The Institute Blog

Steve Keen: How He Saw "It" Coming, and Others Did Not

The two intersecting lines of supply and demand penetrate economics textbooks like Einstein's mass-energy equivalence penetrates physics textbooks. The theory behind the two lines is inherently flawed, says Steve Keen.

It is not possible logically to derive from individuals and their preferences the aggregate demand and supply curves presented in economic textbooks -- unless one is willing to make a host of unrealistic assumptions, such as that all people are alike. That is why the theory is flawed, according to Steve Keen, Professor of Economics at University of Western Sydney in Australia.

The Naked Emperor Dethroned

In part 1 of the INET interview, he talks about the flaws in economic theory, and explains why the second edition of his book, Debunking Economics, carries the subtitle The Naked Emperor Dethroned.

How He Saw "It" Coming

In part 2 of the interview, he talks about how in his search for a realistic framework of capitalism he ended up with the work of Hyman Minsky. Unlike standard theory, Keen says, Minsky emphasizes the role of money and debt in the economy. What firms do is they borrow money to invest during a boom, and then they have to repay part of that debt during a slump. Keen was able to put this simple idea into a mathematical model, in a paper he published in 1995.

The model helped him to predict the financial crisis. Keen is the recipient of the Revere Award, an award given to the economist who first and most cogently warned the world of the coming financial collapse. In this video clip, Keen tells us how being an expert witness in a court case in Perth, Australia, helped him see "it" coming.

Credit Created Out of Thin Air

The neoclassical vision of saving and lending -- the standard model being taught in universities -- causes economists to be blindsided by the dynamics of debt in the economy, according to Steve Keen. In part 3 of the INET interview, Keen talks about the role of private debt in the economy.

It is true that one person's debt is another person's asset, but it is equally true that banks create money when they lend. This kind of endogenous expansion of debt, Keen says, drives economic activity, and most economists are completely oblivious to it.

Predicting a Crash Makes You Lonesome

In part 4 of the INET interview, Steve Keen tells us why he prefers to speak of the credit accelerator, rather than the credit impulse. "An impulse implies it comes and it goes; acceleration is always with you."

Keen also talks about how tough it was to contend that Australia was doomed. He had, early on, and in a minority of one, publicly warned of the coming crash in the housing market -- the mortgage industry was not amused. "It's personally difficult to continue doing that, but I simply couldn't see how I was wrong on all this."

We Must Cancel the Debt

In part 5 of the INET interview, Steve Keen talks about the world economic outlook. "We're in a depression", he says. We can avoid one or two decades of near stagnation, Keen warns, but only if we abolish the mountain of debt that is dragging down the major economies. Debt that the financial sector dishonorably extended should not be honored, he says.

On Europe, China, and Brazil

In part 6 of the INET interview, Steve Keen shares his views on Europe, China, and Brazil.

Urging Economists to Put Money into Their Models

In a monetary economy, all transactions are three-sided: There is a buyer, a seller, and a bank that records the transfer of money between the two parties. A realistic model of capitalism should have money in it, says Steve Keen in part 7 of the INET interview.

Keen and his collaborators are using the INET grant to adapt existing software, traditionally employed by engineers, to the needs of economists. The goal is to develop software with which students can model a monetary economy.

Comments

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Self-searching examination, admission of mistakes, at times even feelings of guilt are marks of the vitality of the works of INET.

But the transition from actual theory to the practical world remains thinly drawn. Thus there is still alive among many redears that INET risk degenrating into what is called in Hungary,a "mere blah-blah" theartre, allwing highly paid staff to sound off. As follow up, then, too little points to actual change.

But the works of Oliver Williamson seem to be different. By focsing on import across boundaries of organizations, on the process of conversion within the struture, and the output in costs, he is making a new and much needed us of GST, General Systems Theory for living systems. What is striking are that analysis of date from satelites for comparison of farnlands, converge with his observation of the nuclear family as a lviving system.

Can Williamson's group be asked to share in the discussions?

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"In a monetary economy, all transactions are three-sided: There is a buyer, a seller, and a bank that records the transfer of money between the two parties. A realistic model of capitalism should have money in it, says Steve Keen in part 7 of the INET interview.

Keen and his collaborators are using the INET grant to adapt existing software, traditionally employed by engineers, to the needs of economists. The goal is to develop software with which students can model a monetary economy."

These problems are already solved and the solution is the answer to the following question:

If the investors or owners have (N) and the bond holders have (B) and the investors approach the bond holders to strike a new deal with respect to forming or buying a company, or to restructuring the debt of the company that they own, what is the best outcome within the demonstrated societal standards of risk aversion and bargaining practice?

Answer:

1. If an investor has (p), they might prudently expect a return of p(1+w) and (not or) be prepared for a loss to p(1-w); “prudence” is in the word “and” not “or” and “prepared” is in the word “guaranteed” to be no less than p(1-w);

2. The “return” (w) has nothing to do with “volatility” or a “standard deviation” which must accept either p(1 ± w) without distinction, and whatever return an investor might suppose or hope for, we can calculate the value of (w) that must be expected within the demonstrated societal standards of risk aversion and bargaining practice, and we have a fair chance to obtain it;

3. If the return is “satisfactory” in the above sense, then we can show that 2/3 < (1-w) < 2; that is, the prudent investor should expect to lose no more than 1/3 of their capital and plan to gain no more than 100% and although we don't need to – and probably can't either logically or legally - guarantee the latter, we can guarantee the former;

4. Anything else is just a gamble.

This is not just homework. The authorities are John Nash, Ariel Rubinstein, Ronald Coase, James Tobin and a new theory of the firm that calculates the balance sheet worth of the trading connections in the sense of Coase that we have called the "N/B/W"-financing model (Goetze 2009).

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Hello!
Thanks for these comments!
Can ou please give the complete reference
for the model "N/B/W"-financing model (Goetze 2009)?

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Great interview, on point, crisp and very thoughtful... I think I need to go find his book

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When I consider the fact that Mr. Keen's prescient analysis was initially largely ignored, and in fact reviled, I wonder if what we need is only new economic thinking.

It seems what we truly need is an effective method of bringing sound economic analysis into the minds of the general public.

Is there any division of INET devoted to studying and resolving the problem that the vast majority of people probably have zero understanding of economic principles? I would be very interested in any discussion pertaining to such analysis.

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I believe that this is precisely the sort of model that Keen is attacking when he talks about the Krugman paper.

Borrowing does not require savings. That is one of Keen's (and Minsky's) key points. I fear that no mainstream economist will ever be able to come to terms with the implications of that simple fact.

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God bless you, Steve - one of the only sane men at the Madhatter's Tea Party that is economics.

I voted for you at the RWER award, and if there were a living human being who more deserved a nobel for his work, I don't know who that might be....

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Dear Steve,

I have without any very technical knowledge about the macro economy (other than teaching High School Business and Eco) also could see the day coming when debt levels would become unsustainable, and the housing in Australia was a Ponzi.

I don't intend to offend, but I think much of this was common sense.

What I would like you to model or explain, is, the effect of deleveraging on existing debt. ie fractional reserve banking (credit creation) in reverse.

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Nice solid expose of the nonsense that passes for modern economics, Steve. When we understand it's the interaction between people and planet that generates wealth, we'll see we've gone wrong on all the secondary human constructs, finance, credit & debt, which are meant to be the 'service sector'. In service to whom?

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When I started to listen to interview 1 with Mr Keen I got very excited: at last someone else (in addition to me!) saying "economics is totally useless", "the intersecting supply and demand curves is not how any market system works".
But then in Interview 7 I heard that he has received an INET grant to build "an monetary model of the capitalism": another model. Is this going to do any thing to prevent 2007/2008 happening again - in my opinion, NO.
I agree with EMendelson, we need to find a way to inform the general public (the man in the street) what really happens in the purely theoretical world of economics and the influence that has on the practical world of finance. The necessary changes to the practical world will only come about when the man in the street demands change through the democratic system.
I was excited at the formation of INET, but what has it done so far to really address the issue of preventing 2008 happening again? Every grant seems to be for research to develop new economic models - the very things that contributed (and only contributed) to the problems before.
Perhaps I should submit a grant proposal to INET!

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As an administrator of the Occupy Australia Facebook page and a member of Occupy Brisbane I am doing my best to get the word out. Keep it up, you give us hope!

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