Post Keynesian Theories of Crisis

• Published date: 01 March 2015
• Date: 01 March 2015
• DOI: http://doi.org/10.1111/ajes.12099
• Author: Steve Keen

Post Keynesian Theories of Crisis

By STEVE KEEN*

ABSTRACT. Post Keynesian economics has two complementary

theories of crisis that were used to predict the 2007 crisis and diagnose

its causes: Minsky’s financial instability hypothesis and Godley’s stock-

flow-consistent approach. Both theories take a monetary perspective

on capitalism and argue that the dynamics of private debt caused the

crisis. As well as explaining the crisis and enabling its occurrence

(though not precise timing) to be predicted, both theories imply that

the current recovery will be short-lived because the underlying cause of

the last crisis has not been addressed by subsequent economic policy.

Before the economiccrisis in 2007, neoclassical economists were trium-

phant, confident that they had banishedeconomic crises completely:

Macroeconomics was born as a distinct field in the 1940’s, as a part of

the intellectual response to the Great Depression. The term then referred

to the body of knowledge and expertise that we hoped would prevent

the recurrence of that economic disaster. My thesis in this lecture is that

macroeconomics in this original sense has succeeded: Its central problem

of depression prevention has been solved, for all practical purposes, and

has in fact been solved for many decades. (Lucas 2003: 1, emphasis

added)

After the crisis, even staunch defenders of neoclassical methodology

concede that it cannot explain crises: “The state ofthe art in macro can’t

generate financial crises yet” Yates (2014). Meanwhile, recent research

papers express bemusement over the very fact of business cycles,

let alone of serious financial crises:

One of the remarkable conundrums in theoretical economics is the so-

called “business cycle,” i.e. the existence of considerable, persistent

*Professor and Head, School of Economics, Politics, and History, Kingston Univer-

sity, London. Websites: www.debtdeflation.com/blogs; www.ideaeconomics.org.

Author: Debunking Economics: The Naked Emperor Dethroned. Email: steve.keen@

kingston.ac.uk

American Journal of Economics and Sociology, Vol. 74, No. 2 (March, 2015).

DOI: 10.1111/ajes.12099

V

C2015 American Journal of Economics and Sociology, Inc.

fluctuations of the GDP, even for very large economies ...These fluctua-

tions can culminate in crises, such as the most recent one of 2008 ...

Naively, however, the output fluctuations of large economies should be

very small. (Bonart et al. 2014: 1)

In contrast, Post Keynesian economics has at least two extant

approaches to explain financial crises: Minsky’s “Financial Instability

Hypothesis’” and Godley’s stock-flow-consistent method.

Minsky’s Financial Instability Hypothesis

Minsky’s objective in developing the “Financial Instability Hypothesis”

was to meet his objective criteria for an adequate theory of economics:

“Can “ It”—a Great Depression—happen again? And if “It” can hap-

pen, why didn’t “It” occur in the years since World War II? These are

questions that naturally follow from both the historical record and the

comparative success of the past thirty-five years. To answer these ques-

tions it is necessary to have an economic theory which makes great

depressions one of the possible states in which our type of capitalist

economy can find itself. (Minsky 1982: xii,emphasis added)”

The development of Minsky’s theory commenced with two factors

that neoclassical economics ignores: 1) the existence of macroeco-

nomic cycles and 2) private debt. He then posited a relationship

between them. Whereas neoclassical economics argues that private

debts are merely “pure redistributions” that “should have no significant

macro-economic effects” (Bernanke 2000: 24), Minsky argued that the

change in debt actually added to aggregate demand and aggregate

income, an issue I return to later. He further posited a tendency for

debt in a pure capitalist economy (one without a government sector) to

rise relative to GDP over a number of business cycles, culminating in a

debt level that caused a crisis like both the Great Depression and the

2007 “Global Financial Crisis.”

Minsky’s analysis was rooted in historical time, in sharp contrast to

the ahistorical perspective of neoclassical economics. His instability

hypothesis takes as its initial condition an economy that is experiencing

tranquil growth aftera recent economic crisis:

Post Keynesian Theories of Crisis 299