Thomas Palley’s Nice Critique Of Steve Keen’s Models

Thomas Palley has a new paper Effective Demand, Endogenous Money, And Debt: A Keynesian Critique Of Keen And An Alternative Theoretical Framework, which can be found on his blog.

In the abstract, among other things, Palley points out that Steve Keen’s treatment of endogenous money “falls into the theoretical morass regarding the black box of velocity of money via its adoption of a form of Fisher equation to determine AD.”

The part I found most interesting was that Keen’s new equation suggests that “changes in income are … driven exclusively by borrowing and loan repayment” and Palley illustrates the inaccuracy by considering cases where expenditure can be changed without borrowing:

The assumption that only borrowing and loan repayment can change AD is implausible. Households and firms can change their propensities to spend without borrowing or repaying loans. A central insight of Keynesian economics concerns the role of money which can act as a sink for purchasing power. Spending can be reduced by adding to idle balances, and it can be increased by activating existing idle balances. In the US, firms currently hold massive cash hoards. Those hoards can be activated to finance investment spending that increases AD. Export levels can change, and households and firms may also change the composition of their spending between domestic output and imports. Changes in the distribution of income, at both the functional and personal levels, can affect AD because of different propensities to spend out of income among agents. All of these changes can be accomplished independently of new borrowing or debt repayment. Moreover, borrowing in prior periods creates debt service transfers from debtors to creditors and these transfers will affect the pattern of leakages to the extent debtors and creditors have different propensities to save. Given all of that, there is no reason why this period’s aggregate demand should equal last period’s income or last period’s aggregate demand.

The paper is available in pdf at Thomas Palley’s blog post.

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