Transcript Powerpoint Slides

EC7005: Financialisation
Steve Keen
Kingston University London
IDEAeconomics
Minsky Open Source System Dynamics
www.debtdeflation.com/blogs
Recap
• Last week:
– The brilliance (& the bad maths) of Graziani
– Coherence of Circuitist vision once stock-flow errors overcome
– Using double-entry bookkeeping to point out lunacy of “Money
Multiplier” model: violates Fundamental Law of Accounting
• This week
– Lunatic idea #2: Neoclassical “Loanable Funds” model of banking
– The role of credit in aggregate demand and income
Lunatic idea #2: Neoclassical “Loanable Funds” model
• Mainstream see banks as “intermediaries”, not “originators” of loans
– “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)
– “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, pp. 146-47)
Lunatic idea #2: Neoclassical “Loanable Funds” model
• The Bank of England knows better:
– “Whenever a bank makes a loan, it simultaneously creates a
matching deposit in the borrower’s bank account, thereby creating
new money.” (Bank of England 2014, p. 14)
• Mainstream can’t see why this matters:
– “OK, color me puzzled. I’ve seen a number of people touting this
Bank of England paper … as offering some kind of radical new way
of looking at the economy…while banks are indeed more
complicated … this doesn’t mean … that they are somehow outside
the usual rules of economics. Don’t let monetary realism slide into
monetary mysticism!” (Krugman 2014)
• Let’s see who’s being the mystic:
– Consider “Loanable Funds” & “Endogenous Money” from double
entry perspective…
Lunatic idea #2: Neoclassical “Loanable Funds” model
• Lending as a “pure redistribution”; bank as intermediary
Assets
Reserves
Lending
Paying interest
Repaying
Bank Fee for arranging loan
Nothing
on Asset
Side
Liabilities
Saver
Equity
Investor
From
To
To
From
Bank
Shuffling
$ on Liability Side
To
From
From
To
• Lending as money creation; bank as originator of loans
Assets
Reserves
Lending
AssetsLiabilities
&
LoansLiabilities
Saver
Investor
From
Rise To
Paying interest
Repaying
From
To
Assets & From
• Is there no essential difference, as Krugman
claims?...
Liabilities
Fall
Equity
Bank
To
Lunatic idea #2: Neoclassical “Loanable Funds” model
• Modelling this in Minsky:
– Two firm sectors: Consumption & Investment
– Consumption is the “Saver”; Investment the “Borrower”
– Set up basic operations in Godley Table for Bank…
• Notice Debt doesn’t appear at all: that’s because it’s an Asset of the
Consumer sector & Liability of the Investment Sector…
Lunatic idea #2: Neoclassical “Loanable Funds” model
• Create 3 more Godley Tables: Consumer Sector, Investment, Workers
Lunatic idea #2: Neoclassical “Loanable Funds” model
• Choose an existing liability as an asset for each table:
• Minsky
populates
column with all
existing
operations on
it:
Lunatic idea #2: Neoclassical “Loanable Funds” model
• Insert “D” for Debt as an asset of the consumer sector; and
• C_E for Equity of the consumer sector
• Enter matching double-entry operation for each row…
Lunatic idea #2: Neoclassical “Loanable Funds” model
• Final state of Consumer Sector’s Godley Table:
• Do the same for Investment Sector & Workers…
Lunatic idea #2: Neoclassical “Loanable Funds” model
• Final set of
Godley Tables:
Lunatic idea #2: Neoclassical “Loanable Funds” model
• Add definitions for flow variables
using stocks & time constants:
Money in C sector
account ($)
Flow of lending
($/Year)
Time constant of
lending (Years)
• Similar definitions for other flows
• Except interest payments (Debt times
interest rate)
• Bank Fee (Fraction of interest payments)
• Share of surplus going to capitalists
(fraction of annual turnover)
• Can define incomes/year as well…
Lunatic idea #2: Neoclassical “Loanable Funds” model
• Shrink the Godley Tables to make room for some graphs:
Sliders to change parameters during simulation
• Now let’s test the
model out…
Lunatic idea #2: Neoclassical “Loanable Funds” model
• Bernanke &
Krugman
are right!
Debt
doesn’t
matter…
• IF banks are just
“intermediaries”
• But what if
they—
shudder—lend
money?
• What if they
originate rather
than merely
intermediate?
Lunatic idea #2: Neoclassical “Loanable Funds” model
• The result is slightly
different…
• Lending creates
money
• And Demand
• And Income
Loanable Funds vs Endogenous Money
• Why is it so different?
– Loanable Funds:
• Banks intermediate between savers & investors
• No creation of money by lending
• No creation of additional demand either
– Endogenous money:
• Banks originate loans to investors (& speculators)
• Money created by lending
• Additional demand created
• Change in Debt thus adds to demand
– But how to reconcile this with “ExpenditureIncome”
identity?...
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
Expenditure
Sector Sector 1
Sector 1
-(A + B)
Sector 2
C
Sector 3
E
Net Income
Sector 2
Sector 3
A
B
-(C+D)
D
F
-(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:
ADSL   A  B    C  D    E  F 
AYSL  A  B  C  D  E  F
• 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
Activity
Expenditure
Sector Sector 1
Sector 1 -(A + B+b)
Sector 2
C
Sector 3
E
Net Income
Sector 2
Sector 3
A
B+b
-(C+D-b)
D-b
F
-(E+F)
• Aggregate outcome clearly the same as without borrowing
• Sound logical basis of Bernanke’s “Absent implausibly large differences
in marginal spending propensities among the groups, it was suggested,
pure redistributions should have no significant macroeconomic effects.”
Endogenous money, aggregate demand & income
• 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
• Causes a rise in Sector 1’s spending, and incomes of Sectors 2 & 3
Bank Assets
Loans
b
0
0
Activity
Expenditure
Net Income
Sector S1
S2
S3
S1
-(A+B+b)
A
B+b
S2
C
-(C+D)
D
S3
E
F
-(E+F)
ADEM   A  B  b    C  D    E  F 
AYEM  A  B  b  C  D  E  F
• Aggregate outcome greater (if b>0) than without borrowing
• Increase in debt causes equivalent increase in expenditure and income
Endogenous money, aggregate demand & income
• More precisely:
– Most loans are effectively “spent into existence”
– Loan is approved (e.g., mortgage) as an allowed ceiling
– No liability incurred until borrowed money transferred to seller
– Loan and expenditure appear simultaneously
– Expenditure of loan becomes income (or source of potential capital
gain) for the seller…
Endogenous money, aggregate demand & income
• Bank-eye-view of Loanable Funds:
Action
Create
Spend
Net
Assets Liabilities: Deposit Accounts
Saver Borrower Recipient
-Lend +Lend
-Lend
+Lend
0
-Lend 0
+Lend
Net Positions
Assets Liabilities
0
0
0
0
0
0
• Bank-eye-view of Endogenous Money:
Action
Create
Spend
Net
Assets
Loans
+Lend
+Lend
Liabilities: Deposit Accounts
Saver Borrower Recipient
+Lend
-Lend
+Lend
0
+Lend
Net Positions
Assets Liabilities
+Lend +Lend
0
0
+Lend +Lend
Endogenous money, aggregate demand & income
•
•
•
•
More formally, using “time constants” introduced earlier
Each sector Sx has bank deposit of Sx $
Each spends at the rate txy on the other sectors
First situation: no borrowing possible…
Assets
BL
S1 0
Liabilities
S1
S
S
 1  1
S2
S1
t 1,2
t1,2 t1,3
S2 0
S3 0
BE 0
S2

S2
t 3,2
0
0
S2
0
S£
t 1,3

S2
t 2,1 t 2,3
t 2,1
S3
t 3,1
S1
Equity
BE
0
t 2,3
S3

S3

0
S3
t 3,1 t 3,2
0
0
• Same situation as before—now expressed using time constants:
AE SL  AYSL 
S1

S1

S2

S2

S3

S3
t 1,2 t 1,3 t 2,1 t 2,3 t 3,1 t 3,2
• Now “Loanable Funds”: non-bank lender devotes splits flow of
expenditure into part expenditure, part lending…
Endogenous money, aggregate demand & income
• Banks intermediate loans…
Assets
BL
S1 0
Liabilities
S1

S2 0
S1
t 1,2
S2
t 2,1

S1 
d
D
dt  r  D
L
t 1,3
S2
S1
r D
t 1,2 L
BE 0
S3
S£
S1 
d
D
dt
t 1,3
Part of flow dS2 wouldd
S  D
S  D
S
dt
have spent
on S3 is dt

t
t
t
lentS to S1 instead S S
2
0
2
2
2,1
S3 0
Equity
BE
0
3
t 3,1
t 3,2
0
0
2,3
2,3

0
3

3
0
t 3,1 t 3,2
0
• Change in debt turns up as part of aggregate demand & income
– If “marginal propensities to spend” differ
S1 S1 S 2 S 2 S3 S3
dD  1
1 
AELF  AYLF 





 rL  D 




t 1,2 t 1,3 t 2,1 t 2,3 t 3,1 t 3,2
dt  t 1,3 t 2,3 
• Logical basis for Bernanke’s “Absent implausibly large differences in
marginal spending propensities among the groups, it was suggested,
pure redistributions should have no significant macro-economic
effects.”
Endogenous money, aggregate demand & income
• Banks originate loans…
Assets
BL
Liabilities
S1
S1 Money
By
S
S S1dspent
d
 1  1  D  rL  D
D
“borrowed”
t1,2 t1,3 ondtS2
dt
S2 0
S3 0
BE 0
S2
t 2,1
S3
t 3,1
BE
t B ,1
S2
S1
t 1,2

S2
S£

S2
t 2,1 t 2,3
Creating
d
 D for
income
t 1,3 dt
S2
S1
rL  D
S2
0
t 2,3
S3

BE
BE
t 3,2
t B ,2
Equity
BE
S3

S3
0
t 3,1 t 3,2
t B ,3

BE

BE

BE
t B,1 t B,2 t B,3
• Change in debt turns up 1:1 as part of aggregate demand & income
AEEM
 1
 1
 1
1 
1 
1 
 AYEM  S1  



  S 2  
  S3  

t
 1,2 t 1,3 
 t 2,1 t 2,3 
 t 3,1 t 3,2 
 1
1
1 
dD
 BE  


 rL  D 

t

t
t
dt
B
,1
B
,2
B
,3


Endogenous money, aggregate demand & income
• Reconciliation with ExpenditureIncome identity
– Expenditure is the sum of
• Expenditure financed by turnover of existing money
– Measured—however poorly—as GDP (Expenditure method)
– Dimensioned in $/Year
• Plus expenditure financed by new debt
– Measured—more accurately—as Change in Debt
– Dimensioned in $/Year
• Plus gross financial transactions (debt & deposit interest)
• Total expenditure is therefore AD  V  M  d D  rD  M  rL  D
dt
• Income side of identity needs amendment too:
– Vast majority of debt today finances asset purchases
– Modern monetary theory must integrate macroeconomics & finance
– Income side is therefore Income plus realized capital gains
GDPY 
d
d
 PA  QA  TA   V  M  D  rD  M  rL  D
dt
dt
Endogenous money, aggregate demand & income
• GDP & capital gains are both affected by change in debt
• GDP growth and realized capital gains affected by debt acceleration
d
d
d
 d

GDP

P

Q

T

V

M

D  rD  M  rL  D 
 A A A 
Y


dt 
dt
dt
 dt 

• Change in debt by far most the volatile element on expenditure side
– Logical basis for extraordinary empirical correlations between
• Change in debt & economic activity (employment rate, etc.)
• Acceleration in debt and change in economic activity
• Acceleration in debt and change in asset market prices
• Empirical findings contradict mainstream macro & finance theory
– Rather than changes in debt being “pure redistributions” with “no
significant macro-economic effects”, changes in debt are the main
determinants of macroeconomic outcomes
– Rather than leverage not affecting asset prices (Modigliani-Miller
theorem), leverage is the main determinant of asset prices…
The historical record from a credit perspective
• We are living during the biggest private debt bubble in history:
Percent of GDP
USA Debt to GDP data
250
Great Depression
WWIIEnd
240
Census
Debt
Data
230
220
Census Bank Loan Data
210
Federal Reserve Board Data (FRB)
200
190
Imputed 1916-50 FRB Data
180
170
Imputed 1834-1916 FRB Data
160
150
140
130
120
110
100
90
80
70
60
50
40
30
20
10
0
1820 1830 1840 1850 1860 1870 1880 1890 1900 1910 1920 1930 1940 1950 1960 1970 1980 1990 2000 2010 2020
Census & Federal Reserve data
The historical record from a credit perspective
• The very long view: every serious crisis caused by deleveraging
Level & Change of Private Debt
200
20
Percent of GDP
150
10
100
0
0
50
0
1850
1900
1950
www.debtdeflation.com/blogs
2000
 10
Percent of GDP per year
Level
Change
The historical record from a credit perspective
• The developed world is on the downside of “Peak Debt”
• Next economic crisis will come from developing world…
Global Debt to GDP
Debt in USD / GDP in USD for 38 countries
180
170
160
GFC
Global
Developed
Developing
150
140
130
120
110
100
90
80
1980
1985
1990
1995
2000
2005
2010
BIS Data (exc. Sweden & Luxembourg)
2015
2020