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Abstract
Debunking Economics exposes what many non-economists may have suspected and a minority of economists have long known: that economic theory is not only unpalatable, but also plain wrong. When the original Debunking was published back in 2001, the market economy seemed invincible, and conventional 'neoclassical' economic theory basked in the limelight. Steve Keen argued that economists deserved none of the credit for the economy's performance, and that 'the false confidence it has engendered in the stability of the market economy has encouraged policy-makers to dismantle some of the institutions which initially evolved to try to keep its instability within limits'. That instability exploded with the devastating financial crisis of 2007, and now haunts the global economy with the prospect of another Depression.
In this radically updated and greatly expanded new edition, Keen builds on his scathing critique of conventional economic theory whilst explaining what mainstream economists cannot: why the crisis occurred, why it is proving to be intractable, and what needs to be done to end it.
Essential for anyone who has ever doubted the advice or reasoning of economists, Debunking Economics provides a signpost to a better future.
'Economics still awaits its Darwin. Keynes came close, but not close enough. Keen comes closer still. Economics, like biology used to be, remains mostly faith-based. No book poses a bigger threat to that faith than the second and expanded edition of Debunking Economics.' - Edward Fullbrook, Editor, Real World Economics Review
'The new edition of 'Debunking Economics'... provide[s] a more persuasive account of the causes of the crash and of its likely evolution than anything that has yet emerged from Constitution Avenue or Threadneedle Street. This is complicated, but it's in your interests to understand it.'
George Monbiot
'It is notorious that only the most mediocre students have the stomach to stick with graduate economics degree. The assumptions become so narrow-minded and tunnel-visioned that reality-based minds drop out. But economics obviously is important too much so to be left to economists. Fortunately, Steve Keen is an empirical mathematician who views the economy logically and systematically. Having made a pioneering explanatory statistical model, he looked through the literature to review the history of economic thought and saw how little today's assumptions had to contribute to Reality Economics. So his book does two things. First, it explains some of the most wrong-headed logical paths that led today's 'free market' economics down its detour to rationalize the status quo. Second, it explains how to view the economy from a more realistic, cause-and-effect light.' - Michael Hudson, Distinguished Research Professor of Economics, University of Missouri
'You would be hard-pressed to find an individual whose pre-crisis analyses of both the world financial system and the economics profession were more dead on than Steve Keen's. The original edition of this book not only demonstrated the irrelevance of modern theory, but it predicted the major economic and social crisis that occurred. This second edition updates earlier chapters and adds new ones that directly address the causes of the collapse and the reasons why standard solutions have been useless. This book is an absolute must read for anyone wondering what caused this catastrophe and how we can truly put it behind us.' - Prof. John T. Harvey, author of 'Currencies, Capital Flows, and Crises: A Post Keynesian Analysis of Exchange Rate Determination'
'Redemption is this book's greatest gift to a world that grew dependent on the thinly disguised forms of mathematised superstition which, over the past thirty years, managed to dominate economic theory and policy. Keen's book is a tour de force that grants its reader the chance of immunity from these, still dominant, economic superstitions.' - Yanis Varoufakis, Professor of Economics, Athens University
'Professor Keen has written a book that will shake the economics community to its core, and for good reason. It could not have been written at a better time.' - Andrew Leeming, author of The Super Analysts
'Much more than simply explaining the causes of the crisis, Keen takes us through a thorough dissection of mainstream neoclassical economics, and the result does not leave the discipline looking in good shape.' - Tanweer Ali, Empire State College, State University of New York, in Heterodox Economics Newsletter
Steve Keen is Associate Professor of Economics & Finance at the University of Western Sydney. 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.
Table of Contents
Section Title | Page | Action | Price |
---|---|---|---|
About the author | i | ||
Tables, figures and boxes | vi | ||
Tables | vi | ||
2.1 Anticipations of the housing crisis and recession | 13 | ||
3.1 ‘Utils’ and change in utils from consuming bananas | 43 | ||
3.2 Utils arising from the consumption of two commodities | 44 | ||
3.3 The commodities in Sippel’s ‘Revealed Preference’ experiment | 69 | ||
4.1 Demand schedule for a hypothetical monopoly | 80 | ||
4.2 Costs for a hypothetical monopoly | 82 | ||
4.3 Sales and costs determine the level of output that maximizes profit | 84 | ||
4.4 Cost and revenue for a ‘perfectly competitive’ industry identical in scale to hypothetical monopoly | 88 | ||
5.1 Input and output data for a hypothetical firm | 106 | ||
5.2 Cost drawings for the survey by Eiteman and Guthrie | 124 | ||
5.3 Empirical research on the nature of cost curves | 126 | ||
7.1 Sraffa’s hypothetical subsistence economy | 149 | ||
7.2 Production with a surplus | 150 | ||
7.3 Relationship between maximum and actual rate of profit and the wage share of surplus | 151 | ||
7.4 The impact of the rate of profit on the measurement of capital | 153 | ||
10.1 Anderson’s ranking of sciences | 208 | ||
12.1 The alleged Money Multiplier process | 307 | ||
13.1 A hypothetical example of the impact of decelerating debt on aggregate demand | 338 | ||
13.2 The actual impact of decelerating debt on aggregate demand | 340 | ||
14.1 A pure credit economy with paper money | 364 | ||
14.2 The dynamics of a pure credit economy with no growth | 365 | ||
14.3 Net incomes | 366 | ||
14.4 A growing pure credit economy with electronic money | 371 | ||
15.1 Von Neumann’s procedure for working out a numerical value for utility | 382 | ||
15.2 The Allais ‘Paradox’ | 383 | ||
15.3 The Allais ‘Paradox’ Part 2 | 384 | ||
16.1 The solvability of mathematical models | 409 | ||
17.1 Marx’s unadjusted value creation table, with the rate of profit dependent upon the variable-to-constant ratio in each sector | 425 | ||
17.2 Marx’s profit distribution table, with the rate of profit now uniform across sectors | 425 | ||
17.3 Steedman’s hypothetical economy | 426 | ||
17.4 Steedman’s physical table in Marx’s value terms | 427 | ||
17.5 Steedman’s prices table in Marx’s terms | 428 | ||
17.6 Profit rate and prices calculated directly from output/wage data | 429 | ||
17.7 Marx’s example where the use-value of machinery exceeds its depreciation | 439 | ||
Figures | vii | ||
Where are the Diagrams? | ix | ||
Preface to the Second Edition | x | ||
Looking back | xii | ||
Looking forward | xiii | ||
Preface to the First Edition | xiv | ||
1 | Predicting the ‘unpredictable’ | 1 | ||
The destabilizing effect of neoclassical economics | 1 | ||
Possibility of debt deflation in the USA | 2 | ||
The likelihood of a Japanese outcome for America after the crash | 2 | ||
The impact of the Maastricht Treaty on Europe during a crisis | 2 | ||
The Efficient Markets Hypothesis encouraging debt-financed speculation | 3 | ||
Deregulation and crisis | 3 | ||
The history of crises causing – and not causing – paradigm shifts in economics | 4 | ||
Public reactions to the failure of neoclassical economics | 5 | ||
Postscript 2011 | 6 | ||
2 | No more Mr Nice Guy | 7 | ||
Why economics must undergo a long-overdue intellectual revolution | 7 | ||
Purge | 8 | ||
Triumph | 9 | ||
Crisis | 10 | ||
‘No one saw this coming’ | 12 | ||
table 2.1 Anticipations of the housing crisis and recession | 13 | ||
Revisionism | 15 | ||
Ignorance | 18 | ||
Educated into ignorance | 19 | ||
Does economics matter? | 22 | ||
Revolt | 23 | ||
But it seems to make sense … | 24 | ||
Sincerity is no defense | 24 | ||
Debunking economics: a user’s guide | 25 | ||
Part 1 | Foundations: The logical flaws in the key concepts of conventional economics | 37 | ||
3 | The calculus of hedonism | 38 | ||
Why the market demand curve is not downward-sloping | 38 | ||
The kernel | 38 | ||
The roadmap | 39 | ||
Pleasure and pain | 40 | ||
Flaws in the glass | 41 | ||
‘The sum of the interests’ | 43 | ||
table 3.1 ‘Utils’ and change in utils from consuming bananas | 43 | ||
table 3.2 Utils arising from the consumption of two commodities | 44 | ||
Deriving the individual demand curve | 46 | ||
The impact of changing prices on consumer demand | 47 | ||
Income and substitution effects and the ‘Law of Demand’ | 48 | ||
How rising income affects demand | 50 | ||
Two is a crowd | 51 | ||
3.1 A valid market demand curve | 52 | ||
Cut off at Pythagoras’ pass | 53 | ||
Drowning the result | 56 | ||
Don’t tell the children | 57 | ||
Following the madding crowd | 63 | ||
So what? | 65 | ||
Addendum: an anti-empirical theory | 67 | ||
table 3.3 The commodities in Sippel’s ‘Revealed Preference’ experiment | 69 | ||
Rational behavior and the curse of dimensionality | 70 | ||
Conclusion | 72 | ||
4 | Size does matter | 74 | ||
Why there is no supply curve | 74 | ||
4.1 Leijonhufvud’s ‘Totems’ of the Econ tribe | 74 | ||
The kernel | 75 | ||
Prelude: the War over Perfect Competition | 76 | ||
4.2 Stigler’s proof that the horizontal firm demand curve is a fallacy | 76 | ||
The roadmap | 78 | ||
Economic perfection | 78 | ||
Monopoly | 79 | ||
table 4.1 Demand schedule for a hypothetical monopoly | 80 | ||
table 4.2 Costs for a hypothetical monopoly | 82 | ||
table 4.3 Sales and costs determine the level of output that maximizes profit | 84 | ||
Perfect competition | 85 | ||
Checking our sums | 87 | ||
Calculus 101 for economists: infinitesmals ain’t zero | 87 | ||
table 4.4 Cost and revenue for a ‘perfectly competitive’ industry identical in scale to hypothetical monopoly | 88 | ||
Returns to scale and the durability of perfect competition | 93 | ||
Addendum: the war over perfect competition | 95 | ||
Equating marginal cost and marginal revenue does not maximize profits | 96 | ||
Calculus schmalculus | 98 | ||
4.3 Output levels for between 1- and 100-firm industries | 100 | ||
Dialogue with the deaf | 100 | ||
So what? | 101 | ||
5 | The price of everything and the value of nothing | 103 | ||
Why most products cost less to produce as output rises | 103 | ||
The kernel | 103 | ||
The roadmap | 104 | ||
Diminishing productivity causes rising price | 104 | ||
table 5.1 Input and output data for a hypothetical firm | 106 | ||
Things don’t add up | 108 | ||
5.1 Capacity utilization over time in the USA | 114 | ||
Resource-constrained versus demand-constrained economies | 114 | ||
Summing up Sraffa | 115 | ||
If not rising marginal cost, what? | 116 | ||
So what? | 118 | ||
The neoclassical rejoinder | 120 | ||
Time and the short run | 121 | ||
table 5.2 Cost drawings for the survey by Eiteman and Guthrie | 124 | ||
Wrong in fact as well as theory | 125 | ||
5.2 Varian’s drawing of cost curves in his ‘advanced’ microeconomics textbook | 126 | ||
7.1 The standard economic ‘circular flow’ diagram | 144 | ||
table 5.3 Empirical research on the nature of cost curves | 126 | ||
A totem in tatters | 127 | ||
6 | To each according to his contribution | 129 | ||
Why productivity doesn’t determine wages | 129 | ||
The kernel | 129 | ||
The roadmap | 130 | ||
Labor demand and supply: an inverted commodity | 130 | ||
Marginal workers | 131 | ||
Aggregate demand | 131 | ||
Indifferent workers | 132 | ||
Problems | 133 | ||
Backward-bending supply curves | 133 | ||
Monopoly and monopsony | 135 | ||
Sraffa’s observations on aggregation | 136 | ||
Freedom and labor | 136 | ||
A three-horse race | 137 | ||
‘A benevolent central authority’ | 138 | ||
So what? | 139 | ||
Part 2 | Complexities: Issues omitted from standard courses that should be part of an education in economics | 141 | ||
7 | The holy war over capital | 142 | ||
Why the productivity of capital doesn’t determine profits | 142 | ||
The kernel | 142 | ||
The roadmap | 143 | ||
Measuring capital | 143 | ||
7.1 The standard economic‘circular flow’ diagram | 144 | ||
The whole box and dice | 148 | ||
table 7.1 Sraffa’s hypothetical subsistence economy | 149 | ||
table 7.2 Production with a surplus | 150 | ||
table 7.3 Relationship between maximum and actual rate of profit and the wage share of surplus | 151 | ||
The punchline: capital behaving badly | 152 | ||
table 7.4 The impact of the rate of profit on the measurement of capital | 153 | ||
So what? | 157 | ||
Ignorance is bliss | 157 | ||
8 | There is madness in their method | 158 | ||
Why assumptions do matter, and why economics is so different from the true sciences | 158 | ||
The kernel | 158 | ||
The roadmap | 159 | ||
A paradoxical proposition | 159 | ||
9 | Let’s do the Time Warp again | 175 | ||
Why economics must finally treat time seriously | 175 | ||
The kernel | 176 | ||
The roadmap | 176 | ||
Cobwebs of the mind | 176 | ||
General equilibrium | 177 | ||
‘The formal identity of uncertainty with certainty’ | 181 | ||
A transitional methodology? | 184 | ||
In the long run, we are all in the short run | 189 | ||
9.1 The time path of one variable in the Lorenz model | 190 | ||
9.2 Structure behind the chaos | 191 | ||
From meteorology to economics | 192 | ||
Addendum: Misunderstanding Bill Phillips, wages and ‘the Phillips Curve’ | 195 | ||
9.3 Phillips’s functional flow block diagram model of the economy | 196 | ||
9.4 The component of Phillips’s Figure 12 including the role of expectations in price setting | 197 | ||
9.5 Phillips’s hand drawing of the output–price-change relationship | 197 | ||
9.6 A modern flow-chart simulation program generating cycles, not equilibrium | 198 | ||
9.7 Phillips’s empirically derived unemployment–money-wage-change relation | 199 | ||
10 | Why they didn’t see it coming | 203 | ||
Why the world’s leading macroeconomists were the last ones capable of realizing that a major economic crisis was imminent | 203 | ||
The kernel | 204 | ||
The roadmap | 204 | ||
Macroeconomics and the reductionist fallacy | 205 | ||
table 10.1 Anderson’s ranking of sciences | 208 | ||
Say, Walras, and the self-equilibrating economy … | 209 | ||
Credit and the fallacy of Walras’s Law | 218 | ||
Walrasian rejoinders? | 221 | ||
So what? | 223 | ||
Hamlet without the prince | 225 | ||
10.1 Hicks’s model of Keynes | 231 | ||
10.2 Unemployment-inflation data in the USA, 1960–70 | 241 | ||
The age of large-scale econometric models | 237 | ||
From IS-LM to the representative agent | 239 | ||
10.2 Unemployment inflation data in the USA, 1960–70 | 241 | ||
10.3 The hog cycle | 248 | ||
Conclusion | 266 | ||
Box 10.1 The Taylor Rule | 267 | ||
Postscript: intellectual miasma or corporate corruption? | 268 | ||
11 | The price is not right | 270 | ||
Why finance markets can get the price of assets so badly wrong | 270 | ||
The kernel | 271 | ||
The roadmap | 272 | ||
Fisher on finance: from reassuring oracle to ignored Cassandra | 272 | ||
Fisher during the Crash: ‘don’t panic’ | 277 | ||
The efficient markets hypothesis | 282 | ||
11.1 How the EMH imagines that investors behave | 288 | ||
11.2 How speculators actually behave | 293 | ||
12.1 Change in M0 and unemployment, 1920–40 | 303 | ||
Addendum: Fama overboard | 294 | ||
So wrong it’s almost right | 295 | ||
12 | Misunderstanding the Great Depression and the Great Recession | 297 | ||
12.1 Change in M0 and unemployment,1920–40 | 303 | ||
After the Great Recession: Bernanke to the rescue? | 304 | ||
12.2 The volume of base money in Bernanke’s ‘quantitative easing’ in historical perspective | 306 | ||
The mythical Money Multiplier | 306 | ||
Table 12.1 The alleged Money Multiplier process | 307 | ||
12.3 The empirical ‘Money Multiplier’, 1920–40 | 311 | ||
Don’t mention the data | 312 | ||
After the Great Recession II: neoclassical responses | 314 | ||
It’s just a jolt to the left … | 315 | ||
‘Like a dog walking on its hind legs’: Krugman’s Minsky model | 318 | ||
Conclusion: neat, plausible, and wrong | 323 | ||
Part 3 | Alternatives: different ways to think about economics | 325 | ||
13 | Why I did see ‘It’ coming | 326 | ||
The Financial Instability Hypothesis | 326 | ||
Modeling Minsky | 331 | ||
13.1 The vortex of debt in my 1995 Minsky model | 334 | ||
Reality check, December 2005 | 336 | ||
13.2 US private debt to GDP, 1955–2005 | 336 | ||
The empirical dynamics of debt | 337 | ||
Table 13.1 A hypothetical example of the impact of decelerating debt on aggregate demand | 338 | ||
13.3 Aggregate demand in the USA, 1965–2015 | 340 | ||
Table 13.2 The actual impact of decelerating debt on aggregate demand | 340 | ||
13.4 The change in debt collapses as the Great Recession begins | 341 | ||
13.5 The Dow Jones nosedives | 342 | ||
13.6 The housing bubble bursts | 342 | ||
13.7 The Credit Impulse and change in employment | 343 | ||
Box 13.1 Definitions of unemployment | 344 | ||
13.8 The biggest collapse in the Credit Impulse ever recorded | 348 | ||
13.9 The two great debt bubbles | 349 | ||
Debt deflation then and now | 349 | ||
13.10 The collapse of debt-financed demand then and now | 352 | ||
Fighting the Great Recession | 353 | ||
Conclusion | 356 | ||
14 | A Monetary Model of Capitalism | 357 | ||
Methodological precepts | 358 | ||
Endogenous money | 358 | ||
14.1 The neoclassical model of exchange as barter | 361 | ||
14.2 The nature of exchange in the real world | 361 | ||
A ‘pure credit’ economy | 362 | ||
Table 14.1 A pure credit economy with paper money | 364 | ||
Table 14.2 The dynamics of a pure credit economy with no growth | 365 | ||
Table 14.3 Net incomes | 366 | ||
14.3 Bank accounts | 367 | ||
A credit crunch | 368 | ||
Whose bailout works best? | 369 | ||
A modern credit crunch | 370 | ||
Table 14.4 A growing pure credit economy with electronic money | 371 | ||
14.4 Unemployment is better with a debtor bailout | 373 | ||
From tranquility to breakdown | 374 | ||
14.5 Modeling the Great Moderation and the Great Recession – inflation, unemployment and debt | 374 | ||
14.6 The Great Moderation and the Great Recession – actual inflation, unemployment and debt | 375 | ||
14.7 Debt and GDP in the model | 376 | ||
14.8 Debt and GDP during the Great Depression | 376 | ||
Making monetary modeling accessible: QED | 376 | ||
Conclusion | 377 | ||
15 | Why stock markets crash | 378 | ||
The kernel | 378 | ||
The roadmap | 378 | ||
Behavioral finance | 378 | ||
Table 15.1 Von Neumann’s procedure for working out a numerical value for utility Consumer: Joan Cheng | 382 | ||
Table 15.2 The Allais ‘Paradox’: Experiment 1 | 383 | ||
Table 15.3 The Allais ‘Paradox’ Part 2: Experiment 2 | 384 | ||
The inherent instability of stock markets | 385 | ||
The Fractal Markets Hypothesis | 386 | ||
The Inefficient Markets Hypothesis | 389 | ||
Econophysics | 390 | ||
Conclusion: progress versus ossification | 393 | ||
Reforming finance? | 393 | ||
Conclusion | 400 | ||
16 | Don’t shoot me, I’m only the piano | 402 | ||
Why mathematics is not the problem | 402 | ||
The kernel | 402 | ||
The roadmap | 403 | ||
Bad mathematics | 403 | ||
Omitted variables | 405 | ||
False equalities | 406 | ||
Unexplored conditions | 406 | ||
The limits to mathematics | 407 | ||
Table 16.1 The solvability of mathematical models | 409 | ||
The recurring nightmare of straight lines | 410 | ||
The future of mathematics in economics | 411 | ||
17 | Nothing to lose but their minds | 412 | ||
Why most Marxists are irrelevant, but most of Marx is not | 412 | ||
The kernel | 412 | ||
The roadmap | 413 | ||
Marxian economics and the economics of Marx | 413 | ||
Value – a prelude | 414 | ||
Physiocrats | 416 | ||
Smith (and Ricardo) | 417 | ||
Marx’s labor theory of value | 420 | ||
The origin of surplus value (I) | 422 | ||
Table 17.1 Marx’s unadjusted value creation table, with the rate of profit dependent upon the variable-to-constant ratio in each sector | 425 | ||
Table 17.2 Marx’s profit distribution table, with the rate of profit now uniform across sectors | 425 | ||
Marxist economics after Sraffa | 426 | ||
Table 17.3 Steedman’s hypothetical economy | 426 | ||
Table 17.4 Steedman’s physical table in Marx’s value terms | 427 | ||
Table 17.5 Steedman’s prices table in Marx’s terms | 428 | ||
Table 17.6 Profit rate and prices calculated directly from output/wage data | 429 | ||
Arun Bose: Marx’s ‘capital axioms’ | 431 | ||
The origin of surplus value (II) | 432 | ||
17.1 A graphical representation of Marx’s dialectics | 433 | ||
Boxes | viii | ||
10.1 The Taylor Rule | 267 | ||
13.1 Definitions of unemployment | 344 | ||
The origin of surplus value (II) | 438 | ||
Table 17.7 Marx’s example where the use-value of machinery exceeds its depreciation | 439 | ||
Marx without the labor theory of value | 439 | ||
The misinterpretation of Marx | 440 | ||
Whither Marxism? | 442 | ||
18 | There are alternatives | 444 | ||
Why there is still hope for a better economics | 444 | ||
Austrian economics | 445 | ||
Post-Keynesian economics | 449 | ||
Sraffian economics | 450 | ||
Complexity theory and Econophysics | 452 | ||
Evolutionary economics | 454 | ||
W(h)ither economics? | 456 | ||
Bibliography | 461 | ||
Index | 472 |