Monday, December 3, 2012

Steve Keen on Debt in Neoclassical Economics

Another talk from Steve Keen, and this time given in Berlin (1 December, 2012).

This talk examines the issue of debt in a capitalist economy, and loanable funds versus endogenous money theory.


  1. I'm not a huge Krugman fan but I do think Keen misrepresents him in this talk.

    He quotes Krugman as saying "debt is basically money we owe to ourselves" and gives the impression that Krugman is talking about private debt.

    I just read Krugman's book and he is talking about govt debt in the context of arguing that running up govt debt in a liquidity trap is not such a big deal - a position that I am sure many post-Keynsians might agree on.

    I'm not sure if this typical of Keen, but it seems a pretty odd thing to do since it was obvious what Krugman meant.

    1. @ Rob:

      I think you are right that Krugman referred with that statement to government debt. However, Steve Keen and Krugman had a huge controversy on NY Times relating to the role of money and banking (see here Further, the argument can be easily transfered to private debt. Since debt of all sectors of a (closed) economy (firms, household, state) net out with assets to zero (one persons liabiloty is another persons asset). The core of the controversy is not that trivial accounting identity but that Keen stresses that debt creation has impact on aggregate demand.

      Keen to my knowledge (and as indicated in his slides where he argues government debt has cushioned deleveraging and hence GDP decline) clearly agrees that government should not embark on austerity in a crisis. However, Keen also argues that banks create loans (and hence assets and debts) out of nothing (without drawing on reserves or prior deposists). Hence, debt is creating new spending power beyond current income (which Krugman rejected in NY Times and in a Minsky model he established since he argues debt is just what other people have deposited beforehand). If now due to huge debt levels in the private sector and crisis households have to reduce private debt levels spending power will be destroyed again.

      Keens political implications are as follows: Firstly, credit and hence debt can be a positive source of growth (e.g. financing investment). However, if it is used to finance asset price booms (such as mortgage debt) it may lead to bubbles, which may burst and put a huge strain on the economy (such as witnessed in two decades of stagnation in Japan). Secondly, government should stabilise th economy in a crisis. However, the political question here is whether it is sound economics to let private debt levels or bubbles accumulate first and then the government (with taxpayers money or future interest commitments which redistribute income again to the financial sector) step in. This is why Keen for instance advocates partial debt cancellation, nationalisation of the financial sector and then monetizing public debt to grow out of the misery. Even in Germany some Keynesians argue that debt should be fully serviced as long as the central bank ensures low interest rates to grow out of the crisis. However, Keen thinks that with a certain level of private debt (which is in volume far more relevant to aggregate demand than public debt) too much private spending will be devoted to servicing debt to the financial sector. In other words: Keen argues that credit allocation and distribution matters (as Post-Keynesians argue that the IS-LM or New Keynesian version of Keynes as simply more deficit spending in a deflationary environment is a caricature since Keynes also stressed distributional factors and fundamental uncertainty and Minsky later the role of Ponzi-finance). If for example the wage share in the US would not have declined or income disparity not widened as much the need for private debt accumulation would have been cushioned and the need for government debt to stabilise the economy would have been reduced.

      In sum: Keen and Krugman do not so much disagree on the need of deficit spending (stabilizing) but on the role private debt can take on in feeding into bubbles and subsequent crisis (destabilizing). Whereas government debt or firms investment in the real economy contribute to GDP, private debt may trigger mere asset price booms which (apart from wealth effects such as shareholders feeling richer and hence spending more) are not productive.