Keen2013NICTA Minsky

8/11/2019 Keen2013NICTA Minsky

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From the Great Moderation to the Lesser Depression• Sudden decay of economic conditions in 2007-08:

1980 1985 1990 1995 2000 2005 2010 2015321012345678

9101112131415

UnemploymentInflation

Unemployment and Inflation

Year; Source BLS, Federal Reserve Flow of Funds

P e r c e n t ,

P e r c e n t c

h a n g e p . a .

0

2008



From the Great Moderation to the Lesser Depression• Crisis not anticipated by DSGE models:

– OECD Economic Outlook June 2007

– “the current economic situation is in many ways better than whatwe have experienced in years …– Our central forecast remains indeed quite benign :

• a soft landing in the United States, a strong and sustainedrecovery in Europe,… In line with recent trends,

• sustained growth in OECD economies would be underpinned bystrong job creation and falling unemployment. ” (Cotis 2007)• Great Moderation & Depression anticipated by Minsky-oriented model

– “From the perspective of economic theory and policy, this vision ofa capitalist economy with finance requires us to go beyond thathabit of mind which Keynes described so well, the excessive relianceon the (stable) recent past as a guide to the future.

– The chaotic dynamics explored in this paper should warn usagainst accepting a period of relative tranquility in a capitalisteconomy as anything other than a lull before the storm .” (Keen1995)



From the Great Moderation to the Lesser Depression• Key empirical difference: focus on role of private debt…

1980 1985 1990 1995 2000 2005 2010 201530

25

20

15

10

5

0

5

10

15

20

100

120

140

160

180

200

220

240

260

280

300

Unemployment

InflationDebt ChangeDebt Ratio

Unemployment, Inflation and Aggregate Private Debt

Year; Source BLS, Federal Reserve Flow of Funds

P e r c e n t ,

P e r c e n t c

h a n g e p . a .

P e r c e n t o f G

D P

0

2008



Minsky approach compared to DGSE approach• Non-equilibrium & instability rather than equilibrium dynamics

– “Stability—or tranquility —in a world with a cyclical past andcapitalist financial institutions is destabilizing” (Minsky 1978)

• Euphoric rather than Rational Expectations– “Once euphoria sets in … Financial institutions … accept

liabilitystructures … that , in a more sober expectational

climate, they would have rejected” ( Minsky 1972)• Complexity & Emergent Properties rather than Microfoundations

– “every polynomial … is an excess demand function for aspecified commodity in some n commodity economy …”

(Sonnenschein 1972)• Linear production rather than diminishing marginal productivity– “Firms … rarely report the upward -sloping marginal cost

curves that are ubiquitous in economic theory. Indeed,downward-sloping marginal cost curves are more common .”(Blinder 1998)



Minsky approach compared to DGSE approach• Endogenous money rather than money neutrality

– “It is always a question, not of transforming purchasing power

which already exists in someone's possession, but of the creation ofnew purchasing power out of nothing …” (Schumpeter 1934)

– “Debt plays a key role in accommodating year-by-year variation ininvestment .” (Fama and French 1999)

• Government homeostatic stabilizer rather than “Policy Ineffectiveness” – “Big government prevents the collapse of profits which is a neces-

sary condition for a deep and long depression…” ( Minsky 1982)• Non-equilibrium methods needed to model Fisher/Minsky processes

– “Theoretically … there must be over-or under-production, …over-

or under- investment … and over or under everything else.– It is as absurd to assume that, for any long period of time, thevariables in the economic organization … will "stay put," in perfectequilibrium, as to assume that the Atlantic Ocean can ever bewithout a wave.” (Fisher 1933)



The Financial Instability Hypothesis

• Economy in historical time• Debt-induced recession in recent past• Firms and banks conservative re debt/equity, assets• Only conservative projects are funded

– Recovery means most projects succeed• Firms and banks revise risk premiums

– Accepted debt/equity ratio rises– Assets revalued upwards…

• “Stability is destabilising ” – Period of tranquility causes expectations to rise…

• Self-fulfilling expectations

– Decline in risk aversion causes increase in investment– Investment expansion causes economy to grow faster• Rising expectations leads to “The Euphoric Economy”…




• Asset prices rise: speculation on assets profitable• Increased willingness to lend increases money supply

– Money supply endogenous, not controlled by CB• Riskier investments enabled, asset speculation rises

• The emergence of “Ponzi” financiers – Cash flow less than debt servicing costs

– Profit by selling assets on rising market– Interest-rate insensitive demand for finance

• Rising debt levels & interest rates lead to crisis– Rising rates make conservative projects speculative– Non-Ponzi investors sell assets to service debts– Entry of new sellers floods asset markets– Rising trend of asset prices falters or reverses




• Boom turns to bust• Ponzi financiers first to go bankrupt

– Can no longer sell assets for a profit– Debt servicing on assets far exceeds cash flows

• Asset prices collapse, increasing debt/equity ratios• Endogenous expansion of money supply reverses

• Investment evaporates; economic growth slows• Economy enters a debt-induced recession

– Back where we started...• Process repeats once debt levels fall

– But starts from higher debt to GDP level• Final crisis where debt burden overwhelms economy• Turning verbal argument into a model…



Cyclical foundations of Minsky model• Goodwin’s cyclical growth model (1967)

Y K v

L Y aL N

/1 hdw dw t P

Y w L dK dt I

• As a reduced system of ODEs (in & w = w/a):

1

h

ddt vd

Pdt

w

w w

• Generalized for nonlinear investment function & depreciation:

w w

h

Iddt v

dPdt

• As dynamic flowchart

– Capital K determines output Y via accelerator v:

– Y determines employment L via labour productivity a :– L determines employment rate given population N:– determines rate of change of the wage rate w:– Output minus the wage bill determines profits :– All profits are invested:

• System has neutral equilibrium– (Dominant eigenvalue has zero real part)

• Cycles even with linear Phillips curve…



Cyclical foundations of Minsky model• System inherently cyclical —structural nonlinearity that wage bill = w.L• Nonlinear functions add realism, not cycles themselves

40 60 80 100 12085

90

95

100

105

Linear Phillips Curve

Nonlinear Phillips Curve Nonlinear Phillips & Investment

Goodwin model: closed curves in phase space

Wages share of output %

E m p

l o y m e n t r a t e

%

• Additional realism tointroduce Minsky– Nonlinear investment

function: investmentexceeds profits duringboom, below profitsduring slump

• No structural change tomodel, but more realistic

simulated values:



Minsky model: introducing debt• Next element of realism: debt-financed investment:

– “More investment tends to generate more debt, while higher

earnings are used to reduce debt.” ( Fama and French 1999)• In equations:

– Rate of change of debt equals investment minus profits– Profit net of interest payments on debt

dD Idt

Y w L r D

• Significant structural change to model• Now 3 dimensions:

– Rate of employment– Wages share of output– Debt to output ratio



Minsky (without government)• As system of ODEs:

1

(1 ) 1 1

h

r d

d I r dd

Iddt

d r I

v

dP

dt

r ddt v

w

w

w

w

w w

• Li and Yorke (1975),“Period Three Implies Chaos” – Stability now dependent on initial conditions, parameters– “Inverse tangent route to chaos” ( Pomeau and Manneville 1980)

• Equilibrium convergence for some initial conditions• Divergence for others

– Apparent convergence to stability followed by breakdown



Finance & Economic Breakdown• Stability for some initial conditions & parameter values…



Finance & Economic Breakdown• Apparent stability followed by instability for others

– “Great Moderation” followed by “Great Depression”…



Finance & Economic Breakdown• Model has 2 equilibria:

– “Good equilibrium”:

• Positive incomes, positive employment, & finite debt– “Bad equilibrium”:

• Zero wage & profit income, zero employment, & infinite debt• Size of basin of attraction of good equilibrium a negative function of

debt to output ratio… • Outside this basin, convergence to bad equilibrium likely• Stability of good equilibrium

– Eliminated by “Ponzi” behavior• Debt-financed speculation on asset prices

– Expanded by government counter-cyclical spending• Cash flow to private sector enables debts to be serviced, repaid

• Role of private debt in economy crucial…







Destabilizing a bad stable equilibrium• Results in 4-dimensional system:

1

(1 ) 1 1

(1 )

h

r d g

d I r d g d d

Iddt v

dP

dt

g g

r I r d g dt v

d I r d g g

dt v

w

w

w w

w

w

w

• Counter-cyclical government spending– Destabilizes bad equilibrium

• Basin of attraction substantially reduced• Economy can be moved from bad equilibrium with large stimulus

– Makes good equilibrium stable but cyclical…





A strictly monetary macroeconomic model• Preceding model implicitly monetary

– Debt finances investment in excess of retained earnings

• Explicitly monetary model needed to– Consider impact of inflation, deflation– Properly incorporate banking sector into macroeconomics

• Innovation: using accounting tables to build financial flow models– Explicitly include bank accounts in macroeconomic model

• Firm Debt, Household Debt, Government Debt, etc.• Deposit accounts of Firms, Households, Government too• Model endogenous money creation process…



A strictly monetary macroeconomic model• Monetary foundation enables explicit inflation modeling

– Price dynamics derived from lagged demand-supply convergence

1

1P

dP W P

dt a s

– Monetary wages with employment, rate of change of employment,

and inflation-compensation dynamics

1,0 1

1h

dd

d dW W P w P w

t Ptd dt

– Simple model with

• Bank lending to Firms only• Deposit and wage income to households• Generates stylized facts of Great Moderation/Depression

– Decline in employment & inflation volatility– Then sudden collapse into deflation & rising unemployment



A strictly monetary macroeconomic model• Model equations:

( ) ( )

( )( ) ( )

( )

( ) ( )

Prices an

Finance

d Wage

Sector

s

V L V

R r L r

L V Lr

L r R r

SD V L Dr L L D D

L r R r W B

D DD D

W

S SL L D D D D

B

B F B

dF B F I Y

dt

BdF B F W I Y r F r F W L

dtdW W

W L r W

ddt

dt

dB Br F r F r W

dt

dPdt

1(1 )

1 1( )

P

h

W P

a s

dW d dW P w P

dt dt P dt

Production

Productivity &

R

RR

R

r RR

L D DLr

R

Y P Y

KY vY

LaL

NIdK

Kdt v

F r F

K

Population

daa

dtdN

Nd

Y W L

t

r

P



Monetary Macroeconomic Model & Economic Data• Uncalibrated model output… • Smoothed actual US data…

0 10 20 30 40 50 6010

8

6

4

2

0

2

4

6

8

10

0

50

100

150

200

250

300

350

400

450

500

InflationUnemploymentDebt to GDP

Inflation, Unemployment & Debt Ratio

P e r c e n t o f

W o r k f o r c e , - P e

r c e n t p . a .

P e r c e n t o f G D P

0

1980 1985 1990 1995 2000 2005 2010 201501234

56789

1011121314

15

150160170180190

200210220230240250260270280290

300

InflationUnemploymentDebt to GDP

Inflation, Unemployment & Debt Ratio

Year; Source BLS

P e r c e n t o f W o r k f o r c e , - P e r c e n t p . a .

P e r c e n t o f G D P

0





Extending Monetary Macroeconomic Modelling• Monetary modelling clearly adds to our understanding of the economy• Preceding model still very simple & incomplete

• New research agenda: building a platform for monetary modelling• Extend existing “system dynamics” technology to handle money flows • Innovation: accounting double-entry creates stock-flow consistent

monetary dynamics– Bank accounts in columns– Transactions between accounts in rows– Multiple banks —including Central Bank—easily modelled– Double-entry to ensure stock-flow consistency– Complex system of financial flow ODEs built with ease…





Extending Monetary Macroeconomic Modelling• Simulate numerically:



Extending Monetary Macroeconomic Modelling• Generate stock-flow consistent system of ODEs automatically:

B W

B

W

Firm Lend Int Wages Cons Cons Repay

Loans Lend Repay

Safe Int Cons

WorkersWages Cons

d dtd

dtd

dtd

dt

• Easily linked to physical production system• Extensible to multiple banks, multiple sectors, input-output dynamics,

international trade and financial flows…



Extending Monetary Macroeconomic Modelling• Multiple banks with Central Bank as clearing house…



Extending Monetary Macroeconomic Modelling• Multiple sectors, input- output dynamics can be modelled…

0 20 40 60 80 1005

0

5

10

15

Capital GoodsConsumer GoodsAgricultureEnergy

The Rate of Profit in a Monetary Multisectoral Model of Production

Years

P r o

f i t / C a p

i t a ( P e r c e n

t )

100 pr K t( )

100 pr C t( )

100 pr A t( )

100 pr E t( )

t



Conclusion• Economic crisis shows need for macro models to incorporate financial

sector, debt & money dynamics

• Minsky’s Hypothesis provides insights missing in DSGE models• Monetary macro models should be added to toolkit of Treasuries,

Central Banks• Technology to make monetary modelling straightforward now exists

– http://sourceforge.net/p/minsky/home/Home/ • Let’s jointly develop the technology & the models…

http://sourceforge.net/p/minsky/home/Home/

https://www.kickstarter.com/projects/2123355930/minsky-reforming-economics-with-visual-monetary-mo?ref=home_location



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Keen2013NICTA Minsky