the fiscal cliff—lessons from the 1930s
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The Fiscal Cliff—Lessons from the 1930s. Steve Keen www.debtdeflation.com/blogs www.debunkingeconomics.com. Key insights. Understanding banks, debt & money key to understanding crisis Economists didn’t see the crisis coming because they ignore banks: - PowerPoint PPT PresentationTRANSCRIPT
The Fiscal Cliff—Lessons from the 1930s
Steve Keenwww.debtdeflation.com/blogs
www.debunkingeconomics.com
Key insights• Understanding banks, debt & money key to understanding
crisis• Economists didn’t see the crisis coming because they
ignore banks:– “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?” (Paul Krugman, “Minsky & Methodology”)
• Banks crucial because lending increases cash flow in the economy– Effective demand is income plus the change in debt– Analysis of dynamics of debt
• Explains the crisis• Gives guidance to what the future may hold…
Key data: Debt to GDP ratios since 1920• Why now is comparable to The Great Depression
1920 1930 1940 1950 1960 1970 1980 1990 2000 2010 20200
26.7
53.3
80
106.7
133.3
160
186.7
213.3
240
266.7
293.3
320PrivatePublic
Long Term Debt to GDP
Perc
ent o
f GD
P
The economic crisis• A fall in GDP, but nothing like the Great Depression…
2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 20149 106
1 107
1.1 107
1.2 107
1.3 107
1.4 107
1.5 107
1.6 107
Nominal GDPInflation-adjusted GDP (2005 dollars)
Nominal and Inflation-adjusted GDP
Source: BEA
US
$ m
illio
n
Begin
GDP and the levels of private & public debt
• Private debt far bigger than both GDP and public debt…
2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 20140
5 106
1 107
1.5 107
2 107
2.5 107
3 107
3.5 107
4 107
4.5 107Private DebtGovernment DebtGDP
USA Debt Levels and Nominal GDP
US Flow of Funds Table L 1
US
$ m
illio
n
Begin
GDP and the change in private & public debt
• Crisis began when growth of private debt stopped…
2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 20143 1062 1061 106
01 1062 1063 1064 1065 1066 1067 1068 1069 1061 107
1.1 1071.2 1071.3 1071.4 1071.5 1071.6 1071.7 1071.8 1071.9 107
Private ChangeGovernment ChangeGDP
Annual Change in Debt and Nominal GDP
US Flow of Funds Table L 1
US
$ m
illio
n
0
Begin
2 years of heavy private2 years of heavy privatesector deleveragingsector deleveraging
Effective demand as GDP plus change in debt
• Now the scale of the crisis is obvious…
2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 20149 106
1 107
1.1 107
1.2 107
1.3 107
1.4 107
1.5 107
1.6 107
1.7 107
1.8 107
1.9 107
2 107GDP+ Private Change+ Government Change
Aggregate demand 2000 till Now
US Flow of Funds Table L 1
US
$ m
illio
n
Begin
Change in debt and unemployment• Rising private debt causes falling unemployment;• Rising unemployment causes rising public debt
2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 20130
1
2
3
4
5
6
7
8
9
10
11
12
20
15
10
5
0
5
10
15
20
25
30
35
40
UnemploymentPrivate DebtGovernment Debt
Unemployment & Change in Debt
Une
mpl
oym
ent r
ate
perc
ent
Ann
ual c
hang
e in
deb
t as p
erce
nt o
f GD
P
0
Begin
Debt and asset prices• Accelerating debt causes rising asset prices
2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 201310
8
6
4
2
0
2
4
6
8
10
100
110
120
130
140
150
160
170
180
190
200
Mortgage Debt ChangeReal House Price Index
House Prices & Change in Mortgage Debt
Perc
ent o
f GD
P p.
a.
Cas
e-Sh
iller
Rea
l Hou
se P
rice
Inde
x (1
890=
100)
0
The 1930s collapse in GDP• Much sharper falls in nominal and real GDP…
1926 1927 1928 1929 1930 1931 1932 1933 1934 1935 1936 1937 1938 1939 194050000
60000
70000
80000
90000
100000
110000
500000
600000
700000
800000
900000
1 106
1.1 106
Nominal GDPInflation-adjusted
Nominal and Inflation-adjusted GDP
US Flow of Funds Table L 1
Nom
inal
GD
P $
mill
ion
Infla
tion-
adju
sted
(200
5 do
llars
)
End
GDP and debt levels• Much smaller debt bubble in the 1930s than today…
1925 1926 1927 1928 1929 1930 1931 1932 1933 1934 1935 1936 1937 1938 19390
100002000030000400005000060000700008000090000
100000110000120000130000140000150000160000170000180000
Private DebtGovernment DebtGDP
USA Debt Levels and Nominal GDP
US Census
US
$ m
illio
n
GDP and change in debt• Much longer period of private sector deleveraging• Much slower and smaller government deficit response
1925 1926 1927 1928 1929 1930 1931 1932 1933 1934 1935 1936 1937 1938 193920000
10000
0
10000
20000
30000
40000
50000
60000
70000
80000
90000
100000
110000
120000
130000Private ChangeGovernment ChangeGDP
Annual Change in Debt and Nominal GDP
US Census
US
$ m
illio
n
0
4 years of heavy private4 years of heavy privatesector deleveragingsector deleveraging 2 more years2 more years
Effective demand: much longer plunge below income
• Extended deleveraging compared to today• Relatively minor government stimulus response
1925 1926 1927 1928 1929 1930 1931 1932 1933 1934 1935 1936 1937 1938 193940000
50000
60000
70000
80000
90000
100000
110000
120000GDP+ Private Change+ Government Change
Aggregate Demand 1925 till 1939
US Census
US
$ m
illio
n
The Fiscal Cliff of 1937• Dip back into Depression as private sector deleveraging recommenced
1925 1926 1927 1928 1929 1930 1931 1932 1933 1934 1935 1936 1937 1938 19390
2.5
5
7.5
10
12.5
15
17.5
20
22.5
25
27.5
30
20
15
10
5
0
5
10
15
20
25
30
35
40UnemploymentPrivate DebtGovernment Debt
Unemployment & Change in Debt
Une
mpl
oym
ent r
ate
perc
ent
Ann
ual c
hang
e in
deb
t as p
erce
nt o
f GD
P
0
Recovery in WWII• Huge increase in government stimulus drives GDP up• Private sector delevers during WWII with minor impact on GDP
1925 1927 1929 1931 1933 1935 1937 1939 1941 1943 19450
30000
60000
90000
120000
150000
180000
210000
240000
270000
300000Private DebtGovernment DebtGDP
USA Debt Levels and Nominal GDP
US Census
US
$ m
illio
n
Private sector deleveraging during WWII• Fall in private sector debt far greater during WWII than during
Great Depression, but little impact on GDP• Stimulus, not austerity, ended Great Depression
1925 1927 1929 1931 1933 1935 1937 1939 1941 1943 194550000
30000
10000
10000
30000
50000
70000
90000
110000
130000
150000
170000
190000
210000
230000Private ChangeGovernment ChangeGDP
Annual Change in Debt and Nominal GDP
US Census
US
$ m
illio
n
0
Private sector finishes deleveraging during WWII
• Private debt 45% of GDP in 1945—down from 175% in 1930
1925 1927 1929 1931 1933 1935 1937 1939 1941 1943 194540000
60000
80000
100000
120000
140000
160000
180000
200000
220000
240000
260000
280000GDP+ Private Change+ Government Change
Annual Change in Debt and Nominal GDP
US Census
US
$ m
illio
n
Takeaway Points• Private debt and government debt are independent
– But they affect each other• Both boost demand in the economy when they rise
– and reduce it when they fall.• Private debt is more important than public debt because
– it is so much larger, and – it drives the economy whereas government debt reacts to it
• The crisis was caused by the growth of private debt collapsing• Government debt rose because the economy collapsed
– and it reduced the severity of the crisis• A premature attempt to reduce government debt through “The
Fiscal Cliff” could trigger a renewed bout of deleveraging by the private sector, which could push the economy back into a recession.
• Main challenge of public policy is not reducing government debt– But managing the impact of the “Rock of Damocles” of
private debt that hangs over the economy.