Prof Steve Keen’s presentation to the UMKC Post Keynesian conference in 2012.
Paul Krugman would argue that Income = Aggregate Demand when the economy is in equilibrium.
Steve Keen shows that the economy is not in equilibrium when aggregate debt is rising or falling:
Income = Aggregate Demand + Change in Debt
He illustrates (at 13:20) how, while GDP fell from $14.5 to $14.0 trillion, the US economy went from $18.5 to $11.5 trillion because of private debt contraction.
This does not seem entirely accurate as my earlier chart of US Debt shows that Domestic (Non-Financial) Debt growth slowed but at no stage contracted during the GFC. I suspect that Steve has omitted Government Debt which acted as an important counter-weight to Private Debt contraction during the GFC.
Steve’s chart include financial debt…
The financial sector acts largely as an intermediary — they borrow from depositors and lend to borrowers — and their net debt is relatively small. Financial debt should therefore be excluded.
Even if Domestic Non-Financial Debt did not contract, a slow-down in the growth rate from 10% to 2.5% of GDP would leave a significant hole aggregate demand — about $1 trillion. There would be no further hole the following year, however, if growth stabilized at 2.5%.
If the financial sector were only an intermediary, you would find higher correlations by excluding financial debt. That’s not the case. The belief that the financial sector only borrow from depositors and lend to borrowers is misguided, that’s not how the financial system works, banks don’t need to borrow from depositors in order to lend, never. Investment banks levers up to invest on the markets and the money doesn’t come from any depositor. Since they buy assets, if you calculate financial sector net debt against the value of the assets they hold, of course, net debt will be relatively small. I also think investors are generally lumped in the financial sector and non-financial debt mostly includes only households and firms.
“banks don’t need to borrow from depositors in order to lend”
Correct. But they need the money loaned to be deposited back in the baking system.
“Investment banks levers up to invest on the markets and the money doesn’t come from any depositor”
If the money does not come from a depositor, it is likely to be borrowed from another bank.
“they need the money loaned to be deposited back in the baking system”
Lending money doesn’t take money out of the banking system, a client withdrawing currency does. Do you have in mind the textbook money multiplier model? In reality, banks don’t lend out the reserves, they create both a deposit and an asset (the loan) and get the reserves later from another bank or the discount window if they need them to cover for interbank transfers or currency withdrawals. Consequently, they don’t lend out the money they have in deposits, a bank will seek to attract deposit in order to get reserves, so they don’t have to borrow them from another bank and they can lend excess reserves to another bank, thus charging interest instead of paying interest.
When we’re talking about financial sector debt, we’re talking about financial institutions who borrow money in order to buy assets. Therefore, the change in financial sector debt is an important part of the demand for those assets and will have an impact on their prices. That’s why you find a higher correlation between the change in debt and unemployment or share prices when you include financial sector debt.
Sorry, I meant to reply to your last comment…
“Lending money doesn’t take money out of the banking system, a client withdrawing currency does”
… different way of saying the same thing. The loan is used to pay for an asset. The recipient either withdraws currency or retains the payment as a bank deposit.
If you look at the $12.8 trillion total assets of commercial banks the major holdings are debt:
Are you perhaps talking about hedge funds?
*Other assets include real estate owned, premises and fixed assets, investments in unconsolidated subsidiaries, intangible assets (including goodwill), direct and indirect investments in real estate ventures, accounts receivable, and other assets.