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Tuesday, June 14, 2011

Transcript: 445 Steve Keen and the Credit Accelerator

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This week, we’re looking at debt and money and the impending double dip with Australian economist Steve Keen.

On Monday, our reading of Keen described how money is not a function of the Fed in its wisdom creating some rate or level of base money that is then multiplied by a passive banking sector. Because introductory and advanced textbooks say this is the way it is doesn’t make it so. Rather, the banking sector creates loans, whose object is deposits in one or another bank account, and goes looking for the reserves later. This makes a difference because the level of debt and the change in debt makes a difference to demand.
You will have no difficulty whatsoever in convincing an intelligent non-economist that demand is comprised of income and net borrowing. But Ben Bernanke, and as we saw, even such liberals as Paul Krugman, say debt is money owed from one person to another. Unless the tendency to spend is widely different between the two, there will be no effect on demand. I know, I know, bubbles depend on debt and easy credit, but what are you going to do? If their economic theories worked, we wouldn’t have gotten in this mess in the first place.

Today, we’re going to follow Keen on into debt. I guess we’re already in debt, but we’re going to follow Keen into an understanding of debt and what he calls the credit accelerator.
Credit and money is still the major weakness in the understanding of most progressive economists, but also notably the monetary authorities at the Fed.

“Clearly the scale of government spending, and the enormous increase in Base Money by Bernanke, had some impact,” says Keen, “But the main factor that caused the brief recovery—and will also cause the dreaded “double dip”—is the Credit Accelerator.”
The Credit Accelerator is Keen’s term for the function at any point in time of the change in the change in debt over previous year, divided by the GDP figure for that point in time. So it is net borrowing as a proportion of total demand. Keen is a demand sider in the sense that he concurs that contrary to the neoclassical model, a capitalist economy is characterized by excess supply, even during booms, and – here is a quote from Keen – “The main constraint facing capitalist economies is not supply, but demand.”

All demand is monetary, and there are two sources of money – incomes and the change in debt.

This Aggregate Demand is exercised not on just goods and services, but also on net sales of existing assets. Keen shows that the behavior of asset prices is directly related to the change, the acceleration, whether plus or minus, of debt. It’s not the only factor , but particularly in the current days of casino capitalism, that’s where debt goes, to finance asset price bubbles. The strong economy during the Great Moderation?


it wasn’t “improved monetary policy” that caused the Great Moderation, as Bernanke once argued, but bad monetary policy that wrongly ignored the impact of rising private debt upon the economy.

and later, quote

The factor that makes the recent recovery … different to all previous ones—save the Great Depression itself—is that this strong boost from the Credit Accelerator has occurred while the change in private debt is still massively negative. “

That is, we are de-leveraging, but the change is positive.

I believe this is conceptually easier if you consider much of the deleveraging is default and write-down, not paydown of debt, so it does not subtract from demand for new goods, services and assets, which is funded by incomes and new borrowing. This is a useful concept to carry forward, because whatever the moral stain attached, write-downs reduce the debt load without reducing – as much – the demand and output of the economy. But that is our view, not anything we found in Keen.

Back to the master, who illustrates – or shall we say, verifies – the impact of the credit accelerator in charts – reproduced online at Demandsideeconomics dot net.

The recent recovery in unemployment was largely caused by the dramatic reversal of the Credit Accelerator—from strongly negative to strongly positive—since late 2009:

The Credit Accelerator also caused the temporary recovery in house prices:

And it was the primary factor driving the Bear Market rally in the stock market:

These confirmations of the direct link between the acceleration of debt and the change in asset prices, expose the dangerous positive feedback loop in which the economy has been trapped, similar to what George Soros calls a reflexive process: we borrow money to gamble on rising asset prices, and the acceleration of debt causes asset prices to rise.

This is the basis of a Ponzi Scheme. But because it relies not merely on growing debt, but on accelerating debt, and ultimately that acceleration must either become infinite or end, so the scheme must end. When the acceleration of debt ceases, asset prices collapse.

If you look at the quarterly data, as opposed to the annual credit accelerator, it’s apparent that the strong acceleration of debt in mid to late 2010 is petering out. This diminished stimulus from accelerating debt is turning up in the data now.

“From now on, unless we do the sensible thing of abolishing debt that should never have been created in the first place,” Keen says, “we are likely to be subject to wild gyrations in the Credit Accelerator, and a general tendency for it to be negative rather than positive.” Remember, the debt acceleerator is operating as the general level of debt is falling. People are deleveraging, but at a greater or lesser pace. And Soros’s reflexivity starts to work in reverse. With each plunge in asset prices, the public becomes more wary of taking on more debt, reinforcing the downward movement.

Current private debt level is, Keen believes, perhaps 170% of GDP above the level where it typically finances entrepreneurial investment rather than Ponzi Schemes. “The end game here will be many years in the future. The only sure road to recovery is debt abolition—but that will require defeating the political power of the finance sector, and ending the influence of neoclassical economists on economic policy. That day is still a long way off.

Steve Keen


In drawing the line to the final dot, Demand Side suggests that any return to productive investment in private goods on a large scale is illusory. In the context of reducing private debt, there is no realistic scenario in which it bounces back in the way a mathematical model can bounce back. Debt and investment must be taken on by the public sector. We’re not going to produce real value in anything other than public infrastructure, education, rational energy uses, and climate change mitigation.

1 comment:

  1. The problem for policy makers is that to de-lever to a point where the economy and its debt level is stable means that the credit accelerator is going to work against policy makers for years. I doubt whether they have factored this in to their decisions.