Debt Does Matter | 80 comments (80 topical, editorial, 0 hidden)

When I read these both posts by Krugman I get the impression that the conversation goes something like this:

One key component of Minsky's thought is the capacity for the banking sector to create spending power "out of nothing"--to quote Schumpeter.

Krugman

[Keen] asserts that putting banks in the story is essential. Now, I'm all for including the banking sector in stories where it's relevant; but why is it so crucial to a story about debt and leverage?

Krugman again

[Banks] exploits the law of large numbers to offer a better tradeoff between liquidity and returns, but does so at the cost of taking on very high leverage, with all the risks that entails.

I see here a conflict between an empirical and an idealistic approach. In the empirical approach it is crucial if banks do or do not create spending power out of thin air. In the idealistic approach, it is crucial if it makes a better story.

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by A swedish kind of death on Wed Mar 28th, 2012 at 04:52:50 AM EST
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Re: Debt Does Matter (none / 1)

In the empirical approach it is crucial if banks do or do not create spending power out of thin air.

But that is not crucial at all. It appears to be important to Keen, but it's not actually important in Minsky.

The crucial difference is that an economy with a single bank is more financially stable than an economy with many interconnected banks.

To make a thermodynamic analogy, in thermodynamics it is usual to encircle a chunk of your system in an imaginary boundary, call the imaginary boundary a "subsystem" and consider it a black box described only by its aggregate thermodynamic quantities (temperature, pressure...) and the aggregate flows through the boundary.

In economics, you can do the same with "the banking sector" and you get the "one bank" toy model used to explain the (bogus) money multiplier (see the table illustrating the "process of money multiplication" here).

In a real economy the black box "the bankign sector" may be "one bank" with an aggregate (net! meaning interbank debt, since it isn't debt between the inside and outside of the "imaginary boundary", doesn't count) balance sheet actually contains a dynamical system which is quite capable of generating its own instabilities, which then propagate to "the real economy" outside the "imaginary boundary" because it does matter to individual agents in the real economy which individual bank goes belly up inside the "imaginary boundary" even if the aggregate "ona bank" is still solvent and functioning.

That is why you need to model explicitly the banking sector as many banks.

There are three stories about the euro crisis: the Republican story, the German story, and the truth. -- Paul Krugman

by Migeru (migeru at eurotrib dot com) on Wed Mar 28th, 2012 at 05:01:34 AM EST
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Re: Debt Does Matter (4.00 / 4)

I see your point, but I was aiming at something else. I'll rephrase.

I see a conflict between an empirical and an idealistic approach. In the empirical approach wheter banks do or do not create spending power out of thin air is an empirical question that can be checked. In the idealistic approach wheter banks do or do not create spending power out of thin air is a question that is ruled by getting the simplest representation possible.

The idealistic models will thus have a preference for simplicity that is unchecked by empirical findings. Which then leads to oversimplification.

This may look terribly unfair, but Krugman is arguing that his description of banks is better because it has fever assumptions, without any reference to wheter the assumptions can be checked or not. And that is just straight out of scholasticism.

Or to put it another way, this is the impression I get when I read these articles.

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by A swedish kind of death on Wed Mar 28th, 2012 at 08:11:06 AM EST
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Re: Debt Does Matter (none / 1)

Yanis Varoufakis: Keynesian Legacies neither Europe nor Keynes deserved: A critique of New and ISLM Keynesians in the context of Europe's Crisis (28 March, 2012)

The answer is: Because `Keynesianism' had, after Keynes had met his `long run', accepted the preposterous proposition that one can think of the macroeconomy as if it comprised of millions of clones of a single person; a genetically reproduced Robinson Crusoe whose clones think the same thoughts (plus or minus some random error). (Recall the disastrous Samuelsonian interpretation of Keynes.) And why did they make this concession? In order to put Keynes' thought into a closed mathematical model or, at the textbook level, to capture his `thought' in terms of some appealing, easy to explain geometry. To see that this concession destroyed whatever analytical value Keynes had to offer, consider again the little game I presented (in blue) in Section 2. Suppose that the players are clones and they think identical thoughts, plus or minus a random error. Suddenly, the game loses all its interest: The outcome becomes predicable (each will choose 0 and everyone will gain $1000) and the game's subtle point (that it is impossible even for the smartest player to know what to do; the result depending on the average degree of optimism) vanishes. Similarly, the moment Keynes' thought was imprisoned in these mathematical models, populated by telepathic clones of some Robinson Crusoe, Keynes was doomed to oblivion.

There are three stories about the euro crisis: the Republican story, the German story, and the truth. -- Paul Krugman

by Migeru (migeru at eurotrib dot com) on Wed Mar 28th, 2012 at 09:44:53 AM EST
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