Keen, Krugman and National Accounting
from Merijn Knibbe
A little bit about the Keen-Krugman debate. According to Steve Keen,
“The Walras-Schumpeter-Minsky proposition [is] that aggregate demand is income plus the change in debt, and that this is expended on both goods and services and purchases of financial claims on existing assets.”
Steve should have called this the Walras-Schumpeter-Minsky-National Accounting proposition. As can be seen from the next graph, these accounts use the same idea (the accounts use gross income and not net income, but this doesn’t matter for the argument, at the moment):
Source: Centraal Bureau voor de Statistiek, National Accounts, tables S14B and S14M.
So, Steve is right, at least in a technical sense. His concept is entirely consistent with National Accounting which means that Paul Krugmans endeavour to debunk it by using phrases like mysticism is bonkers. But does this mean that Krugman is wrong with his approach? Not necessarily. In the National Accounts, investments are, by definition, equal to everything owned by companies and the governments lasting more than one year (well, with some exceptions, of course). And, by definition, these investments are supposed to be ‘real’ saving. This means that when consumer durables are redefined as ‘capital goods’ (they are not supposed to be capital at the moment, except for (new) houses), the rate of saving increases! Investment by wise definition and accounting necessity drives savings, in the National Accounts – you should not save to guarantee your future, we have to invest to guarantee our future! And this is financed, in a passive way, by net lending or increases in equity. ‘Investments’ in financial assets are in the National Accounts by definition considered as just a way to change the color of money and not as ‘real’ investments which add to the productive capacity of a society. And money set aside to invest in these financial assets is not seen as ‘real’savings. This however does not mean that flows of money are not important. People and companies might still lend a part of the money they need to finance these investments (including consumer durables), which gives rise to a kind of ‘net’ debt. Eggertson and Krugman should have been much more precise about this, but this is consistent with National Accounting, too (but their use of indifference curves is, of course, ‘mysticism’, as these are, contrary to the other concepts mentioned here, not rooted in consistent concepts, well designed definition or embedded in elaborate systems of measurement). Borio and Disyatat have written a nice article outlining the differences between the concept of saving and investment on one side and ‘financing’ on the other side. Its telling that when it comes to money and lending practical economists from the Bank of International Settlements/Central Bank of Thailand use the same concepts as Post-Keynesians and, to an extent, Austrians – but not the same concepts as neo classical economists.
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Real-World Economics Review Blog 
When you write:
In the National Accounts, investments are, by definition, equal to everything owned by companies and the governments lasting more than one year (well, with some exceptions, of course).
I suppose that R&D expenses, (labour and non-durable) are amongst those exceptions.
It is mystifying to discover that two economists may be talking about different things when they mention “savings” or “investment”.
Part of the problem is Keen’s piggybacking on a term which already has a widely accepted meaning. AD is the schedule of real economy-wide planned expenditures over possible prices. When Keen offers his “proposition” what he is actually doing is defining a new nominal aggregate– not offering to explain AD.
If that’s really all he means, then it would surely help to call his thing something other than “aggregate demand”
You’re quit right about the terminology!
Looking at the conclusion from the Borio and Disyatat paper :
“The distinguishing characteristic of our economies is that they are monetary economies, in which credit creation plays a fundamental role. The financial system can endogenously generate financing means, regardless of the underlying real resources backing them. In other words, the system is highly elastic. And this elasticity can also result in the volume of financing expanding in ways that are disconnected from the underlying productive capacity of the economy. In macroeconomic models, the role of money and credit should be essential, not ancillary. This calls for a revival of an old and highly respected tradition in macroeconomics – one which, sadly, has been largely neglected in the current prevailing paradigm.”
This is a statement that could just as easily have come from the works of Keen or Minsky , but not from those of Krugman with his “loanable funds” worldview.
Debt – who holds it , and how much they hold relative to their incomes – matters. Keen gets that , Krugman doesn’t.
Debt – who holds it , and how much they hold relative to their incomes – matters. Keen gets that , Krugman doesn’t.
But the question is, how helpful is Keen’s specific way of formalizing that insight?
“But the question is, how helpful is Keen’s specific way of formalizing that insight?”
I think it remains to be seen. I’d like to see him devote as much focus to public debt as he does to private , and I have the feeling that the financial sector should be examined separately , both with regards to their share of debt and their share of GDP. As a parasite on the productive economy , with some ( possible ) symbiotic effects that we want to retain , we should cut finance down , probably dramatically , and then re-examine the influence of financial sector debt on their operations , safety , etc.
For debt/gdp guidelines , the best insight we have at the moment is probably the empirical work of R&R , Cecchetti et al , etc , which seem to arrive at limits of ~80-90% debt/gdp as the levels when growth-inhibiting effects show up for public , business , and household debt burdens. I don’t know if we have any handle on the interactions between sectoral debt levels and what the combined limit should be , but in the U.S. , at least , we know that we grew just fine after WWII at a total nonfinancial debt/gdp that was stable at ~ 150% until the late 70’s or so.
Given that there seems to be a fairly predictable impact of the “credit impulse” on GDP growth , I’d like to see Keen , or somebody , model the counterfactual growth path of U.S. GDP since the 70’s , assuming nonfinancial debt/gdp had remained at that 150% level. You could easily tease out the relatively small financial sector component of GDP , so that the analysis was not influenced by the increasing debt growth in that sector. I realize the models are incomplete at this stage , but I think it would be a useful exercise nonetheless. He should also take a stab at predicting growth going forward , assuming certain debt/gdp trajectories. His star would brighten considerably 5 or 10 years down the road if his predictions turned out to be close to the mark.
BTW , why did you remove your last Keen post on your blog ?
“Debt – who holds it , and how much they hold relative to their incomes – matters. Keen gets that , Krugman doesn’t.”
That’s patently untrue. Krugman has explicitly stated so. Indeed, debt is the focus of his recent paper with Eggertson. It begins:
“In this paper we present a simple New Keynesian-style model of debt-driven slumps – that is, situations in which an overhang of debt on the part of some agents, who are forced into rapid deleveraging, is depressing aggregate demand.”
OK. I’ll modify my take on Krugman. He gets it , but at a primitive , superficial level compared to Keen or , he gets it completely , but won’t admit it. I think it may be the latter. Here’s Krugman :
“Keen then goes on to assert that lending is, by definition (at least as I understand it), an addition to aggregate demand. I guess I don’t get that at all. If I decide to cut back on my spending and stash the funds in a bank, which lends them out to someone else, this doesn’t have to represent a net increase in demand. Yes, in some (many) cases lending is associated with higher demand, because resources are being transferred to people with a higher propensity to spend; but Keen seems to be saying something else, and I’m not sure what. I think it has something to do with the notion that creating money = creating demand, but again that isn’t right in any model I understand.”
That last bit – “that isn’t right in any model I understand” – is the crux of Krugman’s problem. A casual glance at the economic data during the last few years of the housing boom tells you that ” creating money ( aka lending) = creating demand “. Keen looks to find , or invent , a model that explains what’s obviously happening based on empirical observation. Krugman says it’s not right in any of his models , so the empirical observations must be wrong.
Krugman should be leading the charge here , instead of pretending that he’s really , really willing and trying to understand , but just can’t accept something that doesn’t fit the models.
Krugman works for the N.Y. Times. Does either really want to see the financial sector – the heart of the N.Y. economy – slashed by half or more , as it should be ? Why is Krugman so tentative in calling out the fraudulent activities of bankers , relative to those like Bill Black and Janet Takavoli who call them out relentlessly?
Krugman in the past has claimed that he sees no reason why you can’t have a vibrant economy with extremes of inequality. That’s what his models tell him. How convenient for him and his wealthy paymasters.
Try running that model with one person having all the wealth and income and everyone else slaves. That’s the way we’re heading. The difference between the policies of the Right and those of “Third Way” neolibs like Krugman and DeLong amount to debates about how best to get there without anyone noticing what’s happening.
OK. First of all, Krugman is correct. Whatever Keen is trying to describe, it’s not AD. (See my early comment.) It’s one thing to incorporate debt into a model– which, mind you, happens all the time, even if you may dislike or are simply unaware of those models. But Keen doesn’t seem to acknowledge that he’s redefining terms which are in common use within economics, and this leads to both sloppiness on Keen’s part and confusion on the part of his critics.
Of course, there should be a relation among aggregate income, net lending and quantity of expenditures. But gross? This is nonsense.
I don’t mean that you don’t “see” the relation in the data, but…
If you and I lent each other $100 trillion at 10 percent interest, we could sit on our rears all year round and have no problem servicing our respective debts. But if I lend you $200 trillion (same increase in gross debt) that’s not the same thing.
For the country as a whole, the appropriate measure of lending is the current account deficit– a *net* measure. If course, within the country there may be critical sectoral imbalances, say, rapidly growing household debt. And within sectors, etc.
Now, perhaps what Keen means is that when gross lending becomes in some way excessive there are surely net sectoral imbalances which underlie that lending. But then why not just stick to the sectoral imbalances? Why start redefining terms when it merely sows confusion?
As for the rest, I’m not even going to bother with a second round. The fact that you’re lumping in Krugman and Third Way tells me you’re not actually reading at least one of them.
D R-
It’s not so simple. A system with high gross debt is more unstable, in the sense that any it is harder for any interruption to contractual payment flows to be made up for by other adjustments to current income or expenditure. When there is high gross debt, the system is more vulnerable to chains of defaults.
You are implicitly assuming that all assets are perfectly liquid, so that offsetting claims can be netted out costlessly whenever necessary. But the real world is not like that, and it’s important.
Conventional measures of leverage are almost always measures of the ratio of gross debt to income or net worth.
That’s fine. I’m not sure of what you’re trying to convince me. Nothing you say seems to address the confusion Keen sows.
I’m trying to convince you that net intersectoral lending is *not* all that matters. It may be that growth requires an increasing volume of intra-sectoral debt, and it may be that the volume of gross debt has implications for macro outcomes. I am disagreeing with your claim that “For the country as a whole, the appropriate measure of lending is the current account deficit.” Gross debt matters.
(I am not defending Keen specifically. I think he is right on the big question of endogenous money, but I find the specific ways he tries to formalize it confusing.)
Everything matters. The number of mosquito bites I suffer each summer matters. The question is how much any thing matters.
I pointed to a couple of specific reasons gross debt matters — that increasing expenditure relative to current income may require an increase in gross debt, and that gross debt creates financial instability. If you pick up the business pages, or read reports by various consultants and multilateral agencies, you’ll see all kids of discussions of leverage in terms of *gross* debt. An economy in which I owe you $1,000,000 and you owe me the same is more subject to financial shocks than one without those offsetting debts, even though they net to zero.
Your assumption that all assets are perfectly liquid is not a good one. This is not a fringe position Just read Holmstrom and Tirole.
*sigh*
To repeat. Everything matters.
Gross debt is critically important to economic *instability* because it increases the degree to which people have counterparty risk.
Admit it. This is why the process of “netting out” CDSes was being done, because it reduced financial instability….
See my above comment. The one to which you replied.
Let’s see if I understand this.
The “appropriate measure of lending is the current account deficit”, which means that gross debt is not appropriate.
But then we find that “everything matters” (gross debt is part of everything, so it matters).
Assuming “appropriate” means the same as “matters”, which of the two statements reflects your position?
I was going to attempt to explain how Keen’s statement that Aggregate Demand is current income plus the change in debt, is in fact correct, but then I realized that I would be only restating what has already said.
Instead I will refer those interest to a paper which mathematically demonstrates the propostition that aggregate demand is income plus change in debt.
Click to access TowardsUnificationMonetaryMacroeconomicsMathArgument.pdf
Here is also the link to the Field Institute MMT-MCT lectures which also discuss this topic.
Matheus Grasselli – Extensions of the Keen-Minsky Model for Financial Fragility
and the rest
DR, I am not an economist but, your argument about “me” and “you” lending to each other $100m misses the point completely. It is not me and you those lending to domestic agents; it is the banks. The aggregate of your and my liquidity problems will have to be managed by the banking system.
Click to access keen-steve-berlin-paper.pdf
One more thing. If “you” or “me” capture some of the money created by banks at interest and lend it out again, either this money will not be available to balance the principal of the original loan by the bank, or it will not be available to repay “you” or “me”.
Sorry; wrong video. Here is the correct one:
Perhaps,maybe the real question here is: Is there really TWO kinds of debt.
As Frederick Soddy wrote ( “The Role Of Money”)Entire book as a free download… http://archive.org/details/roleofmoney032861mbp
***Excerpt from pages 62-63***
“Genuine and Fictitious Loans.-For a loan,if it is a genuine loan does not make a deposit, because what the borrower gets the lender GIVES UP, and there is no increase in the quantity of money,but only an alteration in the identity of the individual owners of it. But if the lender gives up nothing at all what the borrower receives is a new issue of money and the quantity is proportionately increased (is a fictitious loan)….”
“These vast sums of money are entirely of the banks creation…When the bank pretends to lend their money they do not reduce the amount of the claims of the owners to goods and services on demand by a …(CENT). They do not inform them that they can no longer draw it out as it has been lent to others! “
Of course, banks do not do such things and, of course, what a bank does is not lending in a real sense, but, nonetheless, it is backed by a debt contract! Thus, a bank’s “loan” creates a claim on the borrower, treated as the bank’s asset, just as in the case of the “real” loan, meaning that a bank’s loan is as real as any other in legal terms. It makes no sense to distinguish “real” and “non real” loans like that, as if the economy could function under a different legal status.
BTW, not only a bank loan is not a real loan, but also your bank “deposit” is not your bank deposit, but the money the bank owes you.
YES,…”a bank’s loan is as real as…” the money you have in your pocket,there’s the rub-they have issued ‘new currency’ and they are taxing it (when the note is in a mortgage, by using compound interest their tax is greater than 200%).
When we we talk about , how we have failed our sovereignty as Soddy points out:
in “The Role of Money”,(Entire book as a free download) http://archive.org/details/roleofmoney032861mbp
PREFACE
This book attempts to clear up the mystery of
money in its social aspect. With the monetary
system of the whole world in chaos, this mystery
has never been so carefully fostered as it is to-day.
And this is all the more curious inasmuch as
there is not the slightest reason for this mystery.
This book will show what money now is, what it
does, and what it should do. From this will
emerge the recognition of what has always been
the true role of money. The standpoint from
which most books on modern money are written
has been reversed. In this book the subject is not
treated from the point of view of the bankers
as those are called who create by far the greater
proportion of money but from that of the
PUBLIC, who at present have to give up valuable
goods and services to the bankers in return for
the money that they have so cleverly created
and create. This, surely, is what the public
really wants to know about money.
It was recognized in Athens and Sparta ten
centuries before the birth of Christ that one
of the most vital prerogatives of the State was
the sole right to issue money. How curious that
the unique quality of this prerogative is only now
being re-discovered. The” money-power
” which has been able to overshadow ostensibly responsible
government, is not the power of the merely ultrarich,
but is nothing more nor less than a new
technique designed to create and destroy money
by adding and withdrawing figures in bank ledgers,
without the slightest concern for the interests of
the community or the real role that money ought
to perform therein.