Keen, continued:

These authors made frequent references to the ratio of private debt to GDP, and the ratio of asset prices to commodity prices--both indicators of financial fragility that were emphasized by Minsky in his financial instability hypothesis (Minsky (1982)), which is a common thread in the credit-oriented analysis of the Bezemer-Fullbrook Group. Since these indicators are not commonly considered in mainstream economic analysis, I reproduce this key data in the next 2 figures, before contrasting them to those followed by Ben Bernanke (the acknowledged mainstream expert on the Great Depression) in his analysis of the Great Depression.

Figure 1: Ratio of private debt to GDP, USA and Australia

Figure 2: US asset price bubbles

Note that we had two massive asset bubbles in a decade--the dot.com stock bubble and the real estate bubble. The stock bubble appears worse than the one that led to the Great Depression, but we dealt with it, but only by inflating the real estate bubble.

So, on to the comparison, from Keen:

The Great Depression: Errant Monetary Policy or the Dynamics of Debt?

Bernanke precedes the summary of his explanation for the Great Depression with the statement that its causes must be found in factors that caused a sharp decline in aggregate demand:

   Because the Depression was characterized by sharp declines in both output and prices, the premise of this essay is that declines in aggregate demand were the dominant factor in the onset of the Depression. This starting point leads naturally to two questions:

    First, what caused the worldwide collapse in aggregate demand in the late 1920s and early 1930s (the "aggregate demand puzzle")?

    Second, why did the Depression last so long? In particular, why didn't the "normal" stabilizing mechanisms of the economy, such as the adjustment of wages and prices to changes in demand, limit the real economic impact of the fall in aggregate demand (the "aggregate supply puzzle")? Bernanke (2000, p. ix)

His explanation has two components: a contraction in money caused by poor monetary management (and a flawed system based upon the gold standard), and the impact of nonmonetary financial factors:

   there is now overwhelming evidence that the main factor depressing aggregate demand was a worldwide contraction in world money supplies. This monetary collapse was itself the result of a poorly managed and technically flawed international monetary system...

    I also have ascribed an important role to nonmonetary financial factors, such as banking panics and business failures, in choking off normal flows of credit and hence exacerbating the world economic collapse. Bernanke (2000, p. ix)

With regard to the role of poor monetary management in causing the Great Depression, Bernanke favourably cites Friedman and Schwartz's identification of "Four Monetary Policy Episodes" where respectively a tightening or loosening of monetary policy caused a decline or expansion during the Great Depression (Bernanke (2002), citing Friedman and Schwartz (1963)). (See Keen's article for Table 1.)

Bernanke largely dismissed the debt-deflation explanation given by Fisher, on the grounds that debt-deflation was a distributive mechanism and not a macroeconomic one:

   debt-deflation represented no more than a redistribution from one group (debtors) to another (creditors). Absent implausibly large differences in marginal spending propensities among the groups, it was suggested, pure redistributions should have no significant macroeconomic effects. Bernanke (1995, p. 17)

In fairness I must note that the most recent quote from Bernanke is from 2002. I think it would be excellent were a Senator or Congressman to ask Chairman Bernanke during a hearing if he still thinks that debt-deflation related "re-distribution" from debtors to creditors has had no significant effect during the ongoing GFC. I strongly suspect that he would maintain his original position for largely tendentious reasons. Were he to admit that the GFC is the result of the bursting of an asset bubble then the policies that led to that bubble would be fair game for criticism. But that whole process was the money machine for Wall Street for the last two decades and Bernanke does not want to discredit that money machine.

Bernanke then re-interpreted Fisher from an equilibrium perspective, whereas Minsky accepted and built upon Fisher's explicit non-equilibrium basis:

   We may tentatively assume that, ordinarily and within wide limits, all, or almost all, economic variables tend, in a general way, toward a stable equilibrium... But the exact equilibrium thus sought is seldom reached and never long maintained..., in actual fact, any variable is almost always above or below the ideal equilibrium...

    Theoretically ... there must be- over- or under-production ... and over or under everything else. It is as absurd to assume that, for any long period of time, the variables in the economic organization, or any part of them, will "stay put," in perfect equilibrium, as to assume that the Atlantic Ocean can ever be without a wave...

    in the great booms and depressions ... [there are] two dominant factors, namely over-indebtedness to start with and deflation following soon after   Fisher (1933, p. 341)

Minsky adopted this disequilibrium perspective, and argued that a reduction in debt does have macroeconomic effects, because it reverses the process of debt adding to aggregate demand that must occur during a period of expansion:

   For real aggregate demand to be increasing ... it is necessary that current spending plans, summed over all sectors, be greater than current received income and that some market technique exist by which aggregate spending in excess of aggregate anticipated income can be financed. It follows that over a period during which economic growth takes place, at least some sectors finance a part of their spending by emitting debt or selling assets. Minsky (1982, p. 6; emphasis added)

Minsky's thus defines aggregate demand as the sum of GDP plus the change in debt, and this demand is expended on both commodity and asset markets, in contrast to the mainstream macroeconomic focus on commodity markets alone. Bernanke's interpretation and statistical measures of tight monetary policy also implicitly accepts the money multiplier explanation of the relationship between base money and broader measures of money such as M1. The Bezemer-Fullbrook Group instead argues that the money supply is endogenously determined, and that changes in base money follow rather than cause changes in broad money, so that there is no direct causal link between M0 and M1 (Moore (1979); see also Kydland and Prescott (1990)). The Bernanke-Friedman-Schwartz assertion is that declines in the rate of growth of the money supply initiated by the Federal Reserve caused the Great Depression; the Bezemer-Fullbrook Group asserts instead that contracting debt caused the Great Depression. These explanations can be compared empirically, by considering the correlations between the rate of growth of the money supply and unemployment, versus changes in the debt-financed proportion of aggregate demand and unemployment.

Keen then dissects both the Great Depression and the GFC from his perspective to show why we are far from done with the GFC: namely, debt has not been written down. All indications are that this "Great Recession" will be worse than the Great Depression of the 1930s.

I recommend the entire article. But I will only show text and graphs from one more section, where Keen shows the relationship between M1, M0 and unemployment. M0 is currency, coins and bank notes in circulation and in bank vaults, and M1 is the currency, coins and bank notes in circulation plus traveler's checks, demand deposits, (ordinary checking accounts), and other checkable deposits, such as cashier's checks, at banks and credit unions.

Money and Unemployment in the Great Depression

Figure 3 shows the relationship between M0 and M1 over the period from 1920 to 1940. Though the two measures move in concert with each other in the period from 1920 to 1930, it is obvious that there was a breakdown in the relationship between these two aggregates in the period between 1931 and 1934. Inferences that are based on the apparent relationship between M0 and M1 in 1920-1930 will thus be suspect in the period 1931-1934.

Figure 3: Rates of change of M0 and M1 1920-1940

This is borne out by a comparison of the correlation of the rate of growth of the money supply as measured by M1 and unemployment in the period 1930-1940, and the correlation using M0. Figure 4 shows that the correlation is moderate and has the expected sign for M1 (-0.3): an increase in the rate of growth of M1 is correlated with a fall in unemployment, as Bernanke, Friedman and Schwartz hypothesize (the rate of unemployment is inverted on the right hand axis, to enhance visual inspection of the correlation: when the two series move in the same direction--or high rates of money growth correspond to falling rates of unemployment--the hypothesized relation holds)

Figure 4: M1 Money supply growth and unemployment

The correlation with M0, on the other hand, has the wrong sign (0.42): increases in the rate of growth of M0 are correlated with increases in the rate of unemployment.

Figure 5: M0 Money supply growth and unemployment

The possibility that this apparent paradox reflects the fact that monetary policy acts with a lag is dispelled in Table 2 on page 11, which shows that though the negative correlation of changes in M1 does strengthen (peaking at -0.5 at a 12 month lag), the positive correlation between changes in M0 and unemployment remains. One way to make sense of this paradox is to conclude that, contrary to Bernanke's interpretation, the Federal Reserve during the 1930s did try to counter the Great Depression by expanding the money supply, but that not until 1938 were its attempts successful. This information was masked by statistical analysis that used M1 rather than M0, since only M0 is directly under the control of the Federal Reserve. Subtracting M1 from M0 confirms this hypothesis: non-M0 M1 is more strongly correlated with unemployment than M1 alone (-0.41, peaking at -0.52 with an 8 month lag).

Figure 6: Non-M0 M1 Money supply growth and unemployment

To me this makes sense. During the Great Depression banks failed. Even though the Fed increased M0, that did not compensate for the loss of money supply due to collapsing banks and defaulting loans. In the GFC, M0 goes off scale, (literally in Keen's graph, not shown), but the banks that received this M0 courtesy of the TARP kept it for themselves, as the Fed was paying interest on "excess reserves"--a sort of "ambulance policy" for banks to try to get them well, but it hasn't worked as the bad loans are still there and it is impossible to service all of the debt that the Fed has attempted to prevent from defaulting. In effect, the Fed and Treasury policy is preventing recovery, even as it holds off pain for the holders of unsustainable debt. The time to be concerned with debt is before the loan is made. It is called good risk management.