE BE BE BE BE "Expenditure" rDS1 rDS2 rDS3 rDS1 rDS2 rDS3 B1 B2 B3 B1 B2 B3 11 11 11 1 1 1 ADSSS B EM Turnover123 of existing money E 1,21,3 2,12,3 3,13,2BB ,1,2,3 B d rSSS rD D GrossDL123 financeNewdt Debt 11 11 11 1 11 AYSSS B EM 123E 1,21,3 2,12,3 3,13,2 BB,1 ,2 B ,3 d rSSS rD D DL123 dt Endogenous money, aggregate demand & income • 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 transactions •Dynamic non‐equilibrium endogenous version of Quantity Theory: d ADEM AYFriedman EM V MNew Debt D r D M r L D dt dd dddDebt change2 & ADAYMVVDD... dddt EMdt EM ddddt daccelerationt dt 2 •So a monetary vision of capitalism is essential • Private debt biggest “omitted variable error” in mainstream economics –This is why they didn’t see the crisis coming –Not because unpredictable – But because thei r modldels excldlude the varibliables that caused the criiisis: –Rate of change and acceleration of private debt Endogenous money, aggregate demand & income • Mainstream (Neoclassical)
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