Or maybe not. But either way I'm going to say it.
There's a fine line somewhere between: just fixing obvious typos in what someone actually said; and totally changing what they actually said. Or maybe there is no line, and it's just a continuous slope. Anyway, I'm going to cross that fine line here, and go a long way down that slope. But I don't really care. Because ideas are more important than our fallible attempts to express them. So while it would be sorta neat if Steve said "That's exactly what I was trying to say!", it probably won't happen, and it doesn't really matter, and it's much more important if people say "Saying it that way makes sense". Because it does make sense, if we say it this way.
So with that very big caveat understood, here's what I think Steve Keen is maybe trying to say:
Aggregate planned nominal expenditure equals aggregate expected nominal income plus amount of new money created by the banking system minus increase in the stock of money demanded. (All four terms in that equation have the units dollars per month, and all are referring to the same month, or whatever.)
And let's assume that people actually realise their planned expenditures, which is a reasonable assumption for an economy where goods and productive resources are in excess supply, so that aggregate planned nominal expenditure equals aggregate actual nominal expenditure. And let's recognise that aggregate actual nominal expenditure is the same as actual nominal income, by accounting identity. So the original equation now becomes:
Aggregate actual nominal income equals aggregate expected nominal income plus amount of new money created by the banking system minus increase in the stock of money demanded.
Nothing in the above violates any national income accounting identity.
Here's the intuition:
Start with aggregate planned and actual and expected income and expenditure all equal. Now suppose that something changes, and every individual plans to borrow an extra $100 from the banking system and spend that extra $100 during the coming month. He does not plan to hold that extra $100 in his chequing account at the end of the month (the quantity of money demanded is unchanged, in other words). And suppose that the banking system lends an extra $100 to every individual and does this by creating $100 more money. The individuals are borrowing $100 because they plan to spend $100 more than they expect to earn during the coming month.
Now if the average individual knew that every other individual was also planning to borrow and spend an extra $100, and could put two and two together and figure out that this would mean his own income would rise by $100, he would immediately revise his plans on how much to borrow and spend. Under full information and fully rational expectations we couldn't have aggregate planned expenditure different from aggregate expected income for the same coming month.
But maybe the average individual does not know that every other individual is doing the same thing. Or maybe he does know this, but thinks their extra expenditure will increase someone else's income and not his. Aggregate expected income, which is what we are talking about here, is not the same as expected aggregate income. The first aggregates across individuals' expectations of their own incomes; the second is (someone's) expectation of aggregate income. It would be perfectly possible to build a model in which individuals face a Lucasian signal-processing problem and cannot distinguish aggregate/nominal from individual-specific/real shocks.
So at the end of the month the average individual is surprised to discover that his income was $100 more than he expected it to be, and that he has $100 more in his chequing account than he expected to have and planned to have. This means the actual quantity of money is $100 greater than the quantity of money demanded. And next month he will revise his plans and expectations because of this surprise. How he revises his plans and expectations will depend on whether he thinks this is a temporary or a permanent shock, which has its own signal-processing problem. And these revised plans may create more surprises the following month.
It doesn't matter for this story what that "something" was that changed and started the whole thing rolling. It might have been: a change in the central bank's behaviour; a change in commercial banks' behaviour; or some change from outside the banking system.
We know that a sensible central bank would eventually do something else to stop the whole thing rolling before aggregate planned nominal expenditure gets too big for consistency with the inflation or whatever target. Because there is a supply-side and Phillips Curve out there somewhere. If this process doesn't stop by itself, the central bank will make it stop. This is not a long run story. It won't explain long run increases in money or debt. And it is not a story about all growth in income, because it is perfectly possible to have income growth where planned and expected and actual expenditure and income are all the same. It's a demand-side story of the transition from one growth path to another, where expectations may be false during that transition.
We are talking about a Hayekian process in which individuals' plans and expectations are mutually inconsistent in aggregate. We are talking about a disequilibrium process in which people's plans and expectations get revised in the light of the surprises that occur because of that mutual inconsistency. We are talking about what Old Keynesians talk about when they zig-zag slowly to the equilibrium point in the Keynesian Cross diagram. We are talking about what monetarists talk about when they talk about the hot potato process where the actual stock of money is greater than the quantity of money demanded.
Worthwhile Canadian Initiative 
Nick,
In your discussion each individual, at the beginning of each month, make a financial decision about how the rest of the month will go for him. Would I be correct in interpreting you as implying that there are two factors in his decision, how much consumption he wants and how much money demand.
First, he considers how much of a flow of goods he wants to consume based on an implicit “consumption function.” Second, he considers how much money he wants to hold as stock based on an implicit “money demand function.” When these two function collide he makes a decision. In summary, he must make a decision about how much he wants as stock AND as flow, each determined by their own “function.”
More of one necessarily means less of the either, either to him or somebody else from whom he gets the money to hold as stock or purchase as flow.
Did I get that right?
Nick, this looks fascinating… this and your last post. When I get the chance I’m plan to go through them very carefully…. rather than the cursory treatment I’m given them now. Thanks for posting! (plus your links to those old posts that I overlooked)
I believe this is what Keen said/says.
From:
http://www.debtdeflation.com/blogs/2012/01/28/economics-in-the-age-of-deleveraging/
“In a credit-based economy, aggregate demand is therefore the sum of income plus the change in debt, with the change in debt spending new money into existence in the economy. This is then spent not only goods and services, but on financial assets as well—shares and property. Changes in the level of debt therefore have direct and potentially enormous impacts on the macroeconomy and asset markets, as the GFC—which was predicted only by a handful of credit-aware economists (Bezemer 2009)—made abundantly clear.”
aggregate demand = income plus change in debt
Possible better terms.
Consumption goods plus investment goods plus financial assets = income plus change in debt
Comment in spam?
JoeMac: I don’t think we have to treat those as separate decisions.
Tom: thanks! I’m not sure if Steve Keen’s followers will respond the same way. Oh well.
TMF: Yep. That’s what he actually said. But you can immediately see two problems with it:
1. The National income accounting problem, because if people actually buy the goods they demand, aggregate demand will equal income.
2. Some debt does not involve money. If I borrow $100 from you (and you are not a bank) debt goes up my $100, but there is no money creation. And it’s not obvious whether this causes AD to go up or down, because we don’t know whether it was caused by my increased desire to spend or your increased desire to save.
Nick, couldn’t you also “prove” this identity by constructing it for individuals, and then aggregating?
planned nominal expenditure equals expected nominal income plus money borrowed from the banking system minus increase in the stock of money demanded
The reason I suggest this is that it’s weird to imagine that individuals form expectations about aggregate bank lending or aggregate money demand. (I know that’s not what your identity says, but it took me a couple moments to figure that out.)
Nick’s post said:
“1. The National income accounting problem, because if people actually buy the goods they demand, aggregate demand will equal income.
2. Some debt does not involve money. If I borrow $100 from you (and you are not a bank) debt goes up my $100, but there is no money creation. And it’s not obvious whether this causes AD to go up or down, because we don’t know whether it was caused by my increased desire to spend or your increased desire to save.”
1) Should the definition of aggregate demand (AD) include financial assets? I think Keen includes it in his definition of AD.
2) No “money” creation, OK. If I save $100 in “money” taking it out of circulation and you borrow the $100 and spend it on goods/services, isn’t AD unchanged?
Heaven forbid should anyone try to use math here. Let’s just keep on trying to guess what we all meant!
+1 David.
Seems fitting given Noah’s (somewhat bizarre) recent post, and Krugman’s (exactly on point) reply.
Also, we’ve all seen Keen’s struggles with basic math before, so maybe we are all better of if he avoids trying to use it.
If Steve Keen is saying what Nick thinks he is saying, then what Steve is saying is much the same as what MMTers say: i.e. that hot potatoes are important. Or put another way, the above lot have all tumbled to something that was obvious to the average street sweeper all along, namely that if someone wins on the lottery, they’re liable to spend some of their winnings. Or have I missed something?
“”In a credit-based economy, aggregate demand is therefore the sum of income plus the change in debt”
this always sounds to me rather like assuming V is a constant in MV=PY, so changing M changes PY. I think he’s getting at the point that credit creation via banks increases the money supply, and puts money in people’s hands they can spend without having earned it first, which is fair enough, I think that is part of the process whereby AD may rise, but what’s the velocity of this “change in debt”? I may have misunderstood him.
this is a great post and I think what you describe actually happens. But I think the claim “This is not a long run story” could potentially be modified, depending on what you think happens on the supply side. Suppose there is a persistent (decade-long) credit expansion, the usual story about people funding spending by borrowing, extracting equity from property. Isn’t there a coherent story in which this “demand pull” draws forth a supply side response (more investment, more labour supply, perhaps innovation)? So the CB wouldn’t necessarily slam on the brakes (perhaps also because cheap imports were interfering within inflation data). So not a long long-run story but perhaps a decade-long story?
I am trying to figure out whether standard mainstream macro is missing anything important by abstracting from all this. According to my shaky understanding of mainstream macro, if for some reason – animal spirits – people want to consume more today than they did yesterday, the required supply side response (increase in labour supply and investment?) just happens smoothly and simultaneously, the model doesn’t worry about breaking the process down into granular time and explaining how somebody can spend more one period than they earn, how different agents’ expectations adjust as they observe what the actions of other agents mean for their own incomes etc. It’s all just rolled up.
So this omission means mainstream macro won’t be telling any stories about credit expansion fuelled booms. But mainstream macro spends most of its time studying monetary and fiscal policy responses to negative shocks, and doesn’t worry too much about fleshing out the detail of those shocks. I cannot guess whether the answers to those questions would change if mainstream macro introduced this role for banks. Everybody is busy trying to add the financial sector to macro models, but I am less sure about this aspect of the financial sector.
Alex: “Nick, couldn’t you also “prove” this identity by constructing it for individuals, and then aggregating?”
I’ve been wondering about that. A better way to say what you just said: what assumptions would I need to make to ensure that that equation holds? Clearly I need to assume that each individual has a coherent plan, given his expected income (that his plan does not violate his budget constraint). At the individual level, that equation wouldn’t hold, because an individual could also be planning to buy or sell things like land or used goods or non-monetary financial assets. The question is whether those things would cancel out in aggregate. And they might not, because if everyone were (say) planning to sell $1,000 worth of land, in aggregate their plans would be inconsistent.
Which brings me to TMF’s point: “1) Should the definition of aggregate demand (AD) include financial assets? I think Keen includes it in his definition of AD.”
Or include things like land too. Well it might be more useful to redefine “AD” that way, but in this post I wanted to stick to the conventional definitions of everything, because I wanted to make sure I got a version that did not violate NIA identities, which are expressed in terms of those conventional definitions.
TMF: “2) If I save $100 in “money” taking it out of circulation and you borrow the $100 and spend it on goods/services, isn’t AD unchanged?”
Yep, which goes back to Say’s Law. Except that if you decide to save more, that might lower interest rates to persuade me to spend more, which might affect borrowing from banks.
David: Hey! I did use math! There are three equations in this post, and I used algebra to substitute the second equation into the first, to derive the third. I just wrote them out longhand, writing “equals” instead of “=”.
And I wrote: “Aggregate expected income, which is what we are talking about here, is not the same as expected aggregate income. The first aggregates across individuals’ expectations of their own incomes; the second is (someone’s) expectation of aggregate income.” which makes the important math point that it matters whether “E” appears to the right or left of the summation operator!
Evan: and maybe we are all better off if you don’t see me struggle with math too! (Especially trying to write it in Typepad.)
Ralph: I think that misses something. Money is unique in being the medium of exchange. Almost anything is wealth.
Luis Enrique: (quoting Steve Keen) “””In a credit-based economy, aggregate demand is therefore the sum of income plus the change in debt””
What that misses is that some debt has nothing to do with the creation of money, and doesn’t have any obvious effect on either the supply or demand for money, or on AD. Like if I borrow $100 from TMF. Plus, in an economy with excess supply of goods, actual income will always equal AD, regardless of whether debt or money is increasing.
The reason it can’t be a long run story is that it requires people to be consistently surprised on the upside. Every month, for month after month, their income is higher than they expected it to be.
If you promise to pay me $100, and then I take the note to a bank and factor it in exchange for $95 of bank-created money, then unquestionably money has been created. People create lendable collateral all the time independent of monetary policy–this is why the MMT “all money flows from government spending” concept is a fallacy.
Hi Nick,
yep I see that, I think when Keen writes “debt” he does not have personal borrowing or whatever in mind, I assumed he meant net credit creation via the banking system, or something similar, so that he is talking about money creation. Maybe I assume wrong.
I don’t quite follow the requiring people to be consistently surprised thing. I guess some people might keep getting nice surprises, but I had in mind an expansion in which each year planned nominal expenditure equals aggregate expected nominal income plus amount of new money created by the banking system, and the “new money created by the banking system” is a positive for say 10 years in a row, or something. So aggregate household debt rises 10 years in a row. Each year people are spending more than they earn and that’s greasing the wheels of demand expansion and accompanying supply side response. Does that story really necessitate that people are surprised by their realised income 10 years in a row?
Ecomedian: “this is why the MMT “all money flows from government spending” concept is a fallacy.”
Do they say that? If so, yes they are wrong.
Luis Enrique: Consider an equilibrium where money growth is a fully-anticipated and constant 50% per year. The quantity of money demanded would also be growing at 50% per year, so the right hand side of my equation would be zero, which is compatible with AD and actual income equalling aggregate expected income, so the left hand side would be zero too.
OK, thanks Nick. I don’t really understand why money demand subtracts from things, will have to go away and digest.
TooMuchFed
This post deserves a longer reply but in response to TOOMUchFeds point
There is no exante exposte accounting identity problem see this talk by Steve at last years Seminar at the fields institute http://www.youtube.com/watch?v=pOxZixjorho Basically ex ante is before the credit creation, then credit is an instantaneous creation of money, then looking backwards ex poste you need to account for that creation of money. The fields institute has modelled this using Lebeseque integration – see this nice diagram on my webpage http://andrewlainton.wordpress.com/2012/12/06/some-notes-on-pontus-rendahls-review-of-keensian-economics/ because of Carethedory’s theorum any model using Lebesque integration can be modelled using ODEs which is what Keen uses.
On your second point, no Steve is not talking about mercentile ‘credit’ only net creation of money through financial assets. This is important for example he agrees with me and Werner that treasury bonds Iexcept when purchased by central bank money creation) do not lead to net credit creation – they are simply transfer payments.
Nick an interesting post though trying a bid too hard to squeeze into a neoclassical box a profoundly disequailibrium process. The ‘minus the increase in money demanded’ (surely this dimensionally should be a flow as the units are dollars/time?) I think comes from my comments to him that this ‘flow’ i.e. change to the rate of savings (increase or decrease in idle balances) should form part of the equations, as it did from at least one historical precursor of this theory. (you know the wepage im talking about you commented on it).
I think the big gap in your treatment is whether debt finances an increase in investment – growth – or increase in asset prices. Youve left out Steve’s Minksyian influence. If the former then whether or not the increase in income is fully anticipated there will be an increase in net wealth. Also the change in debt can be negative, people paying back debts leads to net decreases in money. However if peoples real incomes have grown because of productive investment then the real cost of debt servicing will fall and people will be better off despite the deflationary effect of deleveraging. I see Steve’s theory very much as a theory of growth in the classical ‘expanding the market’ tradition. Your treatment has the lucasian advice of real things only happening to the economy if their are ‘surprises’ or ‘shocks’. Of course some spending from credit will not lead to an increase in production, it may simply run down inventory, but this is no blow to Keen Credit Cycle theory, after all Hawtry developed a very similar theory where almost identical equations were expressed verbally involving the building up and running down of normal buffer stock inventories.
Dear all: I’m off canoeing for a few days, in the wild places where even cellphones don’t work.
Have fun, play nice, and if your comment doesn’t appear it probably means it has gone into spam, and will be fished out later.
I believe Steve Keen is aware of your second problem. It looks like he means increase in net credit, and change in debt is only a proxy for this, and it’s not clear how good a one.
Your first point is trickier. You’re doing different accounting based on different assumptions.
Try something simple. People borrow a Billion dollars of new bank money this year. They spend the money on goods and services tracked by GDP. GDP increases.
But you say, they’ll get this billion back as income
“So at the end of the month the average individual is surprised to discover that his income was $100 more than he expected it to be, and that he has $100 more in his chequing account than he expected to have and planned to have”
This is what happens when you believe in representative agents. You can drown in a lake with an average depth of 1 foot.
The borrowers aren’t necessarily the people who will be getting the money back as earnings, nor are they acting in timeless simultaneity.
Where then does the money go? Some of it adds to the inflation component of NGDP, some adds to asset prices not tracked by NGDP, some counteracts certain underlying deflationary trends (cheap imports, decreasing labor share…), and some is spread over an increasing population.
This is exactly what we’ve seen. People borrow to compensate for wage stagnation and to run up the value of assets, and the pain is lessened by low import prices. I can buy a DVD player for $30, an air conditioner for $100 (it will soon cost more to recycle one than to buy one) and a 32″ flat screen TV for $250. OTOH I hope I never need a plumber.
The question is, what happens when you turn off the tap.
In NIPA accounting net credit works invisibly, but it still works. Timeless NIPA accounting can’t be applied to equations with explicit time without some sort of modification. You wouldn’t ask how many kilowatts are in a megawatt hour, would you?
“We know that a sensible central bank would eventually do something else to stop the whole thing rolling before aggregate planned nominal expenditure gets too big for consistency with the inflation or whatever target.”
I don’t quite understand how this bit fits into Keen’s model. He thinks that bank lending drives up and becomes increasing part of AD over time during a boom period but this eventually become unsustainable, then loans start not getting renewed causing downward pressure on AD and a recession. Keens shows charts to back this theory up showing debt/gdp ratios increasing in the lead up to 2008 and then declining afterwards.
However this all seems to happen during a period where the CB was indeed targeting inflation and NGDP was growing at a steady 5% annually.
Luis,
“I don’t really understand why money demand subtracts from things.”
It allows planned expenditure to go unrealized. Just because you demand a loan from a bank does not mean that you get one. Nick’s equation:
“Aggregate planned nominal expenditure equals aggregate expected nominal income plus amount of new money created by the banking system minus increase in the stock of money demanded.”
Aggregate planned nominal expenditures could exceed national income plus the amount of loans the banking system is willing to make. If everyone planned on spending $1 billion dollars today, the banking system may not be willing to extend enough credit to make it happen.
Nick: I don’t get your rebuttal of my August 23, 2013 at 04:09 AM point.
Frank,
No, that’s not what Nick is talking about. The reason money demand subtracts from things is that if I borrow $100, but I do so because I want to walk around with $100 in my pocket rather than having a specific plan for what to do with that $100, then aggregate demand won’t go up. (If I do spend the $100 at the store the next day AD will go up.)
Alex,
Okay, gotcha. Nick is referring to liquidity preference (demand for the most liquid of assets). It would kind of strange for someone to borrow money without a planned purchase for that money. Not saying it never happens, just that it would be quite unusual.
Frank, in a sense I “borrow” money without a planned purchase for it all the time – when I visit the ATM to refill my wallet. I have a very literal money demand – I want to hold a physical stock of money purely for the liquidity value.
More generally, you probably won’t see people taking out actual loans just to hold on to the cash, but when you introduce multiple people you can get the same effect. My employer might borrow money to pay my salary, and when I receive my salary I don’t have any specific plan for what to do with it so I let it sit in my bank account.
Alex Godofsky,
“in a sense I “borrow” money without a planned purchase for it all the time – when I visit the ATM to refill my wallet. I have a very literal money demand – I want to hold a physical stock of money purely for the liquidity value.”
In what sense is that borrowing?
Ron,
NGDP doesn’t include transactions that are not value added – no purchase of goods already accounted for, capital gains, borrowing etc. There’s nothing to make any level of debt incompatible with steady NGDP growth per se. That requires some other part of your economic model.
This comes back to the economic blog perennials that asset inflation isn’t inflation, and whether central banks should target asset inflation when CPI inflation or NGDP is on target(depending on your preference of target).
W Peden:
In the sense that I am selling a slightly-less-liquid interest-bearing asset (deposits) for a slightly-more-liquid non-interest-bearing asset (currency).
Solipsinomics?
Single agent Si wants to buy a DVD player. Si goes to the bank and gets $100 in a deposits (a bank liability). Through the magic of fractional reserve banking, the bank creates a $100 deposit liability for Si and an offsetting $100 asset (the loan) which it holds on its books against Si. With the deposits (skipping over steps involved with exchanging deposits for currency and back), Si buys a DVD player from Si the manufacturer. Si as manufacturer, hires Si as an employee to make the DVD player, paying Si with the money customer Si payed for it. This payment is income to Si employee, which Si employee/customer deposits in the bank. At some future time Si and the bank may decide cancel the banks deposit liability and loan asset. The loop is closed, GDP = GDI = GDE = $100, and Si is his own grandpa.
Does this sound about right, sarcasm aside?
Alex Godofsky,
I still don’t see how moving from one asset to another constitutes “borrowing”. No new liabilities have been incurred by you.
If you placed cash in a bank account, then this is borrowing, but on the part of the bank.
Peter N,
Good point. The money supply and total loans could be going up in parallel. If most of this new money goes towards increased spending on asset that don’t count for NGDP (rather than final goods, that do) then this could indeed lead to increasing debt/gdp ratios while NGDP growth stays on trend. In fact its quite possible that in a boom you could well see banks becoming more leveraged by lending more against existing assets and this new money then drives up asset prices while NGDP is little affected. If the CB targets NGDP growth this may dampen things down enough in terms of final sales but not necessarily in terms of bank leverage or asset price inflation.
So if Nick’s view of what Keane says is correct then one can make something of a case that if the CB is only looking at NGDP it might miss other bad things that are happening in the economy until they cause a crisis that affects NGDP negatively and drives the economy into a ZLB scenario.
Ron,
You also have to consider purchases of low cost foreign goods reducing CPI inflation, while the recycled money fuels the fire.
The problem is you have so many trends reaching their Stein’s law endpoints at the same time:
Demographics
The China credit cycle
The European banking crisis
The problem of the Euro
A hypertrophied financial system
The rise of our robot masters
Who knows in what order these train wrecks will occur?
Peter N — exactly. CPI has been an unreliable indicator for a long time. This point is not made enough. It’s impossible to separate the recent spate of credit bubbles from the fact that, increasingly, preferred monetary gauges are not working correctly.
Back from canoeing, in case anyone is still reading. Drive 3 hours from the capital city, paddle a few hours, get your own private beach, on what might as well be your own private lake too, swim in water probably clean enough to drink, and all for $8 per person per night. Canada eh!
Andrew: “Nick an interesting post though trying a bid too hard to squeeze into a neoclassical box a profoundly disequailibrium process.”
But I did keep saying “this is a disequilibrium process”! Expectations falsified, money demand not equal to quantity of money, that’s diequilibrium.
“The ‘minus the increase in money demanded’ (surely this dimensionally should be a flow as the units are dollars/time?)”
Yes, it’s a flow. I said that. Quantity of money demanded is a stock, that has the units $, and the amount by which it is increasing per month is a flow, with units $/month.
Ron: “”We know that a sensible central bank would eventually do something else to stop the whole thing rolling before aggregate planned nominal expenditure gets too big for consistency with the inflation or whatever target.”
I don’t quite understand how this bit fits into Keen’s model.”
It doesn’t. I think this theory can work for a short run increase in bank credit, starting from a recession, but I don’t think it does work as a long run theory of all debt.
PeterN @5.22: that sounds about right. Except: “At some future time Si and the bank may decide cancel the banks deposit liability and loan asset.”
We are not sure when that future time will be. Because Si has been surprised to find: he’s got a job and is earning $1,000 per month more income than he expected; he has $1,000 more in his chequing account than he expected. He will revise his plans in the light of those surprises. He might pay back the loan, or he might decide to spend more. It will depend on whether he thinks this is a temporary or permanent change.
Yes the loan probably won’t be repaid. In fact let’s assume that Si borrows an additional $100 every month.
The questions are
1) how is the effect of the additional credit distributed between RGDP, CPI inflation and inflation of assets not part of GDP.
2) what happens when instead of borrowing Si has to start repaying the loans.
This is the Steve Keen question stripped down to its most basic possible form. The mechanism is certainly of great interest, but first it would be nice to agree on the effects as stylized fact. Of course the bank may securitize the loans and sell them, but I think poor Si has worked hard enough. Single agent models within NIPA can get extremely perverse warping time, space and motivation.
As far as debt goes, net credit is net credit. This should be observable. It’s effects may be subject to debate, but not its existence.
I found this searching Google. Take a look at 2008:
Damn I wish I’d gotten here earlier for this discussion. Couple of points:
Do we need to add “planned borrowing/paybacks” to the equation? Think about both aggregate planned borrowing and planned aggregate borrowing?
If planned borrowing goes up, does this increase demand (planned expenditure)? Ceteris paribus, you’d have to say yes.
“Nothing in the above violates any national income accounting identity.”
Actually that equation can’t be right or wrong, because demand is not an accounting measure. You’ll never find “demand” in that national accounts, in balance sheets, income statements, or flows of funds. In its general form it’s a curve, not an amount. You can’t put a curve in an accounting identity.
“Demand” is an expression of what people, at a given moment in time, would buy over the ensuing period at various price points. It’s a formula (often expressed as a curve), not an amount.
And there’s no simple accounting measure that can tell us what “demand” was at a given moment, with that moment’s given price point — what people at that moment wanted to buy over the ensuing period.
Nick accommodates Steve’s effort to construct demand as such, but I think that effort (by both) results in part of the disconnect.
Here’s a way to frame the question: “Looking back: what was aggregate demand on July 31, 2010?” That could be an amount (given prices at that moment). And one could construct a formula trying to suss out the answer, built from national account data now available post hoc, describing that moment.
Now, in the simplest S/D construct, if you know the price point at that moment and assume that it will remain unchanged over the ensuing period, you can specify demand as an amount — an output from the formula, a point on the curve. Talking short term as Nick does here, that’s an okay assumption.
But what we’re really asking: what’s the formula? Looking back we can ask, what was demand on August 12, 2011? A single accounting measure can’t answer that. For instance, GDP can’t be the answer. The amount sold might be affected by short supply. So “demand” was higher than satisfied demand (GDP).
So what combination of accounting measures (available now, looking back, post-hoc) can we use to suss out that answer? How much did people at that moment want to buy over the ensuing period at that moment’s price point? We might get the best feel for that number using measures both preceding and succeeding that moment. You could come up with any number of formulas, using any number of measures.
Steve’s formula is problematic because it doesn’t specify what dates we’re looking at to determine “demand” at that moment. Preceding six months’ GDP/debt change? Succeeding six months? (Google “instantaneous flow” to see thoughts on what surrounding flow-over-time measures can be used to derive such an instantaneous measure, and what formulas can be used to derive it.)
I’m kind of taken with Ed Lambert’s work here (effectivedemand.typepad.com), because he seems to (at least intuitively and implicitly) understand this conceptual situation. His formula and chosen measures might be singular or idiosyncratic, but I would expect such a formula to be so. It’s trying to construct an economic measure (“demand” at a given point in time) from an infinite menu of available accounting measures — stock measures describing that moment, and flow measures describing periods surrounding that moment — and an infinite number of possible formulas combining those measures.
“GDP plus new debt” is insufficiently specified unless you say “GDP plus new debt over some specified periods relative to the moment at which you’re trying to estimate ‘demand’.
Demand is an economic concept describing people’s desires, not an accounting measure. But we might be able to create an effective, useful estimate/measure of demand at a given moment by combining accounting measures using a formula. It would be especially great if the accounting measures used were all antecedent to the “demand moment.” Then we could estimate in semi-real-time what “demand” is right now.
I find it significant that out-of-the-boxers Steve Keen and Ed Lambert are the only people I know of who are trying to define demand rigorously and formulaically — and potentially usefully. Or am I wrong on that?
Steve: “I find it significant that out-of-the-boxers Steve Keen and Ed Lambert are the only people I know of who are trying to define demand rigorously and formulaically — and potentially usefully. Or am I wrong on that?”
Do you mean deriving (and empirically estimating) an aggregate demand function? In mathematical form? If so, yes, you are wrong on that. Most first and second year macro texts mainly do a diagrammatic exposition, but it’s a simple matter to put those diagrams into equations and derive an aggregate demand function. Sometimes this is done in the main text, and sometimes it’s in an appendix. And various types of econometricians use various different ways to try to put real world numbers into those functions. How useful this mathematisation is is debatable, but they’ve been doing it since before we were born.
A very quick response Nick. Given that we use different languages to express our economics, I think you’ve provided a pretty good characterization of my argument. I’m very pleased about that, given that there has been so much non-communication involved in this overall issue until now. I’ll leave any discussion of differences of opinion to later.
I also note the caveats about bringing math in here, but Matheus Grasselli has recently done a comprehensive analysis of the stock-flow mathematics in one of my models to show that the statement that “effective demand of the non-bank public is income plus change in debt” is accounting-consistent with “income = expenditure” when the banking sector and the non-bank sector are lumped together.
Matheus’s blog is here:
http://fieldsfinance.blogspot.com/2013/08/accounting-identities-for-keen-model.html
and the PDF is here:
Click to access keen2011_table.pdf
The issue of whether rising debt adds to demand then comes down to whether loans turn up on the asset or the liability side of the banking system ledger. If we treat banks as mere intermediaries as in the Loanable Funds model, then all lending occurs on the liability side of the ledger, and changes in the level of debt have no impact on aggregate demand–as Krugman has repeatedly argued. If however loans turn up on the asset side of the banking ledger, then the change in debt does add to demand via the money creation mechanism you note.
I think the empirical issue here is obvious–bank loans do occur on the asset side of the banking system’s ledger–so that rising private debt does add to effective demand (to revive an old term, as Nathan Tankus first recommended). So integrating banking into macroeconomics significantly alters it from a macroeconomics in which banks (and normally also debt and money) are omitted.
Having done a more considered re-read, I very happily stand by my first reaction to your post: you’ve done a very good job of providing a Rosetta Stone between standard Neoclassical macroeconomics, and the perspective on endogenous money macroeconomics that I put forward (along with Richard Werner, Michael Hudson, Dirk Bezemer, Matheus Grasselli and a few others–and I hasten to add that it is still a minority position even within Post Keynesian economics).
This is a first Nick, and I have to sincerely thank you for it. It is truly appreciated.
Cheers, Steve Keen
Ecomedian,
“this is why the MMT “all money flows from government spending” concept is a fallacy.”
No, we don’t say anything of the sort and never have. That would be obviously false, as Nick noted. Obviously a misinterpretation somewhere in there, either by you or by whomever you heard it from if that is the case.
Ecomedian,
“this is why the MMT “all money flows from government spending” concept is a fallacy.”
I’m not sure this is right, but perhaps:
Much popular MMT tends to display things in a three-sector model — government, private domestic, and rest of world. Or even a two-sector model: government and private assuming a closed economy. This I think for simplicity of explanation. In those sectoral models, it very much looks like any additional money in the private sector comes from government (or trade surpluses). It emphasizes that the private sector can’t acquire net new financial assets except when there are injections from those sectors.
But that is very far from the full scope of MMT, which in my opinion is best viewed via a four-sector model: private nonfinancial, financial, government, ROW — or even better five sectors, splitting out private nonfinancial into households and firms. In those models we very much perceive banks, firms, and households as agencies in the economic process.
None of these sectoral models is wrong, but they give different impressions of how economies work.
Steve, you don’t need four or five sectors in MMT to demonstrate private sector creation of ‘horizontal money’.
Nick: I’ve been hard-pressed to find a function whose inputs are national accounting measures. They all seem to built on unobservables (or at least unobserveds) like MPC or autonomous consumption.
I’ve been really hard pressed to see a graph of aggregate demand over time that has as observational basis in measures from the national accounts.
Maybe my googling’s just been insufficient, but if such things are out there they sure are talked about rarely.
I just feel like if we’re going to use the term, we should have some formulaic definition in mind, based on observed measures, so we can look at the actual derived measure and see how it behaves over time relative to our surmises and other measures.
ProfSteveKeen said: “the statement that “effective demand of the non-bank public is income plus change in debt” is accounting-consistent with “income = expenditure” when the banking sector and the non-bank sector are lumped together.”
Does effective demand include financial assets? Yes/No
Does income include financial assets? Yes/No
ProfSteveKeen said: “I think the empirical issue here is obvious–bank loans do occur on the asset side of the banking system’s ledger–so that rising private debt does add to effective demand (to revive an old term, as Nathan Tankus first recommended). So integrating banking into macroeconomics significantly alters it from a macroeconomics in which banks (and normally also debt and money) are omitted.”
I believe you are actually getting at the idea that the capital requirement becomes a capital multiplier. Thoughts?
Nick’s post said: “Luis Enrique: (quoting Steve Keen) “””In a credit-based economy, aggregate demand is therefore the sum of income plus the change in debt””
What that misses is that some debt has nothing to do with the creation of money, and doesn’t have any obvious effect on either the supply or demand for money, or on AD. Like if I borrow $100 from TMF.”
I save $100. I lend $100 to Nick Rowe (Nick Rowe borrows $100 from me). I believe Steve Keen would call me saving $100 negative debt. Nick Rowe borrowing $100 from me would be called positive debt. Minus $100 plus positive $100 equals zero.