Monday, 13 June 2011

Steve Keen on rising debt trend and its end

Steve Keen says that the bull market of the past few decades had been the result of a secular trend of rising debt.

[T]he rate of change of asset prices is related to the acceleration of debt. It’s not the only factor obviously—change in incomes is also a factor, and as Schumpeter argued, there will be a link between accelerating debt and rising income if that debt is used to finance entrepreneurial activity. Our great misfortune is that accelerating debt hasn’t been primarily used for that purpose, but has instead financed asset price bubbles.

However, Keen says that the trend of rising debt has reached an end.

In a well-functioning economy, periods of acceleration of debt would be followed by periods of deceleration, so that the ratio of debt to GDP cycled but did not rise over time. In a Ponzi economy, the acceleration of debt remains positive most of the time, leading not merely to cycles in the debt to GDP ratio, but a secular trend towards rising debt. When that trend exhausts itself, a Depression ensues—which is where we are now. Deleveraging replaces rising debt, the debt to GDP ratio falls, and debt starts to reduce aggregate demand rather than increase it as happens during a boom.

Some of the equations that were omitted in the post (at the time of writing) can be found in the PDF version of the article.

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