# The Non-existence Of NAIRU In SFC Models

Simon Wren-Lewis has a post on his blog, The NAIRU: A Response To Critics. In that he refers to a blog post from me where I refer to the book Monetary Economics by Wynne Godley and Marc Lavoie. He perhaps doesn’t like me just citing the textbook and needs an explanation. How is that for an argument! Suppose I write a paper on gravitation. Do I always have to derive Einstein’s equations? Can’t I just refer it to the reader?

In other words, how is telling somone that, “SFC models have no NAIRU” not a good argument? Easy to check.

Anyway, an explanation: In stock-flow coherent models, the wage dynamics is given by equations such as these (page 302) :

ωT= (W/p)T = Ω0 + Ω1·pr + Ω2·(N/Nfe)

W = W–1·(1 + Ω3·(ωT−1W-1/p-1))

Here,

is the price level, is the nominal wage rate, ωis the target real wage rate, pr is the labour productivity, is the level of employment, Nfe is the full employment level and the three Ωs are parameters.

Wages change only discretely. Workers have a target wage rate which depends on productivity and the employment level. The actual wage rate is the outcome of bargaining of employees of firms with management. So workers try to catch up to what they consider fair. And their target depends on the level of employment. If unemployment is high, negotiation is more difficult and if unemployment is low, it’s easier as jobs can be switched. So there’s a Phillips curve.

Another important point is that there is no inflation expectations here.

The parameters Ωs used by the authors Godley-Lavoie and Gennaro Zezza are: –0.4, 1, 1.2 and 0.3.

Simulations of such models do not produce a runaway inflation, only higher inflation at full employment.

It’s not difficult to see why. How does the wage dynamics equations imply a runaway inflation? Can you inspect them conclude in a straightforward manner that there’s NAIRU? Anyway, simulations confirm.

That doesn’t mean there can’t be a wage-price spiral. This might happen—as the authors Godley and Lavoie explain—if the parameters Ωs change fast with time or if wage settlement happen more frequently. But as I have mentioned, it’s not necessarily so.

More realistic models have a flatter segment like this (Figure 11.1, page 387 from Monetary Economics, Ed. 1):

snipping via amazon.com

In this model (the “growth model prototype”) with behavioural equations for the government, central bank, firms, banks and households, the wage dynamics are similar to the equations above except that they have a flat segment. Again no accelerating prices!

In the discussion above (with no flat segment), I mention that there’s no NAIRU, but just to confirm I asked Marc Lavoie if this is crucial and he said no. Quoting his email with his permission:

The (unique) NAIRU has to be associated with a relationship that says that any negative discrepancy between the actual rate of unemployment and the NAIRU will lead to an acceleration of the rate of inflation. In terms of the rate of employment, it implies that any positive discrepancy between the actual rate of employment and the NAIRU will lead to an acceleration of the rate of inflation. This means that we can draw an upward-sloping curve relating the rate of employment to the change in the rate of inflation, where the change is zero when the economy is at the NAIRU.

In the case of Godley and Lavoie (2007), whether it is chapter 9 or 11, the equations that define the real wage target are such that they do not lead to such a curve. What we get is an upward-sloping curve that relates the rate of employment to the rate of inflation, and not to its change. When we are in the flat area of Figure 11.1, this means that the rate of inflation remains constant even if the rate of employment is higher. Besides the flat area, we have a kind of old Phillips curve: to a higher rate of employment is associated a higher rate of inflation, but that is all. There is no acceleration. Another way to put it is to say that there is an infinite number of NAIRU or a multiplicity of NAIRU (of rates of employment with steady inflation).

So with explanations about wage dynamics which has a Phillips curve (with or without a flat segment), I show that SFC models have no NAIRU.

# Simon Wren-Lewis, NAIRU And TINA

Last month, Matthew C Klein wrote an article for Financial Times’ blog Alphaville arguing against the concept of NAIRU. Today, Simon Wren-Lewis published a reply to Klein on his blog defending NAIRU. SWL’s argument is essentially that there is no alternative (TINA):

… But here is the rub. If we really think there is no relationship between unemployment and inflation, why on earth are we not trying to get unemployment below 4%? We know that the government could, by spending more, raise demand and reduce unemployment. And why would we ever raise interest rates above their lower bound?

… There is a relationship between inflation and unemployment, but it is just very difficult to pin down. For most macroeconomists, the concept of the NAIRU really just stands for that basic macroeconomic truth.

The sad part of this argument is that NAIRU isn’t the only answer to the relationship between (un)employment and inflation. Both of the following can be true:

• There is a relationship between employment and inflation.
• The concept of NAIRU is false.

What is NAIRU (non-accelerating inflation rate of unemployment)? According to the originators of this incorrect idea, it is the rate of unemployment U* below which inflation starts rising indefinitely. It’s a bit of a misnomer as it’s prices which is accelerating, not inflation. Nonetheless, the extreme nature of this should be clearly stated: NAIRU advocates think that a fraction of the workforce should be kept unemployed to keep inflation under control.

Post-Keynesians have rejected these arguments since the beginning. In their book Monetary Economics, Wynne Godley and Marc Lavoie show that in their model full employment can be achieved without a runaway inflation.

This is not the first time SWL has defended orthodoxy. A few years ago, he called rational expectations “one of economics’ major achievements” and also that:

It is not a debate about rational expectations in the abstract, but about a choice between different ways of modelling expectations, none of which will be ideal. This choice has to involve feasible alternatives, by which I mean theories of expectations that can be practically implemented in usable macroeconomic models.

However for the foreseeable future, rational expectations will remain the starting point for macro analysis, because it is better than the only practical alternative.

# Remarkable Admission On Fiscal Policy

There’s a paper by Jason Furman who is the Chairman of the Council of Economic Advisers which concedes how wrong economists were on fiscal policy. The link is a file hosted at the White House’s website! The paper starts off with a remarkable admission on fiscal policy (h/t and words borrowed from Jo Michell)

1. Discretionary fiscal policy is dominated by monetary policy as a stabilization tool because of lags in the application, impact, and removal of discretionary fiscal stimulus.
2. Even if policymakers get the timing right, discretionary fiscal stimulus would be somewhere between completely ineffective (the Ricardian view) or somewhat ineffective with bad side effects (higher interest rates and crowding-out of private investment).
3. Moreover, fiscal stabilization needs to be undertaken with trepidation, if at all, because the biggest fiscal policy priority should be the long-run fiscal balance.
4. Policymakers foolish enough to ignore (1) through (3) should at least make sure that any fiscal stimulus is very short-run, including pulling demand forward, to support the economy before monetary policy stimulus fully kicks in while minimizing harmful side effects and long-run fiscal harm.

Today, the tide of expert opinion is shifting the other way from this “Old View,” to almost the opposite view on all four points. This shift is partly the result of the prolonged aftermath of the global financial crisis and the increased realization that equilibrium interest rates have been declining for decades. It is also partly due to a better understanding of economic policy from the experience of the last eight years, including new empirical research on the impact of fiscal policy as well as observations of the reaction of sovereign debt markets to the large increases in debt as a share of GDP in the wake of the global financial crisis. In the first part of my remarks, I will discuss the theory and evidence underlying this “New View” of fiscal policy (with, admittedly, the core of this theory being an “Old Old View” that dates back to John Maynard Keynes and the liquidity trap).

Compare that to the Post-Keynesian view, which according to Wynne Godley and Marc Lavoie in their book Monetary Economics written before the crisis (from chapter 1, Introduction):

The alternative paradigm, which has come to be called ‘post-Keynesian’ or ‘structuralist’, derives originally from those economists who were more or less closely associated personally with Keynes such as Joan Robinson, Richard Kahn, Nicholas Kaldor, and James Meade, as well as Michal Kalecki who derived most of his ideas independently.

… According to post-Keynesian ideas, there is no natural tendency for economies to generate full employment, and for this and other reasons growth and stability require the active participation of governments in the form of fiscal, monetary and incomes policy.

# DSGE, SFC And Behaviour

This is a continuation of my post Simon Wren-Lewis On Wynne Godley’s Models. I was comparing stock-flow coherent models to DSGE models implicitly (didn’t mention the ‘DSGE’).

One of the things I spoke of was behaviour: firms deciding how much to produce. In stock-flow consistent models, it is decided by trends in sales. So if entrepreneurs see a fall in their inventory-to-sales ratio, they’ll produce more typically. This can be made more accurate. See Wynne Godley and Marc Lavoie’s text Monetary Economics for more details.

Here I want to concentrate on models such as DSGE or any other model used by institutions such as the UK Treasury for the case of production. In these models, there is a production function describing how much firms will produce. This is incorrect to begin with. It says nothing about behaviour. If households start borrowing a lot, in DSGE models, producers are still producing the same because production is governed by the production function. In stock-flow consistent models, simple modeling assumptions about how much firms produce are far superior. So in this case, in SFC, more borrowing leads to more sales and a change in sales trends, inventory/sales ratio and hence affecting how much will be produced.

The DSGE production function is thus inconsistent with the Keynesian principle of effective demand. DSGE is not even Keynesian. It’s thus ridiculous how economists defending DSGE models and its ancestors accuse SFC modelers of not paying attention to behaviour.

New Bank Of England Paper On The Financial Balances Model For The United Kingdom

Stephen Kinsella is out with a new paper with co-authors Stephen Burgess, Oliver Burrows, Antoine Godin, and Stephen Millard published by the Bank of England.

From the paper:

Our paper makes two contributions to the literature. First, we develop, estimate, and calibrate the model itself from first principles as well as describing the stock-flow consistent database we construct to validate the model; as far as we know, we are the first to develop such a sophisticated SFC model of the UK economy in recent years.4 And second, we impose several scenarios on the model to test its usefulness as a medium-term scenario analysis tool. The approach we propose to use links decisions about real variables to credit creation in the financial sector and decisions about asset allocation among investors. It was developed in the 1980s and 1990s by James Tobin on the one hand, and Wynne Godley and co-authors on the other, and is known as the ‘stock-flow consistent’ (SFC) approach. The approach is best described in Godley and Lavoie (2012) and Caverzasi and Godin (2015) and underpins the models of Barwell and Burrows (2011), Greiff et al. (2011), and Caiani et al. (2014a,b). Dos Santos (2006) describes how SFC models incorporate detailed accounting constraints typically found in systems of national accounts. SFC models allow us to build a framework for the model where every flow comes from somewhere in the economy and goes somewhere, and sectoral savings/borrowings and capital gains/losses add or subtract from stocks of wealth/debt, following Copeland (1949). Accounting constraints allow us to identify relationships between sectoral transactions in the short and long run. The addition of accounting constraints is crucial, as one aspect of the economy we would like to model is the way it might react differently when policies such as fiscal consolidations are imposed slowly or quickly

4 Such models were popular in the past; for example Davis (1987a, 1987b) developed a rudimentary stock flow consistent model of the UK economy.

# On The Blogs

Two things caught my attention in the last two days.

First is the claim by Roger Farmer:

The Keynesian economics of the General Theory is static.

That’s the strangest critique of the GT I have ever seen. How is the GT static? John Maynard Keynes highlighted how a fall in the propensity to consume reduces output. His mechanism was quite dynamic. He was arguing that a fall in the propensity to consume will reduce consumption and hence firms’ sales and hence production and hence employment and hence consumption and so on. Keynes did not explicitly write down a mathematical model like as done for example in the book Monetary Economics by Wynne Godley and Marc Lavoie. But his arguments were quite dynamic in nature. So was his argument about how investment creates saving. And also the Keynesian multiplier. “Stock-flow consistent” models are quite close to Keynes’ spirit.

The second is this paragraph from Michael Pettis:

… This is one of the most fundamental errors that arise from a failure to understand the balance of payments mechanisms. As I explained four years ago in an article for Foreign Policy, “it may be correct to say that the role of the dollar allows Americans to consume beyond their means, but it is just as correct, and probably more so, to say that foreign accumulations of dollars force Americans to consume beyond their means.” As counter-intuitive as it may seem at first, the US does not need foreign capital because the US savings rate is low. The US savings rate is low because it must counterbalance foreign capital inflows, and this is true out of arithmetical necessity, as I showed in a May, 2014 blog entry.

Oh boy! That’s confusing accounting identities with behaviour. A simple way to show how inaccurate this is by using standard Keynesian analysis. Assume US households reduce the propensity to consume. This leads to a fall in output and income and hence a fall in imports and an increase in the current account balance of payments (assuming exports are exogenous to the model). This can be seen more precisely in a stock-flow consistent model.

Pettis’ arguments are in response to Stephen Roach’s recent article on US balance of payments and I discussed that recently here.  Both Roach and Pettis are incorrect.

Balance of payments is important and in my opinion, the most important thing in Economics. Michael Pettis gets the attention because he realizes the importance of balance of payments in the economic dynamics of the world. However looked more closely, many of his arguments appear vacuous.

# Is Floating Better? Is The Stock Of Money Exogenous In Fixed Exchange Rate Regimes?

I believe that the basic problem today is not the exchange rate regime, whether fixed or floating. Debate on the regime evades and obscures the essential problem … Clearly flexible rates have not been the panacea which their more extravagant advocates had hoped … I still think that floating rates are an improvement on the Bretton Woods system. I do contend that the major problems we are now experiencing will continue unless something else is done too.

– James Tobin, A Proposal For Monetary Reform, 1978

Frances Coppola has written a post saying that floating exchange rates are not the panacea. Although I agree with her point, there are however a few points in her article which has some issues. She says that money stock is exogenous in gold standard.

Under a strict gold standard, the quantity of money circulating in the economy is effectively set externally. The domestic money supply can only grow through foreign earnings, which bring gold into the country.

… This is evident from the quantity theory of money equation MV = PQ, which is fundamentally flawed in a fiat currency fractional reserve system but works admirably under a strict gold standard or equivalent.

Frances is critiquing Neochartalists there but ends up accepting their notion that macroeconomics is something different when a nation’s currency is not floating and there’s an exogenous stock of money in fixed exchange rate regimes. There is absolutely no proof that it is so. Money stock can grow if there’s higher economic activity due to rise in private expenditure relative to income or via fiscal policy. But why this obsession with Monetarism? It doesn’t work anywhere: whether the exchange rate is fixed or floating. All arguments made in Post Keynesian economics carry through to the gold standard. Indeed Robert Mundell himself realized this in 1961 [1].

Here’s a quote from the book Monetary Economics by Wynne Godley and Marc Lavoie, page 197, footnote 11:

It must be pointed out that Mundell (1961), whose other works are often invoked to justify the elevance of the rules of the game in textbooks and the IS/LM/BP model, was himself aware that the automaticity of the rules of the game relied on a particular behaviour of the central bank. Indeed he lamented the fact that modern central banks were following the banking principle instead of the bullionist principle, and hence adjusting ‘the domestic supply of notes to accord with the needs of trade’ (1961: 153), which is another way to say that the money supply was endogenous and that central banks were concerned with maintaining the targeted interest rates. This was in 1961!

Bretton Woods was the emperor’s new clothes and floating exchange rates are the emperor’s new new clothes. The important question is whether floating exchange rates offer any market mechanism to resolve balance of payments imbalances and the answer is that it doesn’t. In gold standard, current account deficits can be financed by official sale of gold in international markets and residents borrowing from abroad. In floating exchange rate regimes, it is financed by borrowing from abroad. Hardly much difference. So the main adjustment is left to movement of the exchange rate. One needs to suspend all doubt and believe in the invisible hand to think the movement of exchange rates can do the trick. The reason it is the emperor’s new new clothes is that the promises never worked. And similar promises were made by economists that there’s a market mechanism to resolve balance of payments imbalances in fixed exchange rate regimes.

To summarize, my argument is that the only point to debate is whether floating the exchange rate resolves imbalances as compared to fixed exchange rates, not about the endogeneity of money. Although there is a role because of the movement of the exchange rate, floating exchanges is not a panacea. Although I am not on the side of the Neochartalists in the debate, I thought I’d point this out: do not fall into the pitfall of your opponent.

1. Mundell, R. (1961) ‘The international disequilibrium system’, Kyklos, 14 (2),
pp. 153–72.

# Stock-Flow Inconsistent?

The first rule of Post-Keynesian Economics is: You do not talk make accounting mistakes. The second rule of Post-Keynesian Economics is: You do not talk make accounting mistakes.

– Anonymous.

Jason Smith—who is a physicist—but writes a blog in Macroeconomics, wonders how equations in the simplest stock-flow consistent model given in the textbook Monetary Economics written by Wynne Godley and Marc Lavoie make any sense from a dimensional analysis viewpoint.

He says he

seem[s] to have found a major flaw.

He sees the equation:

ΔH = GT

and wonders where the time dimensions are. For, H is the stock of money and hence has no time dimension, whereas the right hand side has flows and has time dimensions of inverse of time. For example if the US government spends \$4 tn in one year, is \$4 tn/year.

In continuous time, the above equation is:

dH/dt = GT

So how are these two equations the same?

Perhaps, Jason is not familiar with difference equations. He instead seems to prefer:

τ·ΔH = GT

Well that’s just wrong if τ is anything different from 1, as a matter of accounting.

Now moving on to time scales, it is true that in difference equations some time scale is implicit. But it doesn’t mean the methodology itself is wrong. Many physicists for example set all constants to 1 and then talk of numbers which are dimensionless.

So if a relativist sets “c=1”, i.e, the speed of light to 1, all velocities are in relation to the speed of light. So if somebody says the speed is 0.004, he/she means the speed is 0.004 times the speed of light.

But Jason Smith says:

Where does this time scale come from over which the adjustment happens? There is some decay constant (half life). It’s never specified (more on scales here and here). If you think this unspecified time scale doesn’t matter, then we can take Δtlp and the adjustment happens instantaneously. Every model would achieve its steady state in the Planck time.

That’s not true. String theorists for example set the parameter α’ = 1. But nobody ever claims that macroscopic adjustments happen at Planckian length scales or time scales.

Coming back to economics, there’s nothing wrong in

ΔH = GT

There’s an implicit time scale yes, such as a day, or a month, or a year, or even an infinitesimal. But parameters change accordingly. So in G&L models we have the consumption function

C = α1 ·YD + α2 ·W

where is household consumption, YD, the disposable income and W, the household wealth.

Let’s say I start with a time period of 1 year for simplicity. αmight be 0.4. But if I choose a time period of 1 quarter, αwill correspondingly change to 0.1. In English: if households consume of 4/10th  of their wealth in one year, they consume in 1/10th one quarter.

So if we were to model using a time scale of a quarter instead of a year, α2 will change accordingly.

But the equation

ΔH = GT

won’t change because it is an accounting identity!

It’s the difference equation version of the differential equation:

dH/dt = GT

Physicists can pontificate on economic matters. I myself know string theory well. But boy, they shouldn’t make mathematical errors and embarrass themselves!

In other words, accounting identities can be written as accounting identities in difference equations. What changes is values of parameters when one chooses a time scale for difference equations.

Wynne Godley’s model is touched by genius. In fact according to one of the reviewers of Monetary Economics, Lance Taylor says that it is out of choice that Wynne Godley chose a difference equation framework. They can be changed to differential equations and we’ll obtain the same underlying dynamics.

Here’s Lance Taylor in A foxy hedgehog: Wynne Godley and macroeconomic modelling

Godley has always preferred to work in discrete time, responding to the way the data are presented.

Question: is the equation ΔH = Gconsistent with dimensional analysis?

Answer: Yes. H is the stock of money at the end of previous period. Δis the change in stock of money in a period. and are the government expenditure and tax revenues in that period. So H, ΔH, G and T have no times dimensions in difference equations. All are in the unit of account. Such as \$10tn, \$400bn, \$4 tn, \$3.6tn. Time dynamics is captured by model parameters.

In G&L’s book Monetary Economics, in Appendix 3 of Chapter 3, there’s a mean-lag theorem, which tells you the mean lag between two equilibrium (defined as a state where stock/flow ratios have stabilized):

it is:

[(1 − α1)/α2 ]· [(1 – θ)/θ]

where θ is the tax rate.

So, in the model, assuming a value of 0.6 for α1, 0.4 for α2, and 0.2 for θ we have the mean-lag equal to 4.

Let’s assume that time period is yearly. This means the mean lag is 4 years.

If instead, we were to use quarterly time periods, α2 would be 0.1 and the mean lag evaluates to 16, i.e., sixteen quarters, which is 4 years, same as before.

So there is really no inconsistency in stock-flow consistent models.

tl;dr summary: In difference equations, there’s nothing wrong with equations such as ΔH = GT. It is an accounting identity. By a choice of a time scale, one implicity chooses a time scale for parameter values. What’s wrong? Jason Smith would obtain the same results as the simplest Godley/Lavoie model if he were to work in continuous time and write equations such as dH/dt = GT. I will leave it to him as an exercise!

# Credit And Economic Growth

In a new column for Bloomberg, Noah Smith questions the intuition that credit fuels economic growth.

He says:

It seems like the only people who don’t instinctively believe in credit-fueled growth are academic economists.

The academics have good reason for being skeptical.

His reason (in short) is the following:

It’s pretty obvious how credit drives my personal household consumption. If I borrow, I can get a nice big TV and a new car, but eventually I’ll have to skimp to pay it back. In a way, the consumption-fueled borrowing binge is an illusion of wealth — after all, borrowing doesn’t increase my salary. Pleasure today means pain tomorrow.

Notice how Smith’s argument uses a lot of national accounting and flow of funds concepts: consumption, borrowing, wealth, repayment (of loans) and so on. The interesting thing is that one can use the system of national accounts and flow of funds to create models which show precisely the opposite of what Smith is saying. The best place obviously to look out for is the book Monetary Economics: An Integrated Approach to Credit, Money, Income, Production and Wealth by Wynne Godley and Marc Lavoie which has models called stock-flow consistent models or SFC models. It is however difficult to write down a simple SFC model in a blog post, so I will try to highlight how it works in words but refer the reader to these models.

Here’s how in a simple model:

1. Consumers decide to borrow more and banks respond by granting them loans.
2. Consumers spend the funds received on consumption goods.
3. Since loans make deposits, it’s not as if someone forgoes consumption to lend as neoclassical textbooks say.
4. Firms see their inventories go down and respond by increasing their inventories by producing more.
5. For producing more, firms hire more labour and pay salary/compensation.
6. People newly employed spend their income and there’s further rise in production as firms produce more when seeing a higher demand for their products.
7. Higher production leads to a rise in productivity and wages/household incomes of the already employed rise in response (although not necessarily the case).

So we have a higher output than what we started with and higher national income.

One can take several issues with this and this is one reasons models are really helpful and pinpoint what’s going on. This is the reason I referred to the book by Godley and Lavoie above. So for example, one can ask: what if the rise in the national income and output is just a rise in the nominal value but that it’s possible that prices have changed and that the real output hasn’t changed. This of course needs a model of prices and inflation but a familiarity with stock-flow consistent models will make you realize that it is an extreme assumption to think that the real output hasn’t risen in the sequence of events highlighted above.

The second thing is the above “model” in words had just banks lending to households whereas in the real world, credit (as in any credit, such as firms borrowing) is via credit markets of which banks are only one part. This issue is not so simple to argue out, but it can be shown that it really doesn’t matter (in the first approximation). I do not know how to quickly argue it out in short here but will leave that for now.

Of course the above model can be misleading. For example, if households take a lot of debt, debt repayment burden will hit and cause a slowdown as households’ consumption will drop and this may lead to an economic slowdown. This point may look similar to what Noah Smith is saying, but that is not the case. One can imagine an economy starting with a GDP of 100 and growing to 120 in some time period and then slowing down to 118 because of the debt burden. Also the above model was implicitly a pure private sector model and in general one has both the government and the overseas sector adding more complications. Again more reasons why having a proper mathematical model for such things is important.

Another critique of Smith (in my mini-exchange of tweets with him on Twitter) was that SFC models do have behavioural assumptions. I agree, but my point was that there’s no reason to dismiss the argument “credit fuels growth” by purely theoretical arguments. If at all, the system of national income and flow of funds make it more convincing that credit is important.

Of course none of this means that policies should be promoted to ease credit conditions always and try to create a boom and what Smith says is somewhat true – there can be pain later, so it is important to consider fiscal policy, balance of payments and so on but the story told here is quite different from the one told by Noah Smith.

Steve Keen has replied to Thomas Palley’s critique of him with an article How not to win an economic argument.

All models are incomplete because they ignore many complications in order to highlight a few key concepts. In other times, a simple model is a starting point with the aim that the modeler adds more complications to make it more realistic. So it is sometimes not a good critique to point out what the models misses. But Steve Keen is making it look as if Palley’s critique is of what his models do not have.

This is diverting attention. For about two years or more, Keen has given all sorts of definitions of aggregate demand. The reason Palley’s critique is so solid is that it again points out that Keen’s definitions are wrong. Keen has repeated statements on aggregate demand and “change in debt” many times, making it sound like a universal law. Palley has shown via very straightforward arguments as quoted in my previous post Thomas Palley’s Nice Critique Of Steve Keen’s Models that the definition is incorrect. Moreover, Keen has changed his definitions as highlighted by a nice blog article by JKH. In my opinion Keen himself is confused on which definition is right and uses all of them together many times without realizing that they are different. His earlier definitions were simply incorrect on basic flow of funds accounting.

In short, there is no simple expression for changes in aggregate demand with changes in debt, a point mentioned by Nick Edmonds on his blog. Even if not, one could argue that it is useful but that is not the case because even at the theoretical level, there are conceptual issues, a lot because Keen doesn’t do his accounting right. Such things are not mere technicalities but the concepts of flow of funds is highly important to make some progress in analytic modeling.

Keen says:

My approach was to take the other side’s model, and show that if their assumptions were correct, they were right: banks could be ignored in macroeconomics, and changes in private debt had only a miniscule effect on demand.

Then I made one realistic small change, and hey presto — banks were essential to macroeconomics, and changes in private debt were the main game (but not the only one) in changing aggregate demand.

True neoclassical economists do not incorporate money and debt in their analysis but Keen has all this while given hints that Post-Keynesians themselves have not if you see his videos. Even the above quotes suggests as if nobody has done this before Keen. That coupled with the fact that Keen considers anyone having issues his models to be sinful of the loanable funds model. There is an irony here because Keen himself makes errors of the loanable funds approach when distinguishing bank debt and non-bank debt.

In my opinion Keen should completely get rid of this aggregate demand/change in debt slogan. Rejection of this does not mean debt is unimportant and all that. There are nice and realistic models such as that of Wynne Godley and Marc Lavoie (G&L) in which money and credit are central to the analysis and with no need at all for Keen’s fondness of aggregate demand/change in debt. These models have a very important role for aggregate demand and credit and feedback effects and so on but there is no need for inventing new definitions.

Neither is there any need for Lebesgue integrals. If one repeats Keen’s analysis where an economic unit pays for a good with a debit card or cash instead of a credit card, then it violates his own aggregate demand/change in debt definitions.