Policymakers, disillusioned with conventional general equilibrium models that failed to forecast the 2007/08 financial crisis, are showing interest in a new financial instability model developed by Australian economist Steve Keen.
Keen told the annual Association for Heterodox Economics conference in Southampton today that government agencies responsible for economic and monetary policy are at last willing to consider alternative approaches that take into account the impact of private debt.
“Given that bank lending creates money and repayment of debt destroys it, the change in debt plays an integral role in macroeconomics by dynamically varying the level of aggregate demand,” Keen says in a paper presented at the conference. “The omission of this factor from mainstream economic models is the reason that these models failed to warn of the dangers of the dramatic build up in private debt since WWII—and especially since 1993… It is also the reason why they failed to anticipate the crisis that began in 2007.”
Keen has used the monetary modelling program Minsky to put the New Keynesian model of banking into a strictly monetary model.
Keen says that New Keynesian economists argue that banks are not sources of debt and, in effect, act as brokers between savers and borrowers. In contrast, adherents to post-Keynesian and endogenous money traditions say credit creation and the accounting mechanics of bank lending should be given a proper role in any model of the economy.
“Given the key public policy role of economics, and the acknowledged failure of neoclassical models in general to anticipate the financial crisis, the existence within academic economics of two diametrically opposed perspectives which fail to communicate is a disservice to the public,” Keen says.
The paper that Keen presented at the AHE conference can be found here.
The financial instability model is designed to present greater accuracy and realism than conventional dynamic stochastic general equilibrium (DGSE) models used by central banks before the financial crisis. Central bankers have admitted the models they used before the crisis failed.