One of my recurring fantasies is to reanimate Maggie Thatcher and Ronald Reagan on UK and Dutch trains, to tell them the year, and then ask them where they think they are—with only the ownership information and the performance and quality of the carriages to go on. The UK has privatised its rail system, the Netherlands’ system is still in public ownership; one has high quality modern fast trains, while the other is still operating museum pieces.

In researching this post, I’ve realised that I’m being a bit harsh on Thatcher—it was her successor John Majors who privatised the UK’s railways, and Thatcher herself was apprehensive about how privatisation would actually perform (McCartney and Stittle 2017, p. 2). But apart from that, I’d bet bottom dollar that they would get their locations 100% wrong. When sitting in the modern, high-speed trains, they’d think they were in the UK; and when sitting in the museum pieces slowly vibrating their way forward, they’d think they were in The Netherlands.

As someone who spends a lot of time on both rail systems, I know that the opposite is starkly true. British rail services are antiquated, unreliable, expensive, and slow. Dutch—and most European publicly owned and operated rail services—are modern, reliable, cheap and fast.

So, why did it all go do wrong, Maggie and Ronnie?

The numbers—charts here come from an EU survey (Steer-Davies-Gleave 2016)—are stark. Passenger miles, remarkably, have grown more in the UK than anywhere else in Europe (see Figure 1), so there’s reason to expect the UK might have benefited from economies of scale in this high-fixed-cost industry. If so, fares should have grown more slowly in the UK than elsewhere—and this is what (McCartney and Stittle 2017) predict would have happened, had the UK’s system not been privatised.

Figure 1: (Steer-Davies-Gleave 2016, p. 6 )

But the privatised system has resulted in much higher costs for UK commuters than their European counterparts, at every distance from suburban (see Figure 2) to interurban (see Figure 3, Figure 4, and Figure 5).

Figure 2: (Steer-Davies-Gleave 2016, p. 37) The list is alphabetical, and the UK tops the costs for suburban fares

Figure 3:(Steer-Davies-Gleave 2016, p. 56)

The outcome is worst at the interurban level, where UK trains are two to six times as expensive as their European counterparts—see Figure 4.

Figure 4: (Steer-Davies-Gleave 2016, p. 60)

The practical import of this is to make the UK into a set of isolated city economies, with only one of those—London—being of any significant scale. A rail journey of any distance in the UK is a prohibitively slow and expensive undertaking, so private sector economic activity remains small scale (or roads take the burden, but at higher monetary, environmental and time costs). The poor quality and high cost of the UK’s rail system has led to a fragmented and underperforming private sector as well.

Figure 5: (Steer-Davies-Gleave 2016, p. 63) The Netherlands isn’t listed because it’s too small for +300km interurban routes

McCartney and Stittle conclude that “in cost terms alone, the dismantling of British Rail was ill-judged and has proved to be a major public policy error… proponents of privatisation argued that the private sector would improve efficiency and provide ‘better value for money’ over the ‘dead hand’ of the state. But this was largely an illusion… (McCartney and Stittle 2017, pp. 16-17).

Why did privatisation fail, on its own grounds? McCartney and Stittle give a good analysis of this in terms of the conditions of the rail industry alone, but I’m thinking of the wider issue: is there a general issue behind the failure of privatisation to deliver what its proponents expected in so many areas, from rail to education to sewerage management?

The Payback Period

Avner Offer provides such a general principle in his recent book Understanding the Private-Public Divide: Markets, Governments and Time Horizons (Offer 2022): the time horizon for investment in ventures like railways, schools and sewerage systems lies outside the payback period that private investors expect:

in market societies, undertakings that pay off inside the credit time horizon are typically undertaken by business. This suggests a division of labour: market competition for short-term provision; government, not-for-profits, and the family for long or uncertain durations. This boundary predicts where the limit is likely to run and sets down where it ought to be. When violated in either direction, poor outcomes are likely, inefficiency, corruption, or failure. (Offer 2022, p. 13)

The current UK catastrophe with sewerage-laden rivers provides a particularly stark example of this: it is, as one TV commentator remarked, “immensely profitable” not to invest in the infrastructure that would stop raw sewerage being dumped into UK rivers. The returns from the investment are slow and occur over long time horizon; it’s actually more profitable to not make the investment now, and either dump the cost on the community (degraded waterways), or let some future management wear the disaster management costs in the distant future.

Public ownership, on the other hand, leads to public-service-oriented management, and the investment will be made because it’s the right thing to do in public service terms, and not because it creates a higher return today. Paradoxically, this can lead to lower costs and prices to the public from public ownership, because keeping the infrastructure up to date reduces maintenance and other costs indefinitely.

This perspective takes ideology out of the public-private question: businesses with short-term or medium-term returns are the private sector’s forte; services with long-term returns are best handled by the public sector.

I’d go one step further than Offer in defining the payback period—which he relates mainly to the length of time it takes for interest on a loan to equal the original loan itself:

The higher the market interest rate (or the private discount rate), the less time is available to break even… The time boundary between private and public enterprise is easy to draw. It is the ‘payback period’, the time required for interest on a loan to add up to the original advance, under the prevailing interest rate… A project which takes longer than the payback period to break even cannot pay its capital cost and cannot be undertaken for profit. (Offer 2022, pp. 13-14. Emphasis added)

Even at currently elevated interest rates, that implies that the time-division between favouring private and public ownership is 20 years. But the payback period that businesses contemplate is often much shorter than that: Offer notes that “Three different studies suggest rates of return around 15 per cent (payback 6.6 years)” (Offer 2022, p. 15). Also, investment advisors disparage the payback period “because it ignores the time value of money”. However, the mathematician-turned-economist John Blatt provided an ingenious explanation of how the payback period in fact includes not only “the time value of money” but also uncertainty about the future (Blatt 1983, 1980, 1979).

Standard time value of money calculations like Net Present Value discount expected future returns by the prevailing interest rate, plus sometimes an additional margin for uncertainty. Blatt points out that this implies that uncertainty is constant over time, but at the very least, uncertainty about future returns rises with time. So, he proposed discounting by the interest rate plus an additional amount multiplied by time: discount by , rather than just by : the additional factor  accounts for the uncertainty of future returns.

This gives a sharply nonlinear profile to the discount, which can be factored into the desired rate of return and the probability of a failure of expected returns to occur. The payback period combines the two, and it is therefore more sophisticated, in terms of accounting for time, than Net Present Value.

It also explains the very short private sector payback period that Offer found rules in practice, of not 20 years but 6-7. Uncertainty about the future is more important than the interest rate.

Privatising the rail system was thus one of many own-goals in UK public policy. The expectations were that this policy would boost the UK’s performance:

When a commitment to privatise the railways was finally made by the Major government (in the Conservatives’ Election Manifesto in 1992) these problems [considered by Thatcher] were simply ignored. The subsequent White Paper, a slim document of 21 pages ‘rather lightweight’ on the economic rationale behind the privatisation plans blandly asserted that a privatised industry would ‘mean more competition, greater efficiency and a wider choice of services more closely tailored to what customers want’ and ‘provide greater opportunities to . . . reduce costs, without sacrificing quality’ (McCartney and Stittle 2017, p. 2).

Not only did the opposite occur, but fallacy led to farce, in that the UK’s poorly functioning private rail sector is largely owned by the EU’s well-functioning public one:

and indeed now, in a farcical twist that nobody could have foreseen, many of the franchises are actually run, not by private enterprise but by state-owned European rail operators—the very ones that British Rail was out-performing in the 1980s. (McCartney and Stittle 2017, p. 17)

Blatt, John M. 1979. ‘Investment Evaluation Under Uncertainty’, Financial Management Association, Summer 1979: 66-81.

———. 1980. ‘The Utility of Being Hanged on the Gallows’, Journal of Post Keynesian Economics, 2: 231-39.

———. 1983. Dynamic economic systems: a post-Keynesian approach (Routledge: New York).

McCartney, S., and J. Stittle. 2017. ”A Very Costly Industry’: The cost of Britain’s privatised railway’, Critical perspectives on accounting, 49: 1-17.

Offer, Avner. 2022. Understanding the Private-Public Divide: Markets, Governments and Time Horizons (Cambridge University Press: Cambridge).

Steer-Davies-Gleave. 2016. “Study on the prices and quality of rail passenger services.” In, edited by European Commission Directorate General for Mobility and Transport. European Commission Directorate General for Mobility and Transport.

 

Pardon two nostalgia posts in a row, but after writing The Day I Pranked Paul Samuelson, I realised that I’d let pass possibly the most important anniversary in my peripatetic life: the 50^th anniversary of “The Day of Protest” at Sydney University on July 25^th 1973.

It was, to my knowledge, the first ever protest over economic theory and how it was taught at a university. Nothing like it happened again for almost 30 years, when French students created the Protest Against Autistic Economics (PAECON) in September 2000.

Another dozen years passed before students at Manchester University formed the Post-Crash Economics Society to revolt against their Neoclassical curriculum in the aftermath to the Global Financial Crisis.

All three protests had the same motivation. To quote from the first issue of the Post-Autistic Economics Newsletter, the French protesters called for “an end to the hegemony of neoclassical theory and approaches derived from it, in favour of a pluralism that will include other approaches, especially those which permit the consideration of “concrete realities”.”

Each of these protests was successful in the short-term. Our protest at Sydney University led to the formation of a Department of Political Economy; the French students’ protest gave birth to the Real-World Economics Review, which is still going today; and the Manchester protests led to the formation of Rethinking Economics, which supports students around the world who are dissatisfied with the state of economics today.

But more than 50 years after our protest, that same hegemony is alive and well—or at least undead. The Neoclassical pedagogy that I railed against in the 1970s has evolved into something even more absurd and anti-realistic than the absurd and anti-realistic dogmas I protested against in 1973 (Krueger 1991). So, since the objective of our protests was to replace the fantasies of Neoclassical economics with a realistic approach to economics, they have failed.

Of course, we didn’t know that we would fail, back in July 1973, when 300+ students voted to hold a “Day of Protest” against the boring and delusional theories we were being fed by the conservative curriculum at Sydney University. Instead, we experienced the thrill of openly challenging our Professors, giving alternative lectures on the actual day, marching, chanting, waving banners, partying, and, in subsequent years, occasionally occupying the Vice-Chancellor’s office.

It was an exciting and life-changing experience for us all—for me more than most, since I devoted the rest of my life to continuing the rebellion we started in 1973. The buzz of optimistic rebellion is hard to explain to today’s harassed students, flitting between one part-time job and another as they try to pay their student debts. In 1973, it felt like real change was possible.

What do we want?
Political Economy!
When do we want it?
Now!

But what have we got, 50 years later? Political economy has continued on, but the mainstream is as ascendant as ever—despite its numerous failings at the time and since.

I had hoped, in those subsequent years, that a clear failure by Neoclassical economics would help expose it for the fraud it is: the failure to realise, in the Noughties, that a serious economic crisis was imminent (Keen 2006, 1995, 2020). Not only did they not realise it, they actually thought that they had eliminated the very possibility of crises. Speaking as the incoming President of the American Economic Association, Robert Lucas—one of the fountainheads of modern Neoclassical macroeconomics—made the following bold and utterly false statement in his Presidential lecture at the end of 2002:

Macroeconomics was born as a distinct field in the 1940’s, as a part, of the intellectual response to the Great Depression. The term then referred to the body of knowledge and expertise that we hoped would prevent the recurrence of that economic disaster. My thesis in this lecture is that macroeconomics in this original sense has succeeded: Its central problem of depression prevention has been solved, for all practical purposes, and has in fact been solved for many decades. (Lucas 2003, p. 1. Emphasis added)

Two decades later, despite the failure of Neoclassical “Dynamic Stochastic General Equilibrium” models to anticipate the biggest economic crisis since the Great Depression, and despite Nobel Laureates like Paul Romer and Joseph Stiglitz rubbishing them, they are still the workhorses of Neoclassical economics.

Today’s students are still required to learn these arcane and misleading models, as if the crisis they failed to anticipate did not occur.

Why has Neoclassical economics persisted, despite its many failures? Mainly because, as Max Planck put it, a real science overthrows a false paradigm, not by persuading existing believers to change their minds, but by generational change:

It is one of the most painful experiences of my entire scientific life that I have but seldom—in fact, I might say, never—succeeded in gaining universal recognition for a new result, the truth of which I could demonstrate by a conclusive, albeit only theoretical proof… A new scientific truth does not triumph by convincing its opponents and making them see the light, but rather because its opponents eventually die, and a new generation grows up that is familiar with it. (Planck 1949, pp. 22-4. Emphasis added)

Generational change occurs in sciences because, once an anomaly is discovered that contradicts a prediction of the dominant paradigm, the anomaly exists forever, and any student can replicate it for themselves. Once the Michelson-Morely experiment disproved the theory of the “aether“—a substance that, according to the Maxwellian theory of electromagnetics, was supposed to fill space to enable light waves to be transmitted through it—then any student could find the anomaly for themselves.

But in economics, anomalies are historical and transient. The Great Depression, WWII, the post-War “Golden Age of Capitalism”, the 70s Stagflation, the 80s stock market bubble, the 90s recession, the Great Recession, now the post(?)-Covid boom and inflation… Each new crisis knocked the previous one off its pedestal. The fact that Neoclassical economics can’t explain the Great Depression—or that it has an explanation which is an insult to anyone who lived through it (Prescott 1999)—doesn’t matter to any modern economist who is working on the Covid inflation issue. Old failures can be forgotten.

Just as importantly, the underlying Neoclassical vision of capitalism is a highly seductive one: it is a meritocracy in which what you earn is what you deserve, where harmony rules because of equilibrium, and which is free of coercion: there’s no need for government control when the market works perfectly. Therefore, even if some students break away from Neoclassical economics because of one of its failures, enough “true believers” can be found in the student body to replace existing “true believers” when they retire. I spent my late teens fighting against believers in Neoclassical economics who were then two to three times my age. Now in my seventies, I am fighting believers in Neoclassical economics who range from being my contemporaries (Paul Krugman is one month older than me) to being one third of my age.

In a nutshell, funerals aren’t enough for a true scientific revolution in economics.

The final factor that enables economics to escape the revolutionary change it desperately needs is rather ironic: myths in economics survive because, despite the dominance of our politics by economic ideas, you don’t need economic theory or economists to have an economy. The economy exists independently of economists, and would probably function a lot better if economists simply didn’t exist. In contrast, engineering doesn’t exist independently of engineers: you need engineers to create the technological marvels the rest of us take for granted, and when something goes wrong with the things that engineers create, engineers face real consequences: a collapsing bridge fingers the engineers who didn’t take account of its harmonics, a crashing plane implicates the engineers (or their managers) who approved a faulty design.

To use Nicholas Taleb’s phrase, economists don’t have any “skin in the game”: they don’t suffer any serious consequences when their advice is badly wrong, and there is a myriad of complicating factors that they can point at to explain away any failure. Ironically, the fact that economists aren’t strictly necessary is something that gives them great power—they are the witchdoctors of capitalism, holding the leaders of our society in their thrall, while at the same time having no idea how that society actually works.

So, do I regret organizing The Day of Protest, half a century ago? Not a bit of it.

Firstly, though our protest failed to dislodge the mainstream, we were as right about Neoclassical economics being a false paradigm as Galileo was about the Ptolemaic model of the universe—and these days I’ve taken to referring to Neoclassical economics as Ptolemaic Economics to highlight that point. One should never regret fighting for truth and against fallacy.

Secondly, it was rewarding hard work. The 50 or so of us who put The Day of Protest together had never worked so hard in our lives before, and possibly since, and we worked for passion and a commitment to truth, rather than for money. Richard Osborne first proposed the idea, and became a pivotal part of our negotiating team; Greg Crough, Graham Kerridge, Richard Fields and I initiated the revolt and gave several of the alternative lectures; Bill Nichols responded to the need for banners by producing two 25 metre-long calico banners and numerous smaller ones; Kevin McAndrew churned out posters like an automaton.

Thirdly, I saw real courage at work. Several of the staff openly sided with the students: Paul Roberts, Jock Collins, and above all Frank Stilwell, put their careers on the line by speaking out in our favor, literally in full view of the Professors. Margaret Powers and Geelum Simson-Lee assisted us within the confines of the University’s administrative system. Other departments—including Accounting and Politics (then called Government) surreptitiously assisted us with printing facilities, and voted with us in the eventual successful Faculty motion to investigate the Department of Economics.

Fourthly, it was great, great fun. Hundreds of students attended the alternative lectures we put on, and most stayed for the mother of all parties that finished the evening.

Finally, it pointed the right way when the world was about to embark on a journey in the opposite direction. We didn’t realise it then, but our rebellion in 1973 was the counterpoint to the ascendancy of Neoclassical economics in the world of policy: at the same time that we were trying to pull it down, politicians, administrators and journalists around the world were succumbing to its fantasies. The stagnant and crisis-ridden decades that followed showed the gap between its promises and the impact of imposing its false beliefs on the real world.

If I had done nothing else of significance in the following 50 years, I could still look back on The Day of Protest with great pride and pleasure. So, from my 70-year-old self in 2023, to the 20-year old rebel in 1973, here’s lookin’ at you, kid.

Keen, Steve. 1995. ‘Finance and Economic Breakdown: Modeling Minsky’s ‘Financial Instability Hypothesis.”, Journal of Post Keynesian Economics, 17: 607-35.

———. 2006. “Steve Keen’s Monthly Debt Report November 2006 “The Recession We Can’t Avoid?”.” In Steve Keen’s Debtwatch, 21. Sydney.

———. 2020. ‘Emergent Macroeconomics: Deriving Minsky’s Financial Instability Hypothesis Directly from Macroeconomic Definitions’, Review of Political Economy, 32: 342-70.

Krueger, Anne O. 1991. ‘Report of the Commission on Graduate Education in Economics’, Journal of Economic Literature, 29: 1035-53.

Lucas, Robert E., Jr. 2003. ‘Macroeconomic Priorities’, American Economic Review, 93: 1-14.

Planck, Max. 1949. Scientific Autobiography and Other Papers (Philosophical Library; Williams & Norgate: London).

Prescott, Edward C. 1999. ‘Some Observations on the Great Depression’, Federal Reserve Bank of Minneapolis Quarterly Review, 23: 25-31.

 

“Poets are the unacknowledged legislators of the World.” It was a poet who said that, exercising occupational license. Some sage, it may have been I, declared in similar vein: “I don’t care who writes a nation’s laws—or crafts its advanced treaties—if I can write its economic textbooks.” The first lick is the privileged one, impinging on the beginner’s tabula rasa at its most impressionable state.

The opening paragraph in Paul Samuelson’s Foreword to The Principles of economics course: a handbook for instructors (Saunders and Walstad 1990, p. ix)

We hear a lot (as in far too much) about and from Larry Summers these days, but in the good old days, Summers was more famous for being Paul Samuelson‘s nephew than he was for being himself.

Samuelson, and not Keynes, was the true father of what became known as “Keynesian economics”. Samuelson developed what came to be known as the “Keynesian-Neoclassical synthesis” in his PhD thesis (Samuelson 1947). His textbook—initially called Economics: An Introductory Analysis (Samuelson 1948), later simplified to just Economics (Samuelson and Nordhaus 2010)—presented a palatable version of this thesis as an introductory textbook for students of economics in the post-WWII world. It quickly became the dominant economics textbook on the planet, and everything that has happened in economics since can be traced back to it.

Samuelson’s impact on the development of economic theory was so profound that he was the first sole recipient of the “Sveriges Riksbank Prize in Economic Sciences in Memory of Alfred Nobel“, in its second year of 1970. That was also the year that an Australian edition of his textbook was published, and adopted as a textbook by the Economics Department at the University of Sydney, where I began my undergraduate degree in 1971.

Two years later, in March 1973, Samuelson came to Sydney. This was big news at the time: “it was the first time an economics Nobel Prize winner had graced Australian shores”, Alex Millmow noted, and “Samuelson’s arrival made front page news in Australia’s business daily The Australian Financial Review (AFR)” (Millmow 2019).

Samuelson’s formal reason for the visit was to promote the Fulbright Scholarship scheme, but he also agreed to give a seminar at the University of Sydney—but not to the students. It was to be a staff-only seminar.

By this stage, I was an implacable critic of the entire Neoclassical edifice that Samuelson had created, and many of the academic staff felt the same way. They let me and a fellow student rebel, Richard Fields, know of the planned staff-only seminar, and we decided to prank it. I think Richard came up with the idea that we should put up posters announcing that Paul Samuelson would give a lecture in Merewether 1—the main lecture theatre in the Economics faculty building—at precisely the same time as his scheduled staff-only seminar. We’d publicity-shame them to move the seminar into the public arena.

Our ruse worked. At the appointed hour on March 22^nd 1973, the conservative staff in the department duly rolled into a lecture theatre that had about 150 students and some progressive staff already in attendance. They sat in the front two rows while Samuelson, ever the showman as well as the intellectual, explained that he was going to give us the talk he’d give “if my grandmother asked, what’s this ‘General Equilibrium’ thing?”.

The blackboards filled up with masses of equations, and then Samuelson got even with a prank of his own—though it was at the expense of the conservative staff, rather than us.

I was sitting about halfway back in the lecture theatre, next to Tony Phipps, the quantitative methods lecturer in the department. Tony was a great bloke: everyone liked him regardless of politics, and he didn’t take sides in the then very antagonistic arguments between the Neoclassical and anti-Neoclassical staff. We were sitting together to help each other follow the mathematics.

We were doing well until at one point, Samuelson made what appeared to both of us to be a simple error: putting a plus sign where he should have put a minus. One of us leaned over to the other—I can’t remember whether it was Tony to me or vice versa—and said, “Shouldn’t that have been a minus?”. “Yeah, I think”, the other replied, “but this is Samuelson”. I didn’t have the courage to put my hand up and query the maestro (even if I didn’t like his music), and neither did Tony.

A few minutes later, Samuelson stopped mid-sentence and said “Ooh, wait a minute, I made a mistake a few lines back. I put a plus where I should have put a minus!”. Pointing at the conservative staff in the front rows, he continued “You guys should have corrected me!”.

Touché Samuelson.

When he finished, my fellow student critic Richard C. “Gull” Fields asked the first question, which was why Samuelson had not spoken on “the aims and orientation of economics,” and “meeting the radical challenge to orthodoxy” rather than presenting “an academic model of strictly limited interest.” I can’t remember his answer, but my guess is that the real reason for such an esoteric choice of topic is that it’s what Professor Simkin, the effective head of the department, wanted Samuelson to lecture on.

Some commentators attributed the subsequent rebellion in the department—which began in earnest 4 months later with the “Day of Protest” (Butler, Jones, and Stilwell 2009, pp. 9-10 et seq.)—to Samuelson’s lecture. Millmow expressed this belief in his abstract to “The Samuelson Revolution in Australia”:

For the most part, Samuelson was given a rapturous reception, but his guest lecture at the University of Sydney on an ill-chosen subject merely fanned the flames of rebellion by students wanting an alternative to mainstream economics. (Millmow 2019)

In reality, if mathematical lectures played any role in fomenting the rebellion that began 4 months after Samuelson’s lecture (Butler, Jones, and Stilwell 2009), then the most significant catalyst was Simkin’s macroeconomics course, which he taught from his own textbook, Economics at Large.

The title was the best thing about this book, and it was replete with mathematical errors of its own—possibly due mainly to typesetting problems. Simkin would open every lecture with a list of the errors that students needed to amend in their copies, and in response I once asked him to produce an errata book to save us the trouble.

He replied that maybe I should produce that errata book myself instead.

Ultimately, I did. It’s called Debunking Economics (Keen 2011), and it covers most of the nonsense masquerading as logic that makes up Samuelson’s child of modern Neoclassical economics.

I’d like to think that I got the last laugh on both Simkin and Samuelson, but that’s not true. Having attended the funerals of two leading members of non-mainstream economics in recent years—Geoff Harcourt and Vicki Chick—I’ve realised that I too am likely to die before Neoclassical economics does.

Ultimately, my attempt to bring down this edifice of absurd assumptions and flimsy logic may end up being no more than a prank. The Neoclassical edifice will instead probably outlast not just me and its many other critics, but also the market economy that is supposed to be its subject. The truly dreadful work on climate change that has been done by William Nordhaus, who is also today’s editor of Samuelson’s seminal textbook (Samuelson and Nordhaus 2010), will see to that (Keen 2023).

Butler, Gavan, Evan Jones, and Frank Stilwell. 2009. Political Economy Now!: The struggle for alternative economics at the University of Sydney (Darlington Press: Sydney).

Keen, Steve. 2011. Debunking economics: The naked emperor dethroned? (Zed Books: London).

———. 2023. “Loading the DICE against pension funds: Flawed economic thinking on climate has put your pension at risk ” In. London: Carbon Tracker.

Millmow, Alex. 2019. ‘The Samuelson Revolution in Australia.’ in Robert A. Cord, Richard G. Anderson and William A. Barnett (eds.), Paul Samuelson: Master of Modern Economics (Palgrave Macmillan UK: London).

Offer, Avner, and Gabriel Söderberg. 2016. The Nobel factor: the prize in economics, social democracy, and the market turn (Princeton University Press: Princeton).

Samuelson, P. A. 1947. Foundations of Economic Analysis (Harvard University Press: Cambridge, MA).

———. 1948. Economics: An Introductory Analysis (McGraw-Hill: New York).

Samuelson, Paul A., and William D. Nordhaus. 2010. Economics (McGraw-Hill: New York).

Saunders, Phillip, and William B Walstad. 1990. The Principles of economics course : a handbook for instructors (McGraw-Hill: New York).

 

This report, which I wrote for Carbon Tracker, has just been released (Keen 2023). The main report can be downloaded from this link, after logging in to Carbon Tracker (which just requires submitting your email and a password—no financial involved):

Loading the DICE Against Pensions – Carbon Tracker Initiative

I’d prefer if you downloaded from there, to enable Carbon Tracker to keep track of how many copies are in circulation. But I’ve also attached it to this post on Patreon (and Substack, if I can work out how to do it!).

There is also a freely downloadable Supporting Document (no login required):

Supporting-Document-To-Rolling-The-DICE-How-Did-We-Get-Here.pdf (carbontracker.org)

This report shows that pension funds have drastically underestimated the damage that climate change will do to pensions, not through any wrongdoing on their part, but because they were advised by consultants who trusted refereed papers published by mainstream economists.

This report extends the research I did for the paper “The appallingly bad neoclassical economics of climate change” (Keen 2020). It details how ludicrously bad research by economists has been taken at face value by pension funds, financial regulators and governments, resulting in the pitifully weak responses that humanity has made to date to the threat of climate change. Comments like the following from a Federal Reserve Governor are a direct product of the juvenile analysis of global warming by mainstream economists:

Climate change is real, but I do not believe it poses a serious risk to the safety and soundness of large banks or the financial stability of the United States. Risks are risks. There is no need for us to focus on one set of risks in a way that crowds out our focus on others. My job is to make sure that the financial system is resilient to a range of risks. And I believe risks posed by climate change are not sufficiently unique or material to merit special treatment relative to others. (Waller 2023, p. 1)

In reality, the threats from climate change are utterly unique in human history, and dwarf the importance of all other risks to our financial, economic and social systems. Assurances by economists that increases in global temperatures of as much as 7ׄ°C will have only a trivial impact on the economy—reducing annual economic growth by a mere 0.02% (Howard and Sylvan 2021, Figure 11, p. 23)—will soon be blown out of the water by the climate itself. The weird weather of 2023 is just a foretaste of what is to come, now that global warming has reached the +1°C levels that concern scientists.

Please download this report (and the Supporting Document), read it, and share it as widely as possible.

Howard, Peter, and Derek Sylvan. 2021. “Gauging Economic Consensus on Climate Change.” In. New York: Institute for Policy Integrity, New York University School of Law.

Keen, Steve. 2020. ‘The appallingly bad neoclassical economics of climate change’, Globalizations: 1-29.

———. 2023. “Loading the DICE against pension funds: Flawed economic thinking on climate has put your pension at risk ” In. London: Carbon Tracker.

Waller, Christopher J. 2023. “Climate Change and Financial Stability.” In Current Challenges in Economics & Finance. Madrid: IE University.

 

The Italian Edition of The New Economics: A Manifesto (Keen 2021) will be published in November by Meltemi, and I will attend the BookCity book fair in Milan to launch the book on November 18^th. I owe a great intellectual debt to many great Italian economists, from Pierro Sraffa (Sraffa 1960, 1926) and Pierangelo Garegnani (Garegnani 1970), to Augusto Graziani (Graziani 1989): without their work, I could never have made the contributions that I have managed to add to sound economics. It is great pleasure to know that I will in part repay that debt by having my book appear in Italian.

Below is the preface that will be published (in Italian, of course) with the book.

There are few countries on the planet that illustrate the weaknesses of mainstream macroeconomic thinking better than Italy. As I explain in this book, amongst its many other weaknesses, mainstream “Neoclassical” economics ignores the role of private debt and credit in the economy, and demonises government debt and deficits, both on utterly fallacious grounds.

Mainstream economics dominates economic policy globally, but the extent to which policies based on it can be enforced varies around the world. Since the Maastricht Treaty effectively codified conventional economic thinking via its rules on government debt and deficits—that government debt should not exceed 60% of GDP, and deficits should be below 3% of GDP—the European Union has been the laboratory in which mainstream economics has been tested, and found wanting.

Italy has suffered more than most EU countries from the perverse effects of imposing mainstream economic fantasies on real economies. A country which used to regularly and substantially outperform the USA has now fallen behind it, especially in the aftermath to the abandoning the Lira for the Euro in 1999, and even more so during and after the Global Financial Crisis (GFC) in 2008—see Figure 1.

Figure 1: Real annual economic growth rates for Italy versus the USA

Before Neoclassical econocrats wrestled the reins of power from Italy’s falsely maligned post-WWII “Keynesian” bureaucrats, Italy’s real economic growth was volatile, but almost always substantially higher than the USA’s. Growth in both countries trended down, rather than up, as the Neoclassical orthodoxy displaced Keynesian-style policies, and from the date that the “Growth and Stability Pact” took hold in Europe, things got worse rather than better for Italy. Its diminishing growth rate fell permanently below the USA’s, it suffered more from the GFC than America—despite not having a Subprime Bubble—and the aftermath to the crisis has seen Italy’s growth rate fluctuate around zero. The Growth and Stability Pact has brought stagnation and instability.

Despite—or rather because of—the EU obsession with reducing the level of government debt, Italy is one of the few countries in the world where government debt substantially exceeds private debt. High private debt is not good for the economy—far from it, as I explain in the second chapter—while high government debt, contrary to Neoclassical economics, is not a major problem for a country which issues its own currency. But to end up with substantially higher government debt, when the objective of the policy was to reduce it—to halve it as a proportion of GDP, in Italy’s case—is a sign of how truly perverse these policies have been in practice.

These effects are obvious when you compare the key economic indicators for Italy (Figure 2) that my approach to economics emphasises—the level of private debt and its annual rate of change—to the same data for America (Figure 3).

Figure 2: Key New Economic Indicators for Italy

Much of this perversity emanates from fallacious mainstream theories of money creation. Despite the Bank of England (McLeay, Radia, and Thomas 2014) and the Bundesbank (Deutsche Bundesbank 2017) both declaring that the Neoclassical models of money creation are wrong, mainstream economists continue to ignore the macroeconomic impact of banks creating money by creating loans—as evidenced by the 2022 award of the “Nobel” Prize in Economics to three economists who continue to pretend that banks are “financial intermediaries” linking savers to borrowers (Committee for the Prize in Economic Sciences in Memory of Alfred Nobel 2022). This pretence leads to the conclusion, as stated by Bernanke in 2000, that credit (which he falsely described as a “pure redistribution”) “should have no significant macroeconomic effects” (Bernanke 2000, p. 24).

The data for both Italy and the USA begs to differ. Between 1985 and 2015, the correlation between credit and unemployment was -0.8 in the USA, and -0.73 in Italy. As I explain in the second chapter, this is not mere correlation, but causation: since banks create money when they loan, and no-one borrows for the sheer pleasure of being in debt—we borrow in order to spend—credit is part of aggregate demand and income, and by far the most volatile part. It therefore is the primary determinant of the economy’s booms and busts.

Figure 3: Key New Economic Indicators for the USA

Absent ignorant policy rules like the “Growth and Stability Pact”, Government deficits tend to respond to the level of economic activity, so that rising government spending attenuates the rise in unemployment during a slump. But the enforcement of the Maastricht Treaty rules on Italy are now resulting in a dramatic decline in government money creation, as Figure 2 shows: the current savage decline in government debt will act to increase unemployment, rather than to reduce it.

From Economics to Climate

The above is written as if economic growth is always and everywhere a good thing. Especially as Europe and America swelter during the hottest summer in recorded history, as droughts damage croplands and cripple power plants, and flash floods destroy towns, that is clearly not the case: we have grossly exceeded the capacity of the biosphere to support our industrial civilisation, and our focus should be on equitably reducing the human ecological footprint, rather than adding to it.

Here again, mainstream economics is a positive hindrance to doing what is right. Beginning with a baseless and ignorant attack by William Nordhaus (Nordhaus 1973) on the research behind the Limits to Growth study in 1972 (Meadows, Randers, and Meadows 1972), mainstream economists have trivialised the dangers posed by climate change in what is, without a doubt, the worst research I have ever read (Keen 2020).

The key point of that chapter, that economists have used spurious data and logic to downplay the dangers of global warming, is highlighted in a survey of economists working on climate change that was published after it was written (Howard and Sylvan 2021). This survey asked how much economic damage would be done by global warming of 3°C by 2075, 5°C by 2130, and 7°C by 2220. The median answer was that this would reduce GDP two centuries hence by 20%, from $3,650 trillion (in USD 2019 terms) to $2,730 trillion. In economic growth terms, this is a fall in the annual rate of economic growth of 0.02%, which is one fifth of the accuracy with which economic growth is measured today. In other words, economists believe that global warming will have an imperceptible impact on the performance of the economy.

Scientists, on the other hand, are warning that a temperature increase of 1°C, which we have already exceeded, could be sufficient to trigger “tipping points” that could seriously damage our sedentary civilisation (Armstrong McKay et al. 2022), and that an increase of the order of 5°C implies “beyond catastrophic, including existential threats” (Xu and Ramanathan 2017).

This failing by mainstream economists is far, far worse than their mistakes leading up to the Global Financial Crisis, when they ignored the rise in private debt and predicted, using their flawed macroeconomic models, that the immediate economic future was bright (Cotis 2007). Then they merely led us blindfolded into the greatest economic crisis since the Great Depression. This time, they are leading us into the potential destruction of the capitalist economy, when they see themselves as the main defenders of capitalism.

Now, more than ever, we need a realistic economics that appreciates the ecological constraints under which we must operate on this finite planet. Its first job will not be to manage the economy, but to salvage what we can as the Prometheus that Neoclassical economists have helped unleash ravages our economic and social systems.

Armstrong McKay, David I., Arie Staal, Jesse F. Abrams, Ricarda Winkelmann, Boris Sakschewski, Sina Loriani, Ingo Fetzer, Sarah E. Cornell, Johan Rockström, Timothy M. Lenton, Ecology Spatial, Change Global, and Sciences Environmental. 2022. ‘Exceeding 1.5°C global warming could trigger multiple climate tipping points’, Science (American Association for the Advancement of Science), 377: 1-eabn7950.

Bernanke, Ben S. 2000. Essays on the Great Depression (Princeton University Press: Princeton).

Committee for the Prize in Economic Sciences in Memory of Alfred Nobel, The. 2022. “Financial Intermediation and the Economy.” In. Stockholm: The Royal Swedish Academy of Sciences.

Cotis, Jean-Philippe. 2007. ‘Editorial: Achieving Further Rebalancing.’ in OECD (ed.), OECD Economic Outlook (OECD: Paris).

Deutsche Bundesbank. 2017. ‘The role of banks, non- banks and the central bank in the money creation process’, Deutsche Bundesbank Monthly Report, April 2017: 13-33.

Garegnani, Pierangelo. 1970. ‘Heterogeneous Capital, the Production Function and the Theory of Distribution’, Review of Economic Studies, 37: 407-36.

Graziani, Augusto. 1989. ‘The Theory of the Monetary Circuit’, Thames Papers in Political Economy, Spring: 1-26.

Howard, P. H., and D. Sylvan. 2021. ” Gauging economic consensus on climate change.” In Technical report. Institute for Policy Integrity, New York University School of Law,.

Keen, Steve. 2020. ‘The appallingly bad neoclassical economics of climate change’, Globalizations: 1-29.

———. 2021. The New Economics: A Manifesto (Polity Press: Cambridge, UK).

———. 2023. “Loading the DICE against pension funds: Flawed economic thinking on climate has put your pension at risk ” In. London: Carbon Tracker.

McLeay, Michael, Amar Radia, and Ryland Thomas. 2014. ‘Money in the modern economy: an introduction’, Bank of England Quarterly Bulletin, 2014 Q1: 4-13.

Meadows, Donella H., Jorgen Randers, and Dennis Meadows. 1972. The limits to growth (Signet: New York).

Nordhaus, William D. 1973. ‘World Dynamics: Measurement Without Data’, The Economic Journal, 83: 1156-83.

Sraffa, Piero. 1926. ‘The Laws of Returns under Competitive Conditions’, The Economic Journal, 36: 535-50.

———. 1960. Production of commodities by means of commodities: prelude to a critique of economic theory (Cambridge University Press: Cambridge).

Xu, Y., and V. Ramanathan. 2017. ‘Well below 2 °C: Mitigation strategies for avoiding dangerous to catastrophic climate changes’, Proceedings of the National Academy of Sciences of the United States of America, 114: 10315-23.

 

If those words mean absolutely nothing to you, please buy The Hitchhiker’s Guide to the Galaxy now. If your local bookshop is too many planetary systems away, you can buy it from local outlet of the one of the great publishing corporations of Ursa Minor at https://www.amazon.com/Complete-Hitchhikers-Guide-Galaxy-Boxset/dp/1529044197/ or https://www.amazon.com/Hitchhikers-Guide-Galaxy-Douglas-Adams-ebook/dp/B000XUBC2C/. Read at least the first volume immediately, before you continue with this post. You can thank me later.

If you have already read it, and that sentence still doesn’t make sense to you, that’s OK iff (not a misprint) you’ve drunk too many (i.e., more than 1/50^th of one) Pan Galactic Gargle Blasters: it’s a known side-effect.

If you have, and it (the title of this post: please pay attention!) still doesn’t make sense, and you haven’t, then shame on you. Go back and read all five volumes in the trilogy now, while drinking a 1/5^th of a Pan Galactic Gargle Blaster. You can thank me if and when you sober up.

Where was I? Ah, yes: I am Zaphod Beeblebrox.

Like I am sure many male readers of Douglas Adams’s brilliant novellas, I have often wondered which of the male characters I was most like.

Was I the bumbling Arthur Dent, the human so often surprised by the turn of Galactic—and indeed, interpersonal—events, and permanently attired in a dressing gown? Or Ford Prefect, the poorly named but dashing, cocky and cynical Galactic traveller, bon vivant and researcher for The Guide? Surely, I was not Zaphod Beeblebrox, the reckless, ludicrously gifted and erratically driven inventor of the Pan Galactic Gargle Blaster, Galactic President and the (two-headed) man who stole, on its maiden voyage, the spaceship The Heart of Gold, with its unique and wildly improbable Infinite Improbability Drive?

I’d always leant towards being Ford Prefect. I clearly had his knack for getting into trouble but somehow surviving, and we shared the same respect for authority—which is to say, none. But as my life unfolds, so have the similarities to Zaphod. The clincher was this bot (that was a misprint, but I like it, so it’s staying) of dialog as the Heart of Gold orbited above what Zaphod insisted was the fabled planet-building planet of Magrathea, which Ford insisted was a myth:

‘You’re crazy, Zaphod,’ he was saying, ‘Magrathea is a myth, a fairy story, it’s what parents tell their kids about at night if they want them to grow up to become economists, it’s . . .’

Oh dear. There was Douglas Adams saying, as only he can, that economics is a fantasy.

Figure 1: The one, the only, the late and oh-so-much lamented Douglas Adams

I could have remained Ford in my own mind at that point, except that the story continued on to ponder Zaphod’s two heads, their weird mental gifts, and how those gifts had ruled Zaphod’s unruly life:

‘I freewheel a lot. I get an idea to do something, and, hey, why not, I do it. I reckon I’ll become President of the Galaxy, and it just happens, it’s easy. I decide to steal this ship. I decide to look for Magrathea, and it all just happens. Yeah, I work out how it can best be done, right, but it always works out.’

‘It’s like having a Galactic credit card which keeps on working though you never send off the cheques…’ Zaphod paused for a while. For a while there was silence. Then he frowned and said, ‘Last night I was worrying about this again. About the fact that part of my mind just didn’t seem to work properly. Then it occurred to me that the way it seemed was that someone else was using my mind to have good ideas with, without telling me about it’.

That has been my life. Weird ideas pop into my head that turn out to be right, before I am able to prove that they are, and with me having no idea how they came about. I did not deduce them from any set of logical premises, they simply turned up in my head, largely fully formed. Often, they occurred to me when I wasn’t working—the last one occurred on a late-night trip back from the bathroom during an interrupted sleep. In Paris.

The first was that Marx’s philosophy contradicted his economics, which led to the conclusion that there was no “scientific” necessity for socialism (Keen 1993a, 1993b). The Labor Theory of Value, which is an article of faith for Marxists, was wrong, and the “Tendency for the Rate of Profit to Fall”, which is critical to the notion that capitalism must give way to socialism, was false.

The second was that the “Hicks Hansen Samuelson Second Order Difference Equation” model of the trade cycle was based on an economic fallacy of equating desired (“ex-ante”) investment to actual (“ex-post”) savings (Keen 2020, 2000). There is no theory of economics that says they are equal: Keynes’s “Savings=Investment” is based on equating actual savings to actual investment (“ex-post” to “ex-post”). I therefore knew that Minsky’s own attempt at a mathematical model of his own “Financial Instability Hypothesis” must be wrong, since he built it by turning a parameter in that model into a variable. That in turn led to my decision to do my PhD on building a proper mathematical model of the Financial Instability Hypothesis (Keen 1995).

There have been about ten all up. The last one I’ve published came from the insight that “labour without energy is a corpse, capital without energy is a sculpture” (Keen, Ayres, and Standish 2019), which let me finally show that energy was an integral aspect to production—when both Neoclassical and Post Keynesian “production functions” ignore energy.

Occasionally I knew a stimulus to the thought, but the formation of the thought itself was and remains a mystery. Whether I’ll have any more remains a mystery too, though perhaps having one more too many Pan Galactic Gargle Blasters might resolve that mystery in the negative.

It’s worth a try…

Keen, Steve. 1993a. ‘The Misinterpretation of Marx’s Theory of Value’, Journal of the history of economic thought, 15: 282-300.

———. 1993b. ‘Use-Value, Exchange Value, and the Demise of Marx’s Labor Theory of Value’, Journal of the history of economic thought, 15: 107-21.

———. 1995. ‘Finance and Economic Breakdown: Modeling Minsky’s ‘Financial Instability Hypothesis.”, Journal of Post Keynesian Economics, 17: 607-35.

———. 2000. ‘The Nonlinear Economics of Debt Deflation.’ in William A. Barnett, Carl Chiarella, Steve Keen, Robert Marks and H. Schnabl (eds.), Commerce, complexity, and evolution: Topics in economics, finance, marketing, and management: Proceedings of the Twelfth International Symposium in Economic Theory and Econometrics (Cambridge University Press: New York).

———. 2020. ‘Burying Samuelson’s Multiplier-Accelerator and resurrecting Goodwin’s Growth Cycle in Minsky.’ in Robert Y. Cavana, Brian C. Dangerfield, Oleg V. Pavlov, Michael J. Radzicki and I. David Wheat (eds.), Feedback Economics : Applications of System Dynamics to Issues in Economics (Springer: New York).

Keen, Steve, Robert U. Ayres, and Russell Standish. 2019. ‘A Note on the Role of Energy in Production’, Ecological Economics, 157: 40-46.

 

Many people seem offended by the very idea that banks can create money “out of nothing”, or that governments can finance their spending by creating money, rather than borrowing. They seem wedded to the idea that money must be a physical thing, and therefore it can’t be created “out of nothing”.

This probably arises from the myth of barter that economics has been infected with ever since Adam Smith’s declaration that barter was an innate characteristic of humans:

THIS division of labour, from which so many advantages are derived, is the … consequence of … the propensity to truck, barter, and exchange one thing for another… Nobody ever saw a dog make a fair and deliberate exchange of one bone for another with another dog. (Smith 1776)

Barter involves two parties with physical things to exchange—a flower seller has flowers, a carpenter has chairs. There are two parties, two commodities, and the exchange takes place when both parties are satisfied with the exchange ratio of flowers to chairs. Barter is thus a two party, two commodity thing.

Banking, people seem to think, replaced an imagined (but not real) past in which we literally did exchange one physical thing for another—flowers for chairs—with a present in which we transfer funds electronically between bank accounts, but there is still a physical thing, like gold, backing today’s electronic money.

There isn’t, because money is not a physical thing: it’s a social thing, an “IOU”, which everyone in a society accepts in payment. It is a third party’s “promise to pay” that a buyer transfers to a seller, and the seller accepts this third party’s promise as complete payment for whatever physical object or service the seller transfers to the buyer. That third party is a bank.

The great Italian monetary theorist Augusto Graziani put it this way—in a paper written in 1989 when cheques (or cash), rather than transfers between bank accounts, were the main ways that bank payments were made:

When an agent makes a payment by means of a cheque, he satisfies his partner by the promise of the bank to pay the amount due. Once the payment is made, no debt and credit relationships are left between the two agents. But one of them is now a creditor of the bank, while the second is a debtor of the same bank… any monetary payment must therefore be a triangular transaction, involving at least three agents, the payer, the payee, and the bank. (Graziani 1989)

Graziani’s insight inspired me to design Minsky, an Open Source (i.e., free) system dynamics program which uses double-entry bookkeeping to model financial flows (click on the link to download a copy). In this post, I’ll show how Minsky can prove that both banks and governments can create “Money from Nothing”. Banks create money when new loans exceed loan repayments; Governments create money when their spending exceeds taxation. Though in practice, they start from non-zero—there are existing loans, existing deposits, existing government bonds, etc.—the mathematics of the systems by which they create money mean that they can start from zero and still create money.

This explains how government (“Fiat”) and bank (“Credit”) money are both effectively “endogenous”. The word “endogenous” used to be thrown around a lot in monetary debates, to distinguish the Post Keynesian view that banks controlled the money supply (Moore 1979; Jarsulic 1989; Wray 1989; Wray 1990; Lavoie 1995; Palley 2002; Godley 2004; Wray 2007; Fullwiler 2013; Wheat 2017; Lavoie and Reissl 2019) from the Neoclassical view that banks needed to be “seeded” by the creation of Reserves by the government (Kinsella 2010; Deleidi and Fontana 2019; Axilrod and Lindsey 1981; de Soto 1995; O’Brien 2007; Keister and McAndrews 2009; Martin, McAndrews, and Skeie 2013), before they could create more money themselves by lending. The practice developed—at least amongst Post Keynesian economists—or referring to private bank money creation as endogenous, and government money creation as exogenous.

However, in a strictly mathematical sense, both Fiat and Credit money are endogenous, in that they can both start from zero and create money. The Minsky model in this post proves this, working from an extremely simplified aggregate model of banking. Figure 1 shows the basic operations of Fiat and Credit money. Working down its seven rows, the first four rows show the basic operations of Fiat money creation, while the last three show the basics of Credit money creation:

• The excess of government spending over taxation “Fiat” (this is positive when spending exceeds taxation and normally called a “Deficit”, and negative when taxation exceeds spending and normally called a “Surplus”) is added to private sector bank accounts (“Deposits“) and also bank settlement accounts (“Reserves“);
• The Treasury pays interest to banks on existing bonds (“Int_B^B“);
• Treasury sells bonds of equivalent value to the “deficit”—which I call Fiat here—and interest on existing bonds owned by banks (“Bonds_B“);
• The Central Bank buys bonds from private banks (“Bonds_B^CB“);
• Private banks net lending (which can be positive or negative) adds Credit dollars per year to Deposits and also to Loans;
• The non-bank private sector pays Int_L dollars per year on existing debt, which is credited to the Banking sector’s short-term equity Banks_Equity; and
• Banks spend Spend_B dollars per year buying goods and services from the private non-bank sector.

Figure 1: The basic operations in Fiat and Credit money

Most countries have laws that require the Treasury to not run an overdraft at the Central Bank. In practice this means that the Treasury issues bonds equivalent to the excess of spending over taxation (“Fiat” here), plus interest on outstanding bonds. I model this here by the relationship that:

        

Secondly, Central Banks buy and sell bonds in trade with private banks in what are called Open Market Operations (OM)). This model captures the aggregate of this buying and selling over a year, and for convenience I assume that the net buying of bonds by the Central Bank equals the interest on existing bonds Int_B^B. This results in equation 1.2:

        

The interest rate that Treasury pays on bonds owned by the banks, and that the private sector pays on Loans, are introduced as parameters:

        

Bank spending on the non-bank private sector is modelled using the engineering concept of a “time constant” , which indicates how many years that banks could spend without exhausting their equity:

        

Finally, GDP is modelled as the velocity of money times the money stock, which is defined here as Deposits plus Banks_Equity:

        

These equations are entered as flowcharts on the canvas—see Figure 2.

Figure 2: The flow equations in the model, as entered on Minsky’s canvas

Fiat and Credit are left undefined, so that they can be varied during a simulation.

Figure 3 shows a run of the model in which Credit and Fiat were increased and decreased at different times. This both created and destroyed money, leading to varying rates of growth of GDP.

Figure 3: A simulation with varying levels of Fiat and Credit

The key result for this model is shown in Figure 4; though the model began with zero in every account, the flows generated positive sums for all accounts except Treasury_D, the Treasury’s account at the Central Bank—and this account remained non-negative, as required by law, since the expenditure out of the account was precisely matched by the monetary flows into in from bond sales.

Figure 4: The “Godley Tables” for the four sectors of the economy

Both credit money and fiat money creation are therefore “endogenous”: they don’t require any external input to enable money creation to commence. The decisions, by the government to spend more than it gets back in taxes, and by the banking system to create net new loans, not only create money but also ensure that the other accounts reach levels required by law. Banks, in particular, achieve positive equity—their Assets exceed their Liabilities—even though they began with zero equity in this simulation.

Figure 5 shows a simulation with only Credit money creation. Notice in this case that the positive equity for the banking sector is precisely equal to the negative equity for the non-bank private sector. This shows that in the absence of government money creation, the non-bank private sector must end up in negative net financial equity, since the banking sector must have positive (or more precisely, non-negative) financial equity.

 

Figure 5: Credit money creation only

Figure 6 shows only Fiat money creation, and here the negative equity of the government sector—64.2 in this simulation—is precisely equal to the positive equity of the non-government sector—with 61.9 for the non-bank private sector and 2.3 for the banking sector.

Figure 6: Fiat money creation only

Therefore, neither the government nor the banks needs a stock of anything—gold, flowers, chairs, or anything else—before they create money. What they do need are people with whom they can have a financial relationship: taxpayers for the government, borrowers for the banks. Borrowers have to agree to go into debt; taxpayers simply have to be subjects of a given government, in which case they are recipients of government spending, and liable to pay taxation.

Libertarians might instinctively prefer private money creation (Credit) over government (Fiat), because the former involves free choice and the latter involves compulsion. But from a practical point of view, the “free choice” generates compulsion while the “compulsion” option generates freedom.

Credit money creation effectively forces the non-bank private sector into negative equity. Banks, by definition, have to have non-negative equity: if their assets exceed their liabilities, they are bankrupt. Bank lending generates positive equity for the banks, and it therefore necessarily generates negative equity for the non-bank private sector: if banks have financial assets that exceed their liabilities, then by the logic of double-entry bookkeeping, non-banks have identical negative financial equity.

This reality of private money creation is, I believe, a major reason why banks can entice us into speculation on the value of non-financial assets—things like houses and shares—which we buy with yet more borrowed money. We end up with asset bubbles and speculation dominating true enterprise.

On the other hand, though no-one enjoys paying taxes, if a government routinely spends more than it takes back in taxation, then the non-government sector gains positive financial equity—which is precisely equal in magnitude to the negative financial equity of the government sector. This effectively creates “free money” for the non-bank private sector, which allows it to undertake commerce on its own terms, without necessarily having to borrow from banks in the first instance.

Figure 7 shows a “pulse” of Credit money creation, followed by a pulse of Fiat money creation. Though you’ll need to run the model yourself to see this clearly (I’ll post it on Patreon and link to it on Substack), when the credit money pulse stops, so does expansion of the economy. However when the fiat money pulse stops, growth continues because the interest paid on government bonds continues to create money.

Figure 7: Credit and Fiat money creation

If we could just get our heads around these practical realities of money creation, and throw the myths of Neoclassical and Austrian economists into the rubbish bin of history where they belong, then the monetary side of capitalism would function a damn sight better than it has under the last forty years of Neoliberalism.

Figure 8: The plots from the simulation in Figure 7

Axilrod, Stephen H., and David E. Lindsey. 1981. ‘Federal Reserve System Implementation of Monetary Policy: Analytical Foundations of the New Approach’, American Economic Review, 71: 246-52.

de Soto, Jesus Huerta. 1995. ‘A Critical Analysis of Central Banks and Fractional-Reserve Free Banking from the Austrian School Perspective’, Review of Austrian Economics, 8: 25-38.

Deleidi, Matteo, and Giuseppe Fontana. 2019. ‘Money Creation in the Eurozone: An Empirical Assessment of the Endogenous and the Exogenous Money Theories’, Review of Political Economy, 31: 559-81.

Fullwiler, Scott T. 2013. ‘An endogenous money perspective on the post-crisis monetary policy debate’, Review of Keynesian Economics, 1: 171–94.

Godley, Wynne. 2004. ‘Weaving Cloth from Graziani’s Thread: Endogenous Money in a Simple (but Complete) Keynesian Model.’ in Richard Arena and Neri Salvadori (eds.), Money, credit and the role of the state: Essays in honour of Augusto Graziani (Ashgate: Aldershot).

Graziani, Augusto. 1989. ‘The Theory of the Monetary Circuit’, Thames Papers in Political Economy, Spring: 1-26.

Jarsulic, M. 1989. ‘Endogenous credit and endogenous business cycles’, Journal of Post Keynesian Economics, 12: 35-48.

Keister, T., and J. McAndrews. 2009. “Why Are Banks Holding So Many Excess Reserves?” In. New York: Federal Reserve Bank of New York.

Kinsella, Stephen. 2010. ‘Pedagogical Approaches to Theories of Endogenous versus Exogenous Money’, International Journal of Pluralism and Economics Education, 1: 276-82.

Lavoie, M. 1995. “Loanable Funds, Endogenous Money, and Minsky’s Financial Fragility Hypothesis.” In, 19 pages. University of Ottawa, Department of Economics, Working Papers.

Lavoie, Marc, and Severin Reissl. 2019. ‘Further insights on endogenous money and the liquidity preference theory of interest’, Journal of Post Keynesian Economics, 42: 503-26.

Martin, Antoine, James McAndrews, and David Skeie. 2013. “Bank Lending in Times of Large Bank Reserves.” In.: Federal Reserve Bank of New York.

Moore, Basil J. 1979. ‘The Endogenous Money Supply’, Journal of Post Keynesian Economics, 2: 49-70.

O’Brien, Yueh-Yun June C. 2007. ‘Reserve Requirement Systems in OECD Countries’, SSRN eLibrary.

Palley, Thomas I. 2002. ‘Endogenous Money: What It Is and Why It Matters’, Metroeconomica, 53: 152-80.

Smith, Adam. 1776. An Inquiry Into the Nature and Causes of the Wealth of Nations (Liberty Fund: Indianapolis).

Wheat, David. 2017. ‘Teaching endogenous money with systems thinking and simulation tools’, Int. J. of Pluralism and Economics Education, 8.

Wray, L. Randall. 1990. Money and credit in capitalist economies: The endogenous money approach (Aldershot, U.K. and Brookfield, Vt.:

Elgar).

———. 2007. “‘Endogenous Money: Structuralist and Horizontalist’.” In.: Levy Economics Institute, The, Economics Working Paper Archive.

Wray, Larry Randall. 1989. ‘The Endogenous Theory of Money’, Washington University.

 

I realized, while watching the semi-final at Roland Garros between Djokovic and Alcaraz, that I have lived a uniquely blessed and cursed life. My life has coincided with the best years of humanity, and I have played a unique but ultimately losing role in the two great crises of our age: the collapse of the speculative financial bubble of the 1990s-2010s, and now the impending—and imminent—crisis of climate change.

I was born in 1953, 8 years after the Nazis were defeated, when the United Nations was formed, during what was later termed “The Golden Age of Capitalism” (Marglin and Schor 1992). Yes, there have been wars, from the Vietnam War to Ukraine, horrors like Pol Pot, political crises like the Cuban Missile Crisis and economic ones like the Global Financial Crisis. But the generation before us had far worse crises—World Wars I and II, Nazi extermination camps, the Great Depression—and earlier Ages had theirs, from the American Civil War back to the collapse of Rome.

As a generation, we—yes, the “Baby Boomers”—had the best times in human history.

I’ve been more rarely blessed as well. I am a tennis tragic, who, had circumstances been different, would have tried his hand at professional tennis rather than academic economics. Instead, as a child, I modelled my game on the great Rod Laver, while as an adult, I had the sublime pleasure of watching Roger Federer, who did the same, play the most graceful and innovative tennis in the history of the sport.

Professionally, I’ve lived a blessed life as well. Most academic critics of economics are kept below the rank of Professor, but somehow I ended up as a Head of School (though to be frank, I wasn’t very good one: my fortes are teaching and research, not administration), and I “retired” with the honorary rank of Professor. Post-university, I’m living a relatively comfortable life thanks to my supporters on Patreon and Substack—something that most of my heterodox allies can only dream of.

I have therefore been uniquely blessed. But for each blessing there is a curse.

At the relatively trivial level of sport, while I enjoyed watching this contest, I’d much rather watch a replay of any Federer match than a live contest today. I’ve already witnessed the most gifted player and the greatest rivalries in the history of tennis. Tennis matches from here on will be a disappointment in comparison—as this match ultimately proved to be, when Alcaraz’s incredible athleticism became his undoing, as his chronically cramped body ended his challenge to Djokovic.

At the far more significant level of the climate, I believe—based on my own research into the economics of climate change, and from reading hundreds of scientific papers on global warming—that we are at the beginning of the end for industrial civilisation.

The ever-improving living standards that Baby Boomers have taken for granted were actually propelled by the exploitation of the fossil fuel energy reserves on this planet, but paradoxically, energy, which is the critical factor in economic growth, is completely ignored by the conventional economic model of production (Keen 2020; Keen, Ayres, and Standish 2019). We have over-exploited these energy reserves, and ignored the carbon dioxide that their exploitation generates, so much that, this year, global temperatures hit 1.5℃ over pre-industrial levels on two occasions—with that second occasion being two days ago (June 8^th—see Figure 1). We may very soon experience a sustained 1.5℃ over pre-industrial levels, which will wreak havoc on the production systems that, until now, have given us an ever-rising standard of living.

Figure 1: https://twitter.com/EliotJacobson/status/1667165187894558721?s=20

That brings me to the uniquely personal curse of my life, which is the focus of this post. I have been Cassandra not once, but twice, and on two very different—though not unrelated—topics. Why me?

Cassandra Squared

For those who don’t know their Greek mythology, Cassandra was the Trojan priestess who was fated to make accurate prophesies that were never believed.

I have now been a Cassandra on two occasions: the “Global Financial Crisis” (GFC—or “Great Recession” as Americans tend to call it) of 2007-10, and—though I’m very late to the game, and far from the most important Cassandra—the possible destruction of our industrial civilisation by climate change.

Cassandra Mark I: The Global Financial Crisis

My oracular capability on the GFC came from both understanding Hyman Minsky’s “Financial Instability Hypothesis” (Minsky 1978), and being able, as Minsky himself was not, to put it into a mathematical format (Keen 1995). That led to the model shown in Figure 2, which showed a decline in economic volatility as private rose, followed by a rise in volatility and finally a crisis as debt overwhelmed the economy. The striking and unexpected decline in volatility before the crisis (Minsky did say that “stability is destabilizing”, but he was thinking in terms of one single cycle, rather than the many-cycles process illustrated in Figure 2) led to the oracular conclusion to my 1995 paper, that:

this vision of a capitalist economy with finance requires us to go beyond that habit of mind that Keynes described so well, the excessive reliance on the (stable) recent past as a guide to the future. The chaotic dynamics explored in this paper should warn us against accepting a period of relative tranquillity in a capitalist economy as anything other than a lull before the storm. (Keen 1995, p. 634. Emphasis added)

Figure 2: My model of Minsky’s FIH in Minsky, showing the impact of rising debt and negative credit

That hypothetical warning turned real when, in December 2005, I saw the level of private debt in Australia and America hit levels never seen since WWII, while the ratio of private debt to GDP was rising exponentially in both countries. And, tellingly, the period prior to the crisis that I then believed was inevitable was marked by declining volatility in the business cycle—something that my model predicted would precede a crisis.

I established my first (and now largely dormant) blog http://www.debtdeflation.com/blogs/ and started to warn publicly about the dangers of rising private debt from December of 2005. In May 2007, I literally described myself as a Cassandra when I gave a succinct summary of why I expected a recession—and a severe one:

    At some point, the debt to GDP ratio must stabilise–and on past trends, it won’t stop simply at stabilising. When that inevitable reversal of the unsustainable occurs, we will have a recession.

Figure 3: My Cassandra profile from 2007, before the Global Financial Crisis began

The recession duly arrived in the USA, and as Figure 4 shows, negative credit was the dominant factor behind it. Credit rose to be the equivalent of 15% of GDP—its highest level in history—and then plunged to reach minus 5% of GDP in 2009. Since, contra Neoclassical theory, credit is a component of aggregate demand and income, and by far the most volatile component, the economy moved in opposing lock step with credit, booming as it rose, and collapsing as it fell and turned negative.

Figure 4: Private Debt and Credit in the USA 1990-2010

After the crisis, the Dutch economist Dirk Bezemer looked through economic literature to identify people who could legitimately claim to have predicted it, and I turned up as one of twelve Cassandras—see Figure 5.

Figure 5: Bezemer’s list of the dozen economists who warned of the GFC before it happened

I wasn’t the first Cassandra though. Dirk’s table implies that Fred Harrison was the first, but if you check the academic literature, Wynne Godley deserves that accolade, for the warning he published jointly with Randall Wray in 2000, entitled “Is Goldilocks Doomed?” (Godley and Wray 2000). My warning emanated from my interpretation of Minsky, and the role of credit in the economy, whereas Godley and Wray used the sectoral balances approach that Wynne pioneered, and which is the foundation of “Modern Monetary Theory”:

It has been widely recognized that there are two black spots that blemish the appearance of our Goldilocks economy: low household saving (which has actually fallen below zero) and the burgeoning trade deficit. However, commentators have not noted so clearly that public sector surpluses and international current account deficits require domestic private sector deficits. Once this is understood, it will become clear that Goldilocks is doomed. (Godley and Wray 2000, pp. 201-202. Emphasis added)

Of course, we were all ignored until after the crisis—and then we were only acknowledged by the underground of economics, rather than the mainstream. We therefore never cut through into public debate—though the one positive legacy of those ignored warnings may well be the rise of MMT.

Cassandra Mark II: Economists and the Global Warming Crisis

The common theme between being an ignored prophet on financial crises, and being an ignored prophet on climate change, is that the key people who claimed there was not going to be a financial crisis, or an ecological crisis, were economists.

In the case of the GFC, the inability of economists to see that a crisis was imminent emanated from their shared ignorance of the role of money—and in particular, credit—in the economy. With their eyes blindfolded to this critical factor in macroeconomics, there was no way to see the danger ahead, unless one stepped outside the Neoclassical canon. That’s why only one Neoclassical name—Robert Shiller, the author of Irrational Exuberance (Shiller 2005)—turns up in Bezemer’s list.

In the case of the looming ecological crisis, economists also have a shared ignorance on the role of energy in production. But there was no intrinsic reason why their empirical work on climate change had to be as bad as that done by Nordhaus. The facts that he could assume that a roof—or in his words, a “carefully controlled environment”—meant that 87% “of United States national output is produced … in sectors that are negligibly affected by climate change” (Nordhaus 1991, p. 930), and that his initial estimate was that 3℃ of warming would reduce future GDP by no more than 2% (Nordhaus 1991, p. 933), betrayed a complete lack of understanding of what climate actually means:

The low, medium, and high damage curves are, respectively, (i) economic costs actually identified in this study (¼% of total output), (ii) the costs raised to 1 percentage point to allow for a significant amount of potential unmeasured damage, and (iii) an estimate of 2% to allow for maximum plausible damages.     (Nordhaus 1991, p. 934. Emphasis added)

There was no innate reason why economic referees would approve the publication of a paper as full of ignorant assumptions as Nordhaus’s paper was, except that the referees themselves were not experts on climate change, and were in no position to sensibly evaluate his claims. Since Nordhaus’s nonsense is the foundation of all the empirical trivialisation of the dangers of climate change, he has played a pivotal role in blinding us to the dangers that scientists have been warning about for over half a century now.

As the only critic of Nordhaus’s to focus on the absurdity of his and his followers’ empirical estimates, I have joined the scientists Jim Hansen (Hansen et al. 2006; Hansen et al. 2022), Tim Lenton (Lenton et al. 2008; Lenton et al. 2019; Xu et al. 2020), Will Steffen (Steffen et al. 2018) and many others as a Cassandra on climate change. They are the experts on climate change, and why it is so dangerous, not me. But I have helped explain one thing they could not: why were their warnings being ignored?

Yes., it was because the fossil fuel industry ran a disinformation campaign, so that the gravy train on which they rode could continue until the end. But the fossil fuel industry, and shrills like Bjorn Lomborg (Lomborg 2020), could not have been as effective if they were not able to rely upon predictions by economists that the economic consequences of climate change would be slight. If fossil fuel companies are the armies fighting against meaningful action on climate change, then economists are their arms dealers.

The Trojan Horse Arrives?

In mythology, and possibly even history, Cassandra’s key prediction was to “Beware of Greeks bearing gifts”: the Trojan Horse. That ignored warning led to the sacking of Troy. Well over half a century of climate change warnings have been ignored to date, and the data for this year is making many climate scientists fearful that the Climate Trojan Horse has finally arrived. The current data for climate anomalies is simply off the scale compared to any previous year. The following graphs—sourced from Climate Change Twitter—emphasise just how scarily unique 2023 is proving to be.

Everything Everywhere, All At Once

The most visible impact of climate change so far this year has been the smoke from Canadian wildfires which made the air in New York hazardous. Neil Lareau, who is Professor of Atmospheric Sciences at the University of Nevada Reno, posted this chart showing the total energy output from Canadian wildfires over time. With 2 months of summer still to go, 2023 has already exceeded the level of all bar one previous year.

Figure 6: https://twitter.com/nplareau/status/1666919867864469504?s=20 from

The global temperature anomaly today (June 10^th 2023) would occur only once every 3,500 years, if temperature variations were simply a random process.

Figure 7: https://twitter.com/EliotJacobson/status/1667198969347440641?s=20

Antarctic sea ice is also way, way below all previous lows.

 

Figure 8: https://twitter.com/ZLabe/status/1666811217753833484?s=20

The average sea temperature between the Poles is a once-every-two-centuries anomaly.

Figure 9: https://twitter.com/EliotJacobson/status/1666825025427750912?s=20

All these divergences are not only unprecedented in the historical record, they are all still growing, and at alarming rates. Climate scientists are frankly scared by the data they’re seeing in 2023, but like me, most of them are also resigned to being ignored. Being a Cassandra is no fun at all.

Godley, Wynne, and L. Randall Wray. 2000. ‘Is Goldilocks Doomed?’, Journal of Economic Issues, 34: 201-06.

Hansen, James, Makiko Sato, Reto Ruedy, Ken Lo, David W. Lea, and Martin Medina-Elizade. 2006. ‘Global temperature change’, Proceedings of the National Academy of Sciences, 103: 14288-93.

Hansen, James, Makiko Sato, Leon Simons, Larissa S. Nazarenko, Karina von Schuckmann, and Norman G. Loeb. 2022. ‘Global warming in the pipeline’, arXiv pre-print server.

Keen, Steve. 1995. ‘Finance and Economic Breakdown: Modeling Minsky’s ‘Financial Instability Hypothesis.”, Journal of Post Keynesian Economics, 17: 607-35.

———. 2020. ‘The appallingly bad neoclassical economics of climate change’, Globalizations: 1-29.

Keen, Steve, Robert U. Ayres, and Russell Standish. 2019. ‘A Note on the Role of Energy in Production’, Ecological Economics, 157: 40-46.

Lenton, Timothy M., Hermann Held, Elmar Kriegler, Jim W. Hall, Wolfgang Lucht, Stefan Rahmstorf, and Hans Joachim Schellnhuber. 2008. ‘Tipping elements in the Earth’s climate system’, Proceedings of the National Academy of Sciences, 105: 1786-93.

Lenton, Timothy, Johan Rockström, Owen Gaffney, Stefan Rahmstorf, Katherine Richardson, Will Steffen, and Hans Schellnhuber. 2019. ‘Climate tipping points – too risky to bet against’, Nature, 575: 592-95.

Lomborg, Bjorn. 2020. ‘Welfare in the 21st century: Increasing development, reducing inequality, the impact of climate change, and the cost of climate policies’, Technological Forecasting and Social Change, 156: 119981.

Marglin, Stephen A., and Juliet B. Schor. 1992. Golden Age of Capitalism (Clarendon Press Oxford: Oxford, UK).

Minsky, Hyman P. 1978. ‘The Financial Instability Hypothesis: A Restatement’, Thames Papers in Political Economy, Autumn 1978.

Nordhaus, William D. 1991. ‘To Slow or Not to Slow: The Economics of The Greenhouse Effect’, The Economic Journal, 101: 920-37.

Shiller, Robert J. 2005. Irrational exuberance (Broadway Books: Princeton, N.J.).

Steffen, Will, Johan Rockström, Katherine Richardson, Timothy M. Lenton, Carl Folke, Diana Liverman, Colin P. Summerhayes, Anthony D. Barnosky, Sarah E. Cornell, Michel Crucifix, Jonathan F. Donges, Ingo Fetzer, Steven J. Lade, Marten Scheffer, Ricarda Winkelmann, and Hans Joachim Schellnhuber. 2018. ‘Trajectories of the Earth System in the Anthropocene’, Proceedings of the National Academy of Sciences, 115: 8252-59.

Xu, Chi, Timothy A. Kohler, Timothy M. Lenton, Jens-Christian Svenning, and Marten Scheffer. 2020. ‘Future of the human climate niche’, Proceedings of the National Academy of Sciences, 117: 11350-55.

 

Mainstream economists are professional trolls.

By this, I don’t mean that mainstream economists work in troll farms and are being paid by Putin—though it would be better for humanity if they were: they’d do far less damage. I mean that, almost to a person, they behave as trolls when debating critics of economics, and when discussing issues that, to their mindset, can only be solved by economic theory. They ridicule their opponents rather than engaging with them, because, like trolls, they are smugly confident that their critics couldn’t possibly be right.

Philip N Cohen (@familyunequal) used this insight to come up with the perfect collective name for a group of economists: A “smug” of Economists:

They are smug because they believe that mainstream, “Neoclassical” economics is an accurate model of the real world, and therefore anyone who criticises it must be wrong.

This smugness would merely be infuriating if they were just trolls, with nasty attitudes but no real power. But in fact, they do have power: though they’ll frequently complain that politicians don’t listen to them enough, the majority of advisors to politicians are economists, and most decisions taken by politicians follow mainstream economic advice. Their smugness therefore leads them to dismiss sound criticism, and that locks in bad policy based on either bad theory, or bad work by other Neoclassical economists.

I experienced two instances of their smugness last week on (where else?) Twitter, via the Londoner Tim Worstall (@worstall) on climate change, and an anonymous New Zealander “Econgrad” (@Econgrad5143), on the role of money in economics.

Worstall trolled Peter Kalmus for saying that “I don’t know how more parents aren’t climate activists“, with the claim that all we need is a carbon tax, citing both Lord Stern and “Nobel Prize” winner Nordhaus as examples of “actual science”.

Worstall probably neither knew nor cared that Peter Kalmus in fact is a climate scientist (see https://en.wikipedia.org/wiki/Peter_Kalmus_(climate_scientist)). But he also clearly does not know that Nicholas Stern is a critic of Nordhaus’s work on climate change. In fact, in a recent open-access paper “A Time for Action on Climate Change and a Time for Change in Economics“, Stern directly rejects Worstall’s advice:

the suggestion that ‘theory says’ that the carbon price is the most effective route is simply wrong and involves a number of mistakes. (Stern 2022)

I tried to alert Worstall to the fact that Nordhaus’s work is dangerously misleading, and he rejected my warning because, hey, I’m a known critic of Neoclassical economics:

So a critic must be wrong, because he’s a critic? Well, here is Lord Nicholas Stern on precisely the same point:

a recent version of the DICE model estimates losses of 8.5% of current GDP at a global temperature rise of 6°C. If this were plausible, there would be little cause for concern about climate change because 6°C of warming will not be reached, even with bad luck, probably for over 100 years, by which point, with a modest amount of economic growth, losing less than 10 percentage points of GDP would be of minor significance in relation to GDP which had more than doubled (at say an underlying growth rate of 1% per annum).

But a 6°C temperature rise would likely be deeply dangerous, indeed existential for hundreds of millions, or billions, of people. It could be a world that could support a far lower population, and we could see deaths on a huge scale, migration of billions of people, and severe conflicts around the world, as large areas, many densely populated currently, became more or less uninhabitable as a result of submersion, desertification, storm surge and extreme weather events, or because the heat was so intense for extended periods that humans could not survive outdoors. It is profoundly implausible that numbers around 10% of GDP offer a sensible description of the kind of disruption and catastrophe that 6°C of warming could cause. (Stern 2022. Emphasis added)

My paper “The appallingly bad neoclassical economics of climate change” (Keen 2020), which Worstall claims to have skimmed, explains how Nordhaus generated these profoundly implausible numbers, and ironically, Neoclassical economics itself was not guilty. In fact, other Neoclassical economists, such as Robert Pindyck, have noted that the function in Nordhaus’s DICE model that purports to show the relationship between global warming and GDP “is made up out of thin air. It isn’t based on any economic (or other) theory or any data” (Pindyck 2017, pp. 103-104).

Ignorant of all this, and with the confidence of a troll, Worstall regularly attacks climate scientists, and dismisses warnings about the dangers of climate change:

Our beefs will quite probably be well and truly be cooked by global warming, thanks in part to the smug trolls of Neoclassical economics, and the appallingly bad work that they witlessly defend.

Keen, Steve. 2020. ‘The appallingly bad neoclassical economics of climate change’, Globalizations: 1-29.

Pindyck, Robert S. 2017. ‘The Use and Misuse of Models for Climate Policy’, Review of Environmental Economics and Policy, 11: 100-14.

Stern, Nicholas. 2022. ‘A Time for Action on Climate Change and a Time for Change in Economics’, The Economic Journal, 132: 1259-89.

 

As I say in the first video in this short series, “come for the clickbait, stay for the education”. No, this post is not money-making advice: it’s telling you how money is actually made, by both banks and the government, using my Minsky software.

Firstly, here are the videos. If you’re a visual learner, you may prefer them to this post:

https://www.youtube.com/watch?v=4tXW1hnqifo

https://www.youtube.com/watch?v=QcwPGLgYrwQ

https://www.youtube.com/watch?v=-of4i2vp77o

https://www.youtube.com/watch?v=nw5ePEyxoOU

A Pure Credit Economy

I start with a model of a pure credit economy—one in which there is no government. Though such a thing has never existed, it’s approximately the situation of 19^th century America, when government debt never exceeded 26% of GDP (even during the Civil War), the government normally ran a balanced budget or a surplus, and government spending was normally under 10% of GDP—see Figure 1.

Figure 1: Private & Public Debt and money creation since 1830

A bank must have positive equity: the value of its (short-term) assets much exceed the value of its (short term) liabilities. If you take a bank which has just been established, it will have assets, but no liabilities, and hence positive equity equal to its Assets. This initial position is shown in Figure 1. This bank’s assets are listed as “Reserves”, it has no liabilities, so its Equity starts equal to its Assets.

Figure 2: A bank must start with, and maintain, positive equity

A bank creates money by issuing loans. It simply adds the amount Credit dollars per year to its depositors, and recording that much additional debt for them as well. This is shown in Figure 2—and notice that Reserves play no role at all.

Figure 3: Creating Loans and Deposits simultaneously

This applies at the aggregate level as well as at the individual bank, so I now consider the aggregate, economic level. Borrowers pay interest on outstanding debt, and banks purchase goods and services from the non-banks. That gives us Figure 4.

Figure 4: Interest payments and bank spending

This is enough to start modelling a pure credit economy in Minsky. Minsky uses flowcharts to define mathematical relationships. The most obvious one here is that Interest equals Loans times the rate of interest. With an initial level of loans of $550 billion in Figure 4, and an interest rate of 5 percent per year, Interest payments start at $27.5 billion—see Figure 5.

Figure 5: Defining the flow “Interest”

I relate spending by banks to the amount of money they hold—their short-term equity—using the engineering concept of a “time constant”. This basically asks the question “how many years could banks spend without any inflows into their accounts?” This will be a substantial time period, compared to (for example) how long workers could survive without getting any income. I set the time constant for banks to 2 years in Figure 6, so that with initial equity of $150 billion, they will spend $75 billion in the first year.

Figure 6: Spending by banks related to bank short-term equity by a time constant

Now I need to define Credit. There are many ways to do this—I could, for example, argue that banks have a target Loans to Equity ratio, and lend till they reach it. But for simplicity, I model credit as a percentage of GDP—see Figure 7.

Figure 7: Credit as a percentage of GDP

Now I have to define nominal GDP, and again for simplicity I model it as being caused by the turnover of money—a simple “velocity of money” model.

Money is the sum of the Liabilities plus short-term Equity of the banking sector—see Figure 8.

Figure 8: Money as the sum of Deposits plus short term bank equity

The Velocity of Money times Money defines GDP—see Figure 9.

Figure 9: Money times Velocity determines nominal GDP

With those definitions, I can model what happens to nominal GDP as credit rises and falls. Positive credit increases both the money supply and GDP; negative credit causes the money supply and GDP to fall.

Figure 10: A pure credit economy

Did you notice anything unconventional in the above explanation? Reserves, which play a pivotal role in the mainstream model of bank lending, played no role at all here. As I explain in “The Dead Parrot of Mainstream economics”, banks can’t “lend from Reserves” (you can read this post on Substack or Patreon). Instead, Reserves play a crucial role in the next aspect of money creation: government deficits.

A Pure Fiat Economy

A pure fiat money economy is as much of an abstraction as a pure credit economy, but it lets us isolate the key factors in money creation by governments. This is shown in Figure 11: when a government spends more than it gets back in taxation, it adds Fiat dollars per year to Deposit accounts. That is creating money, just as bank lending creates money, but with one critical difference: the bank asset that is created along with Deposits is Reserves, rather than Loans.

Figure 11: The absolute basics of government money creation

Reserves, which played no role in the model of a pure credit economy, play a central role here. As is well known—even by Neoclassical economists—Reserves are a liability of the Central Bank. Therefore, we have to include the Central Bank to properly model government money creation, and this shows that the increase in Reserves is caused by a transfer of funds from the Treasury’s accounts at the Central Bank, as shown in Figure 12.

Figure 12: The Central Bank’s main Liabilities are Reserves and the Treasury’s Deposit account

Finally, we need to look at the Treasury’s books: where does it get the funds? Figure 13 shows the source: the Treasury doesn’t “get” the funds from anywhere: it simply creates them by going into negative equity.

Figure 13: Treasury creates the funds by going into negative equity

I know lots of people will have a “that’s not right” response to this, and in sense that’s partially correct: it’s not right, it’s also “might”. The whole idea of a fiat currency is that the power controlling a nation, the government, can declare that its liabilities are to be used as the form of money in the domain it controls. It therefore needs to create those liabilities, and a deficit—spending more than it takes back in taxation—is the means by which it does that.

Furthermore, its liabilities become the asset of the non-governmental sectors, which is easily seen by looking at the economy from the private sector’s point of view—see Figure 14. The negative equity of the government creates the identical positive equity for the private sector. Therefore, rather than being a “bug” of the system, it is a critically important feature: negative equity for the government is a pre-requisite for the existence of a fiat currency.

Figure 14: The private sector’s positive equity is created by the government’s negative equity

The full picture of government money creation by fiat is shown in Figure 15, and it makes it obvious that the negative equity for the government is the positive equity for the private sector. I’ve set all accounts to zero so that I can show in the next figure that the government can, effectively, create a monetary economy from nothing: whereas the banking sector needs to have positive equity to function, a government can hypothetically start from zero and establish a monetary economy.

Figure 15: The 4 primary sectors of a fiat economy

In Figure 16, I have the government creating $10 (billion) of fiat money per year, by spending $10 billion more than it takes back in taxes. Over 30 years, it creates negative equity for itself of $300 billion, and identical positive equity for the private sector.

Figure 16: Fiat creation of $10 (billion) a year creates money and positive equity for the private sector

I’ve deliberately omitted government bonds until now, because I want to emphasise the fundamental point that, whereas a bank creates money by expanding its assets and liabilities equally, a government creates money by creating negative equity for itself, and identical positive equity for the non-government sector. Bonds play no role in that. But if a government doesn’t issue bonds, then it wears its negative equity on its account at the Central Bank: notice that the Treasury’s account at the Central Bank goes into overdraft. Most governments have passed laws to prevent this: they require the Treasury to maintain a positive balance in its account at the Central Bank.

Figure 17 shows this legislatively required situation from the point of view of the banking sector: government spending in excess of taxation creates Fiat money; the government issues bonds equivalent to the amount of Fait money created, plus interest on outstanding bonds; and the Central Bank, in its “Open Market Operations” with private banks, can also purchase bonds as assets for itself on the secondary market (since the same laws also normally ban the Central Bank from buying bonds directly from the Treasury).

Figure 17: Bond sales, interest on bonds and Central Bank bond purchases

This only substantive difference this makes to the situation without bond sales is that, as well as Fiat creating money for the private non-bank sector, interest on bonds owned by the banks creates money (and positive equity) for the banking sector. In addition, because the sale of bonds is required by law to match the excess of government spending over taxation plus the interest paid on bonds owned by the banks, the Treasury’s account at the Central Bank does not go into overdraft.

To model this in Minsky, I made bond sales equal to the sum of Fiat plus interest on existing bonds, and had the Central Bank purchase bonds equivalent to the interest on bonds—see Figure 18

Figure 18: Modelling the requirement to sell bonds in Minsky

Figure 19 models this with Fiat creation (otherwise misleadingly known as the government deficit) of $10 (billion) per year and a 3% rate of interest on bonds. The outcome is that this creates a growing economy, and generates positive equity for both the private non-banking sector and the banking sector.

Figure 19: A Fiat Currency “lifting itself by its own bootstraps”

Fiat creates money for the non-bank private sector; interest on bonds creates money for the banking sector; and the turnover of money creates GDP. Far from the servicing of government debt being a burden on future generations, as Neoclassical economists claim, the payment of interest on government bonds finances the banking sector while the excess of government spending over taxation creates money and positive equity for the non-bank private sector.

The real world is a mixed fiat-credit system of course, and Minsky can model the two together—which I’ve done in posts before and will doubtless do again. Once you understand this system, the Neoclassical obsession with reducing government debt can be seen for what it is: it is an attitude born of ignorance of the actual system of money creation, and it results in policies that make capitalism malfunction even more so than it would do without their intervention.