Can we avoid another financial crisis? Steve Keen’s latest book

Professor Steve Keen is an economist working in the post-Keynesian tradition at Kingston University here in the UK. He is well-known as a critic of mainstream economics (see his excellent and wide-ranging book Debunking Economics) and its failure to predict or satisfactorily explain the Great Financial Crisis (GFC) and recession, which he did some years before it occurred. His latest book is Can we avoid another financial crisis?a 130-page polemic aimed at the intelligent layman.

Keen’s central thesis is that mainstream economics failed because it ignores the role of private debt creation by the financial system, known in the jargon as ‘endogenous money’. This grew unsustainably in many countries in the decades prior to the crisis and drove a boom in the real economy and, even moreso, in asset prices (stock markets and housing). Credit expansion in economies such as the US and UK started growing consistently more rapidly than GDP in the 1980s, following the deregulation of the financial sector. Although it was subject to cycles, the trend in private debt as a share of GDP was upward. When its growth slowed or even went into reverse, the result was a severe recession and the aftermath is still with us both economically and politically.

This explanation of the GFC is handy, because it is fairly simple and can be easily understood by the non-economist. It is therefore disconcerting that much of the focus of political debate since the crisis has been on public (government) deficits and debt, and the necessary degree of austerity required in order to ‘live within our means’. The level and growth in private debt tends to be neglected. This is surely due to its neglect in mainstream macroeconomic theory and neoliberal thinking among particular elites which deifies the market and decries government ‘meddling’.

Keen criticises the use of a ‘representative agent’ in neoclassical micro and macroeconomics, and argues that instead of beginning with ‘microfoundations‘, macroeconomics should begin with the analysis of larger units, such as classes (workers, capitalists, bankers etc), which have ’emergent’ properties. The behaviour of such groups is not reducible to that of individual representative agents. It is thus more helpful to start with macrofoundations when engaging in macroeconomic analysis, and Keen explains how the latter benefits from drawing on some of the methodology found in complexity and chaos theory.

The author then describes his dynamic model of the economy, which was first set out in a paper from 1995(!). He shows how, remarkably, it predicted the following potential outcomes: low inflation and unemployment alongside stable growth, which could stimulate rising private debt, rising inequality and the increasing dominance of the financial sector (known as financialization), eventually giving way to a severe financial crisis and recession, sharply rising unemployment and slower growth after the recession due to the debt burden among households and firms. In short, it predicted many of the aspects of the GFC. Summing up the model, and in the words of one of Keen’s major influences, the late Hyman Minsky, ‘stability is destabilizing’. The apparently good performance of the global economy over a number of years led policymakers to ignore the unsustainable accumulation of private debt.

Keen shows that private debt levels in many economies are still at historically high levels relative to GDP. As a policy response, he calls for a ‘Modern Debt Jubilee’, which would aim to drastically reduce the debt ratio to sustainable levels while avoiding another collapse or long stagnation in GDP growth.  Without this, economic performance in the affected countries is likely to be poor for many years. He even predicts fairly imminent financial crises for his home nation of Australia (which avoided recession in 2008-9), as well as in China, Canada, South Korea and elsewhere. These are his ‘Debt Zombies’.

In sum, the book is an informative read, and definitely recommended for its enlightened and iconoclastic thinking by an economist who actually saw ‘it’ (the GFC) coming. Where I would offer some critique is in Keen’s neglect of the interdependent nature of national economies globally and the role of global financial imbalances in the buildup of debt. This has been the focus of another economics Professor inspired by Minsky, Michael Pettis.

In The Great Rebalancing, Pettis argues that government policies and institutions that have raised inequality and shifted income from households to firms in economies such as China, Germany and Japan, have raised domestic savings in excess of domestic investment needs. The resulting surplus of savings has been exported and fueled asset-price bubbles and consumption booms funded by borrowing in economies such as the US, the UK and in the periphery of the eurozone. So financial deregulation is perhaps only half of the story. A ‘rebalancing’ sufficient to restore satisfactory and sustainable growth globally will require changes in both national and international policies and institutions that are difficult to achieve politically, so that sluggish growth may be the norm for some time. With global demand weak, conflict over trade and political instability are some of the resultant outcomes.

I have been greatly inspired by both Keen and Pettis and hope that their work will become increasingly influential among citizens and policymakers; this would ultimately help to resolve the defects afflicting our economies and societies. Sadly, and echoing the title of the book’s final chapter A Cynic’s Conclusion, this may only happen, if at all, with the advent of further serious crises. But Can we avoid another financial crisis? remains well worth reading for all those interested in exploring the flawed nature of both mainstream economics and our financialized economies.


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