Debt Deflation

Here is an interesting analysis by Steve Keen at Debtwatch about America’s current economic predicament.  The blog post “What Bernanke Doesn’t Understand about Deflation,” finds:

Debt reduction is now the real story of the American economy, just as real story behind the apparent free lunch of the last two decades was rising debt. The secret that has completely eluded Bernanke is that aggregate demand is the sum of GDP plus the change in debt. So when debt is rising demand exceeds what it could be on the basis of earned incomes alone, and when debt is falling the opposite happens.

I’ve been banging the drum on this for years now, but it’s a hard idea to communicate because it’s so alien to the way most economists (and many people) think. For a start, it involves a redefinition of aggregate demand. Most economists are conditioned to think of commodity markets and asset markets as two separate spheres, but my definition lumps them together: aggregate demand is the sum of expenditure on goods and services, PLUS the net amount of money spent buying assets (shares and property) on the secondary markets. This expenditure is financed by the sum of what we earn from productive activities (largely wages and profits) PLUS the change in our debt levels. So total demand in the economy is the sum of GDP plus the change in debt.

From his website, he appears to be a follower of Hyman Minsky.  I don’t know much about Minsky, but much of what Keen appears to be saying, especially his critique of neoclassical economics, would not surprise an Austrian economist.  He has also posted this follow-up to his original blog.  I will certainly have to explore his website more thoroughly.

Hat tip to John Mauldin . . . if you haven’t already, be sure to subscribe to his newsletter here.

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