The Global Financial Crisis Is Not Behind Us

Guest Author: Steve Keen, Associate Professor of Economics & Finance at the University of Western Sydney (bio below)

Editor’s Note: This article was first posted one year ago today.  Unfortunately little has changed or improved – and the subject matter remains as relevant today as last year.

A majority of the 16 individuals identified in Bezemer (2009) and (Fullbrook (2010)) as having anticipated the Global Financial Crisis followed non-mainstream approaches to economics, with most of them identifying as Post-Keynesian (Dean Baker, Wynne Godley, Michael Hudson, Steve Keen, Ann Pettifor) or Austrian (Kurt Richelbacher, Peter Schiff). The theoretical foundations of these authors therefore differ substantially from those of more mainstream neoclassical economists. In this paper I will restrict my attention to the Post-Keynesian subset, which I will hereinafter refer to as the Bezemer-Fullbrook Group. Bezemer identified the factors that these authors have in common as:

the distinction between financial wealth and real assets… A concern with debt as the counterpart of financial wealth… a further concern, that growth in financial wealth and the attendant growth in debt can become a determinant (instead of an outcome) of economic growth …[the] recessionary impact of the bursting of asset bubbles… [and] Finally, emphasis on the role of credit cycles in the business cycle… (Bezemer (2009))

These authors made frequent references to the ratio of private debt to GDP, and the ratio of asset prices to commodity prices—both indicators of financial fragility that were emphasized by Minsky in his financial instability hypothesis (Minsky (1982)), which is a common thread in the credit-oriented analysis of the Bezemer-Fullbrook Group. Since these indicators are not commonly considered in mainstream economic analysis, I reproduce this key data in the next 2 figures, before contrasting them to those followed by Ben Bernanke (the acknowledged mainstream expert on the Great Depression) in his analysis of the Great Depression.

Figure 1: Ratio of private debt to GDP, USA and Australia

Figure 2: US asset price bubbles

The Great Depression: Errant Monetary Policy or the Dynamics of Debt?

Bernanke precedes the summary of his explanation for the Great Depression with the statement that its causes must be found in factors that caused a sharp decline in aggregate demand:

Because the Depression was characterized by sharp declines in both output and prices, the premise of this essay is that declines in aggregate demand were the dominant factor in the onset of the Depression. This starting point leads naturally to two questions:

First, what caused the worldwide collapse in aggregate demand in the late 1920s and early 1930s (the “aggregate demand puzzle”)?

Second, why did the Depression last so long? In particular, why didn’t the “normal” stabilizing mechanisms of the economy, such as the adjustment of wages and prices to changes in demand, limit the real economic impact of the fall in aggregate demand (the “aggregate supply puzzle”)? Bernanke (2000, p. ix)

His explanation has two components: a contraction in money caused by poor monetary management (and a flawed system based upon the gold standard), and the impact of nonmonetary financial factors:

there is now overwhelming evidence that the main factor depressing aggregate demand was a worldwide contraction in world money supplies. This monetary collapse was itself the result of a poorly managed and technically flawed international monetary system…

I also have ascribed an important role to nonmonetary financial factors, such as banking panics and business failures, in choking off normal flows of credit and hence exacerbating the world economic collapse. Bernanke (2000, p. ix)

With regard to the role of poor monetary management in causing the Great Depression, Bernanke favourably cites Friedman and Schwartz’s identification of “Four Monetary Policy Episodes” where respectively a tightening or loosening of monetary policy caused a decline or expansion during the Great Depression (Bernanke (2002), citing Friedman and Schwartz (1963)). These four episodes are summarized in Table 1.

Table 1: Friedman-Schwartz identified periods in US monetary policy during the Great Depression (Bernanke (2002))

Policy Type Start End
Tighten Spring 1928 October 1929
Tighten September 1931 October 1931
Loosen April 1932 June 1932
Tighten 1933 March 1933

Bernanke largely dismissed the debt-deflation explanation given by Fisher, on the grounds that debt-deflation was a distributive mechanism and not a macroeconomic one:

debt-deflation represented no more than a redistribution from one group (debtors) to another (creditors). Absent implausibly large differences in marginal spending propensities among the groups, it was suggested, pure redistributions should have no significant macroeconomic effects. Bernanke (1995, p. 17)

Bernanke then re-interpreted Fisher from an equilibrium perspective, whereas Minsky accepted and built upon Fisher’s explicit non-equilibrium basis:

We may tentatively assume that, ordinarily and within wide limits, all, or almost all, economic variables tend, in a general way, toward a stable equilibrium… But the exact equilibrium thus sought is seldom reached and never long maintained…, in actual fact, any variable is almost always above or below the ideal equilibrium…

Theoretically … there must be- over- or under-production … and over or under everything else. It is as absurd to assume that, for any long period of time, the variables in the economic organization, or any part of them, will “stay put,” in perfect equilibrium, as to assume that the Atlantic Ocean can ever be without a wave…

in the great booms and depressions … [there are] two dominant factors, namely over-indebtedness to start with and deflation following soon after Fisher (1933, p. 341)

Minsky adopted this disequilibrium perspective, and argued that a reduction in debt does have macroeconomic effects, because it reverses the process of debt adding to aggregate demand that must occur during a period of expansion:

For real aggregate demand to be increasing … it is necessary that current spending plans, summed over all sectors, be greater than current received income and that some market technique exist by which aggregate spending in excess of aggregate anticipated income can be financed. It follows that over a period during which economic growth takes place, at least some sectors finance a part of their spending by emitting debt or selling assets. Minsky (1982, p. 6; emphasis added)

Minsky’s thus defines aggregate demand as the sum of GDP plus the change in debt, and this demand is expended on both commodity and asset markets, in contrast to the mainstream macroeconomic focus on commodity markets alone. Bernanke’s interpretation and statistical measures of tight monetary policy also implicitly accepts the money multiplier explanation of the relationship between base money and broader measures of money such as M1. The Bezemer-Fullbrook Group instead argues that the money supply is endogenously determined, and that changes in base money follow rather than cause changes in broad money, so that there is no direct causal link between M0 and M1 (Moore (1979); see also Kydland and Prescott (1990)). The Bernanke-Friedman-Schwartz assertion is that declines in the rate of growth of the money supply initiated by the Federal Reserve caused the Great Depression; the Bezemer-Fullbrook Group asserts instead that contracting debt caused the Great Depression. These explanations can be compared empirically, by considering the correlations between the rate of growth of the money supply and unemployment, versus changes in the debt-financed proportion of aggregate demand and unemployment.

Money and Unemployment in the Great Depression

Figure 3 shows the relationship between M0 and M1 over the period from 1920 to 1940. Though the two measures move in concert with each other in the period from 1920 to 1930, it is obvious that there was a breakdown in the relationship between these two aggregates in the period between 1931 and 1934. Inferences that are based on the apparent relationship between M0 and M1 in 1920-1930 will thus be suspect in the period 1931-1934.

Figure 3: Rates of change of M0 and M1 1920-1940

This is borne out by a comparison of the correlation of the rate of growth of the money supply as measured by M1 and unemployment in the period 1930-1940, and the correlation using M0. Figure 4 shows that the correlation is moderate and has the expected sign for M1 (-0.3): an increase in the rate of growth of M1 is correlated with a fall in unemployment, as Bernanke, Friedman and Schwartz hypothesize (the rate of unemployment is inverted on the right hand axis, to enhance visual inspection of the correlation: when the two series move in the same direction—or high rates of money growth correspond to falling rates of unemployment—the hypothesized relation holds).

Figure 4: M1 Money supply growth and unemployment

The correlation with M0, on the other hand, has the wrong sign (0.42): increases in the rate of growth of M0 are correlated with increases in the rate of unemployment.

Figure 5: M0 Money supply growth and unemployment

The possibility that this apparent paradox reflects the fact that monetary policy acts with a lag is dispelled in Table 2 on page 11, which shows that though the negative correlation of changes in M1 does strengthen (peaking at -0.5 at a 12 month lag), the positive correlation between changes in M0 and unemployment remains. One way to make sense of this paradox is to conclude that, contrary to Bernanke’s interpretation, the Federal Reserve during the 1930s did try to counter the Great Depression by expanding the money supply, but that not until 1938 were its attempts successful. This information was masked by statistical analysis that used M1 rather than M0, since only M0 is directly under the control of the Federal Reserve. Subtracting M1 from M0 confirms this hypothesis: non-M0 M1 is more strongly correlated with unemployment than M1 alone (-0.41, peaking at -0.52 with an 8 month lag).

Figure 6: Non-M0 M1 Money supply growth and unemployment

A second way to resolve the paradox follows from the first. Since M1 (and more expansive definitions of the money supply) is determined by the actions of the private financial system as well as the Federal Reserve, the public and private money creation systems were working in opposing directions in the 1930s. For the first eight years, the private sector’s reductions in credit overwhelmed the public sector’s attempts to expand the money supply. By mid-1938, when the USA’s private debt to GDP ratio had fallen to 140 percent of GDP (from its deflation-enhanced peak of 238 percent in 1932), substantial increases in M0 were able to expand the aggregate money supply and increase economic activity by enough to cause unemployment to fall.

This interpretation brings us to the debt-driven analysis of the Bezemer-Fullbrook Group, applied in this instance to the Great Depression. From this perspective, both the boom of the 1920s and the slump of the Great Depression were caused by changing levels of debt in an economy that had become fundamentally speculative in nature. Rising debt used to finance speculation during the 1920s made that decade “The Roaring Twenties”, while private sector deleveraging when the speculative bubble burst caused a collapse in aggregate demand that ushered in the Great Depression in the 1930a. Figure 7 illustrates both the rising debt of the 1920s and the falling debt of the 1930s.

Figure 7: US Private Debt and Nominal GDP, 1920-1940

Figure 8 illustrates how much the increase in debt during the 1920s added to demand, and then how much its fall in the 1930s subtracted from demand.

Figure 8: Aggregate demand is the sum of GDP plus the change in debt

Figure 9 correlates the change in debt with the unemployment rate: the correlation has the expected sign, and is significantly larger than that for either M1 or M1-M0 (up to -0.85 for a lag of 15 months; see Table 2 on page 11).

Figure 9: Change in private debt and unemployment

Table 2: Lagged correlations between changes in monetary variables and unemployment

This brings us to the current financial crisis, and why—on the analysis of those who predicted it—this crisis is far from over.

The Great Moderation and the Great Recession

As is well known, a major topic in mainstream macroeconomic debate was explaining the sources of “The Great Moderation” (Bernanke (2004); see also Davis and Kahn (2008) and Gali and Gambetti (2009)). Now the focusing is on explaining—and hopefully escaping from—”The Great Recession” that followed it. From the point of view of the Bezemer-Fullbrook Group, these two events have the same cause, as did the Roaring Twenties and the Great Depression before them: a debt-driven speculative boom, followed by a deleveraging-driven downturn. As an aside, there is no doubt that Ben Bernanke is applying the lessons he took from the Great Depression in his attempts to avoid a second such crisis. Figure 10 shows the annual rate of change of M0, M1, M2 and M3 (which the Fed stopped recording in 2006) over the two decades since 1990. Growth in M0 is off the scale from late 2008 until early 2010, as the Federal Reserve more than doubled the level of base money (the average annual rate of growth of M0 over this period exceeded 100%). However, as during the Great Depression, broader measures of the money supply are failing to respond as dramatically. While there has been growth in M1, it has been one sixth that of M0 (and measured M0 now exceeds M1); M2′s growth never exceeded 10 percent and is now close to zero; it is likely that growth in the now unrecorded M3 is either anemic or negative.

Figure 10: Changes in US money stock levels since 1990

Changes in debt, on the other hand, were dramatic. Figure 11 and Figure 12 are the modern equivalent of Figure 7 and Figure 8 from the 1920s-1940s, and it is evident that the level of debt-financed demand during “the Great Moderation” far exceeded the level of The Roaring Twenties.

Figure 11: US private debt and GDP 1990-2010

Figure 12: US aggregate demand 1990-2010

However, the negative contribution from deleveraging has yet to approach the maximum levels set during the Great Depression. The debt contribution to demand began at a far higher level this time than last, peaking at 22% in 2008 versus at 8.7% in 1928. On this basis, the fall in aggregate demand caused by private sector deleveraging today is more rapid than in the 1930s, has not reached the maximum rate sustained during the Great Depression, and shows no signs of abating. Figure 13 graphs the debt contribution to aggregate demand—defined as the annual change in debt, divided by the sum of GDP plus the annual change in debt. On this measure, deleveraging since the peak level of debt in 2008 has been more severe than deleveraging from the comparable level in 1928, and the reduction in demand from private sector deleveraging shows no signs of abating.

Figure 13: Comparing the Great Depression and the Great Recession from both private and  government borrowing

The relationship between change in debt and unemployment is also much stronger over the period 1990-2010 (a correlation of -0.95) than it was for the period from 1930 till 1940.

Figure 14: Correlation of change in private debt and unemployment, 1990-2010

Lags now make little difference to the results (presumably because all data is now quarterly or monthly in frequency).

Table 3: Lags add no explanatory power to the correlations

On the indicator of choice by the group that anticipated the GFC, it therefore appears that the GFC is far from over. This raises one final empirical issue before I consider the theoretical foundations of the Bezemer-Fullbrook Group: if private sector deleveraging this time round is falling from a greater level and at a greater rate than in the 1930s, then why has the economy stabilized (to some extent) now, versus the almost relentless decline of the Great Depression? The answer appears to lie in the scale of the government response to this crisis. Figure 13 (on page 14) includes the impact of government debt on aggregate demand. While this added substantially to demand during the depths of the Great Depression (more than 7% of aggregate demand between 1931 and 1933 was financed by government debt), in 1930–2 years after the peak rate of growth of private debt in 1928—government debt added a mere 1.2% to aggregate demand. This time, given the fear of another Great Depression that policymakers had in 2008, the government response has been far larger and more immediate. In 2010, government debt was responsible for over 12% of aggregate demand, and this almost counteracted the -15% contribution from private sector deleveraging. While this success is heartening, the figures indicate that growth cannot be expected to continue if the government deficit is reduced. Private sector deleveraging is still accelerating and has some time to go before it could be expected to slow. In the absence of net government spending, it is highly likely that the downward spiral in output and employment would continue.

Non-mainstream modeling of the GFC

Only two of the economists in the Bezemer-Fullbrook Group employ mathematical macroeconomic models in their research: Wynne Godley (Godley (1999), Godley and Izurieta (2002), Godley and Izurieta (2004), Godley and Lavoie (2007)) and myself (Keen (1995), Keen (2000), Keen (2008), Keen (2009a), Keen (2009b), Keen (2009d)). Both authors’ models differ substantially from mainstream “Neoclassical” models, in that they explicitly eschew concepts of optimizing agents, work in aggregative and generally monetary terms, and display non-equilibrium-reverting dynamics.


Godley’s models employed an accounting framework he described as “stock-flow consistent” on the basis that accounting must be correct, and only a limited degree of rationality is needed to accurately model economic behavior:

Post Keynesian economics … is sometimes accused of lacking coherence, formalism, and logic. The method proposed here is designed to show that it is possible to pursue heterodox economics, with alternative foundations, which are more solid than those of the mainstream. The stock-flow monetary accounting framework provides such an alternative foundation that is based essentially on two principles.

First, the accounting must be right. All stocks and all flows must have counterparts somewhere in the rest of the economy. The watertight stock flow accounting imposes system constraints that have qualitative implications. This is not just a matter of logical coherence; it also feeds into the intrinsic dynamics of the model.

Second, we need only assume, in contrast to neoclassical theory, a very limited amount of rationality on the part of economic agents. Agents act on the basis of their budget constraints. Otherwise, the essential rationality principle is that of adjustment. Agents react to what they perceive as disequilibria, or to the disequilibria that they take note of, by making successive corrections. There is no need to assume optimization, perfect information, rational expectations, or generalized price-clearing mechanisms. (Lavoie and Godley (2000, p. 307))

Figure 15 gives an example of the Godley social accounting matrix.

Figure 15: An example of the Godley social accounting matrix (Godley (1999, p. 395))

Figure 16 shows a simulation from this model.

Figure 16: Results of a simulation of the model in Godley (1999, p. 400)

Models are assembled from the stock-flow matrix. For example, household disposable income in nominal terms is defined as:

Figure 17: Equation for household disposable income in Godley (1999, p. 405)

These terms are taken from the Households column of Figure 15, and are the sum of income from profits, wages and interest payments plus changes in household bank balances. On the basis of projections using this framework and US data, Godley observed in 2002 and again in 2004 that the US seemed inevitably headed for a serious recession:

So the medium term alternatives for the US economy look pretty stark. Either an unconvenanted and sustained rise in net export demand provides a motor for expansion in a quite new way; or the fiscal policy continues to generate twin (budget and balance of payments) deficits, possibly growing …, or the US economy relapses into stagnation. (Godley and Izurieta (2004, p. 138))


I concur with Godley on the need for accurate accounting, and the capacity to model macrodynamic behavior with only realistic levels of rationality—by which I mean that agents rationally react to their own situation, but neither know nor can predict the characteristics or future behavior of the entire economy. They therefore employ “rules of thumb” in their reactions to relevant economic stimuli (where these reactions tend to be consistent within each social class, but differ between classes). The most important rule of thumb is that identified by Keynes in 1936:

The essence of this convention—though it does not, of course, work out quite so simply—lies in assuming that the existing state of affairs will continue indefinitely, except in so far as we have specific reasons to expect a change. Keynes (1936, p. 152)

The assumption of a continuance of current conditions in the highly nonlinear real world (and its simulacrum in these models) leads to unexpected outcomes and hence changes in both the model and the state of expectations. I add to Godley’s method an insistence on modeling social classes distinctly (I do not employ an aggregate household sector, but instead divide agents into at the minimum capitalists, workers and bankers), and I work in continuous time rather than the more awkward if simpler framework of discrete time (see Keen (2006) and Keen (2008)). I employ two different frameworks in my models: an extension of Goodwin’s growth cycle model (Goodwin (1967)) to include debt (Keen (1995)), and a development of Godley’s stock-flow consistent framework in continuous time (Keen (2008), Keen (2009a)). The former set of models generate debt dynamics that, under some initial conditions, qualitatively approximate the debt accumulation data seen in Figure 1. The models are expressed as systems of coupled ordinary differential equations (Figure 18).

Figure 18: Equations for the model in Keen (2009d, p. 353)

In this system, the state variables are respectively GDP, the wage rate, private debt, the level of speculative investment as a fraction of GDP, labour productivity, and population (g, ?r and ? are variables representing the rate of growth, profit rate and the employment rate that themselves depend on the values of the state variables). Without speculative borrowing—defined as borrowing that finances speculation on asset prices but does not finance the construction of new assets—the model generates a cyclical system which generally does not break down; with speculative borrowing, the model almost inevitably approaches a crisis caused by the accumulation of debt to levels that exceed the economy’s debt servicing capacity.

Figure 19: Results of a simulation with the model in Keen (2009d)

Figure 20: Results of a simulation with the model in Keen (2009d) continued

My own version of Stock-Flow consistent modeling uses a tabular approach to building systems of coupled differential equations. The system states are bank accounts attributed to specific social classes, and the rows in each table reflects flows between accounts. The models are derived simply by symbolically adding up the columns of the relevant matrix. An example system is shown in Table 4.

Table 4: A sample table of financial flows (Keen (2009c))

Bank Accounts Assets (Reserves & Loans) Liabilities (Deposits)
Actions Reserves (BR) Loans (FL) Firms (FD) Workers (WD) Banks (BI)
A Compound Interest A
B Pay Interest -B -B +B
C Deposit Interest +C -C
D Wages -D +D
E Worker Interest +E -E
F+G Consumption +F+G -F -G
H Loan Repayment +H -H -H
I Money relending -I +I +I
J Money creation +J +J
K Rescue Banks +K
Rescue Firms +K

The dynamics of the model are simply given by adding up the symbolic entries in each column (Table 5):

Table 5: Dynamics of the model shown in Table 4

Rate of change of… Equals…
Bank Reserves BR H-I+K
Firm Loans FL -H+I+J
Firm Deposits FD -B+C-D+F+G-H+I+J+K
Worker Deposits WD D+E+F
Bank Income BI +B-C-E-G

Each of the symbols A to K is replaced by a suitable operator based on the 5 system states in the model (Table 6):

Table 6: Symbolic substitutions for the model in Table 5

Action Description Terms
A Compound Interest Outstanding debt FL is increased at the rate of interest on loans rL. rL.FL
B Pay Interest Accrued interest on outstanding debt is paid. This involves a transfer from the firm sector’s deposits FD to the bank sector’s income account BI, and the recording of this transfer on the debt ledger FL. rD.FL
C Deposit Interest Interest is paid (at the lower rate rD) on the balance in the firm sector’s deposit account rD.FD
D Wages This is a transfer from the firm sector’s deposit accounts to workers’ deposit accounts WD, using two insights from Marx: firstly that the surplus in production is distributed between workers and capitalists (in shares that sum to 1 in this model–so workers get 1-s and capitalists get s); secondly that there is a turnover period (?S as a fraction of a year) between M and M+ (see Capital II Chapter 12). (1-s).FD/?S
E Worker Interest The deposit interest rate times the balance in workers’ accounts. rD.WD
F+G Consumption This employs the concept of a time lag–the length of time it takes workers to spend their wages is 2 weeks (say) or 1/26th of a year so that ?W equals 1/26. Wealthier bankers spend their account balances much more slowly. WD/?W+BI/?B
H Loan Repayment The rate of loan repayment is proportional to the outstanding level of loans divided by the time lag ?L in loan repayment (for a standard housing loan this would be shown as ?L =25) FL/?L
I Money relending The rate of new money creation is the balance in the banking sector’s unlent reserves, divided by a turnover lag representing how rapidly existing money is recycled. BR/?R
J Money creation The rate of new money creation is the balance in the firm sector’s deposit account, divided by a time lag that represents the length of time it takes for the money supply to double. FD/?M
K Rescue Banks This is a ‘Deus Ex Machina‘ injection of 100 currency units one year after the crisis begins, for a period of one year, into either the banking sectors reserves BR or the firm sector’s deposit accounts FD. 100
Rescue Firms

The model’s equations are as shown in

Figure 21: Equations for the model simulated in Keen (2009a) and Keen (2009c)

A simulation of a credit crunch and two different policy responses is shown in Figure 22.

Figure 22: Simulation of a credit crunch using the model in Keen (2009c)


The core propositions shared by the Bezemer-Fullbrook group were that the superficially good economic performance during “The Great Moderation” was driven by a debt-financed speculative bubble, which would necessarily burst because the debt added to the economy’s servicing costs without increasing its capacity to finance those costs. At some stage, the growth of unproductive debt had to falter, and when it did a serious financial crisis would ensue as aggregate demand collapsed. The policy rescues since that prediction came true have not addressed the fundamental cause of the crisis, which was the excessive level of private debt. The deleveraging that the Group predicted has thus been slowed to some degree by government action, but the need for that deleveraging has not been removed. As Figure 13 in particular emphasizes, the scale of that potential deleveraging appears certain to exceed that experienced in the Great Depression.


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Steve Keen is Associate Professor of Economics & Finance at the University of Western Sydney, and author of the popular book Debunking Economics (Zed Books UK, 2001;

Steve predicted the financial crisis as long ago as December 2005, and warned that back in 1995 that a period of apparent stability could merely be “the calm before the storm”. His leading role as one of the tiny minority of economists to both foresee the crisis and warn of it was recognised by his peers when he received the Revere Award from the Real World Economics Review for being the economist who most cogently warned of the crisis, and whose work is most likely to prevent future crises.

He has over 50 academic publications on topics as diverse as financial instability, the money creation process, mathematical flaws in the conventional model of supply and demand, flaws in Marxian economics, the application of physics to economics, Islamic finance, and the role of chaos and complexity theory in economics. His work has been translated into Chinese, German and Russian.

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