1. What was the driving force behind writing the paper Finance and Economic Breakdown: Modeling Minsky’s Financial Instability Hypothesis?
I had become a critic of mainstream economics way back in 1971, in my first year at University, courtesy of being exposed to the “Theory of the Second Best” (Lancaster 1966) by our brilliant lecturer Frank Stilwell (Butler, Jones et al. 2009), and then discovering the “Cambridge Controversies” (Harcourt 1972) on my own in the economic department’s library. I was particularly struck by Samuelson’s concession of defeat in 1966 (Samuelson 1966), since we were using Samuelson’s textbook at the time, and there was no sign of this debate in his textbook, let alone the fact that he conceded that the rebels were right.
I was also doing first year mathematics at the time, and loved differential equations, but they simply did not turn up in my economics courses, where the mathematical techniques used seemed arcane by comparison.
Like all critics, I looked for alternative analyses to Neoclassical economics. None of the alternative literature really inspired me, until I read Minsky. Marxian economics had an obvious flaw to me that I spotted when I first read Capital in 1973: Marx’s dialectical philosophy contradicted the Labour Theory of Value (Keen 1993; Keen 1993). Austrian economics was watered-down Neoclassicism. Post Keynesian was realistic but felt arbitrary—there was no unifying theory of value.
Most of the critiques of capitalism argued that it had a tendency to stagnation (Baran 1968), something that in my own experience I couldn’t see. My Arts Degree coincided with a huge boom, driven largely by real estate in Sydney (Daly 1982), and it seemed to me there was a tendency to euphoria rather than depression. Then the boom busted spectacularly in 1975 when I was completing my Law degree. There were financial failures everywhere, and unemployment trebled. I wanted a theory that would explain that process.
I finally found this theory when I went back to university in my mid-30s to do a Masters degree as a prelude to undertaking my PhD. Bill Junor, an excellent Keynesian lecturer there, set us the task of reviewing a major book in the Macroeconomics module in 1987. Minsky’s John Maynard Keynes (Minsky 1975) was one of the books on the list. I’d heard of his name before, but I hadn’t read anything by him. So, I chose to review it.
It was a revelationary experience. Finally, I had found a critic of capitalism who appeared to understand its tendency to credit-driven booms and busts, and who was free of the proclivity to reason in equilibrium terms:
“we are dealing with a system that is inherently unstable, and the fundamental instability is “upward.”” (Minsky 1975, p. 162)
However to me, there was one obvious weakness in Minsky’s analysis: the mathematical model he had tried to build of his Financial Instability Hypothesis was based on Hicks’s 2nd order difference equation model of the trade cycle:
I already knew that this was a bad model in itself, because I had applied my mathematics training to analyzing it in another course, and showed that it was economically invalid. It was derived from adding together, as Hicks defined them, actual savings 
and desired investment 
. There is no economic theory, Keynesian or otherwise, that says that this addition makes any sense (Keen 2020). But at the same time, Minsky’s verbal model was eminently suited to treating in differential equation terms. It considered an economy in historical time, as opposed to the faux equilibrium “time” of Neoclassical models, and even the logical time of Robinson’s “Golden Age” analysis. It had the “initial condition” that it began after a preceding economic crisis—because we are dealing with the real world where such a history exists, rather than the stale blackboard abstractions of Neoclassicism.
While I did my Masters, I also sat in on undergraduate mathematics courses at the University of New South Wales, since it was by then more than 15 years since I had last studied mathematics. The staff there alerted me to the fact that the department’s by-then-deceased founder, the John Blatt, had turned his formidable mathematical skills to critiquing economics, in a brilliant book entitled Dynamic Economic Systems: A Post Keynesian Approach (Blatt 1983). In it, Blatt praised Richard Goodwin’s “A growth cycle” model(Goodwin 1967), and explained it far more clearly than Goodwin himself had done. He concluded that one flaw of the model—that its equilibrium was “not unstable”!—could be remedied by introducing a financial sector:
Of course, the model is far from perfect. In particular, we feel that the existence of an equilibrium which is not unstable (it is neutral) is a flaw in this model; so is the possibility of arbitrarily large cycles. The first flaw can be remedied in several ways: (1) introduction of more disaggregation in the nature of the output, e.g., separate outputs of consumer goods and investment goods; (2) introduction of a financial sector, including money and credit as well as some index of business confidence. Either or both of these changes are likely to make the equilibrium point locally unstable, as is desirable. (Blatt 1983, p. 210)
I took that as my lead, and added the private debt ratio as a third system state to the two in Goodwin’s model, the employment rate and the wages share of GDP. I was astonished to see that the resulting model not only reproduced the prediction Minsky made—that capitalism could fall into a debt-deflationary trap after a series of credit-driven boom and bust cycles—but also generated an unexpected result, that the cycles in the economic growth rate would diminish at first and then rise.
This discovery forced me to take seriously the nascent area of chaos and complexity studies, since it turned out that this phenomenon was first identified in studies of fluid dynamics (Pomeau and Manneville 1980) inspired by Lorenz’s work on turbulence (Lorenz 1963).
Because I have primarily explored the private-sector-only model since then, it is worth noting that I also developed a model of a counter-cyclical government, which generated another model displaying far from equilibrium dynamics. This replicated Minsky’s observation that “Big Government” could stabilize an unstable economy.
2. What influenced the interest in data from the United States if you have previously analyzed Australia?
I first became aware that my Minsky model was becoming an empirical reality when I was asked to write an Expert Witness opinion in a law case over predatory lending, in December 2005 (Keen 2005). Looking at the data through both Minsky’s eyes and the lens of my model, it was apparent to me that this was “It”: the crisis about which Minsky asked “Can “It” Happen Again?”. Minsky had argued that a combination of government deficits and lender of last resort interventions by the Central Bank could prevent a deep crisis (Minsky 1963; Minsky 1982), but Neoliberal ideology had weakened both of these since he wrote. It seemed to me that a repeat of “the Big One”—the bust that led to the Great Depression—was imminent, though its severity would be attenuated by an inevitable rise in net government spending once it occurred. Someone had to warn about it, and at least in Australia, that somebody was me.
I established the blog http://www.debtdeflation.com/blogs/, went on the media as much as I could, and successfully raised the alarm in Australia—only to see its government enact policies that re-started the Australian housing bubble (see FHB Boost is Australia’s “Sub-prime Lite”) and thus prevent a deep crisis in Australia, while one occurred in the USA.
I copped a lot of flak in Australia for being wrong—”there wasn’t a crisis, so what were you worried about?”, while the fact that this was a global crisis was ignored. That alone encouraged me to focus less on my own country and more on the rest of the world.
Also, one of the original difficulties in doing this work was that the core data—the level and rate of change of private debt—wasn’t recorded in a systematic way by any international authority. But then the Bank of International Settlements, following the lead of its superb research director Bill White (Bill was the only person in an official capacity to have read and understood Minsky, and was thus aware of the potential for a crisis, and warning of it via official BIS publications), started publishing an excellent database on private and government debt with data from over 40 countries. This made it easy to analyse debt at the global level.
Despite its problems, America is still the biggest economy on the planet, and the most self-contained. So extraneous factors—like for example, Chinese demand to buy housing, or export price and exchange rate volatility, don’t wash out the inherent dynamics as much in the USA as they can in Australia, Canada, the UK, etc. So it made sense to focus on the USA so that the general principles of monetary macroeconomics were more obvious.
3.Why do you think so few economists predicted the crisis from the year 2008? what should we learn from this lesson?
It’s the same reason that no Ptolemaic astronomer predicted the return of Halley’s comet: they were using the wrong paradigm. In Ptolemy’s model of astronomy, the Earth was at the centre of the Universe, the Heavens were perfect and unchanging, and the Earth was where change and decay occurred. In that paradigm, comets were atmospheric phenomena and therefore couldn’t be predicted.
Likewise, according to the Neoclassical paradigm, credit (which I define as the annual change in private debt), is simply a transfer of money from one non-bank agent to another, and it simply redistributes spending power, without changing its magnitude. With this perspective, increasing or falling levels of credit can’t be predicted to have any significant impact on the economy, unless you know in advance which agents have a higher propensity to spend: it’s quite possible that a fall in credit could cause an increase in aggregate demand because savers had a higher propensity to spend than borrowers. This is exactly the reason that Ben Bernanke, who was in a position to see the data on private debt, and do something about it rising too quickly, completely ignored it instead. He asked the right questions about the Great Depression—what caused aggregate demand to plunge and stay so low:
Because the Depression was characterized by sharp declines in both output and prices, the premise of this essay is that declines in aggregate demand were the dominant factor in the onset of the Depression. This starting point leads naturally to two questions: First, what caused the worldwide collapse in aggregate demand in the late 1920s and early 1930s (the “aggregate demand puzzle”)? Second, why did the Depression last so long? In particular, why didn’t the “normal” stabilizing mechanisms of the economy, such as the adjustment of wages and prices to changes in demand, limit the real economic impact of the fall in aggregate demand (the “aggregate supply puzzle”)? (Bernanke 2000, p. ix)
You can see his Neoclassical paradigm getting in the way already—the belief that capitalism has “”normal” stabilizing mechanisms of the economy, such as the adjustment of wages and prices to changes in demand”. But at least he’s starting from the right question, which is what caused aggregate demand to plunge so much.
But he then rejected the most accurate explanation for what caused that plunge—Irving Fisher’s “Debt Deflation Theory of Great Depressions” (Fisher 1932; Fisher 1933) because it relied on changes in bank lending causing changes in aggregate demand, and in his Neoclassical, “Loanable funds” paradigm, that couldn’t happen:
The idea of debt-deflation goes back to Irving Fisher (1933). Fisher envisioned a dynamic process in which falling asset and commodity prices created pressure on nominal debtors, forcing them into distress sales of assets, which in turn led to further price declines and financial difficulties.” His diagnosis led him to urge President Roosevelt to subordinate exchange-rate considerations to the need for reflation, advice that (ultimately) FDR followed. Fisher’s idea was less influential in academic circles, though, because of the counterargument that debt-deflation represented no more than a redistribution from one group (debtors) to another (creditors). Absent implausibly large differences in marginal spending propensities among the groups, it was suggested, pure redistributions should have no significant macroeconomic effects. (Bernanke 2000, p. 24)
All it would have taken is a look at the data, which was available when Bernanke wrote his Essays on the Great Depression (Census 1949; Census 1975). But he didn’t even look, because his paradigm told him that data was irrelevant.
So much for being irrelevant. But still, over a decade after the crisis, Neoclassicals are ignoring this data, and the Central Banks that are telling them that their textbook models of banking are wrong (Krugman 2014; McLeay, Radia et al. 2014; Deutsche Bundesbank 2017).
What we should learn is that economics is dominated by a paradigm that is as wrong about capitalism as Ptolemaic astronomy was about the universe. We need a new paradigm, and there is virtually nothing in the old paradigm that will be of use in the new.
4. What do you think about consequences from the covid-19 crisis for the World economy?
In the medium run I think it will end the fetish for globalisation, which has really been about the West exploiting low wages and the East using this to industrialize rapidly. The perverse outcome this has led to with Covid-19 is that southeast Asia and China in particular were well prepared for the pandemic by having the manufacturing capability to supply their populations with personal protective equipment (whereas the developed nations, which had outsourced their manufacturing, could not), and the social capacity to enforce social distancing policies. Now China, most of southeast Asia, maybe Japan and South Korea, and a handful of non-Asian countries—including New Zealand and perhaps Australia, but also Norway, Switzerland, Croatia, Lithuania, Angola and Zambia, and other scattered countries—will be a virus-free block. America, Europe, especially the UK, Russia and South America will be in a virus-zone.
It’s a division of the planet unlike anything in our history. Previous blocks have united countries with similar histories or politics; nothing of the sort applies here. But they will form because it will be easy to travel between virus-free countries, difficult to travel between virus-afflicted, and very difficult to cross the viral border. It is a fractured planet.
Figure 1: The www.endcoronavirus.org website’s map of the fractured planet
This will have all sorts of effects on the global economy, some of them contradictory. China’s power and prestige will be enhanced, as will its dominance of its local region—unless Japan manages to overcome the virus as well. Seaborne transportation of manufactured goods will be severely compromised, since ships need crews, who would need to be quarantined at either end of their journeys, drastically increasing the costs and creating points of weakness in disease control measures. Bulk transport of oil and coal and other minerals might still work, but more likely rail transport and pipelines would dominate. This could strengthen Russia over Saudi Arabia, for example.
At the macroeconomic level, it promises a debt-deflation at the end of the measures used to contain the virus. These measures have been successful trials of many progressive ideas—such as a Universal Basic Income, or direct funding of the UK Treasury by the Bank of England—which we might have thought would never see the light of day.
However, governments are likely to revert to Neoliberal type, cut back government supports too early, and institute austerity again to try to reduce government debt levels, even though austerity is a major reason why they were unprepared for the pandemic in the first place. This could lead to a debt-deflationary crisis in the USA, UK and Europe—and even Australia, which is already imposing austerity measures.
One worrying trend here has been a huge jump in corporate indebtedness, probably due to companies borrowing to be able to sustain unavoidable outlays in the midst of a collapse in their cash flows.
There could be a wave of evictions of renters and mortgagors too, thanks to the huge rise in unemployment and collapse in “the gig economy” jobs that kept many households barely solvent before the crisis.
My fear is that the government response to the aftermath of the crisis will be as bad as the response to it during the crisis, generally speaking, was good. So bankruptcies and poverty effects which were minimized during the crisis by the large scale government financing that was needed, will instead occur after the crisis.
That still assumes that there will be an “after”, which depends on the development of a vaccine and its effective distribution to enough of the world’s population to drive the vaccine extinct. That is still a speculation rather than a certainty. It is also possible that Covid-19 is just the first wave in a sequence of global environmental crises that are caused by the excessive pressure of human industrial society on the planet.
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