Steve Keen And Sectoral Balances

Steve Keen has a new article on sectoral balances here.

First apologies in advance for sometimes criticizing heterodox economists more but needless to say, such criticisms are of a totally different nature than criticisms of mainstream economists.

Anyway, I am surprised at why Keen mixes accounting identities, especially when it involves banks in the analysis. In the new article, Keen has an equation:

 Bank lending p.a. = Nominal GDP growth / Velocity of Money + Government Deficit + Trade Surplus

I don’t get this. The correct sectoral balances equation (in a simplified three-sector setting) is:

Net Lending = Government Deficit + Current Account Balance of Payments

Here, net lending is that of the private sector. The terminology net lending is something national accountants use, while Wynne Godley used NAFA  — net accumulation of financial assets which means a slightly different thing in national accounts, but this point is irrelevant here.

Keen’s equation seems to mix many things and it has a term for GDP growth which actually needs a model and is not something that can be derived from an accounting identity. Morever, Keen seems to forever blur bank lending and lending in general and hopefully he gets these things right in the future. The hidden assumption in Keen’s models —something which has been pointed out by Nick Edmonds — is that non-bank lending has no effect on aggregate demand which (the assumption) doesn’t make sense.

The original sectoral balances identity was used by Wynne Godley with a behavioural model around it, although he started building his models when he realized in the 70s that the accounting identity itself is a great revelation. And a narrative around the three balances makes a good story especially for telling a story about future scenarios and so on.

Keen, on the other hand has a relation which is not really an identity but a behavioural equation. By itself there’s nothing wrong but given his mixing things up, it really ends up adding confusions. Keen’s blog title uses the phrase “arithmetic” which simply means a manipulation of numbers but has an equation which is more than arithmetic. Reading his article suggests that he has improved the sectoral balances to take into account bank lending. But the sectoral balances equation is an identity even if banks exists. And Keen seems to derive his equation as if it were an accounting identity.

Again goes on to show, it is highly important in macroeconomics to know flow of funds properly.

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