The International Financial Architecture

Keen on Bancor 2013

https://love-and-theft-2014.blogspot.com/2020/10/the-international-financial-architecture.html @

How did we get into this mess?

. An Irish joke:

* A traveller in Ireland asks a local in Dublin“How do l get to Belfast?

. The local replies:

. “Begorrah, ifthat's whereyou want to go,I wouldn't start from here!"

* Current and future financial architectureis path-dependent

We wouldn't have what we have today

& will have tomorrow

if we hadn't started from

* The wrong plan at Bretton Woods

Two plans offered: White(USA)&Keynes (UK)

- Where differed, White's was adopted With some subterfuge:

●“While Keynes still believed that Unitas representeda truly

supra-national reserve currency, White had already secretly

replaced the term Unitas with the term dollar in those versions

of his documents that were submitted to the US Trez :1>

still using the Unitas-versions in the negotiations with

British." (Jaeger2013)

どうしてこんなことになってしまったのか？

. アイルランドのジョーク。

* アイルランドの旅行者がダブリンの地元の人に「ベルファストにはどうやって行くの？

. 地元の人が答える。

. "Begorrah, もしあなたが行きたいのなら、私はここから始めないわよ！"

* 現在および将来の金融アーキテクチャはパスに依存しています。

今日のようなことにはならない

明日がある

から始めなければ

* ブレトンウッズでの間違った計画

2つのプランをご用意しました。 ホワイト(アメリカ)&ケインズ(イギリス)

- 異なっていたところに、ホワイトのものを少し口実をつけて採用した。

ケインズはまだユニタスが本当に

超国家的基軸通貨、ホワイトはすでに密かに

これらのバージョンでは、ユニタスという用語をドルという用語に置き換えています。

アメリカのトレズに提出された彼の文書の :1>。

との交渉で、まだユニタス版を使用している。

イギリス人" (Jaeger2013)

www.DeepL.com/Translator（無料版）で翻訳しました。

begorrah 【間投】〈アイルランド〉全く◇by Godの婉曲語 -

https://youtu.be/FoLyd_Hq32Q
SteveKeen 2013

276

会議が進行するにつれて、ケインズは一層悲観的になってきた。かくして彼は、R.F·カーンとサー。エドワード。ブリッ

ジズに手紙を書いた。

R.F.カーン宛の手紙から ー九四六年三月一三日

   当地の気候は大層心地よいもので、仕事はこれまでのところ激しいものではありません。他方、われわれは多くの

障害に直面しようとしているように思います。アメリカ側はこれら機関を実際役に立つ国際機関とするについての考

えをもっておらず、ほとんどあらゆる面で考え方がよくありません。それにもかかわらず、われわれ他のものを無視

して、自らの構想をむりやり押し通そうとしていることは明らかです。その結果、これら機関は莫大なアメリカのス

タッフにより運営され、われわれ他のものを圏外に置くアメリカ商会になろうとしているように思われます。これら

機関はいざ開業という段になると、物事が期待どおりにはうまくゆかないだろうと確信します。おそらくその段階に

なって初めて、批判の的中していることがわかってくるでしょう。目下のところ、私はかなり悲観的であるとしか申

しあげられません。アメリカ側は、トップの段階で国際協力についての考えをまったく欠いているように思います。

彼らは最大の共同出資者でありますので、実際上あらゆる点につきトーンを決める権限をもっていると考えていま

す。もし彼らが音楽を解しているならば、それはあまり問題にはならないのでしょうが、不幸にして彼らにはそれが

わかっていないのです。

 

https://www.debtdeflation.com/blogs/2014/02/02/modeling-financial-instability/

http://www.debtdeflation.com/blogs/wp-content/uploads/2014/02/Keen2014ModelingFinancialInstability.pdf

Modeling Financial Instability

By  Steve Keen February 2, 2014 Debtwatch

This paper will be pub lished in a forth com ing book on the cri sis edit ed by Malliaris, Shaw and She frin. In what fol lows, I derive a cor rect ed for mu la for the role of the change in debt in aggre gate demand, which is that ex-post aggre gate demand equals ex-ante income plus the cir cu la tion of new debt, where the lat ter term is the veloc i ty of mon ey times the ex-post cre ation of new debt.

The PDF is avail able here: Keen2014ModelingFinancialInstability. The Min sky mod els used in this paper are here in a ZIP file. The lat est ver sion of Min sky can be down loaded from here.

• Introduction

Lit er al ly no-one dis putes that the finan cial sec tor was the cause of the post-2007 eco nom ic cri sis: dis pu ta tion instead cen ters on the causal mech a nisms. I fol low Fish er (Fish er 1933) and Min sky (Min sky 1980) in assign ing key roles to the growth and con trac tion of aggre gate pri vate debt (Keen 1995; Keen 2000), but this per spec tive is reject ed by New Key ne sian econ o mists on the a pri ori basis that pri vate debts are "pure redis tri b u tions" that "should have no sig nif i cant macro-eco nom ic effects" (Bernanke 2000p. 24), and as a corol lary to the oft-repeat ed tru ism that "one per son 's debt is anoth er per son 's asset" (Krug man 2012c, p. 43).

My analy sis also fol lows the Post Key ne sian tra di tion of endoge nous mon ey (Moore 1979; Moore 1983) in see ing the bank ing sec tor as an essen tial com po nent of the macro econ o my, yet this is also dis missed by New Key ne sian econ o mists on the grounds that banks are mere ly a spe cial ized form of finan cial inter me di ary (Krug man 2012a; Krug man 2012b; Krug man 2013a; Sum n er 2013; Tobin 1963), all of which can be safe ly ignored in macro eco nom ic mod els. When banks are intro duced in New Key ne sian mod els, they func tion not as loan orig i na tors but effec tive ly as bro kers between savers and bor row ers (Eggerts son and Krug man 2012b, pp. 21–22).

In response, authors in the Post Key ne sian and Endoge nous Mon ey tra di tions express exas per a tion that New Key ne sian authors ignore cred it cre ation and the account ing mechan ics of bank lend ing (Full wiler 2012; Roche 2013), as laid out in numer ous Cen tral Bank pub li ca tions (Car pen ter and Demi ralp 2010; ECB 2012; Holmes 1969; Keis ter and McAn drews 2009).

Giv en the key pub lic pol i cy role of eco nom ics, and the acknowl edged fail ure of Neo clas si cal mod els in gen er al to antic i pate the finan cial cri sis (Beze mer 2009; Blan chard 2009; Blan chard, et al. 2010; OECD 2007), the exis tence with in aca d e m ic eco nom ics of two dia met ri cal ly opposed per spec tives which fail to com mu ni cate is a dis ser vice to the pub lic.

In this paper I attempt to con clu sive ly deter mine whether aggre gate pri vate debt and banks mat ter in macro eco nom ics by putting the two rival mod els of lending—Loanable Funds and Endoge nous Money—on a com mon foot ing. Using the dynam ic Open Source mon e tary mod el ing pro gram Min sky, I first ly put the New Key ne sian mod el of bank ing in Eggerts son & Krug man 2012b into a strict ly mon e tary mod el and I show that, if the struc ture of lend ing in this mod el accu rate ly char ac ter izes actu al lend ing, then the Neo clas si cal per spec tive that aggre gate debt is unim por tant, and that banks can safe ly be ignored in macro eco nom ics, is cor rect. I then mod i fy this mod el to match the Post Key ne sian per spec tive on the struc ture of lend ing, and show that in this struc ture, changes in the aggre gate lev el of pri vate debt have a direct impact upon aggre gate demand, and banks there fore play a cru cial role in macro eco nom ics.

1. Loanable Funds vs Endogenous Money

The Neo clas si cal mod el of "Loan able Funds" and the Post Key ne sian con cept of "Endoge nous Mon ey" con sti tute the polar oppo sites on the nature and sig nif i cance of banks, debt and mon ey in macro eco nom ics. Both mod els por tray the mon ey sup ply as vari able, and hence in one sense endoge nous, though by very dif fer ent mech a nisms and to very dif fer ent degrees (Pal ley 2013, p. 411). In the Loan able Funds tra di tion, banks func tion as "mere inter me di aries" (Graziani 1989, p. 8) between savers and bor row ers, pri vate debts are "pure redis tri b u tions" that "should have no sig nif i cant macro-eco nom ic effects" (Bernanke 2000, p. 24), and banks, debt and mon ey can be and are ignored in canon i cal macro eco nom ic mod els (Smets and Wouters 2007; Wood ford 2009). In the Endoge nous Mon ey tra di tion, banks are cru cial to macro eco nom ics because they cre ate mon ey by cre at ing debt (Holmes 1969; Moore 1979), but no con sen sus has yet emerged on how to rep re sent this phe nom e non in Post Key ne sian macro eco nom ic mod els (Pal ley 1991; Pal ley 2002).

There is lit tle com mu ni ca tion between the two approach es, with authors in the Loan able Funds tra di tion fre quent ly derid ing those in the Endoge nous Mon ey camp (Krug man 2012a; Krug man 2012b; Krug man 2012e; Krug man 2012f), and dis miss ing the propo si tion that banks must be includ ed in macro eco nom ics (Krug man 2012a; Krug man 2012b; Krug man 2012d; but see Rowe 2013; Sum n er 2013).

This dis pute can be resolved by an appeal to the Occam's Razor prin ci ple that unless a more com plex mod el makes dif fer ent and bet ter pre dic tions than a less com plex one, the sim pler should be pre ferred. There fore, unless bank lend ing nec es sar i ly affects vital macro economic aggregates in a signif i cant man ner, then even though the "loans cre ate deposits" account ing per spec tive of Endoge nous Mon ey is tech ni cal ly cor rect (Car ney 2012; ECB 2012; Holmes 1969)—as even Paul Krug man has conceded (Krugman 2013a)— the Loanable Funds approach is justi fied, and banks should be exclud ed from macro eco nom ics. Con verse ly, if bank lend ing nec es sar i ly affects macro eco nom ic aggre gates, then banks, debt and the endo gene ity of the mon ey sup ply are inte gral to macro eco nom ics, and mod els that exclude them are not mod els of a cap i tal ist econ o my.

1. A monetary model of Loanable Funds

Eggerts son and Krug man note that the vast major i ty of main stream eco nom ic mod els ignore debt:

If there is a sin gle word that appears most fre quent ly in dis cus sions of the eco nom ic prob lems now afflict ing both the Unit ed States and Europe, that word is sure ly debt… one might have expect ed debt to be at the heart of most main stream macro eco nom ic models—especially the analy sis of mon e tary and fis cal pol i cy. Per haps some what sur pris ing ly, how ev er, it is quite com mon to abstract alto geth er from this fea ture of the econ o my. Even econ o mists try ing to ana lyze the prob lems of mon e tary and fis cal pol i cy at the zero low er bound—and yes, that includes the present authors (see Krug man 1998, Eggerts son and Wood ford 2003)—have often adopt ed rep re sen ta tive agent mod els in which every one is alike and the shock that push es the econ o my into a sit u a tion in which even a zero inter est rate is not low enough takes the form of a shift in every one's pref er ences. (Eggerts son and Krug man 2012a, pp. 1469–71)

In order to intro duce debt into a New Key ne sian two-peri od mod el, Eggerts son and Krug man divid ed agents into two groups who "dif fer only in their rates of time pref er ence": "patient agents" and "impa tient agents" where the lat ter have a high er rate of time pref er ence than the for mer, so that "In that case, "impa tient" indi vid u als will bor row from "patient" indi vid u als." (Eggerts son and Krug man 2012ap. 1474). Debt was explic it ly mod eled through out this paper, and bank ing was intro duced in the Appen dix (Eggerts son and Krug man 2012b) as an inter me di at ing func tion between depos i tors and bor row ers, where bor row ing by impa tient agents was strict ly for invest ment.

The authors describe their mod el as a "just the stan dard New Key ne sian mod el", with one twist, in that the nat ur al rate of inter est, which is nor mal ly an exoge nous para me ter in the IS equa tion, is instead endoge nous with bor row ers' debt being one of its para me ters. There fore the lev el of pri vate debt plays a macro eco nom ic role:

we need to fig ure out the evo lu tion of debt of the "bor row ers" to fig ure out the nat ur al rate of inter est. In par tic u lar we see that if … the econ o my is "over lever aged" … it is easy to get endoge nous ly neg a tive nat ur al rate of inter est. (Eggerts son and Krug man 2012b, p. 24)

The New Key ne sian and "Liq uid i ty Trap" aspects of this mod el (on which see Solow 2003; Solow 2008) are tan gen tial to the top ic of this paper, which is a strict ly struc tur al one: does bank lending—as opposed to lend ing by non-bank agents to each other—significantly alter the macro dy nam ics of the econ o my? To con sid er this ques tion, I ren der the Loan able Funds aspects of Eggerts son and Krug man 2012b in a strict ly mon e tary form in a Min sky mod el.

Min sky is a sys tem dynam ics pro gram which gen er ates dynam ic mod els of finan cial flows from dou ble-entry book keep ing tables (called "God ley Tables" in the pro gram), in which the columns rep re sent bank accounts and the rows are trans ac tions between accounts. The sam ple mod el shown in Fig ure 1 gen er ates the dynam ic equa tions shown in Equa tion (more details on Min sky are giv en in the Appen dix).

Fig ure 1: Sam ple God ley Table and bank ing icon in Min sky

The Loan able Funds fea tures of Eggerts son and Krug man (2012b) are:

• that deposits by the "patient agents" enable loans to "impa tient agents"; and
• that banks inter me di ate between saver and bor row er and prof it by an inter me di a tion fee, but oth er wise play no role in lend ing.

The Min sky mod el shown in Fig ure 2 repli cates these fea tures using the bank accounts of four sep a rate enti ties: the con sump tion goods sec tor (with deposit account Dep_Cons) which is the lender in (Eggerts son and Krug man 2012b); the invest ment goods sec tor (with account Dep_Inv) which is the bor row er; Work ers (with account Work ers) who are employed by both the Con sump tion Sec tor and the Invest ment Sec tor; and
the Bank ing sec tor (with the Asset account Reserves and equi ty account Bankers_NW) which inter me di ates the loans from
the Con sump tion Sec tor to the Invest ment Sec tor, and charges a fee for doing so. Each sec tor main tains a finan cial table show ing the flows into and out of its accounts, and cal cu lates its net worth as a result as the dif fer ence between the val ue of its assets and lia bil i ties (account Bankers_NW for the bank ing sec tor).

Fig ure 2: Loan able Funds model—a 4 account view of Loan able Funds gen er at ed in Min sky

Table 1 shows this finan cial sys tem from the bank ing sec tor's per spec tive, and Table 2 shows it from the per spec tive of the lender, the Con sump tion Sec tor. Fol low ing the con ven tions in Min sky, assets are shown as pos i tive amounts, and lia bil i ties and equi ty are shown as neg a tives, while the source of any finan cial trans ac tion is shown as a pos i tive and its des ti na tion as a neg a tive. All entries in the table rep re sent flows, and Min sky auto mat i cal ly gen er ates the result ing sys tem of dif fer en tial equa tions in LaTeX. The ten flows that define the mod el are all shown in the bank ing sec tor's table, and are respec tive ly:

1. The Con sump tion Sec tor lends to the Invest ment Sec tor via the flow "Lend" from the account Dep_Cons to the account Dep_Inv;
2. The Invest ment sec tor makes Inter est pay ments "Int" to the con sump tion sec tor;
3. The Bank ing Sec tor charges the Con sump tion Sec tor an inter me di a tion fee "Int_Fee";
4. The invest ment Sec tor makes debt repay ments to the Con sump tion Sec tor ("Repay");
5. The Con sump tion Sec tor hires Work ers via the flow "Wages_C";
6. The invest ment Sec tor hires Work ers via the flow "Wages_I";
7. The Invest ment Sec tor pur chas es con sump tion goods ("Cons_I");
8. The Con sump tion Sec tor pur chas es invest ment goods ("Cons_C");
9. Work ers pur chase con sumer goods ("Cons_W"); and
10. Bankers pur chase con sumer goods ("Cons_B");

Table 1: Loan able Funds mod el from the Bank ing Sec tor's per spec tive

Lend ing from the con sump tion to the invest ment sec tor is record ed in the account Loans, which is an asset of the con sump tion sec tor as shown in its finan cial account (see Table 2; it also appears as a lia bil i ty of the Invest ment Sec tor in its table of accounts; Table 2 also dis plays the dynam ics of the Con sump tion Sec tor's net worth in the col umn "Cons_NW").

Table 2: Loan able Funds mod el from the Con sump tion Sec tor's per spec tive

Since (for the sake of sim plic i ty) hold ings of cash are ignored in this mod el, mon ey is the sum of the amounts in the four deposit accounts Dep_Cons, Dep_Inv, Work ers, and Bankers_NW shown in Table 1, while debt is the amount in the account Loans shown in Table 2. Equa tion shows the equa tions for the dynam ics of mon ey and debt in the mod el, with the first 4 equa tions derived from Table 1 show ing the dynam ics of mon ey in the sys tem while the final equa tion, derived from Table 2, shows the dynam ics of debt.

Defin ing mon ey M as the sum of the first four accounts, it is obvi ous that the change in the amount of mon ey is zero:

There fore the amount of money—which for con ve nience we can treat this as hav ing been cre at ed by gov ern ment fiat, with out need ing to spec i fy a gov ern ment sec tor in the model—remains con stant:

With out hav ing to define a full eco nom ic mod el, we can now spec i fy aggre gate demand AD as being equiv a lent to the turnover of the mon ey in the econ o my, using the veloc i ty of mon ey v (see Fig ure 3 and Equa tion ).

Fig ure 3: Veloc i ty of M2 mon ey stock in the USA 1960–2013

As is well known, con trary to Mil ton Fried man's claims (Fried man 1948; Fried man 1959; Fried man 1969; Fried man and Schwartz 1963), the veloc i ty of mon ey is not a constant—"it is also appar ent that mon ey veloc i ties are pro cycli cal and quite volatile" (Kyd land and Prescott 1990, p. 14). How ev er the iden ti ty that can be used in this sim ple mod el to map from the mon ey stock to the lev el of aggre gate demand.

Using the sub script LM to indi cate that this is aggre gate demand in a Loan able Funds mod el, we have that aggre gate demand at time t is the veloc i ty of mon ey times the stock of mon ey at that time:

Aggre gate demand across any defined time peri od t₂-t₁ will there fore be this instan ta neous flow times the time peri od itself:

Final ly, using D for brevi ty in place of Loans in Equa tion , it is obvi ous that there is no link between the dynam ics of debt and either the stock or the turnover of mon ey, and there fore there is no direct rela tion between pri vate debt and aggre gate demand. The amount of mon ey in cir cu la tion remains con stant:

Giv en the absence of a rela tion ship between lend ing and the mon ey sup ply, the amount of debt in exis tence can rise or fall sub stan tial ly with only a minor impact on macro eco nom ic activ i ty via relat ed changes in the veloc i ty of mon ey:

1. A monetary model of Endogenous Money

This struc tur al mod el of Loan able Funds shown in Fig ure 2 is con vert ed into a mod el of Endoge nous Mon ey by three sim ple changes:

• Loans are shift ed from the assets of the con sump tion sec tor to the assets of the bank ing sec tor;

• Inter est pay ments are trans ferred to the equi ty account of the bank ing sec tor, Bankers_NW; and
• Since banks are loan orig i na tors in this mod el and receive inter est pay ments, the inter me di a tion fee is delet ed.

This revised mod el is shown in Fig ure 4 and Table 3. The changes between the Loan able Funds mod el in Table 1 and the Endoge nous Mon ey mod el of Table 3 all occur in the first four rows, with the row for an inter me di a tion fee delet ed, and loca tions of the flows Lend, Int and Repay altered as indi cat ed by the arrows. The two tables are oth er wise iden ti cal.

Fig ure 4: Endoge nous Mon ey mod el in Min sky

Table 3: Endoge nous Mon ey mod el from the bank ing sec tor's per spec tive 

The mon ey and debt equa tions of this mod el are:

Despite the sim plic i ty of the changes need ed to move from Loan able Funds to Endoge nous Mon ey, the dynam ics of mon ey are now pro found ly dif fer ent. The rate of change of mon ey is pre cise ly equal to the rate of change of debt:

The stock of mon ey in the econ o my is there fore the sum of the ini tial lev el of mon ey in exis tence, plus the new mon ey cre at ed by the exten sion of new loans from the bank ing sec tor to the invest ment sec tor. Assum ing for con ve nience that D(0)=0, this yields:

Using the sub script EM to indi cate that this is an Endoge nous Mon ey mod el, aggre gate demand is there fore

Aggre gate demand dur ing some giv en time peri od t₂-t₁ is there fore:

We can now com pare the sym bol ic mea sure of nom i nal aggre gate demand in an Endoge nous Mon ey mod el with its coun ter part in a Loan able Funds mod el (the numer i cal val ues of veloc i ty, demand and debt will clear ly dif fer sub stan tial ly, as the sim u la tions in Sec tion 6 illus trate) to iden ti fy the sub stan tive dif fer ence between a Loan able Funds view of the mon e tary sys tem and that of Endoge nous Mon ey:

The Loan able Funds mod el thus omits the con tri bu tion of the change in debt to the lev el of aggre gate demand.

1. Occam's Razor pass es Endoge nous Mon ey & fails Loan able Funds
   

If banks make loans to non-banks—as is man i fest ly the case—and cre ate mon ey in doing so by cred it ing the deposit accounts of their borrowers—as even the staunch advo cate of Loan able Funds Paul Krug man has conceded—then the Loan able Funds mod el is too extreme a sim pli fi ca tion of the nature of cap i tal ism. As Ein stein put it in rela tion to physics:

It can scarce ly be denied that the supreme goal of all the o ry is to make the irre ducible basic ele ments as sim ple and as few as pos si ble with out hav ing to sur ren der the ade quate rep re sen ta tion of a sin gle datum of expe ri ence. (Ein stein 1934, p. 165, empha sis added)

Omit ting the capac i ty of banks to cre ate mon ey, and the impact this has on key macro eco nom ic aggre gates omits a vital "datum of expe ri ence" from macro eco nom ic mod els. The capac i ty of bank lend ing to alter the lev el of aggre gate demand means that banks, debt and mon ey must be includ ed in any ade quate mod el of macro eco nom ics.

In par tic u lar, the acknowl edge ment of the macro eco nom ic sig nif i cance of Endoge nous Mon ey requires a dynam ic rede f i n i tion of aggre gate demand to include the change in debt. Though this mod el excludes sec ond-order effects such as demand for idle cash bal ances (Rowe 2013), the gener ic for mu la relat ing aggre gate demand (AD) to income (Y) and the change of debt is:

This for mu la cor rects a rule of thumb propo si tion that I have pre vi ous ly assert ed, that aggre gate demand is the sum of income plus the change in debt (Keen 2014; see also Krug man 2013b). The cor rect propo si tion is that, in a world in which the bank ing sec tor endoge nous ly cre ates new mon ey by cre at ing new loans, aggre gate demand in a giv en peri od is the sum of aggre gate demand at the begin ning of that peri od, plus the change in debt over the peri od mul ti plied by the veloc i ty of mon ey.

If we con sid er a time peri od of one year so that and , and spec i fy ing the aver age veloc i ty of mon ey over that year as v(1) and the change in debt as DD(1), we have

Equa tions and enable us to oper a tional ize Key nes's dis tinc tion between ex-ante and ex-post, while prov ing the con sis ten cy of this dynam ic for mu la with the stan dard macro eco nom ic account ing iden ti ty that expen di ture equals income. In words, these equa tions assert that ex-post expen di ture equals ex-ante expen di ture (and hence income), plus the veloc i ty of mon ey mul ti plied by the ex-post change in debt.

Since the veloc i ty of mon ey com fort ably exceeds uni ty (though it is high ly vari able and pro-cycli cal), the numer i cal impact of the change in debt on aggre gate demand is there fore larg er than I have claimed in research pri or to devel op ing this for mal proof (Keen 2014; see also Rowe 2013).

1. Sim u lat ing Loan able Funds and Endoge nous Mon ey
   

A sim u la tion of the two mod els con firms the impor tance of includ ing the change in debt in aggre gate demand. The sim ple mod els used here are iden ti cal except for the struc ture of lend ing, so that the dif fer ences in their behav ior reflects sim ply that issue. The mod els use sim ple vari able time para me ters to relate the var i ous mon e tary flows to each oth er and the mon e tary stocks, so that the results do not depend on any behav ioral assump tions (see the Appen dix for the mod el equa tions and default para me ter val ues). The val ues of two of these parameters—the lend ing and repay ment rates—are var ied over the sim u la tions shown in Fig ure 5 and Fig ure 6.

Fig ure 5: Loan able Funds sim u la tion in Min sky

Fig ure 6: Endoge nous Mon ey sim u la tion in Min sky

Vari a tions in the lend ing and repay ment rates have a minor effect on income in the Loan able Funds mod el (see Fig ure 7) because they impact upon the veloc i ty of cir cu la tion of mon ey (see Fig ure 8). How ev er the lev el does not rise (or fall) sig nif i cant ly, and there is no trend, since vari a tions in the lev el of debt have no impact upon the mon ey sup ply, which remains con stant (see Fig ure 9).

Fig ure 7: GDP as a func tion of Lend ing & Repay ment rates in Loan able Funds

Fig ure 8: Mon ey veloc i ty as a func tion of Lend ing & Repay ment rates in Loan able Funds

Fig ure 9: Mon ey and Debt as func tions of Lend ing & Repay ment rates in Loan able Funds

In con trast, vari a tions in the lend ing and repay ment rates have a dra mat ic impact upon GDP in the Endoge nous Mon ey mod el (see Fig ure 10), because as well as hav ing an impact upon the veloc i ty of mon ey (see Fig ure 11) they alter the rate of cre ation and destruc tion of mon ey (see Fig ure 12).

Fig ure 10: GDP as a func tion of Lend ing & Repay ment rates in Endoge nous Mon ey

Fig ure 11: Mon ey veloc i ty as a func tion of Lend ing & Repay ment rates in Endoge nous Mon ey

Fig ure 12: Mon ey and Debt as func tions of Lend ing & Repay ment rates in Endoge nous Mon ey

1. Modeling financial instability

The pre ced ing proof pro vides a the o ret i cal jus ti fi ca tion for the key role giv en to the lev el and change in aggre gate pri vate debt in Min sky's Finan cial Insta bil i ty Hypoth e sis. Empir i cal research by Fama and French pro vid ed fur ther sup port, by con clud ing that the cor re la tions they found (includ ing a 0.79 cor re la tion between aggre gate cor po rate invest ment and change in long term cor po rate debt) "con firm the impres sion that debt plays a key role in accom mo dat ing year-by-year vari a tion in invest ment" (Fama and French 1999, p. 1954).

Min sky pro vid ed a suc cinct sum ma ry of his Finan cial Insta bil i ty Hypoth e sis, which empha sized the cen tral of pri vate debt to his analy sis (Min sky 1978; reprint ed in Min sky 1982):

The nat ur al start ing place for ana lyz ing the rela tion between debt and income is to take an econ o my with a cycli cal past that is now doing well. The inher it ed debt reflects the his to ry of the econ o my, which includes a peri od in the not too dis tant past in which the econ o my did not do well. Accept able lia bil i ty struc tures are based upon some mar gin of safe ty so that expect ed cash flows, even in peri ods when the econ o my is not doing well, will cov er con trac tu al debt pay ments. As the peri od over which the econ o my does well length ens, two things become evi dent in board rooms. Exist ing debts are eas i ly val i dat ed and units that were heav i ly in debt pros pered; it paid to lever. After the event it becomes appar ent that the mar gins of safe ty built into debt struc tures were too great. As a result, over a peri od in which the econ o my does well, views about accept able debt struc ture change. In the deal mak ing that goes on between banks, invest ment bankers, and busi ness men, the accept able amount of debt to use in financ ing var i ous types of activ i ty and posi tions increas es. This increase in the weight of debt financ ing rais es the mar ket price of cap i tal assets and increas es invest ment. As this con tin ues the econ o my is trans formed into a boom econ o my.

Sta ble growth is incon sis tent with the man ner in which invest ment is deter mined in an econ o my in which debt-financed own er ship of cap i tal assets exists, and the extent to which such debt financ ing can be car ried is mar ket deter mined. It fol lows that the fun da men tal insta bil i ty of a cap i tal ist econ o my is upward. The ten den cy to trans form doing well into a spec u la tive invest ment boom is the basic insta bil i ty in a cap i tal ist econ o my. (Min sky 1982, pp. 66–67)

I mod eled this process by extend ing Good win's cycli cal growth model—in which prof it-rate-moti vat ed invest ment and employ ment-rate-moti vat ed wage demands gen er at ed a closed lim it cycle in employ ment and income dis tri b u tion (Good win 1967)—to include debt-financed invest ment. Good win's mod el reduced to two cou pled dif fer en tial equa tions in the employ ment rate (?) and wages share of out put (?), where is a Phillips-curve rela tion and is an invest ment func tion depend ing on the rate of prof it :

I replaced Good win's "stark ly schema tized" (Good win 1967, p. 54) assump tion that invest ment equalled prof it at all times with an invest ment func tion in which invest ment exceed ed prof it at high rates of prof it, and was below prof it at low rates. An equa tion to rep re sent debt-financed invest ment was added—Equation —and prof it was rede fined as earn ings net of inter est pay ments :

This trans formed Good win's mod el into a three-state mod el of Min sky's hypoth e sis, with the extra equa tion being the dynam ics of the pri vate debt to out put ratio (see Keen 2013, pp. 236–38 for the deriva tion):

In (Keen 1995; Keen 2000) I used non lin ear func tions for both invest ment deter mi na tion and wage set ting; here I use lin ear func tions to empha size that both the cycli cal behav ior of Good win's mod el and the debt-induced break down in the Min sky mod el are endem ic, rather than being prod ucts of the assumed func tion al forms. In the sim u la tions shown in Fig ure 13 and Fig ure 14, the invest ment and wage change func tions are:

Fig ure 13 shows the fixed cycle in Good win's basic mod el.

Fig ure 13: Good win's mod el with lin ear behav ioral func tions sim u lat ed in Min sky

Fig ure 14 shows a typ i cal run of the Min sky mod el, which has three key char ac ter is tics:

• The ini tial behav ior of the mod el involves a reduc tion in the volatil i ty of employ ment and output—effectively a "Great Mod er a tion";
• Work ers' share of out put has a sec u lar ten den cy to fall; and
• The ini tial reduc tion in employ ment and out put volatil i ty gives way to increas ing volatil i ty as the debt to out put lev el ris es (with the ulti mate out come of a debt-induced col lapse in out put and employ ment).

Fig ure 14: Min sky's FIH with lin ear behav ioral func tions sim u lat ed in Min sky

The fact that this sim ple mod el gen er at ed out comes that, in a very styl ized way, mir ror the empir i cal record of the recent eco nom ic past, empha sizes the impor tance of devel op ing an approach to macro eco nom ics in which banks and pri vate debt play inte gral roles. The empir i cal data, inter pret ed in the light of the the o ret i cal argu ments giv en here, fur ther empha sizes the impor tance of pay ing close pol i cy atten tion to the hith er to ignored phe nom e non of the growth of pri vate debt.

1. Empirical Data

For tu nate ly, though main stream eco nom ic the o ry has ignored the role of pri vate debt, sta tis ti cal agen cies have col lect ed the data. Fig ure 15 is an imput ed series com bin ing actu al Fed er al Reserve quar ter ly data on house hold plus non-finan cial cor po rate debt since 1952 (and year ly data from 1945 till 1952) with US Cen sus data from 1916–1970, and par tial Cen sus data on bank loans from 1834 to 1970 (Cen sus 1949; Cen sus 1975).

Fig ure 15: US pri vate debt since 1834

The causal role of the change in debt in aggre gate demand iden ti fied in this paper implies that there should be a strong empir i cal rela tion ship between change in debt and macro eco nom ic data such as the unem ploy ment rate—in con trast to the Loan able-Funds-based pre sump tion that "Absent implau si bly large dif fer ences in mar gin al spend ing propen si ties among the groups … pure redis tri b u tions should have no sig nif i cant macro-eco nom ic effects…" (Bernanke 2000, p. 24). This Loan able Funds pre sump tion is strong ly reject ed by the data. As Fig ure 16 shows, the cor re la tion of the change in debt times veloc i ty (divid ed by GDP) with the lev el of unem ploy ment since 1990 is ‑0.92.

Fig ure 16: Change in debt times veloc i ty and US Unem ploy ment (Cor re la tion ‑0.92)

The first dif fer ence of also implies a strong rela tion ship between the change in the change in debt over two time peri ods and change in unem ploy ment over that peri od. Set ting , the change in aggre gate demand between peri ods t₂-t₁ and t₁-t₀ (nor mal ized by divid ing by  ) is:

Set ting , the cor re la tion between equa tion , which we term the Cred it Accel er a tor (see also Big gs and May er 2010; Big gs, et al. 2010), and the annu al per cent age change in the unem ploy ment rate over the peri od from 1975 till today is ‑0.78 (see Fig ure 17).

Fig ure 17: Cred it accel er a tion and change in unem ploy ment (Cor re la tion ‑0.78)

1. Conclusion

Giv en that bank lend ing cre ates mon ey and repay ment of debt destroys it, the change in debt plays an inte gral role in macro eco nom ics by dynam i cal ly vary ing the lev el of aggre gate demand. The omis sion of this fac tor from main stream eco nom ic mod els is the rea son that these mod els failed to warn of the dan gers of the dra mat ic buildup in pri vate debt since WWII—and espe cial ly since 1993, when the debt-financed recov ery from the 1990s reces sion took the aggre gate pri vate debt lev el past the peak caused by defla tion in the 1930s (see Fig ure 15). It is also the rea son why they failed to antic i pate the cri sis that began in 2007, and instead pre dict ed that, as the OECD put it in June 2007, "the cur rent eco nom ic sit u a tion is in many ways bet ter than what we have expe ri enced in years… Our cen tral fore cast remains indeed quite benign" (OECD 2007). Pol i cy mak ers rely ing upon main stream econ o mists as experts on the func tion ing of the econ o my thus not only received no warn ing about the worst eco nom ic cri sis since the Great Depres sion, but were false ly led to expect benign rather than malig nant eco nom ic con di tions.

The erro neous neglect of the dynam ics of pri vate debt by the eco nom ics pro fes sion has there fore result ed in enor mous social and eco nom ic harm to soci ety. This is the oppo site of the intend ed goal of eco nom ic the o ry and pol i cy. If eco nom ic the o ry and pol i cy are to ful fil their intend ed role, it is imper a tive that a reformed macro eco nom ics be devel oped in which banks, mon ey and the dynam ics of debt play inte gral roles.

1. Appendix

   1. Loanable Funds model

Differential equations for money and debt

Other differential equations

1. Endogenous Money model

Differential equations for money and debt

Other differential equations

Common Definitions

Common Parameters to Loanable Funds and Endogenous Money models

1. Goodwin model

1. Minsky model (new and modified equations only)

1. Common parameters to Goodwin & Minsky models

1. Minsky

Min sky is an addi tion to the fam i ly of sys tem dynam ics pro grams that began with Jay For rester's pio neer ing work on devel op ing a visu al metaphor for con struct ing and sim u lat ing dynam ic mod els of com plex social and eco nom ic process es (For rester 1968). For rester's metaphor was the flow chart (see Fig ure 18): a draw ing of the rela tion ships in a sys tem became the frame work for devel op ing a math e mat i cal mod el of that sys tem:

The pro posed mod el struc ture and method of solu tion retain a one-to-one cor re spon dence between the pre sumed form of the real eco nom ic world and the quan ti ties, coef fi cients, vari ables, and deci sion cri te ria of the mod el. For mu la tion in terms of a "flow dia gram" is pos si ble so that a pic to r i al rep re sen ta tion of the rela tion ships with in the sys tem is avail able at all times. (For rester 2003p. 344 )

Fig ure 18: The first sys tem dynam ics dia gram from For rester 2003 (1956)

There are now at least a dozen pro grams imple ment ing this mod el ing phi los o phy, rang ing from the free Open Source pro gram Xcos to the $20,000-a-copy com mer cial pro gram Simulink. This par a digm is now per va sive in engi neer ing, but it failed to take root in eco nom ics, despite the fact that For rester's con cept was twice antic i pat ed in economics—firstly by Irv ing Fish er in 1891 with a hydraulic mod el for cal cu lat ing equi lib ri um val ues in a Wal rasian mod el (Brainard and Scarf), and then by the engi neer-turned econ o mist Bill Phillips with gen uine ly dynam ic ana log com put er sys tems (Hayes 2011; Lee son 1994a; Lee son 1994b; Lee son 1995; Lee son 2000; Phillips 1950; Phillips 1954; Phillips 1957) some years before For rester. How ev er, there was no devel op ment in eco nom ics com pa ra ble to For rester's inno va tion (in con junc tion with the com put er pro gram mers Phyl lis Fox and Alexan der Pugh–see Lane 2007) of a dig i tal com put er program—DYNAMO—to pro vide a gen er al pur pose foun da tion for build ing dynam ic mod els of com plex sys tems.

Fig ure 19: Fish er's 1891 hydraulic machine for cal cu lat ing Wal rasian equi lib ri um prices, from Brainard and Scarf, p. 69

Fig ure 20: Phillip s's schemat ic dia gram of a dynam ic mul ti pli er-accel er a tor mod el, from Phillips 1954, p. 306

The core par a digm in sys tem dynam ics pro grams is the con struc tion of math e mat i cal equa tions via flow charts iden ti cal in spir it to that devel oped by Phillips (see Fig ure 20). For exam ple, Fig ure 21 is the sys tem dynam ics equiv a lent of the dif fer en tial equa tion for expo nen tial pop u la tion growth .

Fig ure 21: A sim ple alge bra ic equa tion in a sys tem dynam ics pro gram (Min sky)

Sim ple expres sions like this are just as eas i ly ren dered in equa tions or stan dard text-ori ent ed com put er pro grams, but the sys tem dynam ics approach makes it eas i er to com pre hend much more com plex models—hence its dom i nance in the engi neer ing field today.

Min sky pro vides this clas sic sys tem dynam ics approach, and also adds a new method of con struct ing dif fer en tial equa tions to the sys tem dynam ics toolk it that is supe ri or for mod el ling finan cial flows: the God ley Table. Based on the account ing con cept of dou ble-entry book keep ing, each col umn rep re sents the dynam ic equa tion of a giv en finan cial account, while each row rep re sents trans ac tions between accounts. This is a more nat ur al way to por tray finan cial trans ac tions which also helps enforce the fun da men tal rules of accounting—that Assets equal Lia bil i ties plus Equi ty.

Min sky ensures this in three ways. First ly, all row oper a tions in a God ley Table must sum to zero—otherwise an error is flagged. Sec ond ly, the source of any trans ac tion is shown as a pos i tive while the des ti na tion (or "sink" in sys tem dynam ics par lance) is shown as a neg a tive. Third ly, Assets are shown as pos i tive while Lia bil i ties and Equi ty are shown as neg a tive. Fig ure 22 illus trates these three conventions—including show ing what hap pens when they are breached.

Fig ure 22: A sam ple God ley Table

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