Debunking Economics, Part XII: Keen’s Minsky Model

In chapter 14 of Debunking Economics, Steve Keen walks us through the macroeconomic model he has developed in recent years, and discusses the implications its conclusions might have for policy. The model is in its early stages, and Keen himself says there are “many aspects of the model of which [he is] critical.” Nonetheless, it is a promising start to developing an alternative to the dominant DSGE method.

Keen’s is a model of a pure credit economy, with three aggregated agents: workers, firms, and bankers. Instead of focusing on preferences, individuals and market clearing, it focuses on the flow of funds between different sectors. Bankers create their own money in the form of loans*, which at this stage they are only allowed to lend to firms. The firms pay the workers and the interest on the loans, whilst the bankers and workers consume the output of the firms.

The crucial sector here, is, of course, banking, which few neoclassical models include explicitly, as they believe finance plays the role of intermediation between savers and borrowers. However, in Keen’s model the banks are central. He disaggregates them into several accounts: a vault in which to store notes; a safe into which interest is paid and out of which bankers are paid; a loan ledger; firm deposits and worker deposits. The flows between the various agents and accounts are then determined by some arbitrary coefficients, which Keen uses simply to determine whether the model will ‘work’ (i.e. not break down). Each flow (e.g. wages; consumption) is determined by a constant times a stock (e.g. firm’s deposits; worker’s deposits).

This is the point at which economists might scream ‘Lucas Critique,’ but Keen’s comment from an earlier chapter, that is absurd to suggest that any change in policy will have the effect of neutralising arbitrary parameters, applies. Furthermore, there is no theory that is policy-independent, so whilst we must examine the relationship between policy and reality, we cannot render our models immune to it by micro founding them. In any case, the model is in its early stages, and there is plenty of room for adding complexity.

Keen uses this basic model to explore what effect bank bailouts will have. Quelle surprise, bank bailouts have the effect of increasing loans slightly, and benefitting bankers, but don’t do much for the real economy. Conversely, bailing out firms and workers creates a better result for everyone except…the bankers! A small data point can be found in support of this in Australia, where the government bailed out everyone over 18 with $1000, and the economy has performed better than those where the banks have been bailed out. Obviously there are a multitude of conflicting factors, but Keen’s hypothesis does not seem at all unreasonable when taking recent events as whole.

The interesting thing about Keen’s model is that a ‘Great Moderation’ and a ‘Great Recession’ are simply two parts of the same debt-driven process, rather than a ‘black swan’ or some other such event. Debt to GDP rises exponentially in a period of relative tranquility, and this is followed by a huge crash and mass unemployment. A substantial part of this difference from the core DSGE models is created simply by adding banks as explicit agents.

Keen has since developed his model further – he has included ‘Ponzi’ lending, sticky wages/price (which actually stabilise the economy) and a variety of other factors. There is plenty of scope for adding more to the model, such as an exogenously set interest rate with a central bank, but for now the core alone seems to be able to generate behaviour that closely resembles that of a capitalist economy: one prone to cyclical breakdown and intermittent financial crises, not due to any particular ‘friction,’ but due to the inherent characteristics of the system. This should be enough to get any empirically driven economists to pay attention, whether they agree or disagree with the mechanics of the model.

*If you wish to argue about this, please take it here or here!


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  1. #1 by Blue Aurora on October 7, 2012 - 10:41 pm

    Unlearningecon: How much closer are you to the section on econophysics?

    • #2 by Unlearningecon on October 8, 2012 - 9:00 am

      It’s actually the last chapter, which will be in 3 posts time. Having said that, the next chapter explores the fractal markets hypothesis (among other things) so there is at least a taster for you!

  2. #3 by Frances Coppola on October 7, 2012 - 11:51 pm

    Anything that moves us away from the idea that all departures from equilibrium are caused by exogenous “shocks”, and towards the notion that actually the system is in cyclical oscillation rather than equilibrium (so variation is generally endogenous, not exogenous), seems good to me. But then I’m not a proper economist.

    • #4 by Unlearningecon on October 8, 2012 - 9:02 am

      I’m always wary of saying this because, despite the fact that until you really get to the edge of economic research, everything is fairly stable and caused by shocks, economists do have various models that have been played with until they generate something resembling the endogenous cycles we experience in reality.

      However, the difference with Keen’s model is that the underlying mechanics create this, not some sort of ‘friction.’

  3. #5 by Frances Coppola on October 8, 2012 - 9:45 am

    Yes, that’s what I meant by “endogenous”. The system itself causes the natural variation, not “shocks” – although there are of course shocks too, such as oil price changes, which would change the period and/or the amplitude of oscillation. But as I said, I’m not an economist – I’m a musician, so I’m used to things that oscillate! Maybe it’s just the way I see things. If you mess around with a DSGE model enough you can get it to look like an oscillation.

  4. #6 by Bhaskara II on October 16, 2012 - 8:55 pm

    Comments on, “Unlearning the History of Thought II”

    1. Has economics ignored or perverted accounting and bookkeeping and some are rediscovering bookkeeping? This was said about economics treatment of the history of thought of economics.

    2. Comment in reference to Unlearingecon’s previous comment: You made a comment on borrowing and income. Borrowing is a cash flow. Borrowing is not counted as income. Net income would be revenues minus incomes. Borrowing is neither a revenue nor an income. When one borrows they get what they borrow and give a “note” of their obligation to pay. A net zero on the income front and an incomplete transaction. But there is a “cash” flow.

    So, if you will excuse me I rewrote your previous comment changing some of the references of income to cash flow where appropriate.

    Rewriting comment from:

    In the following it is meant to replace the word income with cash flow in places where cash flow would be more appropriate.

    [I don’t want to get too off topic but I’ll try to show you.

    This is the only time I use a household analogy in economics.

    If you think about your household income, you receive your income plus however much you borrow. So say your income is £10 and you borrow £5, your total cash flow, (not income), is £15. But to keep it constant you must continue to borrow £5 a year. To increase your cash flow, (not income), you must borrow more than that each year. If you reduce the amount you borrow [by £2], your cash flow, (not income), will fall [by £2], even though you are still borrowing.

    In the mainstream framework this cancels out at a macro level. However, in the endogenous framework, the banking system is effectively the economy’s ‘bank’ and so it scales up – money paid back goes out of circulation and into the banking system.]

    Income and cash flow are different. For example, if you did every thing by checking you checking account register would show cash flows with the totals being cash levels at that time. This would be the same as net income, if there were no borrowing, lending, or giving and receiving of credit.

    • #7 by Unlearningecon on October 29, 2012 - 12:55 pm

      Wow, sorry for such a late reply – I just stumbled across this.

      1. Yes. Most economists do not seem to know about the inner workings of firms and banks and this contributes heavily toward their misunderstanding of the financial system and firm’s pricing techniques. A course in accounting should be required.

      2. Yes, you are correct, cash flow is a far more illuminating way of putting it. Thank you.

  5. #8 by Bhaskara II on October 16, 2012 - 9:01 pm

    If you borrow are you richer? Your wealth, the accumulation of net income, does not increase with a loan. The currency you have available increases but not your wealth. Example buying a house on credit. You have a house and a loan. The obligation to pay the loan is negative wealth.

    • #9 by Nathanael on October 21, 2012 - 8:38 am

      Depends on whether you manage to repudiate and/or default on the debt later, doesn’t it?

      (And yes, I believe there are subtle and important implications of this for macroeconomics. When an economy has been on a borrowing binge, the only way to make its new wealth permanent is to default/repudiate/forgive debts.)