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Australian Debt

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Anti-cyclical spending and taxation of government enables debts ... Convergence to equilibrium... If capitalists accumulate 'negative debt' But if they don't... – PowerPoint PPT presentation

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Title: Australian Debt


1
Australian Debt monetary model of financial
instability
  • Steve KeenUniversity of Western Sydney

2
Conventional Finance Theory
  • Finance and Economics completely independent
  • Finance markets
  • In equilibrium
  • Efficient
  • The data according to CAPM founder Eugene Fama?
  • the failure of the CAPM in empirical tests
    implies that most applications of the model are
    invalid. (Fama French 2004 25)
  • New model needed to explain empirical data
  • Most striking feature growth of debt relative to
    GDP
  • E.g., Australia 1964-2008

3
Australias debt driven economy
  • Australias private debt to GDP ratio has risen
    exponentially at 4.2 p.a. for over 43 years
  • Not an isolated phenomenon
  • 15 other OECD nations have similar debt to GDP
    data

4
The global debt-driven economy
  • 3 decades of growing debt to GDP across OECD
  • Empirical questions
  • Where would Romania fall on this continuum?
  • Why is France an exception?
  • Theoretical question
  • How to explain phenomenon?
  • An alternative theory

5
Minskys Financial Instability Hypothesis
  • A non-neoclassical vision of capitalism
  • capitalism is inherently flawed, being prone to
    booms, crises and depressions.
  • This instability, in my view, is due to
    characteristics the financial system must possess
    if it is to be consistent with full-blown
    capitalism.
  • Such a financial system will be capable of both
    generating signals that induce an accelerating
    desire to invest and of financing that
    accelerating investment. (1969 224 emphasis
    added)
  • Foundations in Marx, Schumpeter, Fisher, Keynes

Skip Quotes
6
Marx
  • Theoretical a dialectical theory of prices
  • What ... is the price of the loaned
    capital?... What the buyer of an ordinary
    commodity buys is its use-value what he pays for
    is its value. What the borrower of money buys is
    likewise its use-value as capital but what does
    he pay for? Surely not its price, or value, as in
    the case of ordinary commodities. (Marx 1894
    352)
  • Colourful a sceptical view of banking
  • ...The credit system gives this class of
    parasites the fabulous power, not only to
    periodically despoil industrial capitalists, but
    also to interfere in actual production in a most
    dangerous mannerand this gang knows nothing
    about production and has nothing to do with it."
    (Marx 1894 544-45)

7
Schumpeter
  • Well-known cyclical view of capitalism
  • Creative destruction, clusters of innovations,
    etc.
  • Less well-known endogenous view of credit
  • In so far as credit cannot be given out of the
    results of past enterprise it can only consist
    of credit means of payment created ad hoc, which
    can be backed neither by money in the strict
    sense nor by products already in existence...
    (Schumpeter 1934 106)
  • this again leads us to the heresy that money,
    and other means of payment, perform an
    essential function (95)

8
Fisher
  • Debt-deflation theory of Great Depressions
  • Non-equilibrium analysis
  • New disturbances are, humanly speaking, sure to
    occur, so that, in actual fact, any variable is
    almost always above or below the ideal
    equilibrium (1933 339)
  • two dominant factors are over-indebtedness to
    start with and deflation following soon after
  • Thus over-investment and over-speculation are
    often important but they would have far less
    serious results were they not conducted with
    borrowed money
  • I fancy that over-confidence seldom does any
    great harm except when, as, and if, it beguiles
    its victims into debt. (Fisher 1933 340-341)

9
Keynes
  • Well-known (if neglected) views on uncertainty
  • Formalised in Kaleckis principle of increasing
    risk (Kalecki 1937, 1990 285-293)
  • Investment limited not by declining marginal
    efficiency of capital but increasing financial
    risk
  • Also post-General Theory two-price level
    analysis
  • The scale of production of capital assets
  • depends, of course, on the relation between
    their costs of production and the prices which
    they are expected to realise in the market.
    (Keynes 1937a 217)
  • All blended by Minsky to produce Financial
    Instability Hypothesis

10
Financial Instability Hypothesis
  • Economy in historical time
  • Debt-induced recession in recent past
  • Firms and banks conservative re debt/equity
    ratios, asset valuation
  • Only conservative projects are funded
  • Recovery means conservative projects succeed
  • Firms and banks revise risk premiums
  • Accepted debt/equity ratio rises
  • Assets revalued upwards

11
The Euphoric Economy
  • Self-fulfilling expectations
  • Decline in risk aversion causes increase in
    investment
  • Investment causes economy to grow faster
  • Asset prices rise
  • Speculation on assets becomes profitable
  • Increased willingness to lend increases money
    supply
  • Credit money endogenous
  • Riskier investments enabled, more asset
    speculation
  • Emergence of Ponzi financiers
  • Cash flow always less than debt servicing costs
  • Profits made by selling assets on a rising market
  • Interest-rate insensitive demand for finance

12
The Assets Boom and Bust
  • Initial profitability of asset speculation
  • reduces debt and interest rate sensitivity
  • drives up supply of and demand for finance
  • market interest rates rise
  • But eventually
  • rising interest rates make many once conservative
    projects speculative
  • forces non-Ponzi investors to attempt to sell
    assets to service debts
  • entry of new sellers floods asset markets
  • rising trend of asset prices falters or reverses

13
Crisis and Aftermath
  • Ponzi financiers go bankrupt
  • can no longer sell assets for a profit
  • debt servicing on assets far exceeds cash flows
  • Asset prices collapse, drastically increasing
    debt/equity ratios
  • Endogenous expansion of money supply reverses
  • Investment evaporates economic growth slows or
    reverses
  • Economy enters a debt-induced recession ...
  • High Inflation?
  • Debts repaid by rising price level
  • Economic growth remains low Stagflation
  • Renewal of cycle once debt levels reduced

14
Crisis and Aftermath
  • Low Inflation?
  • Debts cannot be repaid
  • Chain of bankruptcy affects even non-speculative
    businesses
  • Economic activity remains suppressed a
    Depression
  • Big Government?
  • Anti-cyclical spending and taxation of government
    enables debts to be repaid
  • Renewal of cycle once debt levels reduced
  • Persuasive verbal model but no successful
    mathematical rendition
  • My research objective

15
Mathematical Foundations
  • Goodwins predator-prey growth cycle model
  • Verbal truisms
  • Workers share of output will rise if (real) wage
    demands exceed sum of population growth and
    labour productivity
  • Employment will rise if the rate of economic
    growth exceeds the rate of population growth
  • In mathematical form, two coupled differential
    equations

Phillips Curve
Depreciation, Productivity Population growth
rates
Workers share of output
Investment Function
Employment rate
16
Mathematical Foundations
  • Generates closed cycle
  • Add financial truisms
  • Banks finance investment and charge interest
  • Generates 3rd order system
  • Debt to output ratio added

Net real interest rate
Profit now net of interest payments
17
The beginnings of chaos
  • Two classes of outcome
  • Convergence to equilibrium
  • If capitalists accumulate negative debt
  • But if they dont

18
The beginnings of chaos
  • An unstable cycle
  • And debt that ratchets up over time to a
    debt-crisis
  • How well does this simple model match empirical
    data?
  • Not very
  • Because the empirical data is much worse!

19
The Ponzi Economy
  • Australias private debt to GDP ratio has risen
    exponentially at 4.2 p.a. for over 43 years
  • Not for the first time in our history either
  • Long term RBA data shows three bubbles in
    Australias financial history
  • Current bubble is the biggest by far!

20
The Ponzi Economy
And Our Generation?
The Baby Boomers Follies
1890s Depression
Great Depression
Melbourne Land Boom
Roaring Twenties
What comes next?
21
The Ponzi Economy
  • Correlation isnt causation, but

Clearly exponential process
Biggest bubble in our history
  • There is a macroeconomic link
  • Aggregate demand GDP change in debt
  • As debt rises, dependence on change in debt has
    risen
  • Now accounts for 18 of aggregate demand
  • Unemployment increasingly linked to change in
    debt

22
The Ponzi Economy
  • Correlation debts contribution to aggregate
    demand of to unemployment initially trivial
  • Exceeds -0.9 by early 1980s
  • Formation of debt also increasingly dominated by
    speculation rather than investment

23
Ponzi Households
  • Lending for housing rises from 5-25 of GDP
  • Proportion that financed housing construction
    falls from 30 to under 10
  • Back to modelling
  • Clear omissions from basic Minsky model are
  • Endogenous money
  • Speculative lending

24
Endogenous Money
  • Exponential growth in credit despite regulatory
    regime implies endogenous (market-determined)
    money
  • Common belief in non-neoclassical schools of
    thought
  • Empirically supported by Kydland Prescott
  • But no accepted mathematical model of process
  • One can be derived from double-entry book-keeping

Skip Systems Note
25
A simple approach to dynamic systems
  • Each column represents a stock (system state)
  • Each row entry represents a flow between stocks
  • Specify relations between system states across
    rows

Relations
Equations
  • To generate the model, add up each column
  • Sum of column is differential equation for stock

26
Money creation in a pure credit economy
  • Stylized linear model with three (classes of)
    agents
  • Banks
  • lend money to firms
  • record all transactions
  • Firms
  • own factories that produce output and
  • Workers
  • work in factories.
  • Model starts with loan L from bank to firm
  • Created out of thin airsimply simultaneous
    recording of asset (debt) and liability (deposit)
    in banks double-entry book-keeping system

27
Money from nothing, but your cheques aint free
  • Loan an asset of bank
  • Simultaneously creates liability of money in
    firms deposit account

  • Sets off series of obligations
  • Interest charged on loan at rL p.a.
  • Interest paid on deposit at rD p.a. where rL gt
    rD
  • Third account needed to record this Bank Deposit
    BD

28
Money from nothing, but your cheques aint free
  • Full system is

Interest flows banklt?gtfirm
Add up terms
Wage flows firm?gtworkers
Interest flows bank?gtworkers
Consumption flows bank workers?gtfirms
  • System of coupled differential equations

Get equation
  • System conservative
  • Amount of money
  • ( debt)
  • remains constant

29
Money from nothing, but your cheques aint free
  • Growth in output requires new money to
  • Hire more workers
  • Pay for intermediate inputs
  • Simultaneous creation of new debt and new money
  • System stable but no growth

Skip Quotes
  • Violates Walras Law
  • Supports Schumpeter Minsky on credit

New money flows bank?gtfirm
30
Money from nothing, but your cheques aint free
  • Schumpeter
  • in so far as credit cannot be given out of the
    results of past enterprise it can only consist
    of credit means of payment created ad hoc, which
    can be backed neither by money in the strict
    sense nor by products already in existence...
    (Schumpeter 1934 106)
  • Minsky
  • If income is to grow, the financial markets
    must generate an aggregate demand that is ever
    rising. For real aggregate demand to be
    increasing, . . . it is necessary that current
    spending plans, summed over all sectors, be
    greater than current received income
  • It follows that over a period during which
    economic growth takes place, at least some
    sectors finance a part of their spending by
    emitting debt or selling assets. (Minsky 1963
    1982 6)

31
Money from nothing, but your cheques aint free
  • Money and debt now grow over time
  • System dissipative
  • Rate of growth of money
  • rate of growth of debt

32
Repayment and Re-lending of Principal
  • Model so far omits loan repayment
  • Easily added by including seignorage free bank
    Vault
  • Repaid loans have to go somewhere
  • If into bank deposit account, bank can pay for
    goods using its money as IOUs
  • NOT the same as re-lending deposited fiat money
  • Pure credit money system requires quarantining
    of bank asset accounts from income (deposit)
    accounts
  • Bank assets now sum of
  • Outstanding Loans
  • Loan Repayments

33
Repayment and Re-lending of Principal
  • Repayments of Loans and
  • Recycling of Loans
  • Transfer money from income to asset accounts
  • Surplus from production drives all net income
  • P is turnover period
  • s is share going to firms
  • (1-s) goes to workers

Wages flow shown as share of production surplus
Repayment flows firm?gtbank
Relending flows bank?gtfirm
34
Would you like a credit card with that?
  • Can now see what happens to bank income as
  • New Money is created
  • Loans are repaid
  • Repaid money is re-lent
  • Surprise surprise!
  • Bank income rises if
  • Loans are repaid slowly (or not at all)
  • Repaid money is recycled more quickly and
  • More new money is created
  • Bank profits by extending more credit
  • Structural explanation for real world phenomenon
    of rising debt to GDP ratio

35
Would you like a credit card with that?
  • Surprise surprise!
  • Bank income rises if
  • Loans are repaid slowly (or not at all)
  • Repaid money is recycled more quickly and
  • More new money is created
  • Lenders profits by extending more credit
  • Structural reason for lenders creating rising
    debt
  • What if they decide to change direction?
  • Impact of credit crunch

36
Im sorry, you cant have a credit card with
that!
  • US Economy now experiencing a Credit Crunch
  • New money created less quickly
  • Loans repaid more quickly
  • Reserves re-lent more slowly?
  • Key relation is link between creation of bank
    assets and liabilities
  • In growing economy, growth of bank liabilities
    (active deposit accounts) positive
  • In a credit crunch, growth of liabilities turns
    negative

37
Dude, Who Moved My Economy?
  • Credit Crunch rate of money creation drops
  • repayment of loans increases
  • relending drops
  • Loans (Assets in circulation) fall even without
    bankruptcy
  • Economy falls into recession
  • Credit-driven economic reversal

38
For future research
  • Combine two models to produce monetary Minsky
    model
  • Speculative investment motivated by increase in
    asset price index
  • Adds to debt does not add to productive capacity
  • First stage a monetary Goodwin model
  • Also includes Phillipss full Monty
  • Wage change related to
  • Rate of employment
  • Rate of change of employment
  • Lagged response to inflation

Skip Model
39
For future research
  • Combine two models to produce monetary Minsky
    model
  • Speculative investment motivated by increase in
    asset price index
  • Adds to debt does not add to productive capacity
  • First stage a monetary Goodwin model
  • Also includes Phillipss full Monty
  • Wage change related to
  • Rate of employment
  • Rate of change of employment
  • Lagged response to inflation

Skip Model
40
A monetary Goodwin model
  • Now six system states
  • But remarkably simple model

Physical Capital
  • Generates open cyclical model

Money Wage
Inflation
Lagged wage response
Technical changePopulation growth
  • With Phillips surface rather than Phillips
    curve inflation and unemployment dynamics

41
Meanwhile, in the real world
  • Combination of record Debt/GDP, high nominal
    interest rates and low inflation means huge real
    interest burden
  • Debt burden
  • Aggregate demand effect of debt reduction
  • Serious downturn inevitable
  • Counter forces
  • China boom
  • Possible global warming/peak oil inflation

42
Selected References
  • Joseph Schumpeter (1934), The Theory of Economic
    Development An Inquiry into Profits, Capital,
    Credit, Interest, and the Business Cycle
    (republished 2004 by Transaction Publishers, New
    Brunswick)
  • Charles Whalen, The U.S. Credit Crunch of 2007
    A Minsky Moment, http//ideas.repec.org/p/lev/lev
    ppb/ppb_92.html
  • Some web-accessible references on Minskys work
  • http//www.debunkingeconomics.com/FinancialInstabi
    lity.htm
  • A Google Scholar search on Minsky
  • http//scholar.google.com.au/scholar?qhymanminsk
    yhlenlr
  • Some web-accessible references on endogenous
    money
  • http//www.debunkingeconomics.com/Lectures/Index.h
    tmFE
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