Thomas Palley’s paper is here:
Some time ago, a few of us were after Steve Keen in respect of his newly defined aggregate demand function, pointing to a time-inconsistency in its income and non-income flow of funds components. He has since corrected this, with a model whose principal defining equation is now compatible with stock/flow consistent accounting.
Thomas Palley notes (his interpretation) this change in Keen’s definition of aggregate demand:
First version (2009):
“In fact, we live in a fundamentally monetary credit-based economy, and in such an economy, aggregate demand is equal to the sum of income plus the change in debt.”
This relation can be expressed as
(1) Et = Yt + ΔDt
(Et is effective (aggregate) demand.)
Second version (2014):
“The starting point of the monetary macroeconomics of endogenous money is instead that effective demand is equal to income plus the turnover of new debt.”
This relation can be expressed as
(2) Et = Yt-1 + vtΔDt
Third version (2014):
“The correct proposition is that, in a world in which the banking sector endogenously creates new money by creating new loans, aggregate demand in a given period is the sum of aggregate demand at the beginning of that period plus the change in debt over the period multiplied by the velocity of money.”
This newest relation can be expressed as
(3) Et = Et-1 + vtΔDt
Note the change in time subscripting following the first version. This is a critical minimum condition for stock flow consistency.
Palley says that “all three relations are fundamentally problematic from a Keynesian standpoint.”
Interestingly, the first thing he does is confirm the kind of stock flow consistency that must prevail, referring to it as “Keynesian goods market closure”:
The Keynesian goods market closure is given by
(4) Yt = Et
Substituting this relation in equation (2) then yields an expression for income given by
(5) Yt = Yt-1 + vtΔDt
With that, he makes his most important observation in my view:
“The central analytic problematic in the Keynesian theory of effective demand is that of injections into and leakages from the circular flow of income… the assumption that only borrowing and loan repayment can change AD is implausible. Households and firms can change their propensities to spend without borrowing or repaying loans.”
He identifies a number of elements in total not yet present or fully revealed in Keen’s conceptual framework:
– Keynesian injections and leakages
– heterogeneous debt applications
– differentiation of bank (endogenous) debt and non-bank (loanable funds) debt
– GDP transactions (income) versus non-GDP transactions (flow of funds)
– Fisher equation-type money velocities inherent as “nominal credit expenditure multipliers”
– decomposition of debt-specific money velocities
This is a rich decomposition of the problem.
Palley assesses Keen’s current model as “post Keynesian monetarist” – in light of its inherent Fisher-velocity characteristic.
He then offers his own alternative framework (1997) to address these aspects (described in the paper).
Palley’s paper is impressive for its concise view of Keynesian aggregate demand modelling in a stock flow consistent framework. The author acknowledges the more comprehensive work of Godley and Lavoie in this area. The paper offers constructive suggestions complementing Steve Keen’s modelling approach. Ideally this should be helpful to Keen in his quest to gain a broader audience for such aggregate demand modelling.