by Michael Roberts
As promised, let me return to the debate within Keynesianism
between Paul Krugman, Nobel prize winner and guru of orthodox
Keynesianism and Steve Keen, the upstart radical ‘Minsky-Keynesian’,
over what are the key processes of modern capitalism and the cause of
the Great Recession.
Steve Keen has recently revised and expanded his excellent book, Debunking Economics (http://debunkingeconomics.com/)
and his attacks on mainstream economics, the nature of capitalist
crisis and what to do about it provoked the great columnist of the New
York Times and scourge of the Republicans, Paul Krugman, to respond.
Krugman wasted no time in dismissing Keen’s ideas in his daily blog as
Keen responded sharply and then a long debate ensued with loads of
other economists with their blogs entering the fray. You can follow the
twists and turns in the debate at http://unlearningeconomics.wordpress.com/2012/04/03/the-keenkrugman-debate-a-summary/.
So I suppose it’s my turn. But first is this debate important and
interesting? Well, I think it is, because the differences expressed help
to show the struggle that mainstream economics has in trying to explain
the slump that world capitalism has just been through and why the
recovery is so weak. This particular debate is not between Keynesians
and the Austerians (see my recent post, The debate on austerity, 14
April 2012) for that). It is between what I call orthodox Keynesianism
and a more radical variety that considers most Keynesians still locked
in many neoclassical theorems that do not allow them to understand
modern finance capital and the banking system. If the orthodox
Keynesians did understand, say the unorthodox, then they would see more
clearly why capitalism gets into crisis and what to do about it. Steve
Keen leans on the ideas of these radical Keynesians, as a follower of
Hyman Minsky and Modern Monetary Theory (MMT), which tries to explain
the key role of banking in capitalism as the major cause of economic
So what are the issues at debate? Well, after perusing thousands of
thousand of words from participants in the debate, I think there are
three issues. The first is whether, in a modern capitalist
economy, money is created endogenously i.e. demand for money drives its
supply, rather than exogenously, namely by the printing or absorption of
money by a central bank. The second is whether the expansion
of debt, particularly private credit, adds to demand in an economy, such
that it can get way out of sync with the expansion of the production of
things and services; and whether this is key to the capitalist crisis.
And third, whether it is the inherent instability of the
financial system that is the kernel of crisis and not just the lack of
‘effective demand’ as orthodox Keynesians argue.
Let’s start with the first issue: endogenous money; namely, the need
to borrow by corporations, households, financial institutions and
government drives bank lending, not vice versa. The MMT says that banks
lend first and that generates deposits, a simple double bookkeeping
process. So banks can create money out of nothing. Banks do not wait
for deposits from customers and central bank cash before lending.
Orthodox Keynesians like Krugman fail to recognise this, says the MMT
guys (and Keen). Banks may drive loan quantity, or create money by
lending, but they are restricted in how much by three factors: interest
rates (the cost of their own borrowing, partly set by the central bank),
required reserves of cash they must hold (as enforced by a central bank
regulation) and the amount of equity capital they must hold (again a
matter of regulation). But these restrictions on lending affect the
profitability of loans for the banks, not the quantity they can make.
The issue in the debate here is whether central banks have any real
control over the money supply and credit in an economy. In effect, the
MMT guys suggest that it is little and the orthodox Keynesians are
kidding themselves that the capitalist economy can be controlled by
central banks by trying to manipulate the money supply exogenously or
even by changing interest rates. The MMT guys are stating the
authorities cannot control the ‘business cycle’, the cycle of boom and
slump, by monetary policy because money is created endogenously. The
orthodox Keynesians like to think that they can and so their policy of
lowering interest rates or squeezing bank reserves will work in
What does Marx say about this? Although Marx did not spell out his
theory of money and credit clearly in one book (as usual!), it is clear
from his writings that he reckoned that money supply is endogenous to
the capitalist system and that the banks can create credit as demanded
by capitalist production without waiting for some exogenous agent to
provide it. As he put it: “The credit given by a banker may assume
various forms, such as bills of exchange on other banks, cheques on
them, credit accounts of the same kind, and finally, if the bank is
entitled to issue notes – bank-notes of the bank itself. A bank-note is
nothing but a draft upon the banker, payable at any time to the bearer,
and given by the banker in place of private drafts. This last form of
credit appears particular important and striking to the layman, first
because this form of credit-money breaks out of the confines of mere
commercial circulation into general circulation, and serves there as
money; and because in most countries the principal banks issuing notes,
being a particular mixture of national and private banks, actually have
the national credit to back them, and their notes are more or less legal
tender; because it is apparent here that the banker deals in credit
itself, a bank-note being merely a circulating token of credit. (Marx, 1894, pp.403-404). What drives bank lending is not the supply of money but the demands of capitalist production: “The quantity of circulation notes is regulated by the turnover requirements (of capital accumulation – MR)), and every superfluous note wends its way back immediately to the issuer.” (Marx, 1894, p. 524). Credit creates deposits.
But the Marxist theory of money makes an important distinction from
the MMT guys. Capitalism is a monetary economy. Capitalists start with
money capital to invest in production and commodity capital, which in
turn, through the expending of labor power, eventually delivers new
value that is realised in more money capital. Thus the demand for money
capital drives the demand for credit. Banks create money or credit as
part of this process of capitalist accumulation, not as something that
makes finance capital separate from capitalist production.
But both Marx and the MMT guys agree that the so-called quantity
theory of money as expounded in the past by Chicago economist Milton
Friedman and others, which dominated the policy of governments in the
early 1980s, is wrong. Governments and central banks cannot ameliorate
the booms and slumps in capitalism by trying to control the money
supply. The dismal record of the current quantitative easing (QE)
programmes adopted by major central banks to try and boost the economy
confirms that. Central bank balance sheets have rocketed since the
crisis in 2008, but bank credit growth has not.
And over the same period, the so-called money multiplier (ratio of
broad money in the economy to central bank money), upon which quantity
theorists rely to judge whether the quantity of money is right, has just
dived (M3/M1). In other words, central banks have tried to boost the
money supply by ‘printing’ money, but it has had minimal or no effect on
the real economy because the demand for borrowing has dropped away.
The orthodox Keynesians like Krugman would say that the collapse of
the money multiplier proves the phenomenon of the ‘liquidity trap’.
This is when aggregate demand in an economy is so weak that people hoard
their money and banks stop lending, so even if interest rates are
lowered to zero (as they more or less are now), it does not spark an
economic recovery. Then we need exogenous policies to kick-start it.
The MMT guys would say because money creation is endogenous, purely
monetary policies like quantitative easing will never work. Marxists
would agree, as long as it is recognised that while banks may be able to
create money out thin air, they won’t do so if capital accumulation has
slumped. Credit growth depends on capital accumulation, even if it is
never in line (so money is never neutral).
That brings me to the second issue: excessive credit or debt. One of
the key arguments of the Austrian school of economics is that credit
can become excessive because it is artificially driven up by central
banks. If there were no central banks, then the ‘free market’ would
eventually bring credit into line with production through a move to an
equilibrium rate of interest. Money would have a neutral effect on
production and there could be no monetary crises, if it were not for
central bank interference.
Steve Keen also argues that the key to crises under capitalism is
excessive credit or private debt. But it is not the Austrian
explanation. Instead, he leans on the ideas of Hyman Minsky, the
radical Keynesian of the 1980s. Keen-Minsky argues that the modern
financial system is inherently trying to expand credit to gain higher
returns. This leads to a Minsky-type of financial speculation (for more
detail on Minsky’s speculation view of banking, see my paper, The causes of the Great Recession).
Private credit rockets as banks speculate in ever riskier forms of
assets (stocks, bonds, property). This creates extra demand in an
economy that cannot eventually be satisfied. Increasingly, borrowing is
raised just to cover previous borrowing in a Ponzi-like scheme.
Eventually, the whole pack of cards collapses in a ‘Minsky moment’ and
capitalism has a slump.
Keen says the best way to look at Keynesian-style ‘aggregate demand’
in a modern capitalist economy is to add to national income the amount
of private debt or borrowing. If you amend Keynes like this, you get a
better indicator of when a crisis is coming. Keen won the Real
Economics Review prize for forecasting the credit crunch. He says that
this came to him as a revelation because he suddenly realised how the
rise in US private debt was preparing a crisis. Keen said the graphic
on US private debt to GDP looked like the ‘hockey stick’ graphic for
The orthodox Keynesians did not consider this and Krugman dismisses
the idea in his debate with Keen. For them, the crisis, namely a
collapse in aggregate or ‘effective demand’, is due to the ending of
what Keynes called ‘animal spirits’, a loss of business confidence that
feeds through to a collapse in investment and a willingness to spend.
It is not due to excessive private debt. A slump ensues and can stay
for a long time if the economy is locked into a liquidity trap. It
needs government intervention to break out.
What does Marx say? Marxist theory agrees with Keen that private
credit can become excessive. Indeed, this flows from the Marxist view
that money is not neutral in the capitalist economy but central to it.
Credit can and will get out of line with the capitalist production.
Credit is really fictitious capital i.e. money capital advanced for the
titles of ownership of productive and unproductive capital i.e. shares,
bonds, derivatives etc. The prices of such assets anticipate future
returns on investment in real and financial assets. But the realisation
of these returns ultimately depends on the creation of new value and
surplus value in the productive capitalist sector. So much of this
money capital can easily turn out to be fictitious.
The key point for Marxists here is profit. The huge rise in private
debt (measured against GDP) is clearly a very good indicator that a
credit bubble is developing. But it alone is not good indicator of when
it will burst. Some economists in the Austrian school have tried to
gauge when the tipping point might be by measuring the divergence
between the growth in credit and GDP growth (see Borio and White, Asset prices, financial and monetary stability,
BIS 2002). But Marxist theory provides a much better guide. It is
when the rate of profit starts to to fall; then more immediately, when
the mass of profits turns down. Then the huge expansion of credit
designed to keep profitability up can no longer deliver.
It is this model of crisis that I adopted back in 2006 for my book, The Great Recession.
It led me to predict a major slump for 2009-10 (I was wrong as it came a
year earlier). The evidence was there for the US, where the global
slump was triggered. The US rate of profit peaked in 1997. At the
beginning of 2006, the mass of profits began to fall and the housing
market turned down. Within 18 months, the credit crunch happened and
the rest is history.
One way of showing how the fall in the rate of profit combined with
excessive debt to bring US capitalism down is to measure the rate of
profit not just conventionally against tangible corporate assets but
also against financial assets (fictitious capital), which had risen so
much. I have done this in several places (including my paper, The profit cycle and economic recession and various posts). Here is the graph again to emphasise the point.
It shows that the US corporate rate of profit as measured against all
assets, was lower in 2002 than it was in 1982, while it was higher
against just physical assets. Once conventional profitability also
turned down in 2006, the crisis began and the impact was much bigger
because of the size of fictitious capital. Now, everywhere capitalism
continues to try and ‘deleverage’ to cleanse not just dead capital out
of the ‘real’ economy, but also to get rid of fictitious capital.
That brings me to the final issue: the cause of crisis. For the
orthodox Keynesians, it is due to the collapse in aggregate or effective
demand in the economy (as expressed in a fall of investment and
consumption). This fall in investment leads to a fall in employment and
thus to less income. Effective demand is the independent variable and
incomes and employment are the dependent variables. There is no mention
of profit or profitability in this schema. Investment creates profits
not vice versa. This is the view of Keynes: “Nothing obviously, can
restore employment which does not first restore business profits. Yet
nothing, in my judgement, can restore business profits that does not
first restore the volume of investment.” (Collected Writing Vol 13, p343.
As I have argued before (see my post, Double dips, deficits and debt,
24 August 2011), these schemas are ‘back to front’ in explaining the
laws of motion of capitalism. Marx’s schema is the opposite. A change
in profits produces a change in investment, which in turn, affects
employment and incomes and thus effective demand.
But if investment is the independent variable, according to Keynes,
Krugman and Minsky-Keen, what causes a fall in investment? It is an
ending of ‘animal spirits’ among entrepreneurs or a ‘lack of
confidence’. As Minsky put it, investment is dependent on “the
subjective nature of expectations about the future course of investment,
as well as the subjective determination of bankers and their business
clients of the appropriate liability structure for the financing of
positions in different types of capital assets”. So profits depend
on expectations and crises are the result of changed expectations by
financial speculators. Investment and credit grow as long as there is
confidence: what others have called ‘magic Tinkerbell fairy dust’, a
belief that things will only get better.
This is the real mysticism of Keynesian economics. For Keen and the
Minsky followers, the orthodox Keynesian/Kalecki identities still apply
(see my post, op cit). Instability in finance and/or excessive credit
leads to a collapse of investment or ‘effective demand’ and then onto
employment and incomes/profits. For Marxists, instability in the
financial sector would not be enough to cause a major crisis if
profitability is rising. The Keynes/Minsky approach is subjective, based
on ‘expectations’. The Marxist approach is objective and based on the
law of value.
Depending on your view, the policies for economic recovery are also
different. Keen advocates controlling the level of private debt as the
main solution. Krugman advocates regulation of finance and easy money.
Failing that, he wants fiscal intervention to stimulate the private
sector. Marxists look to replace the profit system.
The Marxist explanation is the most comprehensive as it integrates
money and credit into the capitalist mode of production, it recognises
that money and credit are not neutral as the Austrians believe; and
argues that money may be a key factor in instability and crisis, as the
Keynesians believe, but also shows that it is not the decisive flaw in
the capitalist mode of production and that sorting out finance is not
enough. Thus it can explain why the Keynesian solutions do not work
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