Modelling with Minsky

The free online companion to The New Economics: A Manifesto

Second Release: January 16 th 2022
© Steve Keen
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Table of Contents
1 Preface ............................................................................................................................................ 5
2 Introduction: A Manual with Attitude ............................................................................................ 6
3 Installation ...................................................................................................................................... 8
4 Understanding money: “Minsky for Dummies” ............................................................................ 13
4.1 Fiat Money ............................................................................................................................ 15
4.2 Bond Sales ............................................................................................................................. 24
4.3 Credit Money ........................................................................................................................ 33
4.4 A significant extension: Nonfinancial Assets......................................................................... 34
4.4.1 Ab initio creation of banks ............................................................................................ 35
4.4.2 Financial Assets and Bubbles in Nonfinancial Asset valuation ..................................... 37
5 The User Interface......................................................................................................................... 41
5.1 Text Formatting ..................................................................................................................... 48
5.2 Multiple copies of variables and parameters ....................................................................... 49
5.2.1 A Keen Rant: Rehabilitating Bill Phillips ........................................................................ 49
5.3 Plots in Minsky ...................................................................................................................... 51
5.4 Building a “Phillips Curve” in Minsky .................................................................................... 55
6 System Dynamics Basics................................................................................................................ 58
6.1 Predator-Prey model............................................................................................................. 60
6.2 Organizing a model ............................................................................................................... 67
6.2.1 Bookmarks .................................................................................................................... 68
6.2.2 Using intermediate variables ........................................................................................ 72
6.3 Documenting a model ........................................................................................................... 72
6.3.1 The Equations, Parameters, Variables, Plots and Godleys Tabs ................................... 74
6.4 Exporting and importing a model ......................................................................................... 75
6.5 A Keen Rant: How not to handle time .................................................................................. 76
6.6 Mathematics and Minsky ...................................................................................................... 79
6.7 Integrals versus differentials ................................................................................................. 80
6.8 A first model, done two ways ............................................................................................... 80
7 Godley Tables ................................................................................................................................ 91
7.1 Creating a Godley Table ........................................................................................................ 91
7.2 The simplest possible monetary model of a pure credit economy ...................................... 92
7.3 Defining the flow elements of a Godley Table ...................................................................... 95
7.4 A Keen Rant: Using Minsky to Revisit the Keen-Krugman Debate ..................................... 107
7.5 A Mixed Godley Table-Flowchart model............................................................................. 121

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8 Money ......................................................................................................................................... 125

8.1 Modelling the Origins of Fiat Money in Minsky: pp. 33-39 of Manifesto ........................... 126
8.1.1 Check the equations.................................................................................................... 137
8.2 Modelling Modern Fiat Money in Minsky: pp. 39-50 of Manifesto .................................... 140
8.3 An integrated view of deficits and credit: pp. 59-65 of Manifesto ..................................... 147
8.3.1 The actual event: Coolidge Surplus and private sector credit binge .......................... 157
8.3.2 Coolidge Surplus with no private sector borrowing ................................................... 158
8.3.3 Coolidge Balanced Budget with the credit binge ........................................................ 158
8.3.4 Coolidge runs a Deficit with the credit binge.............................................................. 158
8.3.5 Coolidge runs a Deficit with no credit ......................................................................... 159
8.3.6 Coolidge runs a Deficit to reproduce the 1920s boom without credit ....................... 159
8.3.7 Disentangling cause and effect ................................................................................... 159
8.4 A Modern Debt Jubilee: pp. 65-68 of Manifesto ................................................................ 163
9 Complexity .................................................................................................................................. 176
9.1 Lorenz model ...................................................................................................................... 176
9.2 A complex systems model of economic instability ............................................................. 179
9.3 Nonlinear Functions in Nonlinear Models .......................................................................... 185
9.4 The switch function ............................................................................................................. 187
10 Energy ..................................................................................................................................... 189
10.1 Forget the “Cobb-Douglas Production Function” (an optional read) ................................. 192
10.2 Generalizing the Leontief Production Function .................................................................. 195
10.3 A Goodwin model with Energy ........................................................................................... 202
10.3.1 Derivation.................................................................................................................... 206
10.4 A Goodwin model with matter and energy ........................................................................ 211
10.5 Derivation: constant technology and population ............................................................... 214
10.6 Growth and pollution .......................................................................................................... 218
11 Analyzing a Model ................................................................................................................... 221
11.1 Of linearity and nonlinearity ............................................................................................... 223
11.2 The absolute basics of stability analysis ............................................................................. 225
11.3 Analyzing a complex model ................................................................................................ 231
11.4 Analyzing the Keen model of Minsky’s Financial Instability Hypothesis ............................ 237
11.5 Why the Jacobian? .............................................................................................................. 245
12 Model fitting notes from a non-statistician ............................................................................ 248
13 Conclusion ............................................................................................................................... 251
14 Appendix: the credit dynamics of house prices ...................................................................... 252
14.1 The argument ...................................................................................................................... 252

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References .......................................................................................................................................... 255

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1 Preface
I closed The New Economics: A Manifesto (Keen 2021) with an observation on the following remark
by John Blatt in his brilliant book Dynamic Economic Systems (Blatt 1983):

At present, the state of our dynamic economics is more akin to a crawl than to a
walk, to say nothing of a run. Indeed, some may think that capitalism as a social
system may disappear before its dynamics are understood by economists. (Blatt
1983, pp. 4–5, emphasis added)

I noted that, when I first read this in 1991, “I thought it was a good piece of hyperbole. I now regard
it as a depressingly prescient prediction”, because:

Given the role that Neoclassical economists have played in humanity making only
trivial responses to the challenge of climate change to date, the social system
that gets us through that challenge—if we do get through it—will be far more a
command than a market economy. (Keen 2021, p. 204)

There is therefore a bitter irony in me releasing a book on dynamic modelling in economics that I
hope would meet Blatt’s standards, right at the time that I expect his bleak prediction to start
coming true. The forces humanity has unleashed, by ignoring the damage its production systems
have done to the biosphere, will transform that biosphere into something almost certainly inimical
to the survival of those production systems, and certainly inimical to their management by the
disaggregated market system that is the hallmark of capitalism. Instead, if human civilization
survives, it will be because of a centralized, coordinated command system, whose only antecedent is
the War Economy of WWII.

What then is the point of showing how to do the dynamic modelling of a monetary production
economy properly, when I expect that system to fail sometime in the next two decades, and
probably sooner than later?

I see two immediate reasons. One is that, having failed to use systems thinking as the ecological
crisis unfolded, we are going to need the capacity to think in a systemic way to manage our attempts
to cope with the crisis. The second is that, unless an alternative paradigm develops in economics, the
old ways of thought—the Neoclassical ways—will keep disturbing our thinking, even as we attempt
to cope with the myriad crises which that way of thinking caused.

Minsky is far from complete: there are many ways in which I would extend the program, had I the
funding to support it. But as it stands, it is capable of doing far more sophisticated modelling than is
the norm in economics, and of supporting a way of thinking about the economy and the planet’s
ecology that could have prevented us experiencing this crisis in the first place. I hope that this book
will enable you to use not just Minsky, but also the integrated, systems way of thinking about the
economy that should always have been the foundation of economics.

This manual is also incomplete: it lacks a chapter on fitting models to data, but with The New
Economics: A Manifesto now published in the USA as well as the UK, I need to have this manual
available immediately for those who wish to learn how to model in Minsky.

I will periodically post updates of this book to https://www.patreon.com/ProfSteveKeen and

http://www.profstevekeen.com/minsky/.

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2 Introduction: A Manual with Attitude

Technically, this book is a free companion to The New Economics: A Manifesto (Keen 2021)—
hereinafter referred to as Manifesto—with two main functions:

• To explain the Minsky models in Manifesto; and

• To be a manual for the Open Source system dynamics program Minsky, which features
prominently in Manifesto.

In practice, it has developed a 3rd function: it’s somewhere for me to rant about issues that I didn’t
get to cover in Manifesto. This was partly for reasons of lack of space: the publisher’s guidelines
limited the book to just 25,000 words. But it’s mainly because the audience for Manifesto was very
broad, whereas the intended audience for this book is very narrow: I want to reach young
economists who wish to construct realistic dynamic models of capitalism.

The main rants are:

• That Bill Phillips (of the Phillips Curve) was a far greater economist—and person—than the
mainstream economics caricature of the Phillips Curve has made him out to be;
• That economists should stop modelling in “discrete time” or periods, and instead should
model in continuous time, using differential equations; and
• That “Loanable Funds”, Paul Krugman’s preferred model of banking, is utterly misleading
about the role of banks, debt and money in macroeconomics.

There’d be a lot less text to read if I treated this as a standard “how to” manual for Minsky itself,
which is what I would do if Minsky were just another, better way to do what you—an established or
nascent economic modeler—are currently doing with different tools. But that’s not the case, even
for Post Keynesian economists who are currently working in the Godley and Lavoie stock-flow
consistent tradition. For those who’ve only been exposed to or developed Neoclassical models,
whether that’s the old-fashioned IS-LM and AS-AD models, or the currently dominant practice of
DSGE modelling, Minsky does not and indeed cannot do what you currently do—and I want to
persuade you that this is a good thing.

Minsky is a system dynamics program. It works only in continuous time—not “periods”: see section
6.2 (starting on page 67) for the rant about why Minsky does not use “periods”—and it is designed
to model systems that operate far-from-equilibrium, rather than systems that are assumed to return
to their equilibrium values after an exogenous shock. Its unique feature, the “Godley Table”, enables
the correct modelling of monetary dynamics, which are absent from mainstream economic models.
Each of those facets of the program, and several others, reflect the needs of an approach to
modelling that I believe is superior to the dominant methods in both Post Keynesian and
Neoclassical economic modelling. 1

The key foundation here is its use of system dynamics. “System” means an interacting set of factors
that cannot be understood in isolation from one another. This puts it in the category that
Neoclassicals call “general” as opposed to “partial”. But for Neoclassicals, “general” goes hand in
hand with “equilibrium”, whereas the second word in the phrase “system dynamics” transcends
“equilibrium”. An equilibrium is a state that a system can be in, but, in all likelihood, the interacting

1
That’s not to say that Minsky is without shortcomings of its own. There are many features I’d like to add to
Minsky that I currently lack the funding to implement.

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forces in a system will be such that its equilibria are unstable, so that they therefore describe
conditions that the system will never display.

System dynamics models in general demonstrate the behaviour of a system of equations that the
modeler believes mimic the behavior of a real-world system which changes over time. There are
many other system dynamics programs out there—Stella, IThink, Vensim, Modelica, AnyLogic,
Matlab’s Simulink, Wolfram’s System Modeler, Insight Maker, to mention but a few. What
distinguishes Minsky from the pack are its “Godley Tables”, which are designed to make it easy to
model the dynamics of monetary systems. System dynamics itself can be challenging, and it involves
many concepts that may be foreign to you when you first use such a program. But Godley Tables are
easy: if you have used a spreadsheet, you can design a model of a monetary system using Godley
Tables.

Minsky is also Open Source, which means that (a) it is free and (b) its source code is available for
anyone for anyone to inspect and, if they wish, modify.

To use Minsky, you first have to download it from one of its online repositories. The main site is
SourceForge (https://sourceforge.net/projects/minsky/), and it is also available for more technically
savvy users at https://github.com/highperformancecoder/minsky. The SourceForge system
recognizes the operating system of the computer you’re using to access SourceForge, and delivers
the appropriate version: Windows builds for windows users, Mac builds for Mac users and source
code tarballs for anyone else. For most popular Linux distros, a prebuilt packaged Minsky is available
from the OpenSUSE Build Service (OBS):

https://software.opensuse.org//download.html?project=home%3Ahpcoder1&package=Minsky

In this manual I exclusively use the Windows version of Minsky, which, at the time of publication of
this book (31st December 2021), is version 2.35. This version has a vast number of improvements
over the previous release, thanks to a £200,000 grant from the Friends Provident Foundation of the
UK. The next major release—expected sometime in January 2022—will implement Minsky’s user
interface in Javascript, rather than its current GUI of Tcl/Tk. 2

Pre-release versions of Minsky are made available as “betas”, to enable users to test extensions to
the program out before a final release. User feedback is an essential part of the software
development process, and we’d be delighted to have you help us out by testing the new versions,
reporting bugs, suggesting improvements to features, etc. If you’d like to assist us in this work,
please download MinskyBeta from https://sourceforge.net/projects/minsky/files/beta%20builds/,
and sign up to the beta-testers program at https://sourceforge.net/p/minsky/mailman/. Both
release and beta versions of Minsky can be installed at the same time.

2
Tcl/Tk (see https://www.tcl.tk/) enabled the rapid development of Minsky with the initial grant from the
Institute for New Economic Thinking (INET: https://www.ineteconomics.org/)—see
https://www.ineteconomics.org/research/grants/extending-macroeconomics-and-developing-a-dynamic-
monetary-simulation-tool. The port to Javascript will enable Minsky to run in a browser, and it will also enable
us to make the program’s graphics more consistent with standard Windows programs.

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3 Installation
To install Minsky on a Windows PC, double click on the MSI (“MicroSoft Installer”) file that you have
downloaded from SourceForge. This will bring up the dialog box shown in Figure 1.
Figure 1: Installer dialog box for Minsky

Click on “Next” and you will see the license agreement dialog box:
Figure 2

Click on the “I accept the terms in the License Agreement” checkbox (this is a standard Open-Source
license, involving no user fees) and the Next button will become available. Click on it, and the install
destination dialog box appears.

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Figure 3

Figure 4

Click on Install, and after a short delay, you screen should go blank, except for the form shown in
Figure 5. Click on “Yes”, and the installation will commence.

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Figure 5

When it finishes, you have one more dialog box to contend with—see Figure 6.
Figure 6

You are now ready to use Minsky. Press the Windows key on your keyboard to bring up the main
Windows menu (or the equivalent on a Mac or Linux box), choose Minsky, and you’re ready to delve
into the world of system dynamics and monetary modelling.

I urge you to not just read this book, but also to build the models in it yourself as you read it. Have
this book open, physically or on screen, with Minsky on your computer, and create the models as
you read. Ideally, you would be doing this in a workshop with a tutor guiding the process—
something I used to do with my students at Kingston University. Especially now in the age of Covid,
this isn’t possible—so it’s up to you to follow the instructions in this book, and then replicate them in
your own Minsky models on your computer. You will doubtless make mistakes. But you will learn
from mistakes and ultimately learn how to use Minsky to learn economics, and to create models of

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your own, for your own purposes. This can range from just the fun of being able to simulate chaotic
systems—see Figure 7—to building a robust, large-scale model of a national economy. 3
Figure 7: The Lorenz model of turbulent flow in Minsky

You will also almost certainly encounter bugs, ranging from minor annoyances—such as, at present,
text boxes for plots running outside the plot boundaries—to fatal crashes, where the program hangs
and suddenly you find yourself staring at the desktop. There will, hopefully, be very few of the
latter—the funding that we received from Friends Provident Foundation in 2018 has allowed us to
dramatically improve the program’s stability, as well as to add numerous features. But they will
happen nonetheless: bugs are a given in any computer software.

If you find a bug, please report it to the beta-testers list, which you can find at
https://sourceforge.net/p/minsky/mailman/. The user groups that exist there are:

• minsky-betatesters: Subscribe | Archive | Search — A list for people who'd like to test beta
versions of Minsky

3
The largest model made to date is a model of the Portuguese economy, constructed by the statistician Pedro
Pratas during his Masters degree. He is now extending for his PhD which he commenced under me, and is
completing under Yannis Dafermos at SOAS. The model is out of date and precedes many of the organisation
and formatting improvements we’ve made to Minsky, but it still shows what is possible with Minsky. It is the
file PortugalModelPedroPratas2019.mky in the ZIP file on my http://www.profstevekeen.com/minsky/
website: http://www.profstevekeen.com/wp-content/uploads/2021/07/MinskyFigures.zip.

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• minsky-developer: Subscribe | Archive | Search

• minsky-users: Subscribe | Archive | Search — For topics related to general usage of Minsky

If you plan on being an active user of Minsky, please sign up to at least minsky-users and minsky-
betatesters. In the former you can get feedback and advice from other users; in the latter, you can
report bugs (or feature requests) that will enable us to improve Minsky over time.

Finally, consider signing up to Minsky’s page on Patreon, https://www.patreon.com/HPCODER. The

minimum signup amount is US$1 per month (plus sales or value added taxes, which vary from
country to country). Ideally, this would provide sufficient funds to enable Minsky’s programmer Dr
Russell Standish to work full-time maintaining and extending Minsky. At present (October 2021), it
raises a small amount—$520 a month from 86 patrons. This at least covers Russell’s costs in
producing compiled versions, which take about 4 hours to generate, but it’s a long way short of
enabling him to work full-time on Minsky itself. I would prefer to see twenty times the revenue
coming in, and forty times the number of Patrons. If you like using Minsky, and if this manual
teaches you anything at all, please help make that wish come true.

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4 Understanding money: “Minsky for Dummies”

This is a very technical book, for the simple reason that it explains how to build economic models
using a mathematical program. But a lot can be done with Minsky without doing mathematical
modelling, because many of the issues in dispute these days in economic theory and policy come
down to “How are you going to pay for it?”

To really answer that question, you have to understand the dynamics of our monetary system—and
that means you have to understand double-entry bookkeeping, because that’s the way banks and
governments create money, and keep track of financial transactions. Minsky was built to do that,
with its unique feature of “Godley Tables”. You can use the Godley Tables alone to answer many of
the questions that dominate political debate today:

• Is there a “magic money tree”?

• Do banks create money?
• What are Reserves used for?
• What do taxes do?

And so on. In this chapter I’ll show how to pose and answer questions like these using Minsky,
without having to write a single equation. Instead, I’ll just use the unique feature of Minsky, its
“Godley Table” (see Figure 8).
Figure 8: The "Godley Table" icon

You can place a Godley Table on Minsky’s design canvas in two ways:

• By choosing “Insert/Godley Table” from the Insert menu; or

• By clicking once on the Godley Table icon on the toolbar (see Figure 9), and then clicking
again to place the icon somewhere on the canvas.
o You may be used to using “click and drag” to insert objects in other programs, like
Paint, This doesn’t work in Minsky—instead you click once to attach an object to the
cursor, and then a second time to place the object somewhere on the canvas.
o At some stage in the future we might support both “click, then click and place” and
“click and drag”, but for the moment, we only support the first method.
Figure 9: Minsky's Toolbar, with the Godley Table icon the 3rd from the right

Once you’ve inserted the Table on the canvas somewhere, it will look like Figure 10.

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Figure 10: Minsky's canvas with a single Godley Table

To use the Godley Table, either double-click on the icon, or click on your right-mouse-button and
choose “Open Godley Table” from the menu—see Figure 11.
Figure 11: The right-click (context-sensitive) menu for a Godley Table

That will bring up a new window for editing the Godley Table—see Figure 12. This is a free-standing
Windows/Mac/Linux window, so you can switch between it and the canvas using Windows
commands and their Mac and Linux equivalents (Alt-Tab is the keyboard shortcut to move between
windows in Windows). You can have multiple Godley Table windows open at once, as well as the
window for the main canvas.

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Figure 12: A Godley Table open for editing in its own window

The top row of the Table has tools for running a model, and for zooming in and out on the Table
itself. The most useful tools at this stage are the magnifying glasses, which let you zoom out, zoom
in, or set the size of the Table to its default. Figure 13 shows the same blank table as in Figure 12
after six clicks on the zoom in tool.
Figure 13: A magnified view of a Godley Table

The next row shows that all accounts in a Godley Table have to be classified either as an Asset (a
claim that you have on someone else), a Liability (a claim that someone else has on you), or Equity
(the gap between Assets and Liabilities).

The Table starts with room for just one Asset, one Liability, and one Equity column, but of course a
significant model is going to have more than one of each. That’s what the +−←→ symbols on the
next row are for: the + adds a new column, the − deletes an existing column, and the ←→ symbols
move a column to the left or right. Now let’s build a simple model that, without the need for any
equations, will show how a modern monetary system works.

4.1 Fiat Money

To use the table, you first have to name the Assets, Liabilities and Equity columns on the table.
That’s where the next row—which starts with “Flows ↓⁄ Stock Vars →”—comes in. If you click in one
of the cells on that row and start typing, you are providing a name for one of the stocks in the Table
(ignore the upside-down triangle there for now—we’ll come to that soon). In Figure 14, I’ve clicked

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in the Asset cell and I’ve started to type the word “Reserves”. Once I press the Enter key (or click
outside the cell using the mouse), I’ve defined the stock “Reserves”.
Figure 14: Naming a stock in a Godley Table

Click in the cell below Liability and enter “Deposits” (without the inverted commas of course!), and
in the cell below Equity, type Bank_E. The underscore tells Minsky to subscript the next character, so
when you press Enter, or click outside the cell, the program will display BankE in that cell (the
subscript stands for “Equity”). When you’re finished, you’ll have the basic elements of the simplest
possible model of banking—in fact, one that’s too simple, because it doesn’t include the key thing
that defines a bank, its capacity to make loans.
Figure 15: A basic Godley Table with 3 stocks: Reserves, Deposits and BankE

We’ll add that by using the + key below the Asset heading. That creates an additional blank cell next
to Reserves. If you type “Loans” into this cell, you have Figure 16: the starting point for
understanding our monetary system: a banking sector with the Assets of Reserves and Loans, the
Liability of Deposits, and the difference between them, the banking sector’s equity BankE—which
must be positive, since one rule of banking is that a bank must have more Assets than Liabilities.
Figure 16: The minimum stocks to show the credit and fiat money roles of banks

If we were going to build a simulation model, then the next row would be critical: this shows the
initial amounts in the various accounts. But since this chapter is about using Minsky without building
a simulation, we’ll skip over it and instead click on the + key at the beginning of the row. This adds a
row for recording a financial transaction. Let’s start with government taxation, using the name “Tax”
as a placeholder for the flow of money out of Deposits. If you type “−𝑇𝑇𝑇𝑇𝑇𝑇” into the cell beneath
Deposits, you’ve recorded what taxation does—it takes money out of the bank accounts of the
public. At this stage, Minsky lets you know that your entry isn’t complete, because you have only one
entry for Tax, when every financial operation requires two entries per row.

Note: One limitation of Minsky at present is that entries in the rows must be variables—words like
“Tax”, “Spend”, etc.—rather than numbers like “900”, “1100”, etc. This is because Minsky was

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developed to build dynamic equation, and the entries in those equations are variables rather than
constants. 4
Figure 17: Taxation entered as a deduction from Deposits

To complete this row, you need to add another entry so that the “Fundamental Law of
Accounting”—that 𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴 − 𝐿𝐿𝐿𝐿𝐿𝐿𝐿𝐿𝐿𝐿𝐿𝐿𝐿𝐿𝐿𝐿𝐿𝐿𝐿𝐿𝐿𝐿 − 𝐸𝐸𝐸𝐸𝐸𝐸𝐸𝐸𝐸𝐸𝐸𝐸 = 0—is enforced. It should be obvious that the
correct thing to do is to add another “−𝑇𝑇𝑇𝑇𝑇𝑇” to the Reserves column as well: it doesn’t make sense
to do insert in the Loans column (which we’ll model in the next section), or to Bank Equity.
Therefore, taxation reduces not only Deposits, but also Reserves (Figure 18).
Figure 18: A fully entered double-entry bookkeeping record of taxation

Once you’ve made these entries in the Godley Table, your canvas should look like Figure 19 (where
I’ve also used the “Title” menu item on the right-click menu to name this table “Banking Sector”).
The stocks you’ve defined in the table are shown at the bottom of the icon; the single flow that
you’ve defined is shown on the left-hand side.

4
We realise, however, that it sometimes helps to see a model of financial flows using actual numbers rather
than variables, and if we get funding to support this, we may add the capability to enter constants into Godley
Tables at some point in the future.

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Figure 19: A Minsky model with the Godley Table shown in Figure 18.

If you were defining an actual model right now, the next stage of the process would be place the
mouse over the icon, and use the right-click menu to “Copy stock variables” and “Copy flow
variables”. Figure 20 shows the model with both operations done, and the stock variables (Reserves,
Loans, Deposits and BankE) placed on the canvas. Then you’d go about defining the flows using the
stocks, additional parameters and variables, etc. But we’ll leave that for now and just continue using
Minsky’s capability to model the interlocking financial assets and liabilities that define a monetary
economy.

To make the canvas less cluttered, I’m going to use the right-click menu to turn off display of these
variables: the option ”Display variables” is ticked by default, and a click on that turns it off so that all
you see is the bank icon itself. 5

5
Displaying flow and stock variables on a Godley Table icon is somewhat of a legacy feature of Minsky. At an
earlier stage, we didn’t have the multiple tabs, including the “Godley Table” tab, so having the variables shown
attached to the icon made it possible to look at the canvas and see the variables in it. The Godley Tables tab
makes this less likely, and in a future iteration, it will be possible to access all variables from the toolbar as
well, making this feature less necessary still. At that point, we’ll probably change the default setting so that
variables are not displayed on a Godley Table.

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Figure 20: The stock and flow variables copied and placed on the canvas

At this stage, we’re simply seeing the financial system from the point of view of the banking sector.
A complete model involves seeing it from all perspectives, including here the public (where Deposits,
which are a Liability of the banking sector, are an Asset of the public), the Central Bank (since
Reserves, which are an Asset of the banking sector, are a Liability of the Central Bank), and the
Treasury (which is the originator of the taxation operation).

To do this, we need to add an additional three Godley Tables—one each for the Public, the Central
Bank, and the Treasury. In Figure 21, I’ve named them all appropriately using the Title option on the
right-mouse menu (you can also name a table when working on the Godley Table itself: “Title” is an
option on the Edit menu, and the right-click menu also has a Title option).
Figure 21: The model with 3 more blank Godley Tables

To populate these tables, we make use of one feature I haven’t yet explained, the upside-
down triangle or wedge , in the cells for naming stocks. If you click on one of these wedges,
Minsky returns a list of all the Liabilities (or Assets) that haven’t already been recorded as an Asset
(or Liability) for some other entity in the model. 6

6
There is one other option here, which we have only just introduced in the latest beta—2.31.0-beta 2: non-
financial assets (like houses, precious metals, artworks) are assets for their owners, but not a liability for
anyone else. If your model includes nonfinancial assets, these are recorded as an additional Equity column in
the same Godley Table. See Section 4.4 on page 34 for a brief discussion of this issue.

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Open up the Godley Table for the Public and click on the wedge in the Asset cell, and one entry will
appear in a drop-down menu: Deposits—see Figure 22.
Figure 22: Using the Assets and Liabilities Wedge

Click on Deposits to choose it, and Minsky will show Deposits as an Asset of the Public, and auto-
populate the column with all the operations that have been entered on the Banking sector table that
affect Deposits—so far, this is only the negative entry for taxation. This gives us Figure 23. Notice
that the A-L-E column has the entry −𝑇𝑇𝑇𝑇𝑇𝑇 in it, showing that the matching double-entry for this
table hasn’t yet been entered.
Figure 23: Deposits as an Asset for the Public

The only sensible option here is that taxation reduces the equity position of the non-bank public
sector. 7 Name the Equity cell PublicE, add the entry “−𝑇𝑇𝑇𝑇𝑇𝑇” on the Government Taxation row, and
this operation is now shown from the public’s perspective: taxation takes money out of the public’s
bank accounts, and reduces its equity. This is a fundamental proposition in MMT—Modern
Monetary Theory—and it’s obviously true, when you see the world through the double-entry
bookkeeping eyes of Minsky.
Figure 24: Taxation shown from the public's point of view

Next, let’s add the public’s liability in this model—loans from the banking sector. If you click on the
wedge under Liabilities, the drop-down menu will reveal two choices: Loans and Reserves. Click on
Loans, and you’ll get Figure 25. We’ll add flows to the Loans column in the next section—in this one
we’re focusing on government operations.

7
Obviously the financial sector gets taxed as well (though it’s surely better than households and non-financial
firms at evading taxes in practice).

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Figure 25: Auto-populating the Public’s Liabilities

Figure 26: The Public's Godley Table completed

That’s taken care of Deposits, which is shown as a Liability of the Banking Sector and an Asset of the
Public. Now we must do the same for Reserves. These, as is well known, are a Liability of the Central
Bank: in effect, Reserves are the deposit accounts of private banks at the Central Bank. Open the
Central Bank’s Godley Table, click on the wedge in the Liabilities cell, and choose “Reserves”. That
generates Figure 27.
Figure 27: The Central Bank Godley Table with Reserves entered

As with the earlier exercise with the Public’s 8 table, we have just a single entry for Tax: there’s
nowhere obvious to record it a second time, since it’s not the Central Bank that does the taxing, but
the Treasury. Therefore, the sensible thing to do here is to add an additional Liability for the Central
Bank, the deposit account of the Treasury—which I simply call Treasury (see Figure 28). I’ve also
named the Equity column for the Central Bank CBE.

8
One of the English language’s quirks that must be so confusing for those with a different native tongue is that
we use the word “Public” to describe the non-government sector, and also refer to the government as the
“Public Sector”. Go figure.

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Figure 28: Treasury account added to Central Bank Godley Table

This now gives us a Liability for the Central Bank—the Treasury’s account—which is an Asset for the
final entity in this model, the Treasury itself. Bring up the Treasury’s Godley Table, click on the
wedge for Assets, choose “Treasury”, and you’ll have Figure 29.
Figure 29: The Treasury's Godley Table on initial entry of its Asset, the Treasury account at the Central Bank

To complete the model at this stage, you need to enter the balancing entry for Tax—and the obvious
place for it to go is in the Equity column for Treasury: taxation increases the Equity of the Treasury
(Figure 30). This is the obverse side of the MMT point that “the Public sector’s surplus is the
Government sector’s deficit”: taxation subtracts from the Equity of the public and increases the
equity of the government.
Figure 30: Treasury Equity shown

This is also the point at which a genuine Fiat money system differs from a commodity-backed
system—a “Gold Standard”, for example—or from one like the Eurozone, where national treasuries
cannot produce the currency they spend. In such systems, Tax would add to the Treasury’s stock of
Gold (or Euros), while government spending—which I’ll introduce shortly—would run that stock
down.

We now have a complete model of the impact of taxation in a Fiat money system, in that every Asset
is shown as another entity’s Liability, and all flows are recorded four times: twice in each table they
appear in, and once each as affecting an Asset and a Liability. Via double-entry bookkeeping, this
gives us eight entries for the one operation.

To see this whole system, click on the Tab labelled “Godleys”, and you’ll see all the Godley Tables at
once. 9 They’ll be a jumble when you first click on the tab, but you can easily move them around to
produce an arrangement like Figure 31.

9
On Minsky’s design canvas, with “Display Variables” turned off, your model consists of just the 4 banking
icons shown in Figure 21.

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Figure 31: The complete basic model, with all four Godley Tables

We can now add government spending to the model, and it’s effectively the opposite of Tax:
government spending increases the public’s equity and reduces the government’s. You can start
anywhere you like in the system—from the Public’s Godley Table, or the Treasury’s, Central Bank or
the Banking Sector—and Minsky will point out where the matching entries are needed. I started with
the Banking Sector’s view in Figure 32:
Figure 32: Adding government spending into the model

A minute or so later, I had the picture shown in Figure 33.

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Figure 33: The complete model with government spending as well as taxation

This lets us see the key points of Modern Monetary Theory—not because I’ve been explaining the
theory itself, but because the “theory” is fundamentally on an accurate portrayal of the accounting. A
government deficit creates net financial assets for the public, and simultaneously creates negative
net financial assets for the government: the government deficit is the private sector surplus.

To complete the picture of a modern fiat money system, we need to include bond sales by the
Treasury to the Banking Sector in the initial auction, sales by the Banking Sector to non-banks (which
can include other financial institutions, such as Pension and Hedge Funds), and purchases by the
Central Bank of bonds from both the Banking Sector and the Public.

4.2 Bond Sales

In the model to date, if the Treasury spends more than it taxes, the Treasury’s account at the Central
Bank will go into overdraft—notice in Figure 33 that the only flow entries in the Treasury’s account
at the Central Bank are −𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆 and +𝑇𝑇𝑇𝑇𝑥𝑥. So if 𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆 is greater than 𝑇𝑇𝑇𝑇𝑇𝑇, then over time, this
account will turn negative.

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For an ordinary customer of an ordinary bank, that’s a serious problem. A negative deposit account
might not be approved in the first place—so that any intended transaction which sends an ordinary
depositor’s account into negative territory would be rejected for insufficient funds. If an overdraft is
approved by the bank, it attracts a punitive interest rate, normally higher than the interest rate on
loans themselves. If the customer breaches the terms of the bank’s overdraft—by not making an
interest payment, or breaching any of the many caveats that a bank can attach to an overdraft
agreement—it can lead to the bank initiating bankruptcy proceedings against its customer.

But what is the situation for the Treasury and the Central Bank? In a country which issues its own
currency, the Treasury is the effective owner of the Central Bank. Though specific laws can change
the situation, technically, the Central Bank is obliged to let the Treasury do what it wants, even if
that means a negative balance on the Treasury’s account at the Central Bank. It would be quite
possible, in an accounting sense, for the government to simply operate with an overdraft account at
the Central Bank: it doesn’t have to sell bonds at all.

However, most countries have passed laws forbidding the Treasury from operating in overdraft
mode, except in exceptional circumstances like the pandemic—where, for example, the Bank of
England initially allowed Treasury to operate its overdraft account, rather than having to sell bonds
to avoid going into overdraft. 10 Some countries also require the Central Bank to charge the Treasury
interest on either overdrafts or loans. But even in countries which do that, the interest is returned to
the Treasury as part of the operating profits of the Central Bank. This is why there is a “magic money
tree”: a currency-issuing country can create money by running a deficit, and it does not have to
borrow from either private banks or the public to finance that deficit.

What do bond sales in fact do? Let’s add them to the model and find out. This requires one more
Asset column for the Banking Sector, which is the sector that initially purchases Treasury Bonds. I’ve
named the Asset for Banks BondsB, to indicate that these are Bonds owned by the banks—rather
than, say, the Central Bank or the Public—and labelled the transaction BuyBondsB in Figure 34.
Figure 34: Banks buy Bonds from the Treasury

That’s showing the increase in the Banking Sector’s Assets from buying the bonds, but how do they
finance the purchase? In other words, where is the second entry required by double-entry
bookkeeping to show the purchase? The only viable option is that the funds used to purchase the
bonds come from Reserves—and these Reserves were created by the deficit: the excess of Spend
over Tax. So, as well as creating money for the private sector, the deficit creates excess Reserves,
which the Banking Sector uses to buy the bonds. As long as the value of bonds sold be Treasury is
equal to or less than the deficit, the Banking Sector has the Reserves needed to buy them: see Figure
35.

10
See https://www.theguardian.com/business/2020/apr/09/bank-of-england-to-finance-uk-government-
covid-19-crisis-spending.

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Figure 35: Bond purchase balanced by showing bonds are bought using Reserves created by the deficit

This completes the Banking Sector’s Godley Table, but it leaves the Central Bank’s incomplete—see
Figure 36.
Figure 36: The Central Bank's Godley Table after the Banking Sector's Table has been completed

The obvious way to complete the Central Bank’s Table is that the proceeds from the sale of Bonds
tops up the Treasury account: see Figure 37.
Figure 37: The Central Bank's Table with the sale of Bonds fully recorded

This shows the real purpose of bond sales, from the Government’s point of view: they enable the
Treasury’s account at the Central Bank to avoid going into overdraft. If the revenue bond sales
(BuyBondsB here) equals 𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆 − 𝑇𝑇𝑇𝑇𝑇𝑇, then there’s no change to the balance in the Treasury
account from running a deficit.

What bonds certainly are not is borrowing money from the banks in the way that individuals do
when they take out a mortgage. When you take out a mortgage, it’s because you haven’t got the
money needed to do what you want to do—buy a house. If you don’t get the mortgage, you can’t
afford to buy the house.

But the government has already created the money it needs to do whatever its proposed activities
are by running the deficit itself. Secondly, the Reserves that are used to buy the bonds were created
by the government running a deficit. If the deficit didn’t exist, then (at least initially—there’s a
change coming when we consider interest payments on bonds) the banks wouldn’t have the funds
needed to buy the bonds.

The final step in recording the impact of the bond sales is to add BondsB as a Liability of the Treasury.
Open the Treasury’s Godley Table and it will look like Figure 38. Click on the wedge below Liability,

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and the drop down will show BondsB as an Asset (for the Banking Sector) that hasn’t yet been
recorded as some other entity’s Liability.
Figure 38: Treasury Godley Table before BondsB is recorded as a liability

Select BondsB and Minsky automatically balances the table: see Figure 39.
Figure 39

To complete modeling bond sales to banks, we need to include the payment of interest on those
bonds. In Figure 40, I’ve labelled this InterestBB—the subscript is there to indicate that it’s interest on
bonds, the superscript to indicate that it’s paid to the banks, to distinguish it from interest paid to
the public when, at a later stage, banks sell some of these bonds to the public. A superscript is
entered into Minsky using the ^ character, which is normally the Shifted character on the 6-key on
your keyboard (So the string you type into the cell is Interest_B^B).
Figure 40: Payment of interest to banks on Treasury Bonds

I’ve already made the obvious deduction that this interest payment increases the equity of the
banking system—which is one obvious reason that, when the Treasury offers to sell bonds to the
banking sector, the offer is always taken up. To do otherwise is to turn down an offer to turn a non-
tradeable, non-income-earning asset—Reserves—into a tradeable, income-earning asset—Bonds. To
complete the model at this stage, we now need to add this flow to the Central Bank’s and the
Treasury’s Godley Tables. When you open up the Central Bank’s Godley Table, it will look like Figure
41: the addition to Reserves is already shown, but the second balancing entry is still needed.

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Figure 41

The obvious thing is that the interest payments come out of the Treasury’s account. Make the entry
−Interest 𝐵𝐵𝐵𝐵 in the Treasury column, and you have Figure 42.
Figure 42

This change in turn cascades into the Treasury’s Godley Table now—see Figure 43.
Figure 43

The obvious closure of this entry is that paying interest reduces the Treasury’s equity—and by
precisely as much as it increases the equity of the banking sector. So just as a deficit creates net
financial assets for the non-bank public (by crediting their deposit accounts with more money from
government spending than is removed by taxation), the interest payments create net financial assets
for the banking sector—see Figure 44.

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Figure 44

So how does the Treasury pay the interest? In practice, there could be many methods. What I’ll
model here is the most sensible for a currency-issuing government: it borrows from the Central
Bank.

In practice, this is forbidden in most countries, by legislation that prevents the Treasury borrowing
directly from the Central Bank. However, the same outcome can be achieved in a two-step process:
the Treasury sells bonds to the private banks to the value of the interest on outstanding bonds, and
the Central Bank then purchases these bonds from the private banks on the secondary market. 11

If you’ve followed me this far, you should be familiar with the steps needed to show this: we add an
Asset to the Central Bank’s Godley Table—LoansCBT (which uses another of Minsky’s formatting
tricks: encase the characters CB in a pair of curly brackets—Loans_{𝐶𝐶𝐶𝐶}^𝑇𝑇—and Minsky subscripts
𝑇𝑇
the two characters together), and use to show the 𝐿𝐿𝐿𝐿𝐿𝐿𝐿𝐿𝐶𝐶𝐶𝐶 actual loans. Figure 45 shows the entries
on the Central Bank’s table (with the actual entry of the text string into the Treasury column, before
Minsky formats it).
Figure 45

If the loan from the Central Bank to Treasury equals the interest payments on the bonds, then the
Treasury’s account at the Central Bank can avoid going into overdraft. It doesn’t change the
aggregate picture: the Treasury’s negative equity from the deficit creates positive equity for the non-
bank public, while interest payments on bonds creates negative equity for the Treasury and identical
positive equity for the banking sector.

Even without attempting to build a mathematical model, this exercise in laying out the structure of
the financial system eradicates a lot of popular myths in mainstream economic thinking:

11
I’m just simplifying this into a single process by calling it a loan from the Central Bank to the Treasury,
because, as I hope you’re realized by now, this government operation is self-financing: the payments of
interest on government bonds held by the banks creates the Reserves that the banks would need to buy the
bonds that were issued to cover the interest.

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• A deficit doesn’t take money from the public—in the sense of the government borrowing
from the public to finance its deficit—but actually puts money into the hands of the public;
• The deficit creates Reserves for the banking sector, and those Reserves are what banks later
use to buy government bonds;
• The deficit creates net equity for the non-bank public, while interest on government bonds
creates net equity for the banking sector.

This symmetry—that a deficit for the government means a surplus of precisely the same magnitude
for the non-government sectors—is apparent in Figure 46. The sum of the non-bank Public’s and the
banking sector’s net equity position is 𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆 + Interest 𝐵𝐵𝐵𝐵 − 𝑇𝑇𝑇𝑇𝑇𝑇; this is the opposite of the
Government’s net equity 𝑇𝑇𝑇𝑇𝑇𝑇 − 𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆 − Interest 𝐵𝐵𝐵𝐵 .
Figure 46: Full system with bond sales to banks

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The final two steps to show to cover the fundamentals of fiat money are sales of bonds by the
banking sector to the public, and purchases of bonds by the Central Bank from both banks and the
public. Figure 47 shows the full system—which, if you want to learn how to use Minsky, you should
try to complete for yourself. It needs:

• Two additional stock variables—BondsCB for bonds owned by the Central Bank, and BondsP
for bonds owned by the public;
• The relevant flows for these stocks: sales of bonds by the Banking Sector to the Public,
SellBondsP; purchases of bonds by the Central Bank from the Banking Sector, BuyBondsCBB;
and purchases of bonds by the Central Bank from the Public, BuyBondsCBP.

As with the previous stages of this exercise, several insights can be gleaned from these Tables that
contradict widespread beliefs about government money creation. One of these is even something
that I used to believe—that money is only created to the extent that the Central Bank buys
government bonds. But in fact, Central Bank purchases of Treasuries are irrelevant to money
creation, and indirectly slightly reduce the amount of money created, because they reduce
payments of interest to the banking sector and the non-bank public to whom banks have sold bonds
they purchased in the primary bond auction (in practice, these bonds are normally purchased from
banks by non-bank financial institutions).

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Figure 47: Full MMT system with bond transactions between Treasury, Banks, Central Bank and the Public

The reason why Central Bank bond purchases from the banking sector don’t affect the amount of
money created by a deficit is apparent in the second table in Figure 47: the purchase reduces the
monetary value of the bonds held by banks, and replaces them by an equivalent value of Reserves.
The Banks would hope to make a trading profit out of this sale, 12 but the sale itself simply swaps one
Asset for the Banks (Bonds) with another Asset (Reserves). In practice, this reduces the process of
the Treasury selling bonds to the banks in the first place: it replaces Bonds with Reserves. It is

12
This could be added to the model with another row showing the trading profit (or loss)—which would be the
difference between the sale price and the purchase price, multiplied by the number of bonds sold. This would
add to Reserves and Bank Equity, in which case it is a mechanism for money creation.

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therefore irrelevant to money creation, because since the level of Assets remain constant, so too do
Liabilities and Bank Equity.

This is an important general point that will recur frequently in this book, and when building models
using Godley Tables: for money to be created, an operation must affect both the Asset and the
Liability/Equity sides of the Banking Sector’s ledger. Central Bank bond purchases from the Banking
Sector only affect the Asset side, and therefore are irrelevant to money creation. The only effect
they do have is to reduce money creation slightly, because the Treasury will no longer pay interest to
the Banks on these bonds.

On the other hand, Central Bank purchases of Bonds from the public do create money: the sale of
the Bonds credits both the public’s deposit accounts at banks, and the reserve accounts of the
banks.

Conversely, the sale of bonds by the Banking Sector to the non-bank Public destroys money: the
Public’s deposit accounts fall and their holdings of Bonds rise. But even in this case, the money being
destroyed was initially created by the deficit itself: only if all the bonds initially purchased by the
banks from the Treasury at the bond auction were sold to the public would the actual creation of
money by the deficit fall to zero.

That covers government money creation. Now let’s turn to private money creation by the Banking
Sector.

4.3 Credit Money

I’m now assuming that you have some fluency with Godley Tables—you have been following my
explanation by reproducing these tables in Minsky yourself, haven’t you?—and so I’ll just cut to the
chase, and enter the three necessary operations for private money creation in one go: new loans by
banks, paying interest on loans, and loan repayment by bank customers. Use the words “Lend”,
“Interest”, and “Repay” for these flows, and make the entries so that the checksum column 𝐴𝐴 − 𝐿𝐿 −
𝐸𝐸 always sums to zero (Figure 48).
Figure 48: The basic operations of fiat and credit money from the Banking Sector’s point of view

As an aside, if you have a background in accounting, you may prefer to see Minsky’s operations using
DR and CR rather than plus and minus entries. You can engage that from the Options menu on the
Table: choose “DR/CR Style”. Then the model in Figure 48 will look like Figure 49 (I prefer the
plus/minus approach, so that’s what I’ll stick with from now on).

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Figure 49:Figure 48 in DR/DR style

Following the general principle noted just above, that to create money, an operation must add to
both the Asset and Liability/Equity sides of the banking sector’s balance sheet, it should be obvious
that lending creates money while repayment destroys it. 13 This simple fact is ignored by the
mainstream model of lending, known as Loanable Funds, which treats banks as “financial
intermediaries” that take in deposits from one set of customers (“Patient people”, to use Paul
Krugman’s non-pejorative 14 term) and then lends them out to other people (“Impatient people” in
Krugman’s lexicon).

I’ll spend a lot of time on the macroeconomic impacts of private money creation in Chapter 8. For
now, without writing a single equation, we’ve come up with a picture of the monetary aspects of a
mixed fiat-credit money system that contradict the conventional wisdoms promulgated by
economics textbooks and mouthed by politicians.

If you’ve followed the argument here to date—especially if you’ve done so by reproducing the model
in Minsky for yourself—then you’re well on the way to understanding the monetary dynamics of
capitalism. I’ll repeat a lot of the points here in subsequent chapters, but with the addition of
defining a mathematical model, rather than stopping at laying out the balance sheets, as I do here.

4.4 A significant extension: Nonfinancial Assets

One weakness of Minsky was that it handled only assets which are also liabilities: something like a
deposit account, for example, is an asset for the depositor, and a liability for the bank. But there are
also assets—such as a house, gold, the market value shares (a share is only a liability for the issuing
company up to its issue price), cryptocurrencies, etc.—which are assets of the holder, but a liability
of no-one. These go by the general moniker of “non-financial assets”.

This term is a bit misleading, since, in most people’s eyes, things like houses and precious metals are
very much financial assets. However, they are not “at call”: your house might be “worth” $2 million
in the current market, but to realize that valuation you’re going to have to sell it, which could take 6-
18 weeks even in a buoyant housing market.

13
This last point is something that I myself didn’t accept before I designed Minsky: though both Minsky himself
and Graziani made this claim, it sounded crazy to me that banks would let money be destroyed after they had
created it, and I wrote the money chapter of the 2nd edition of Debunking Economics to be agnostic on this
point. But in fact, Minsky and Graziani were correct whereas I was wrong, and one of the major reasons I’m
writing a third (and final!) edition of Debunking Economics is to correct this mistake.
14
Irony alert.

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We have just 15 added a means to handle such assets: you can define an Asset for a particular Godley
Table as an Equity for that same Godley Table, once you have enabled multiple Equity columns (this
is an option on the Options/Preferences main menu, and on the menu for Godley Tables). Once you
have recorded some assets for a given entity on its Godley Table, the wedge dropdown on the Equity
column will show assets on that same Godley Table that have not yet been allocated to another
Table’s Liabilities.

Research alert: since we’ve just added this feature, and we are still fine-tuning it, I haven’t
personally explored its implications yet. I believe, but I don’t yet know, that it will enable the
modelling of (a) the “ab initio” creation of a monetary system, complete with the initial formation of
banks, and (b) asset price booms and busts, and how they are generated and fuelled by the banking
sector. Since these are very important topics that have been discussed but, to my knowledge, have
not been modelled, these could both be excellent topics for a PhD.

Figure 50 shows using this feature: the Asset WHouses is obviously an Asset that has no balancing
Liability, while WDeposits is obviously also a Liability of the banking sector.
Figure 50: Dropdown Wedge on Equity column now shows unallocated Assets on the same Godley Table

Notice that WDeposits turns up twice on the Workers Godley Table in Figure 51.
Figure 51: Non-financial assets in a simple model

This feature should support modelling everything from the ab initio creation of banks in a fiat-credit
money system (since banks were often established on the basis of ownership of land by their
founders) to asset bubbles and their denouement in crashes—though to model all this will require a
lot of additional work. But the basic structure needed to do this now exists in Minsky. I’ll sketch the
basics of both topics and leave taking this further as an exercise for the reader.

4.4.1 Ab initio creation of banks

Modern Monetary Theory describes the functioning of an existing monetary system—consisting of a
government with a Treasury, a Central Bank, and its own currency, a private banking system, and the
non-bank public with deposit accounts at the private banks. One common and correct defense of the
MMT proposition that a government spends first and taxes later is that, when a currency is first
created, it must be spent into circulation before it can be taxed back. This pre-supposes the

15
At the time of writing, the current release is version 2.35. This feature was introduced in the beta for version
2.30

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existence of banks at the time, but how can they come into being with the key prerequisite of having
Assets that exceed their Liabilities?

Nonfinancial assets provide the answer: banks are formed by wealthy people pledging various assets
of theirs to the bank, so that it starts with positive nonfinancial assets. You can imagine something
like the situation shown in Figure 52: a bank’s founders form a company and pledge various assets to
the bank, so that it starts with an amount of nonfinancial assets—showing gold and land here—that
give it net positive equity.

Of course, this involves someone valuing these assets (which are denominated in weight and area
respectively) in terms of the new currency. That “someone” will be the ruler or political system
establishing the currency—King Offa in the example I give in Manifesto—so there is, as usual, a
foundational role for the government in establishing a financial system in a fiat money world. This
“ab initio” situation is shown in Figure 52.
Figure 52: "Ab initio" formation of banks

Next, the bank would pledge these assets as collateral to back the bank. These would be valued at a
discount—in Figure 53 I show this as a roughly 10% discount, but it would surely be larger in
practice. As noted earlier, Minsky doesn’t support using constants like 1,000 as flow entries in
Godley Tables. I’ve cheated here by typing 1000 inside parentheses, which is a LaTeX way of typing a
string of characters: {1000}.
Figure 53: Nonfinancial assets pledged at a discount in return for State-issued currency

Swapping back to the Minsky convention of using variable names for flows, I’ll call this State-
valuation of the nonfinancial assets backing the bank “Pledge”:
Figure 54: The same as Figure 53, but with the variable "Pledge" replacing the constant value 1000 in Figure 53

This is a feasible way to show how propertied interests can turn control over physical resources into
the basis of a private monetary system. It would be relevant to the actual historical practice of “Free
Banking” in the 19th century {Rockoff, 1974 #1171;Economopoulos, 1988 #1132;Flanders, 1996
#1161;Hickson, 2002 #1153;Lakomaa, 2007 #1157;Bodenhorn, 2008 #1146}, and also the logical “ab
initio” proof of MMT’s assertion that government spending precedes taxation. Part of that process
requires banks that can purchase government bonds (if we try to build a model that is congruent
with current practices, where bonds are issued to avoid a Treasury overdraft at the Central Bank);
this additional feature of Minsky helps show how that could happen. The State valuation of the

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nonfinancial assets pledged as collateral to establish a private bank gives the private bank both
positive equity in financial assets, and the excess Reserves that will be needed to buy the bonds
issued to cover the initial government deficit.

There is much more work required to this complete this model, but I’ll leave it at this level and invite
research students to consider taking the concept further.

4.4.2 Financial Assets and Bubbles in Nonfinancial Asset valuation

A more contemporary problem is the role of financial assets—fundamentally, bank debt—in
determining the value placed on nonfinancial assets—primarily, housing. The empirical link is
obvious—and as usual, is ignored by Neoclassical economists. The causal relation is easily inferred
from the facts that (a) the supply of housing is very inflexible, so the volatility in the housing market
comes from the demand side, rather than the supply side; (b) the demand side is dominated by
mortgage credit—new mortgage debt—since houses are overwhelmingly purchased with borrowed
money; (c) if you divide new mortgage debt by the average house price, you get a measure of how
many “average” houses can be purchased; (d) given the inflexible supply, there is a strong
relationship between mortgage credit (new mortgage debt) and the house price index; (e) there is
therefore a relationship between change in mortgage credit and change in house prices.

This relationship is apparent even in countries with very different house price and household debt
histories, like the USA and Australia. The USA had a famous boom and bust in house prices, the
“Subprime Crisis” {Silipo, 2011 #3925;Kaboub, 2010 #3922;Dymski, 2010 #3937;Wray, 2008
#3785;Bernanke, 2007 #5578} that led to the “Great Recession”. Australia, on the other hand, sailed
through the “Global Financial Crisis”—as the “Great Recession” is known outside of America—with
only a small dip in house prices, which are now 4 times as high, in real terms, as they were in the
1970s (in the USA, they are “only” 2.5 times as high). When you plot house prices in Australia and
the USA against each other (the top left plot in Figure 55), you see two very different patterns:
effectively always-rising prices in Australia; a boom, bust, and then rising prices once more in the
USA.

Household debt also follows a very different pattern in both countries. Household debt in the USA
rose strongly until 2008, and has fallen ever since—though with a slight blip at the beginning of the
Covid-19 crisis. However, in Australia, household debt, like house prices, just keeps on rising (the top
right plot in Figure 55).

However, when you plot the change in household credit against the change in house prices—the two
bottom plots in Figure 55) you get a very similar pattern: rising house prices goes with rising
household credit, and falling house prices with falling household credit.

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Figure 55: House prices, household debt & the "credit accelerator" in the USA & Australia

Real House Prices Household Debt

450 130
GFC GFC
Australia Australia
USA 120 USA
400

110

350
100

300 90
Index 1972 = 100

Percent of GDP
80
250
70

200 60

50
150

40

100
30

50 20
1970 1975 1980 1985 1990 1995 2000 2005 2010 2015 2020 2025 1970 1975 1980 1985 1990 1995 2000 2005 2010 2015 2020 2025

BIS Data https://www.bis.org/statistics/full_bis_selected_pp_csv.zip BIS Data https://www.bis.org/statistics/full_bis_total_credit_csv.zip

House Price and New Mortgage Change Australia House Price and New Mortgage Change USA
30 9
20 10
Price change Price change
New mortgages change New mortgages change
25 7.5 Change in new household debt % GDP per year 16 8

Change in new household debt % GDP per year

20 6 12 6

8 4
15 4.5
Price change % per year

Price change % per year

4 2
10 3

0 0 0 0
5 1.5

−4 −2
0 0 0 0
−8 −4

−5 − 1.5
− 12 −6

− 10 −3
− 16 −8

− 15 − 4.5
1970 1975 1980 1985 1990 1995 2000 2005 2010 2015 2020 2025 − 20 − 10
1970 1975 1980 1985 1990 1995 2000 2005 2010 2015 2020 2025

The link between rising household credit and rising house prices is therefore obvious: the question
is, how to model it? In the Appendix, starting on page 252, I cover the mathematics of the
relationship between rising household credit and rising house prices; here I show the stylized
relationships between change in financial assets and change in the valuation of houses, using this
new feature of Minsky.

Imagine that Homer Simpson wanted to buy a house off the real estate magnate Mr Burns. Homer
first has to take out a mortgage with the bank, pay the money needed to buy the house to Mr Burns,
pay interest on the mortgage (and principal, but I’m omitting that to focus on the nonfinancial assets
issue here), maybe take out a Home Equity loan in his later years, and then sell the home at the end
of his life. These transactions are shown in Figure 56.
Figure 56: The Bank and financial-assets-only view of house purchase and sale

This view shows the changes in financial assets and liabilities, but omits changes to the distribution
and valuation of the nonfinancial asset which is the subject of the transaction—the house. These are
shown in Figure 57, in the final three rows of the Godley Tables for both Homer and Mr Burns.

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The purchase of the house by Homer—the 3rd last row of his Godley Table—converts an amount of
𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆 dollars worth of financial assets (Homer’s bank account) into an identical valuation of a
nonfinancial assets (the house). If the purchase price was $450,000, Homer’s bank account declines
by $450,000, and he then owns a house with an initial valuation of $450,000. The reverse applies to
Mr Burns—the 3rd last row of his Godley Table. Similarly, the eventual sale of the house (from Homer
back to Mr Burns in this simple example) does the reverse. This will be at a different price to the
original purchase however—so there will be a change in the value of the house when it is sold that
will turn up as a capital gain or loss. In this case, a gain for Mr Burns will be an identical loss for
Homer. The question to be explored in a proper model is what causes the change in valuation—
which will come down to the dynamics of mortgage debt (and demographics and other issues)
explored in the Appendix.

With respect to Minsky’s internal logic, the interaction of nonfinancial with financial assets means
that the rule 𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴 − 𝐿𝐿𝐿𝐿𝐿𝐿𝐿𝐿𝐿𝐿𝐿𝐿𝐿𝐿𝐿𝐿𝐿𝐿𝑒𝑒𝑠𝑠 − 𝐸𝐸𝐸𝐸𝐸𝐸𝐸𝐸𝐸𝐸𝐸𝐸 = 0 no longer applies. If house prices are rising, then
Homer makes a capital gain, which captures the reason that people get caught up in asset bubbles in
the first place: it’s a way to escape the trap of net financial assets summing to zero, by stepping into
another trap of asset price bubbles and private debt.
Figure 57: The full transaction set, including changes in nonfinancial assets (house ownership & valuation)

As this example is set up, there is no aggregate capital gain: Homer’s gain, should he be so lucky, will
be Burn’s loss. This illustrates that the source of collective capital gain over time—the sort of
increase in the aggregate valuation of houses and share (and cryptocurrencies) during asset price
bubbles—must lie elsewhere. In the case of housing, it is in the rising aggregate level of mortgage
debt, as both the correlations shown in Figure 55, and the logical argument made in the Appendix

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illustrate. 16 There would, I expect, be an interesting PhD thesis in taking this financial-nonfinancial
asset valuation issue further.

Many other monetary questions can be answered simply by posing them in Minsky’s unique Godley
Table structure. However, to fully exploit Minsky’s capabilities, you need to understand how to use
the program to build dynamic simulation models. That is the topic of the next and subsequent
chapters.

Note: This feature is still under development, and there are some issues we’re still not sure of. For
example, looking at the sale of the house to Homer by Mr Burns, Burns’s equity changes form from a
house valued at $X, to $X in the bank. So, in aggregate 𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴 − 𝐿𝐿𝐿𝐿𝐿𝐿𝐿𝐿𝐿𝐿𝐿𝐿𝐿𝐿𝐿𝐿𝐿𝐿𝐿𝐿𝐿𝐿 form, the sum is zero.
But in terms of Mr Burns’s stock of houses to sell, the operation results in a fall of −𝐵𝐵𝐵𝐵𝐵𝐵 dollars in
terms of the valuation of his stock of houses—and this is shown both in the specific Equity column
Houses, and in the 𝐴𝐴 − 𝐿𝐿 − 𝐸𝐸 sum for that row.

The Equity columns show the correct dynamics: the rate of change of Burns’s financial equity from
the transaction equals 𝐵𝐵𝐵𝐵𝐵𝐵 dollars per year, and the rate of change of his nonfinancial equity is
−𝐵𝐵𝐵𝐵𝐵𝐵 dollars per year. As to what the A-L-E column should show? We’re still not sure.

This feature will develop, and questions it raises solved, as we release new betas. This is another
reason to support Minsky’s development via its Patreon page https://www.patreon.com/hpcoder.

16
Rickard Nyman’s work for this unpublished joint paper showed strong Granger causality from change in
household credit to change in house prices.

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5 The User Interface

Figure 58 shows how Minsky appears when you first run the program.
Figure 58: Minsky's interface

Minsky’s user interface has five main components:

• The menu bar, with options File/Edit/Bookmarks/Insert/Options/Simulation/Help;

• The simulation control toolbar with tools to reset a simulation, run it, stop it, step through it,
change the speed of the simulation, reverse its direction (simulate backwards in time rather
than forwards), zoom out/in/reset/full scale, record the construction of a model, and replay
its construction;

• Tabs for various aspects of the user interface. The main tab is Wiring, where you lay out your
model using the visual design elements in Minsky; Equations shows the equations generated
by your model; Parameters shows the names and values for model parameters; Variables
lists the definition of the variables in a model; Plots shows selected graphs from a simulation
on a separate canvas; and Godleys shows the double-entry bookkeeping tables used to build
the financial aspects of any model you construct;

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• The Toolbar for designing a model. From left to right, the tools: import data; attach data to a
Ravel (a commercial extension to Minsky); insert a plot; insert a spreadsheet; from a drop-
down menu, insert either a variable, a parameter, or a constant; lock an operation (so that
the locked variable doesn’t change when the model is altered); insert a text note; and insert
a time widget. The next six icons activate a series of drop-down menus to insert
mathematical operators on the canvas. Finally, there is a logical switch operator, the Godley
Table icon, integral block icon, and differential operator;

• And finally, the design canvas, where the contents depend on which Tab is active—see
Figure 59. The main Wiring tab presents you with a design surface that is 100,000 by 100,000
pixels large—in terms of modern computer screens, that’s equivalent to an array of 4K
monitors 25 monitors wide and 50 monitors deep—each with 4,000 pixels horizontally and
2,000 pixels vertically. You are unlikely to design a model that uses even 1% of that design
space, but the room is there if needed to build truly gargantuan models.
Figure 59: Minsky's interface, open on the "Wiring" Tab.

You will spend most of your time on the Wiring Tab when designing a Minsky model. As is standard
in system dynamics programs, you create equations using wires that connect one or more entities to
each other. A simple equation like, for example, a + b =c , looks like this in Minsky:

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Figure 60: A simple equation in Minsky

We have endeavoured to make entering equations as easy as possible, so you can just type
anywhere on the canvas to add a variable to your model. For example, if you wish to define GDP,
you can simply start typing “GDP” on the canvas. When you hit the “G” key, the “textInput” dialog
box will pop up, where you can complete typing the expression: see Figure 61.
Figure 61

When you press the Enter key, or click on “OK”, the variable GDP will be entered on the canvas, and
the Edit dialog box will pop up where, if you wish, you can give it an initial value, specify its units,
give it a short description, etc.—see Figure 62.
Figure 62

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You can also change its type, from “flow” to “parameter”, “constant”, “integral” or “stock” (we’ll
meet the latter two types in the next chapter). Parameters differ from flow variables by (a) having a
different colour (blue rather than red) and (b) having only an output, whereas flow variables have
both an input and an output.

You can see the input and output ports if you put your mouse pointer above an object on the
canvas. These are circles on the right and left ends of a Variable, and the right end only of
Parameters and Constants—see Figure 63, where my mouse pointer was hovering over Variable, so
that both its input and output ports are visible.
Figure 63: Variables, parameters, and constants

If you click anywhere apart from inside one of these circles, then you can drag the entity to
somewhere else on the canvas. If you click inside one of the output circles—those on the right-hand
side—then a “wire” will come out of it, which will attach to the nearest input port (you don’t have to
click on an input port precisely)—see Figure 64, where I’ve started dragging a wire out of the output
port from Parameter towards the input port for Variable.

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Figure 64: Wire being drawn out of output port

When you release the mouse button, the wire “snaps” to the nearest input port, which is that for
Variable—see Figure 65. From now on, Variable’s value will be whatever Parameter’s value is.
Figure 65: Parameter output wired to Variable input

Of course, you’ll want to use mathematical operators to create more complicated definitions, and in
Minsky you can simply type simple mathematical operators—addition, multiplication, division and
subtraction—directly onto the canvas: you don’t have to use the drop-down menus on the icon
bar. 17

Let’s see what the equation for GDP looks like in Minsky, using the standard symbols economists
use:

Y = C + I + (G − T ) + ( X − M ) (1)

In Minsky, this looks like Figure 66: 18

Figure 66

17
The one complication here is that a minus sign (-) is firstly treated as a text entry, because we realise that
sometimes modelers want to enter a negative constant: so if you want to enter a minus operator on the
canvas, press “-“ followed by pressing the Enter key or clicking on OK. To enter a negative constant, say -42,
type -42 in the text entry box and then press the Enter key.
1818
This isn’t to say that Minsky’s layout is better: I think it’s actually harder to read than a standard equation
in this example. However, it can be more intuitive to use a flowchart format when you’re laying out causal
relationships, as I do later. We also hope to enable both ways of displaying equations on the canvas in future
versions of Minsky: both flowchart and standard mathematics. That, as always, is dependent on getting more
funding to write the necessary code.

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You will notice one unusual thing about Figure 66: there are two inputs to the bottom input port of
the “+” key that defines Y. This is a common theme in Minsky, called “overloading”: if an operator
can sensibly accept more than one input, then it does. The reason we do this is that system
dynamics diagrams—which are effectively flowcharts that map across to equations—can get very
messy, with lots of wires which can ultimately produce a “spaghetti diagram” effect. We aim to
minimize clutter on the canvas, so you can replace the four addition and subtraction operators in
Figure 66 with just one, as shown in Figure 67.
Figure 67

You may also have noticed the black dot on top of the Variable and Parameter blocks. This enables
you to change the values of a parameter during a simulation. There are two ways to do this: by using
the mouse to drag the dot to the left to reduce the value, and to the right to increase it; and by
pressing the up key to increase the value, or the down key to reduce it, while the mouse cursor is
hovering over the parameter. The maximum, minimum and step size are all set on the Edit dialog
box—see Figure 68.
Figure 68: The edit dialog box for v, showing the slider Max, Min and Step Size

For example, you might use a “Leontief” production function, where output Y is defined as minimum
of the capital stock K divided by a capital-output ratio 𝑣𝑣, and an output—to-labour ratio 𝑎𝑎 times
labor L:

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K 
=Y min  , a ⋅ L  (2)
v 
Post-Keynesian models generally treat the capital-output ratio as a constant with a value of between
2 and 4. However, economic data implies that this is a variable with a decreasing trend over time
(within a very small range), and that it rises during recessions—see Figure 69.
Figure 69: Capital stock at 2017 prices divided by GDP at 2012 prices (www.myf.red/g/DhPF)

I’ll explain what the capital-output ratio (COR) actually is, and give an explanation for this trend, in
the Energy chapter. For now, this implies that the practice of treating the ratio as a constant is
generally defensible—the range is small, and the measurement of capital stock is compromised
anyway (Sraffa 1960; Pasinetti 1969; Harcourt 1972)—but it would be wise to be able to vary the
parameter and see what happens. Figure 70 shows the effect of varying the value of v from 4 to 3
during a simulation.

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Figure 70: Output with varying capital-output ratio

5.1 Text Formatting

Minsky supports text formatting, including Subscripts, Superscripts, and Greek letters 𝛼𝛼, 𝛽𝛽, etc., using the
LaTeX mathematical formatting conventions. The basic formatting codes are:

• Underscore _, which subscripts the next character;

• Caret ^, which superscripts the next character;
• Brackets { }, which apply the underscore and caret to a string of characters; and
• Backslash \, which initiates a Greek character, using the English-language expression for the
Greek letter. So typing \lambda into the text input dialog box and pressing Enter will
generate the Greek letter 𝜆𝜆.

For example, if you wish to distinguish Real GDP from Nominal GDP, you can create variables GDPReal
and GDPNominal using these conventions. This improves the readability of the model, compared to
standard text-only systems, which to my knowledge are all that are provided by the other system
dynamics programs. Figure 71 shows some examples of LaTeX formatting in Minsky.
Figure 71: Some examples of LaTeX formatting in Minsky

Figure 72 shows the most commonly used Greek characters supported by Minsky, and the English
word that LaTeX displays as a Greek letter if you precede it by a backslash key (\).

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Figure 72: A partial list of Greek characters supported by Minsky & the English word used for it 19

5.2 Multiple copies of variables and parameters

Once you’ve defined a variable or parameter, you can copy it and use it anywhere else on a diagram.
So, for example, if you use the Greek letter lambda (𝜆𝜆) to indicate the employment rate, then you
can make a copy of 𝜆𝜆 and use it elsewhere in your model as an input to a wage determination
model—a so-called “Phillips Curve”.

5.2.1 A Keen Rant: Rehabilitating Bill Phillips

Before I illustrate building a Phillips Curve in Minsky, it’s important to rehabilitate the reputation of
the man behind the name of the curve, the New Zealand engineer-turned-economist Bill Phillips.

Few people have been as badly misrepresented by Neoclassical economists as Bill Phillips: a
courageous and innovative man has been reduced to a caricature of the empirical study he
undertook over one weekend, to validate a hypothesis he made about a nonlinear relationship
between the intensity of economic activity and the rate of change of input prices (Phillips 1958).
Frankly, the Neoclassical caricature of Phillips is probably worse than their caricature of Keynes
(Hicks 1937).

At least with Keynes, Neoclassicals couldn’t completely ignore his outstanding contributions to the
politics and economics of his time. As a leading civil servant, Keynes attended the Treaty of
Versailles, witnessed its distortion by France into a means to destroy its long-standing enemy
Germany, and raised the alarm that the Treaty’s onerous terms would almost certainly lead to
another war in The Economic Consequences of the Peace (Keynes 1920). He was a scion of English
society, and while Hicks’s IS-LM model eviscerated Keynes’s General Theory (Keynes 1936), it didn’t
eviscerate the man himself.

Phillips, on the other hand, had a unremarkable birth as the son of a New Zealand farmer, trained as
an engineer, and spent most of WWII in a Japanese prisoner-of-war camp. But in that camp, among
many other outstanding deeds, he risked his life to fashion a radio out of parts he stole from the
commandant’s office, so that his fellow prisoners could hear British and American news reports on
the progress of the War, rather than merely being force fed Japanese propaganda (Leeson 1994, pp.
606-608).

19
For the full list, see https://github.com/highperformancecoder/minsky/blob/master/engine/latexMarkup.cc.

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On his release, Phillips decided to use his engineering training to bring economics out of its Dark
Ages of equilibrium thinking—using precisely the same modelling techniques that are now used in
system dynamics programs like Minsky. The paper from which the model in Figure 73 is taken,
“Stabilisation Policy in a Closed Economy” (Phillips 1954), pre-dates Forrester’s initial proposal of
system dynamics by 2 years (Forrester 2003 [1956]), and the practical development of system
dynamics software by about six years. Phillips was well ahead of his time, and, of course, his
innovative work was ignored by mainstream economists.

Phillips’s hypothesized relationship between the level of economic activity and the rate of change of
money wages (not prices!) was supposed to fit into the dynamic model shown in Figure 73, where
there would not be a simple “trade-off” between inflation and unemployment, as his statistical work
was bowdlerized down to, 20 but a dynamic feedback process that would be difficult, though not
necessarily impossible, to stabilize.
Figure 73: Phillips's engineering diagram layout of an economic model with his hypothesized Phillips curve relationship inset
(Phillips 1954, p. 309)

20
I have to concede that Phillips did make one statement in his statistical paper that was easily interpreted as
offering politicians a “menu” trading off unemployment against inflation: “Ignoring years in which import
prices rise rapidly enough to initiate a wage-price spiral, which seem to occur very rarely except as a result of
war, and assuming an increase in productivity of 2 per cent per year, it seems from the relation fitted to the
data that if aggregate demand were kept at a value which would maintain a stable level of product prices the
associated level of unemployment would be a little under 2 ½ per cent. If, as is sometimes recommended,
demand were kept at a value which would maintain stable wage rates the associated level of unemployment
would be about 5 ½ per cent” (Phillips 1958, p. 299). But the overall context of his paper, and of his
macroeconomic modelling, was one of dynamic feedbacks, and the difficulty of stabilizing the economy.

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5.3 Plots in Minsky

Figure 74 shows the default shape of the plot widget after you’ve either clicked on the plot icon, or
typed the @ key on the canvas. Also shown, in left to right order from the toolbox, are: the
spreadsheet widget; the other toolbox icons that generate a single object (lock, note, and time at
the left hand end of the toolbox; switch, Godley Table, integral and differential at the right hand
end), plus all the drop-down menus shown as “tear-offs”. Notice the dotted line at the top of the
fundamental constants drop-down menu? There’s one for each, you “tear off” the menu, so that it
remains permanently available while you work on a model, and it can be located anywhere on your
screen.
Figure 74: The "fundamental constants" menu on the toolbar, with the other menus as tear-offs

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Figure 75 shows a plot with its resize arrows visible: these are four arrows, one on each corner. If
you click and drag on one of them, you can resize the plot (a similar feature exists on all objects in a
Minsky model: look for a mini-arrow when your mouse hovers over any element on the canvas).

The coloured input ports are also highlighted (you can see this yourself by hovering your mouse over
a plot). These are used to determine the upper and lower bounds for each axis (the angled inputs)
and to attach variables for plotting (the horizontally aligned port on the two Y-axes, and the vertical
one on the X-axis).
Figure 75: A plot with its resize handles visible

Plots are labelled using the “Options” element on the right-click mouse menu—see Figure 76.
Minsky makes very heavy use of the right mouse button: right-click while hovering over a plot, and
this menu will appear.

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Figure 76: The right-click menu for Plots

“Options” and “Pen Styles” control the appearance of the Plot—see Figure 77.
Figure 77: Options and Pen style dialog boxes

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The top plot in Figure 78 illustrates the default behaviour of a plot: if a variable is wired up to one of
the four input ports on the left hand side of a plot, but nothing is wired to one of the eight input
ports on the bottom, then “time” is treated as the input on the x-axis and the behaviour of the
variable over time is plotted. The bottom plot shows that if you attach an input to the black input on
the x-axis, and another to the black input on the y-axis, Minsky plots x against y, as shown in Figure
80. You can create xy plots of different colours by using matching colour inputs on the horizontal and
vertical axes.

Notice also that several of the connecting lines in Figure 78 are curved. Lines can be turned into
curves by clicking and dragging the blue dot that will appear when your mouse hovers over a line.
Multiple points of curvature can be added to create any curve shape, by clicking and dragging
somewhere on the line away from the existing blue dot(s).

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Figure 78: Using Minsky's Plot widget

5.4 Building a “Phillips Curve” in Minsky

Now back to the “Phillips Curve”. Phillips insisted that the function relating the rate of change of
money wages to the level of unemployment would be nonlinear, and that it would have three causal
factors—the level of unemployment, the rate of change of unemployment, and “the rate of change
of retail prices, operating through cost of living adjustments in wage rates” (Phillips 1958, p. 283).
The model in Figure 80 is a linear model with only one input, but these limitations are easily

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overcome later. For now, I’m just using a linear model here to keep it simple early on. You should
build this model yourself in Minsky before continuing.

The model introduces one more feature of Minsky, the percent operator: this takes an input and
multiplies it by 100. It’s the last entry on the “fundamental constants” toolbar dropdown, which is
headed by the operator e for the value of the transcendental number e. Click on e and the drop-

down menu shown in Figure 74 will appear; click on and that will be attached to the mouse
pointer; move to where you want to place it on the canvas and click the mouse, and it will be
inserted there.

Then wire the model up as shown in Figure 80, using the parameter values shown in Figure 79.
Figure 79: Parameter values in the model in Figure 80 (this Figure was generated by choosing Export Canvas while on the
Parameters Tab)

Table 1 shows what you have to type to get the elements shown on the canvas in Figure 80
Table 1: Variable and parameter names and how to type them

What is displayed on the canvas What you type to get it

𝜆𝜆 \lambda
𝜆𝜆𝑡𝑡𝑡𝑡𝑡𝑡𝑡𝑡
𝑆𝑆𝜆𝜆 S_λ
𝑍𝑍𝜆𝜆 Z_λ
Δ𝑤𝑤 \Delta_w
To simulate this equation, vary the value of the parameter 𝜆𝜆𝑡𝑡𝑡𝑡𝑡𝑡𝑡𝑡 using the arrow keys or the mouse.
As you do, the line shown in the plot in Figure 80 will be drawn.

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Figure 80: A linear "Phillips Curve" in Minsky

Minsky generates the equations of its models in LaTeX. You can export these from the program via
the File menu option “Export Canvas”, which has six options: SVG (a generic vector graphics format
that I’m using to produce the Figures in this book); PDF; EPS (Postscript); EMH (Enhanced Metafile, a
Windows vector graphics format); LaTeX; and Matlab. Choose LaTeX and you’ll save a file with a
*.tex suffix, which you can load into a LaTeX-aware mathematics formatting application (which
includes Word itself as of 2017). The equations behind Figure 80 are shown in Equation (3):

λS = 10
λZ = 0.6
(3)
λtest = 0.63
∆W = λS × ( λ − λZ )

This takes us about as far as we can go without discussing how to handle time in dynamic modeling.

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6 System Dynamics Basics

The Wikipedia defines system dynamics as “an approach to understanding the nonlinear behavior of
complex systems over time using stocks, flows, internal feedback loops, table functions and time
delays”, and “a methodology and mathematical modeling technique to frame, understand, and
discuss complex issues and problems” . 21 That’s correct, but it also assumes a fair bit of prior
knowledge about how to build dynamic models. I prefer to strip this back to its basics, and describe
system dynamics as a method to build systems of ordinary differential equations using a graphical
user interface.

An Ordinary Differential Equation (ODEs) describes the rate of change of some variable as a function
of itself and/or other variables. The fundamental variable in an ODE is time. In this sense, differential
equations are calculus applied to processes in time, which is the essence of dynamics. 22

A simple Differential Equation is the statement that the rate of change of a variable is a constant—
for example, if you’re walking at the speed of 2 metres per second, then the rate of change of your
location is 2 metres per second. If we call your location “x”, then this equation is:

dx
=2 (4)
dt
To model this in a system dynamics program, you first have to convert this into an integral equation.
This is because when most system dynamics programs simulate a model, they do so numerically, and
integration is a much more stable numerical process than differentiation. This is because
differentiation gives you the slope of a curve, which can change very radically, while integration
gives you the area beneath a curve, which changes more slowly than its slope. 23

Expressed as an integral equation, this is:

x ( t ) = x0 + ∫ 2 ⋅ dt (5)

𝑥𝑥0 is the initial position before starting to walk. Figure 81 is this equation in Minsky with 𝑥𝑥0 = 0.

21
https://en.wikipedia.org/wiki/System_dynamics.
22
Partial Differential Equations (PDEs) add a second fundamental variable of location—space. The formal
mathematics of PDEs is much more complicated than that of ODEs, which itself is far more complicated than
the mathematics of differentiation. PDEs are essential for modelling processes that intimately combine
movement with time—such as fluid dynamics. In other areas where space matters, but the convolution of time
and space is not so intimate (or the spatial dimension is much more granular than a fluid), the convention is to
treat processes as if they occur at a point, by having time as the only fundamental variable. Then to take space
into account, you introduce multiple points which interact with each other over time. In economics, these
points can be different economies, different regions within one economy, etc.
23
Minsky has symbolic modelling capabilities which don’t have the same problem, but we follow the system
dynamics convention in using integral rather than differential equations. This may change, if we ever secure
sufficient development funding.

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Figure 81: A simple differential equation in Minsky

An Ordinary Differential Equation is the statement that the rate of change of a variable is a function
of its value. Population growth (and radioactive decay) is the simplest such model. A fish population
𝐹𝐹 (with an effectively unlimited food supply) can be modelled as having a constant annual rate of
𝑑𝑑𝑑𝑑
growth 𝑎𝑎% per year. The percentage rate of growth of a variable 𝐹𝐹 is its rate of change divided by
𝑑𝑑𝑑𝑑
its current level 𝐹𝐹, so the statement that “F grows at a% per year” is in mathematical form:

d
F
dt = a (6)
F
As an ODE, this is:

d
F= a × F (7)
dt
Expressed as an integral equation, this is:

F ( t ) = F0 + ∫ a × F ⋅ dt (8)

In Minsky, with 𝑎𝑎 = 0.1 (or 10% per year), this generates the characteristic outcome of exponential
growth shown in Figure 82.

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Figure 82: A simple population growth model

At a growth rate of 10% per annum, the number of fish doubles every 7 years—illustrating the so
called “Rule of 70”: a growth rate of x% per year means that the population will double every 70/𝑥𝑥
years. 24 After 21 years, the population has risen 8-fold.

This, in a nutshell, is why there must be dynamic systems: though hypothetically a given population
can rise exponentially, in practice it can’t, because the world—even the Universe—isn’t infinite
(Murphy 2021). 25 Something else must limit this process—whether that’s the exhaustion of the
falsely assumed infinite supply of fish food, or the existence of a predator that eats the fish.

Here entereth our first true system dynamics model, the “predator-prey” model of a pair of
interacting species, which keep limits on the numbers of both species. As I explain in Manifesto
(Keen 2021, pp. 76-78), it was initially developed by the Italians Lotka and Volterra in the early
1900s—long before the technology of system dynamics was developed by Forrester in the 1950s.

I’ll use this example to illustrate many of Minsky’s user interface features.

6.1 Predator-Prey model

Lotka’s predator-prey model (Lotka 1920) was the first mathematical model to demonstrate the
hallmarks of complexity: nonlinear interactions in a system leading to sustained non-equilibrium

24
The rule simply derives from the fact that the natural logarithm of 2 is roughly 0.7. Exponential growth as
shown in Figure 82 means that the population in year T will be the initial population times 𝑒𝑒 𝑓𝑓×𝑇𝑇 . If this is twice
the initial population, then you have the formula 2 × 𝐹𝐹0 = 𝐹𝐹0 × 𝑒𝑒 𝑓𝑓×𝑇𝑇 . Cancel the initial conditions and take
𝑙𝑙𝑙𝑙(2)
logs and you get 𝑙𝑙𝑙𝑙(2) = 𝑓𝑓 × 𝑇𝑇. Therefore T—the year by which the population doubles—is , where
𝑓𝑓
𝑙𝑙𝑙𝑙(2) ≈ 0.7=70%. So if you divide 70% by the growth rate in %, you get how long a growth process takes to
double the population. In this example with 𝑓𝑓 = 10%, the doubling period is 7years.
25
Tom Murphy’s excellent (free and online) book Energy and Human Ambitions on a Finite Planet: Assessing
and Adapting to Planetary Limits makes the case that if human energy consumption grows at 2.3% per annum
(which is roughly our current growth rate, and which leads to energy usage increasing by a factor of ten every
century), then waste heat necessarily generated on the surface of the planet, according to the Laws of
Thermodynamics and without any consideration of the factors causing global warming, will be sufficient to
drive the average temperature of the planet’s surface to the boiling point of water—100°C—in just 400 years
(Murphy 2021, p. 12).

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behavior. Its foundations are extremely simple: two population models, a prey species with an
assumed limitless supply of food, as in the previous section, coupled to a predator population whose
survival depends on the availability of prey.

We can start from the equation for population growth—or rather population change. I’ll stick with
Fish for the prey species and introduce Sharks as the predator species S (for Sharks). 26 Then we start
from the same percentage change logic, where Fish numbers grow exponentially at the rate 𝑎𝑎% per
year, and Shark numbers fall at the rate 𝑐𝑐% per year (I’m reserving 𝑏𝑏 and 𝑑𝑑 for the interaction
1 𝑑𝑑𝑑𝑑
terms). The “hat” notation 𝐹𝐹� is a mathematician’s shorthand for ∙ :
𝐹𝐹 𝑑𝑑𝑑𝑑

 1 d
F F a
F dt (9)
 1 d
S S  c
S dt
Expanding this out into differential equation form gives us:

d
F  aF
dt (10)
d
S  c  S
dt
In integral equation form, this is:
t

F t   F0   a  F  s ds
0
t
(11)
S t   S0   c  S  s ds
0

This is precisely how Minsky models it in Figure 83, where the equation (11) can be seen by reading
Minsky’s symbols from right to left:

26
I’m showing my Australian roots here: most European models use Rabbits and Foxes.

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Figure 83: Predator and Prey without interaction

The model in Figure 83

Now we need to include the interaction between the species: predation by sharks reducing fish
numbers, and increasing shark numbers. Lotka made the simplest possible assumption, that sharks
reduce the growth rate of fish by a constant, and decrease the death rate of sharks by another
constant. This is most easily shown using the hat notation used in equation (9):


F  a  b S
(12)
S  c  d  F

In integral form, this is

t

F t    a  b  S  F  s ds
0
t
(13)
S t    c  d  S  s ds
0

This can be put into Minsky by adding the widgets shown in grey in Figure 84, and the characteristic
cycles of the predator-prey model emerge.

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Figure 84: Predator and Prey with interaction

I was actually lucky here: I simply used “suck it and see” values for the parameters and initial
conditions, and they worked out OK: the ranges for the numbers of fish and sharks were reasonable.
But if you do the same, you may well get “crazy” cycles, because the combination of your initial
values and your parameters may have numbers of both species cycling wildly. This is because, in one
of the neatest illustrations of how complex systems behave, the equilibrium value for the number of
fish depends on the parameters for sharks, and the equilibrium for the number of sharks depends on
the parameter for fish.

This is easiest to see by setting the equations in (12) to zero—since this shows you the point at which
the rates of change of the number of fish and the number of sharks are both zero:


F  a  b S  0
(14)
S  c  d  F  0

This is only true for specific—equilibrium—values of F and S, which I denote by 𝐹𝐹𝐸𝐸 and 𝑆𝑆𝐸𝐸
respectively:

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a
SE 
b (15)
c
FE 
d
Figure 85 adds the equilibrium calculations with the greyed widgets, as well as a phase diagram
showing the repeating cycles over time, the equilibrium here (the other equilibrium—which is
unstable—zero sharks and zero fish), and the initial values on the phase plot.
Figure 85: Predator and Prey with phase diagram and equilibria

I was lucky that my choice for the initial number of fish and sharks—1000 and 10 respectively—
weren’t too far from the equilibrium values for fish and sharks—1667 and 33.3 respectively—given
the values I used for the parameters. But if you give initial conditions that differ substantially from
the equilibrium determined by the parameters, you will get wild cycles where each species “almost
disappears” before spiking up dramatically and then collapsing once more—as illustrated by Figure
86.

Your best bet, when designing a model, is to either (a) check the equilibrium conditions of your
model, and choose initial conditions that aren’t too far removed from (one of) the equilibria; (b) if
you’re working from data for the initial conditions, choose parameter values that generate equilibria
that aren’t radically different; or (c) if you’re working on a large-scale empirically based model,
follow the parameter estimation techniques outlined in Chapter 11.

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Figure 86: The same model with badly chosen initial conditions

The final things needed to reproduce the figure in Manifesto is to replace the androgynous 𝑎𝑎, 𝑏𝑏, 𝑐𝑐, 𝑑𝑑
parameters with more meaningful labels, and to put in the plot with the two Y-axes. We can do the
former quickly using the right-mouse button menu item “Rename all instances”—see Figure 87.
Figur
e 87:
Using
"Ren
ame
all
insta
nces"

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Figure 88 shows the final model including two plots with 2 y-axes—one showing the numbers of
Sharks and Fish, and the other showing the rates of change of the two populations. This is partly to

show off Minsky’s rate of change operator —which, unlike similar operators in most other
system dynamics programs, actually performs a symbolic differentiation rather than a numerical
one—and partly to make the point that, no matter how often you “first/second/third difference”
these variables, they will always be out of phase. This is despite the complete lack of time lags in this
model: the instantaneous value of (the rate of change of) Fish depends on the instantaneous value
of Sharks, but in a nonlinear way. So no matter how often they are “differenced”, they will remain
“not cointegrated” in the jargon of econometrics.

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Figure 88: The final model with rates of change shown as well

6.2 Organizing a model

This model is essentially very simple, but with the layout I’ve used, it won’t fit completely on a
computer monitor running at 1920x1080 pixels—see Figure 89

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Figure 89: The model in Figure 88 on a 1920x1080 resolution monitor

This can be simply fixed by clicking on the “fit to window” magnifying glass—the last one of the four
on the control panel bar. But with a large model, that will reduce the variables, parameters etc., to
an illegible size. So, you need to organize the model.

There are two ways to do this, and one of them—the standard method used by all other system
dynamics programs—I recommend that you don’t use, yet. This is grouping.

The reason I don’t recommend using it, yet, is that in the early days of developing Minsky, we
consulted a professional interface designer and he made the novel recommendation of making our
groups transparent: at a preset level of magnification, the contents of a group become visible, and
you can edit the group while still working at the scale of the overall model.

It was a clever idea, and it will work one day, but it generated a plethora of issues in terms of linear
transformations that, unfortunately, we found too late and haven’t yet had the time to debug. This
is one of the problems of lack of funding: we are torn between adding new features and bug killing.
A team of 3 full-time programmers is really needed as a minimum to balance both objectives, and
the best we’ve been able to manage, and even then for only a year with the funding from Friends
Provident Foundation, was two.

So we developed a workaround that works as well, and exploits Minsky’s uniquely huge
100,000x100,000 pixel design space: Bookmarks.

6.2.1 Bookmarks
There are three ways to insert a bookmark:

widget on the toolbar;

2. Choose “Bookmark this position…” under the Bookmark main menu item; and
3. Type the Note shortcut of the % sign on the canvas

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In the current release of Minsky (2.35.0), these methods work somewhat inconsistently, and the
best one to use is the first. We’ll make them consistent in the first release of Minsky with a
Javascript front end, sometime in early 2022.

The first method bring up the “Note” dialog box—see Figure 90. If you don’t click the Bookmark?
Box, this command will insert a text string at the cursor, where the string will be whatever you type
to replace the “Enter your note here”. This can be quite extensive—paragraphs of text rather than
just lines—and some LaTeX formatting is supported, so you can have Greek letters, superscripts and
subscripts in what you type. If you type anything in the “Short Description” window, that will appear
as a tool tip when the mouse hovers over the Note on the canvas.
Figure 90: The Note Widget

However, if you click the “Bookmark?” box, then the note functions as a bookmark as well: the text
you type in “Enter your note here” still appears on the canvas, the Short description still appears as a
tool tip; and as well, the location of the Note on screen is recorded as a Bookmark, with the Short
Description turning up on the Bookmarks menu.

To navigate to the Bookmark, simply click on it on the Bookmarks menu. The screen view of the
canvas will then be reset so that the Note occupies the top-left-hand-corner of the screen.

In Figure 91, I have inserted several bookmarks; in Figure 92, I have chosen the “Equilibrium
Calculations” bookmark from the Bookmarks menu, and the screen has been reset so that that Note
is in the upper left-hand corner of the screen.

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Figure 91: The model with several bookmarks inserted.

Figure 92: The view of the canvas when you click on the "Equilibrium Calculations" Bookmark

Once a Bookmark is defined, you can move it, and the elements of the model you use it to
bookmark, by selecting them and then moving or cut-and-pasting them to a new location. In Figure

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93, I have moved the bookmark “Plots” and the plots themselves to a new location on the canvas.
Clicking on the bookmark “Plots” from the Bookmark menu will relocate the visible canvas so that
the word “Plots” is in the top left hand position.
Figure 93: Figure 92 with the Bookmark "Plots" and the model elements associated with it moved to a new location

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6.2.2 Using intermediate variables

Another way to group components of a model in Minsky is to use intermediate variables, which can
then be deployed anywhere else on the model. For example, we can reduce the two equations for
Fish and Sharks to the simple form of:

d
= Fish FishBirths − FishDeaths
dt
d
= Shark Shark Births − Shark Deaths
dt (16)

This can be done by defining the positive component of the original equations as “Births” and the
negative as “Deaths”—see Figure 94. This approach doesn’t do much to reduce the complexity of
this model, since it is quite simple already, but it is very helpful in much more complicated models.
Figure 94: The Fish-Sharks model with simplified system equations

6.3 Documenting a model

Future versions of Minsky, starting with the first Javascript version that we’ll release in early 2022,
will have a “Publication” Tab, where selected elements of a model can be placed to create an
explanation of the model. This will include text notes, Godley Tables, Plots, selections of flowchart
elements, etc.

The current version, which is the final version to be released with a Tcl/Tk frontend, lets you export
the various Tabs in a range of formats, with the most useful—in terms of producing documentation
of a model—being the vector graphic format SVG (“Scalable Vector Graphic”). Most writing and
presentation programs accept this format, and these graphics files can be inserted into them easily.
Figure 95 and Figure 96 show exports of the Parameters and Plots Tabs respectively.

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Figure 95: The Parameters Tab of this model, exported as an SVG file

Figure 96: The Plots Tab of the model exported as an SVG file

As (pardon me!) noted above, Notes have some capacity for text formatting that makes them useful
to document a model as well—though they can take up a fair bit of screen real estate as a result. The
Publication Tab will ultimately enable in-situ documentation of a model without taking up canvas
space, but at the moment, the Notes widget is the best we can offer.

That said, it has some flexibility since it partially supports the LATEX document formatting language
that is also used by Minsky to enable the equations of a model to be exported and then imported

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into word processor equation editors (including MathType, which I’ve used in this book). The next
quote shows the text typed into a Note, and Figure 97 shows how this appears on screen.

Notes can contain

more than one line of text,

and the text can contain elements formatted using the L_A^TE_X

formatting language too, including _{subscripts} and ^{superscripts},

Greek letters like \lambda, and so on.

You have to get a bit creative with using spaces and

carriage returns to lay text out, but overall it's more flexible than the text
documentation features of our rivals, so hey...

With additional funding, we'll make this a decent little \LaTeX formatter one day.
Figure 97: How Note formats the text in the quote above.

6.3.1 The Equations, Parameters, Variables, Plots and Godleys Tabs

As you develop a model, these additional Tabs to the “Wiring” tab where you design the model are
auto-populated. They are not editable themselves in this version of Minsky—except for the Godleys
and Plots Tabs, where you can relocate each Godley Table and Plot as you wish on the Tab—but they
will be in future versions. You can also control which Plots appear on the Plots Tab, using the right-
click menu on each plot on the design canvas.

In terms of designing a model, probably the most useful Tab is for Equations. This transforms the
flowchart and Godley Table elements of a model into the actual differential equations that are used
to simulate it. This gives you a second way to check whether the model actually expresses what you
want to express—if a model doesn’t work as it should, you might find you’ve forgotten a minus sign,
or used a multiplication symbol rather than a division, etc.—these things happen. You can often
work this out by reading just the flowcharts and Godley Tables on the Wiring Tab, but sometimes the
different—but entirely consistent—view provided by the Equations Tab can help you identify
problems in a model more rapidly.

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6.4 Exporting and importing a model

Minsky’s files use the structured-text language XML. Here, for example, are the first few lines of the
actual MKY file for the predator-prey model developed in this section:

<Minsky xmlns="http://minsky.sf.net/minsky">

<schemaVersion>3</schemaVersion>

<minskyVersion>2.35.0</minskyVersion>

<wires>

<Wire>

<id>261</id>

<from>6</from>

<to>2</to>

</Wire>

<Wire>

<id>262</id>

<from>17</from>

<to>20</to>

</Wire>

<Wire>

<id>263</id>

<from>28</from>

<to>24</to>

</Wire>

This file format makes it relatively easy for Minsky to interface with other file formats, and we
currently support exporting to SVG, PDF, Postscript, PNG, EMF, LaTeX and Matlab—see Figure 98.
This feature is accessed through the “Export Canvas” option on the File menu, and what is exported
is based upon the Tab which you currently have open (except for the last two formats, LaTeX and
Matlab, which are independent of the Tab you have open).

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Figure 98: The choices in the Export Canvas menu

We also support importing models from one of the two market leaders in the System Dynamics
marketplace, Vensim; this is an option on the File menu. Because the layout philosophy of Vensim is
so different to Minsky’s, there are often SNAFUs in how an imported model is laid out, and some
models will fail to import at all. We will repair these over time—and the more people who use this
feature and report bugs back to us, the better.

That’s enough on the interface: now to the crucial issue of why would you want to use Minsky rather
than the more conventional modelling tools—spreadsheets, Eviews, etc.—that economists currently
use. It’s all about time, and economists, as a rule, handle time very badly.

6.5 A Keen Rant: How not to handle time

The vast majority of economic models, whether Neoclassical (Sargent and Stachurski 2020b, 2020a)
or Post Keynesian (Godley and Lavoie 2007b), use what economists term “periods”. A recent
example is the debate in Post Keynesian macroeconomics between Claudio Sardoni (Sardoni 2019)
and Marc Lavoie and Gennaro Zezza (Lavoie and Zezza 2020), where both sides advocate what they
term a “sequential” approach, in preference to “equilibrium” analysis. Sardoni states, quite
correctly, that

sequential analysis represents a clearer conceptual framework to cope with

processes that occur in time. The analysis of the multiplier effects of investment
is one of the cases in which the occurring of events in time should not be ignored.
(Sardoni 2019, p. 243)

But he also comments, immediately before this, and also quite correctly, that:

Keynes may have been right to underline the difficulties of sequential analysis
and, in particular, the difficulty to provide a precise definition of the length of
periods. (Sardoni 2019, p. 243)

The resolution to this paradox is itself paradoxical: there is no “period”. There are instead, economic
processes which, at a “micro” level, are discrete acts—each individual act of consumption,
investment, borrowing, etc. Each of them takes a different amount of time to complete, and each
recurs at a different frequency: no one individual act of consumption is timed precisely with others,
nor each act of investment: they are asynchronous. All these individual “periods”, when viewed from
the perspective of an aggregate economic system, overlap, and a macro-level period cannot be
defined.

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While it would be feasible to model these as discrete processes in a multi-agent model, 27 at the level
of aggregate macroeconomic modelling, asynchronous microeconomic processes are best treated as
happening in what mathematicians call “continuous” time, as opposed to “discrete” time. This in
turn means that the proper mathematical technology for dynamic economic modelling is not the
“difference equation”, but the “differential equation”.

Therefore, equations like the “discrete-time” Equation (17), from the seminal Godley and Lavoie
paper “Fiscal policy in a stock-flow consistent (SFC) model” (Godley and Lavoie 2007a, p. 84,
Equation 19), which defines government debt as a difference equation:

GD ≡ GD−1 + DEFICIT (17)

should instead be written as a differential equation in “continuous time”:

d
GD ≡ DEFICIT (18)
dt
While “sequential analysis” is indeed preferable to equilibrium analysis, continuous time modelling is
preferable to both. There are, of course, rejoinders to this, which I have heard many, many times
from my Post Keynesian colleagues (especially from Marc Lavoie: we are good friends, and, when
our schedules and geography permit, tennis rivals/buddies, as well as intellectual collaborators).

The commonest defense of “sequential analysis” is that economic data is periodic, and therefore
economic models should use equivalent periods. This is a fallacy, as stated bluntly by the father of
System Dynamics, the engineer Jay Forrester, when he first reported on his study of economic
models to his Faculty Seminar at MIT in 1956:

The incremental time intervals for which the variables of a model are solved step-
by-step in time must be much shorter than often supposed… This solution
interval is unrelated to the interval at which national statistics and economic
indicators are measured… (Forrester 2003, pp. 337-345)

Forrester backgrounded this didactic statement in his textbook Industrial Dynamics:

A discontinuous model, which is evaluated at infrequent intervals, such as an

economic model solved for a new set of values annually, should never be justified
by the fact that data in the real system have been collected at such infrequent
intervals. The model should represent the continuously interacting forces in the
system being studied. The frequency with which measurements on the real
system may happen to have been taken is not relevant to the frequency with
which internal dynamic performance must be calculated. (Forrester 2013, p. 65)

Another frequently made rejoinder is that economic decisions, such as investment, are based on
lagged data, rather than current data, and therefore period analysis is needed to capture these lags.
For example, Godley & Lavoie 2007 assume:

that governments react to lagged inflation rates, rather than to actual or

expected inflation rates, on the realistic grounds that fiscal policy may have a
reaction time somewhat longer than monetary policy. (Godley and Lavoie 2007a,
p. 92)

27
I briefly discuss multi-agent modelling in (Keen 2021, p. 149).

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Therefore, they use the two equations shown in Equation (19) to represent “real pure government
expenditures” g, and the “growth rate of real pure government expenditures”, grG , where the rate
of growth of government expenditure is a function of “the growth rate of potential output” gr, the
change in the lagged inflation rate Δ𝜋𝜋−1 , and the deviation of the lagged inflation rate from the
target inflation rate 𝜋𝜋 𝑇𝑇 :

g = g −1 ⋅ (1 + grG )
(19)
grG= gr − β1 ⋅ ∆π −1 − β 2 ⋅ (π −1 − π T )

In fact, lags are easily represented in differential equations, using what is known as a “first-order
time lag”, to relate the delayed perception of the rate of inflation to the actual, instantaneous rate
of inflation 𝜋𝜋. I’ll use 𝜋𝜋𝐿𝐿 rather than 𝜋𝜋−1 for the time-lagged inflation rate, since a time lag can be
any length, not merely “one period”. The time-lagged inflation rate is defined by its rate of
convergence to the actual inflation rate, which is given by the “time constant” 𝜏𝜏𝜋𝜋 (which, in an
elaborate model, can be a variable if desired) which measures the length of time, in years, that it
takes for the perceived rate of inflation 𝜋𝜋𝐿𝐿 to converge to the actual rate of inflation 𝜋𝜋. If 𝜏𝜏𝜋𝜋 = 0.5,
this is a 6-month lag; if 𝜏𝜏𝜋𝜋 = 1, a year, and so on. This rate of convergence is given by the differential
equation shown in Equation (20):

d 1
− ⋅ (π L − π )
πL = (20)
dt τπ
Similarly, the growth rate of government expenditure is expressed as a differential equation:

d
=g grG × g (21)
dt
The variable growth rate 𝑔𝑔𝑔𝑔𝐺𝐺 can now defined as something like Equation (22), or it could be
replaced with its own differential equation.

d
grG = gr − β1 ⋅ π L − β 2 ⋅ (π L − π T ) (22)
dt
This approach is vastly superior to the discrete approach to time lags (which is more correctly called
a time-delay, rather than a time-lag), for many reasons.

Time-lags are flexible. Your lag can be a fraction of a year, or multiple years, or even an irrational
number if you wish: it doesn’t have to be 1,2, 3 “time periods”, as in conventional economic
modeling. And of course, I’m being generous in saying that! Economic models use a time delay of “1
period” for almost everything. In Lavoie and Godley 2007, interest payments have a lag of -1
(equation 1); spending is negatively related to the interest rate with a lag of -1 (equation 2); taxes on
wealth are lagged -1 (equation 7). This is typical. Factors which in the real world occur at vastly
different frequencies—consumption, for example, has a much higher frequency than investment—
are all corralled into the same arbitrary frequency.

Therefore, the time-delays (not time-lags) in discrete time economic models—which is to say, the
majority of economic models—are spurious. They have nothing to do with the actual characteristics
of time-dependent actions in the real economy. Time lags, on the other hand, can be derived from
empirical data. They are also easy to edit: a time lag is a simple scalar, and if you find that you’re
using the wrong value—say, data shows that the time lag in investment is actually 1.5 years when

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your model uses 3 years—then all you have to alter is that number. On the other hand, if discrete-
time economic models did time delays properly, they would have different delays for consumption
(short) versus investment (long). This simply isn’t done. If it were, and then empirical data indicated
that the delay was different to what the model used, a wholesale re-writing of the model is
necessary.

The final objection made to using continuous time is, how then do we derive the values for
parameters in such models, and test them, when the economic data we have is in discrete time
format (quarterly or yearly)? This is in fact a valid issue, since it does take care to do this properly. A
common method is to interpolate intermediate (continuous-time) data points from yearly, quarterly
or monthly data using cubic-spline interpolation. This procedure derives a set of third order
polynomials that join each pair of points in a series, producing a smooth series that approximates
what would have been found by statisticians as the sum of the underlying asynchronous processes, if
they had used a higher sampling rate. The model can then be fitted to the interpolated time series. 28

The bottom line is, stop using difference equations for economic models! They are simply the wrong
technology for the macro modelling of asynchronous micro processes in general, let alone
economics in particular. Difference equations are really only appropriate for macro-level modelling
when the micro-level processes that generate it are synchronized. This is the case for, for example,
the birth dynamics of Christmas Island Red Crabs. These crabs give birth on the same day,
coordinated by the full moon, so that the sheer number born on that day overwhelms
predators, and enables the survival of the species (Adamczewska and Morris 2001). So, if
you’re modelling the life cycle of Christmas Island Red Crabs, go right ahead and use
difference equations. But if you’re modelling anything else…, then don’t use them.

Given how inappropriate difference-equation models are for modelling the economy, and
yet how much they are used by economists, Minsky deliberately does not support time-
delays: “friends don’t let friends use periods”. We may need to introduce time-delays at
some point, to enable the importing of models from other system dynamics programs, but if
so, they will exist solely for that purpose.

6.6 Mathematics and Minsky

One of the reasons that economists have used difference equations is because they’re easy to write
down: anyone can define a simple equation in terms of time differences, and it can easily be
modelled with conventional software like a spreadsheet. You need specialist software (including
mathematics programs like R and Matlab, in addition to system dynamics programs like Minsky) to
simulate differential equations, and it is also much harder to think in terms of differential equations
initially. For this reason, I recommend undertaking some study of differential equations, even
though you can use Minsky without that training.

If you do study them, do a course given by mathematicians rather than economists, and make sure
the tuition extends to third order nonlinear differential equations (or at least their qualitative
features compared to 2nd order equations), since, as I explain in Manifesto, 3-dimensional models
are the foundation of complex systems modelling: as Li and Yorke put it, “Period Three Implies
Chaos” (Li and Yorke 1975). Alternately, get a good textbook: my favourite, because it is so well

28
The blog post https://timodenk.com/blog/cubic-spline-interpolation/ gives a nice outline of the procedure,
for which there are normally built-in routines in programs like R, Matlab, Mathematica, etc. At some point,
funding permitting, we will add interpolation features to Minsky.

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written, and because it covers stability analysis, qualitative analysis, and the basics of the linear
algebra needed for differential equations as well, is Braun’s Ordinary Differential Equations and their
Applications (Braun 1993).

6.7 Integrals versus differentials

Since system dynamics programs simulate systems that change over time, differential equations are
fundamental to them. However, differentiation (working out the slope of a curve) is a much more
volatile operation than integration (working out the area under a curve): the slope of a curve can
vary dramatically over a short interval, but the area beneath it will change less dramatically.
Approximating the slope of a curve numerically can result in large errors, so for this reason (and a
few others), system dynamics programs work with integration rather than differentiation.

Therefore, if you start with a differential equation for population growth, like Equation (23):

d
Population
= Births − Deaths (23)
dt
Where births and deaths are proportional to the existing population:

Births
= ( t ) BirthRate ⋅ Population ( t )
(24)
Deaths
= ( t ) DeathRate ⋅ Population ( t )
Then, in a system dynamics program, you would express Equation (23) in integral form by integrating
both sides:
t
Population ( t ) = ∫ ( Birth
0
Rate ⋅ Population ( s ) − DeathRate ⋅ Population ( s ) ) ⋅ ds (25)

In Minsky, this looks like Figure 99:

Figure 99: A simple equation for population, with the parameters being varied during the simulation

6.8 A first model, done two ways

Now let’s build a first serious model using Minsky: Goodwin’s growth cycle model (Goodwin 1967).
Normally, a system dynamics model is designed by considering causal relationships between
elements of a model, and then connecting them all into a causal loop. We’ll do that in a moment,

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and also follow up with a second method, of deriving the model directly from macroeconomic
definitions. This is to emphasize the point I made in Manifesto that Goodwin’s model—and my
extension of it to model Minsky’s Financial Instability Hypothesis (Keen 1995, 2020b)—are
foundational models for a modern, complex systems approach to macroeconomics.

Figure 100 shows the opening paragraphs of Goodwin’s paper, where he sets out the assumptions
underlying his model (Goodwin 1967, p. 54). I’ll follow this structure in deriving the model in a
system dynamics way, though Goodwin’s own derivation was closer to the second approach we’ll
use later. I should note that I found Goodwin’s explanation of his model interesting but inscrutable
when I first read it, and only properly understood the model—and its potential—when I read Blatt’s
masterful exposition of it in Dynamic economic systems: a post-Keynesian approach (Blatt 1983). If
you’re reading this book with serious intent—in that you plan to become proficient at system
dynamics modelling in economics—then I strongly suggest that you buy a copy of Blatt’s recently
republished masterpiece. 29
Figure 100: Goodwin's statement of the assumptions from which his model is derived

Working from Goodwin’s exposition here—and using slightly different notation—his first two
assumptions are constant exogenous growth of the output to labour ratio 𝑎𝑎 and of population 𝑁𝑁.
Using 𝛼𝛼 for the rate of growth of the output to labour ratio and 𝛽𝛽 for the rate of growth of
population, that gives us these two equations:

29
https://www.taylorfrancis.com/books/dynamic-economic-systems-john-blatt/e/10.4324/9781315496290.

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1 d
a =α
a dt
(26)
1 d
N =β
N dt
In Minsky, these equations are entered as shown in Figure 101:
Figure 101: Exogenous growth rates of technology and population in Minsky

Goodwin’s assumption 6 gives us a constant ratio 𝑣𝑣 between capital K and output Y, while
assumption 5 means that the level of gross investment 𝐼𝐼𝐺𝐺 equals profits Π, which in this simple two-
class (workers and capitalists) model equals output 𝑌𝑌 minus wages 𝑊𝑊. Goodwin neglected to include
depreciation of capital, so I include that as well, defining net investment 𝐼𝐼 to be equal to gross
investment 𝐼𝐼𝐺𝐺 minus depreciation, which is a constant 𝛿𝛿𝐾𝐾 times K:

K
v=
Y
Π= Y −W
IG = Π (27)
I = IG − δ K ⋅ K
d
K=I
dt
These equations can be used to commence building the model, as shown in Figure 102.
Figure 102: Partial Goodwin model, from the definition of profit to the determination of employment

Reading from left to right in Figure 102:

• Output 𝑌𝑌 minus Wages 𝑊𝑊 determines profit: Π (𝑌𝑌 − 𝑊𝑊 → Π);

• all profit is invested: (Π → 𝐼𝐼𝐺𝐺 );

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• net investment 𝐼𝐼 is gross investment 𝐼𝐼𝐺𝐺 minus depreciation 𝛿𝛿𝐾𝐾 ∙ 𝐾𝐾: (𝐼𝐼𝐺𝐺 − 𝛿𝛿𝐾𝐾 ∙ 𝐾𝐾 → 𝐼𝐼 );
• net investment, integrated and added to the initial level of capital stock 𝐾𝐾0 , is the current
capital stock: �∫ 𝐼𝐼 → 𝐾𝐾 + 𝐾𝐾0 �;
𝐾𝐾
• Capital stock divided by the capital output ratio 𝑣𝑣 is output: � → 𝑌𝑌�; and
𝑣𝑣
𝑌𝑌
• Output divided by the output to labour ratio 𝑎𝑎 is Labour: � → 𝐿𝐿�.
𝑎𝑎

This leaves just his assumption 7: “a real wage that rises somewhere in the neighbourhood of full
𝐿𝐿
employment” (Goodwin 1967, p. 54). I’ll use 𝜆𝜆 = for the employment rate, but I’ll relate this to the
𝑁𝑁
total population N, and not just the proportion of the total population that is employable, which is
what Goodwin and Blatt used. 30 In generic mathematical notation, the Phillips Curve relationship is
as stated two equivalent ways in Equation (28):

1 d
w = f (λ )
w dt
(28)
d
w= w ⋅ f ( λ )
dt
We’ve already built a linear version of this, in Figure 80 and Equation (3). So all we need to do is add
the equation defining 𝜆𝜆 as 𝐿𝐿⁄𝑁𝑁 , and then to define 𝑊𝑊 as 𝑤𝑤 ∙ 𝐿𝐿:

L
λ=
N (29)
W= w ⋅ L
This adds the terms in white in the causal diagram part of Figure 103.

30
This approach yields a value of 𝜆𝜆 for stable wages of roughly 0.60, versus the value of about 0.96 that Blatt
used, which arose from treating 𝜆𝜆 as one minus the unemployment rate (1 − 𝑢𝑢). Blatt’s approach results in
the “no-wage-change” value for 𝜆𝜆 being 0.96. If you use a linear function as an approximation of the Phillips
Curve—which is what Goodwin did—then the model generated dynamics that give returns silly results like the
employment rate exceeding 100%. This doesn’t happen as easily if the stable wages value of 𝜆𝜆 is 0.60.

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Figure 103: The completed model, with the original terms in grey and the new ones in white 31

Reading right to left in this section—since I have “flipped” the model components to close the causal
loop: 32

• Labour 𝐿𝐿 divided by population 𝑁𝑁 determines the employment rate 𝜆𝜆;

• The employment rate fed into the “Phillips Curve” function determines the rate of change of
𝑑𝑑
wages 𝑤𝑤;
𝑑𝑑𝑑𝑑
• Multiplied by the current wage, integrated and added to the initial wage 𝑤𝑤0 , this determines
the wage rate 𝑤𝑤;
• From this point on, it’s what one of my undergraduate maths lecturers described as “money
for old rope”:
o The wage rate times 𝐿𝐿 determines W;
o Subtract 𝑊𝑊 from 𝑌𝑌, and the causal loop is closed.

With this completed, we can now see the dynamics of the Goodwin model. A few plots inserted and
wired up to Y, 𝜔𝜔 and 𝜆𝜆 generate Figure 104.

31
Notice the strange wiring at the bottom left, where the wire crosses over the w? That’s a bug: the rotation of
the integral block didn’t update where the output wire emanated from. It’s a good example of the sort of
debugging that is needed to make a computer program work well. We’ve since fixed it (see Figure 104).
Repairing errors like this, as well as adding new features, is a major reason why continued funding is needed to
develop Minsky.
32
This wasn’t necessary—I could have designed the whole model left to right, and terminated it with another
instance of 𝑊𝑊—but that resulted in a model whose elements were too small to read on an A4 wide page.

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Figure 104: Goodwin model with plots

There are many interesting features to this model that we’ll explore later, but I want to address a
criticism that I’ve frequently heard of this model, that it is in some way contrived or “ad hoc”. In fact,
as I noted in Manifesto, this model—and my “Minskian” extension of it to include private debt—can
be derived directly from incontrovertible macroeconomic definitions. For this reason, I regard these
two models as not “ad hoc”, but as foundational models for a complex systems approach to
macroeconomics. I’ll explain why here as I redo the derivation of the model directly from
macroeconomic definitions.

In English, the definitions behind the Goodwin model are:

Labour
Employment Rate ≡
Population
(30)
Wages
WageShare ≡
GDP
Using the symbols we’ve already employed in building the flowchart version of Goodwin’s model,
these are:

L
λ≡
N (31)
W
ω≡
Y
I’ll derive the dynamic model using the differentiation shortcuts that I noted in Manifesto:

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• The percentage rate of change of a variable, say 𝑥𝑥, (expressed as a ratio rather than
1 𝑑𝑑𝑑𝑑
percentage) is ;
𝑥𝑥 𝑑𝑑𝑑𝑑
1 𝑑𝑑𝑑𝑑
• The notation mathematicians use for this expression is 𝑥𝑥� ≡
𝑥𝑥 𝑑𝑑𝑑𝑑
• The percentage rate of change of a ratio is equal to the percentage rate of change of the
�𝑋𝑋
numerator, minus the percentage rate of change of the denominator, so that � � = 𝑋𝑋� − 𝑌𝑌�;
𝑌𝑌
and
• The percentage rate of change of a product is the sum of the percentage rates of change of
�
the two parts of the product so that 𝑋𝑋 ∙ 𝑌𝑌 = 𝑋𝑋� + 𝑌𝑌�.

Putting the definitions in (31) into percentage rate of change format, and using the differentiation
shortcuts, yields:


   L   L  N
 
 
N
(32)
 W  
     W Y
 Y 

In words, Equation (32) is saying that:

• The employment rate will rise if the workforce grows faster than population; and
• The wages share of GDP will rise if total wages rise faster than GDP.

At the moment, these are still true-by-definition statements. To get from here to a model, we need
to introduce one more definition—the output to labour ratio 𝑎𝑎 ≡ 𝑌𝑌⁄𝐿𝐿—and the assumption of a
uniform wage rate 𝑤𝑤. This lets us make the following substitutions:

Y
L≡
a (33)
W= w ⋅ L
Substituting these definitions into the expression for 𝜆𝜆 in (32) yields the following for 𝜆𝜆:

λ= L − N 

Y 
= −N (34)
a
= Y − a − N


And for 𝜔𝜔:

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= W
ω  − Y

=w ⋅ L − Y
+L
=w  − Y
 (35)
=w + Y − Y
a
 + Y − a − Y
= w
 − a
= w
As did Goodwin, we’ll assume a constant rate of technological growth and a constant rate of
population growth. This lets us make the substitutions:

a = α
(36)
=β
N
Our almost completed model is now:

λ = Y − α − β (37)
= w
ω  −α

Now we need to expand 𝑌𝑌� and 𝑤𝑤

�. To do this, we need two more of Goodwin’s simplifying
assumptions:
𝐾𝐾
• A constant capital to output ratio 𝑣𝑣 = (which I discuss further in Chapter 10 on page 189 et
𝑌𝑌
seq.); and
• An investment function (with depreciation, which Goodwin omitted). Goodwin assumed that
all profits were invested.

Because 𝑣𝑣 is assumed to be a constant, the percentage rate of change of 𝑌𝑌 is identical to the

percentage rate of change of 𝐾𝐾:


K
Y =  
 v 
= K  − v (38)
 −0
= K

=K
Therefore, once we work out 𝐾𝐾� , we can substitute this for 𝑌𝑌�, otherwise known as the rate of
economic growth. We also insert Goodwin’s assumption that all profits are invested, so that 𝐼𝐼𝐺𝐺 = Π.

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d
K ≡ IG − δ K ⋅ K = Π −δK ⋅ K
dt
≡ 1 d K=
K
Π
−δK
K dt K
=   Y −W − δ 
K (39)
 K 
 v ⋅Y 
=  1− ω − δ
K K
v
1− ω
= Y −δK
v
That leaves just the rate of change of wages 𝑤𝑤
�, which is the “Phillips Curve”. Using the same linear
function as in Figure 80 give us:

 = S ⋅ (λ − Z )
w (40)
λ λ

Substituting (39) and (40) into (37) yields the reduced-form version of Goodwin’s model:

 1− ω 
λ 
= −δK  −α − β
 v  (41)
 = S ⋅ (λ − Z ) − α
ω λ λ

Expressed in differential equation form, this is:

d   1− ω  
λ = λ ⋅ −δK  −α − β 
dt  v   (42)
d
ω =ω ⋅ ( Sλ ⋅ ( λ − Z λ ) − α )
dt
This model, using the same parameter values as the previous model (plus initial conditions similar to
the initial values for 𝜆𝜆 and 𝜔𝜔) yields the same dynamics as Figure 104:

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Figure 105: The Goodwin model in reduced form

This is a foundational model for macroeconomics, firstly, because it can be derived directly from
incontestable macroeconomic definitions and a set of reasonable simplifying assumptions, and
secondly, because the simplifying assumptions themselves suggest ways in which the model can be
generalized and extended.

The assumption that all profits are invested, for example, is defensible as a first-order approximation
(in the Taylor series sense) in that investment is ultimately a function of profit; but the obvious
extension is that capitalists invest more than profits during a boom, and less than profits during a
slump. 33 This generates a “finance … demand for money”, the omission of which from The General
Theory (Keynes 1936) Keynes later realized was a significant error:

Investment finance in this sense is, of course, only a special case of the finance
required by any productive process; but since it is subject to special fluctuations
of its own, I should (I now think) have done well to have emphasised it when I
analysed the various sources of the demand for money. It may be regarded as
lying half-way, so to speak, between the active and the inactive balances. If
investment is proceeding at a steady rate, the finance (or the commitments to
finance) required can be supplied from a revolving fund of a more or less
constant amount, one entrepreneur having his finance replenished for the

33
Other factors, such as a desired level of capacity utilization, can be added. Matheus Grasselli and colleagues
are working on fitting my Minsky extension of Goodwin to US data, and preliminary results indicate that the
rate of investment should be modelled as depending upon the wages share of GDP (which includes the profit
share and hence the profit rate as an argument), the employment rate (which can be shown to be a proxy for
capacity utilization) and loans and deposit ratios of corporations.

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purpose of a projected investment as another exhausts his on paying for his

completed investment. But if decisions to invest are (e.g.) increasing, the extra
finance involved will constitute an additional demand for money. (Keynes 1937, p.
247. Emphasis added)

In an “endogenous money” world in which bank loans create money, this adds to aggregate demand
and income when the change in debt is positive, and subtracts from it when it is negative (Keen
2020b). As I explain in Chapter 9.2 on page 179, replacing “capitalist invest all their profits” with this
more realistic assumption is how I started the development of my model of Minsky’s Financial
Instability Hypothesis (Keen 1995).

There are therefore at least two methods to go about designing dynamic, complex-systems models
of the economy: the conventional flowchart method, and deriving a model from definitions using
calculus. Both approaches have their strengths: the flowchart method is easier, while the definitional
approach gives you some insights into how a model might be extended—by, for another example,
replacing the single-commodity definitions of 𝐾𝐾 and 𝑌𝑌 with multiple commodities and input-output
dynamics. The closed form solution is also more appropriate for stability analysis. Personally, I find
myself using the two approaches symbiotically as I build models.

But there’s one thing I could never model properly with flowcharts: the dynamics of the monetary
system. My first successful attempts to model monetary dynamics used systems of equations in the
mathematics program Mathcad, with a matrix keeping track of relationships between accounts
(Chapman and Keen 2006). But this only generated “static” plots of the models, when I wanted to
also show the system changing through time, as I could do with the system dynamics program
Vissim. However, every time I tried to put one of my models into Vissim, I’d make a mistake—by
changing one equation (say for debt) but not a related one (for money), or putting the wrong sign in
one equation, and so on. In 2008, I realized that I could generate the equations directly from the
matrix (which I originally did in the program Mathcad). This became the inspiration for creating
Godley Tables, and funding from INET in 2012 finally turned that into reality.

I’ve learnt a lot about money from building Minsky, and extending the capabilities of its Godley
Tables—so much so that I now know that some of what I wrote about money in Debunking
Economics (Keen 2011a) was wrong. I will start work on a 3rd (and final!) edition after completing this
book. And now to Minsky’s raison d’etre, Godley Tables.

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7 Godley Tables
Minsky’s double-entry bookkeeping tables are named after Wynne Godley, for three reasons:

• Godley, in collaboration with Francis Cripps, was the originator of the concept of using
double-entry bookkeeping tables to ensure stock-flow consistent modelling;
• I spent six very pleasant months at the Levy Institute in 2000, writing the first edition of
Debunking Economics while on sabbatical leave, and I learnt a great deal from interacting
with Wynne at that time, including the crucial role of double-entry bookkeeping in ensuring
stock-flow consistency; and
• Because non-Neoclassical economics needs to preserve the names of its heroes. If we leave
history to the victors—which, in the sad case of economics, means leaving it to Neoclassical
economists—then the names of our heroes will be forgotten. Hence the name of Minsky
itself, Godley Tables for our double-entry bookkeeping tool, and—if I can raise further
development funding after our £200,000 grant from Friends Provident Foundation runs
out—Moore Tables to show the macroeconomics of inter-sectoral flows, to honour Basil
Moore (Moore 1979, 1988b).

Godley Tables in Minsky differ from the flow matrix tables in Godley’s own work. Whereas both the
rows and columns in his tables summed to zero “on the principle that every flow comes from
somewhere and goes somewhere” (Godley 1999, p. 394), the rows in a Godley Table sum to zero,
but the sum of the columns adds up all the flows into and out of a given account, and therefore tells
you the rate of change of the account the column represents.

Therefore, when you fill out the rows in a Godley Table, you are actually building a set of differential
equations with which to model an integrated financial system. The rule enforced by the Godley
Table, that each row must sum to zero, ensure that these differential equations are stock-flow
consistent.

7.1 Creating a Godley Table

There are 2 ways to insert a Godley Table onto the canvas: click on the Godley Table icon on the
toolbar, and then click on the canvas where you wish to place it; or choose “Godley Table” from the
main menu item “Insert”.

When you first create a Godley Table, you get a bank icon on the canvas—see Figure 106.
Figure 106: A blank Godley Table icon

Double-click on the icon, or click the right-mouse button and choose “Open Godley Table”, and
Figure 107 will appear, inside a new Window.

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Figure 107: A blank Godley Table opened in an editing window

The top row labels each account as either an Asset, a Liability, or Equity—the difference between
Assets and Liabilities. The final column, labelled 𝐴𝐴 − 𝐿𝐿 − 𝐸𝐸, applies the “golden rule of accounting”,
that Assets minus Liabilities minus Equity equals zero, to each row in the table.

Immediately below this line has buttons to add or delete columns. There is one set of buttons for
each of Asset, Liability and also the Equity columns, if you enable multiple equity columns from the
Options menu (if you don’t, there are no buttons for the Equity column). The + key adds a new
column to the right, the – key deletes the current column, and the arrow keys move the selected
column one position to the left ← or right →.

The third line starts with the top left cell in the table, which notes that the columns are “Stock
variables”, while the rows are flows between these stock variables. The columns to the right are
where you type the names of the accounts (the down-triangle icon is discussed later).

The row below this shows the initial conditions for the accounts—the amount of money in each
account when a simulation commences—which must also follow the 𝐴𝐴 − 𝐿𝐿 − 𝐸𝐸 rule that the
numerical sum of these conditions must be zero. At the left-hand end of this line is a plus key, which
creates the first row. Once you have done this, plus, minus, up and down symbols appear to allow
you to add and delete rows, and move them up and down.

While there can be numerous entries in a row, the norm is two, which must sum to zero according to
the rule 𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴 − 𝐿𝐿𝐿𝐿𝐿𝐿𝐿𝐿𝐿𝐿𝐿𝐿𝐿𝐿𝐿𝐿𝐿𝐿𝐿𝐿𝐿𝐿 − 𝐸𝐸𝐸𝐸𝐸𝐸𝐸𝐸𝐸𝐸𝐸𝐸 = 0, which is checked by the 𝐴𝐴 − 𝐿𝐿 − 𝐸𝐸 column. The
entries are symbolic: words, not numbers. These words can include the formatting tricks discussed in
the first chapter—subscripts, superscripts, grouped text and Greek letters—and if 𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆 you can
have 0.7 × 𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆 in one column and 0.3 × 𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆 in another.

Now let’s use Minsky to build the simplest possible models of a monetary economy, starting with a
model of a pure credit economy in which all money is created by bank loans.

7.2 The simplest possible monetary model of a pure credit economy

Figure 108 shows a simple model with credit (bank-created) money only, with six flows: lending to
firms, interest payments, debt repayment, wages, workers’ consumption, and bank purchases from
firms.

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Figure 108: A simple Godley Table

Minsky takes these entries and creates a set of ordinary differential equations, which you can see
either by clicking on the Equations Tab, or by choosing “Export Canvas” from the File menu, and then
choosing the file type to be LaTeX (*.tex). Equation (43) shows the differential equations for Figure
108.

dBanks
= Interest F − Buy B
dt
dFirms
= Lend F + ConsumeW + Buy B − ( Interest F + Repay F + Wages )
dt (43)
dLoans
= Lend F − Repay F
dt
dWorkers
= Wages − ConsumeW
dt
Though this is quite a simple “toy” model, the same process enables huge, detailed models of the
financial system to be built, with complete confidence that these equations are stock-flow
consistent.

Once you have made entries in a Godley Table, the Godley icon on the canvas changes to show the
flows as inputs on the left-hand side, and the stocks as outputs on the bottom:

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Figure 109: A Godley Table after stocks and flows have been defined

You can also alter the view so that you see the actual Godley Table on the canvas. Choose “Editor
Mode” from the right-click menu, and the table will display as shown in Figure 110.
Figure 110: The Godley Table in Editor Mode

As the name of this display mode implies, you can edit the table here rather than in a separate
window, but you have to activate the row and column buttons that are shown automatically in the
separate window. You can also turn on showing the stocks and flows attached to the table via the

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“Display Variables” option on the right-click menu—see Figure 111 (I have also added a title to the
Table, using the right-click menu option “Title”).
Figure 111: The Table showing editing buttons and the Stock and Flow widgets

One thing Russell Standish and I have focused upon in designing Minsky is enabling quality
documentation of a model by Minsky itself. This includes the capacity to export a Table in either CSV
or LaTeX format, via the “Export to File” option on the right-click menu (and also on the file menu
from within a Godley Table window). Figure 112 shows the LaTeX output for the Table in Figure 111.
Figure 112: A screenshot of the LaTeX rendition of a Godley Table

7.3 Defining the flow elements of a Godley Table

The Godley Table itself clarifies issues in monetary economics, even without a simulation—especially
when it is linked to other Godley Tables in an integrated model. But it also makes the modelling of
monetary dynamics so much easier than with flowchart programs, as noted above.

To turn a Godley Table into a model, the flows in it have to be defined on the canvas itself, using the
same flowchart logic as in the previous section. There are two ways to get the stock and flow
variables in a Godley Table onto the canvas: individually, by right-clicking on the flow or stock
variables attached to either the icon (Figure 109) or the table (Figure 111); or by right-clicking on the

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table and choosing “Copy Flow Variables” and “Copy Stock Variables” commands which copies all
the relevant variables at once. Figure 113 shows the canvas after they have all been copied. 34
Figure 113: All the stock and flow variables from a Godley Table copied to the canvas

How you define a model is up to you, but you can only define it using the variables and stocks you
currently have, or transformations of them—so if you want to define investment flows in a model as
a function of capacity utilization, for example, or the wage level as a function of the level of
employment, then you need to add those variables to your system. Here I’ll just demonstrate
defining a model from the elements of the Godley Table itself.

The simplest flow to define is InterestF, which is the rate of interest on loans multiplied by the
current level of Loans. In Figure 114 I add a new parameter, rLoansF, for the rate of interest on loans to
firms, multiply that by the stock variable Loans, and this defines InterestF (I have also shrunk the
Godley Table using its bounding box arrows).

34
Shortly after this manual is published, a third method of being able to add stocks and flows to the canvas
from a Godley Table will exist. We plan to generalize the current system of inserting variables, parameters and
constants to having a drop-down menu for each starting with “New…”, and the listing the existing stocks, flows
and parameters respectively for selection to place onto the canvas.

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Figure 114: Defining interest payments (without hitting the “Recalc” button before exporting the figure)

To define the other flows, I use the mechanism I explained earlier in these models—the first-order
time lag. As well as being useful to define a lagged variable, such as lagged inflation as a function of
the actual rate of inflation, it can be used to explain a flow as a time-based response to a stock. For
example, the level of repayment of existing debt will be roughly proportional to the current level of
loans—it can be a large proportion or a small one, but there will be some proportionality. This could
be done using a simple scalar—say, for example 10%, so that 10% of loans are repaid every year, as
in Figure 115.
Figure 115: Repayment modelled using a repayment rate (after hitting the “Recalc” button)

I prefer to use a time constant instead, because then the value of the time constant is easily
understood in terms of the time dimension of the model. If I give that time constant a value of 10, as
in Figure 116, then I get the same numerical result as in Figure 115, but the number 10 stands for the
number of years it would take to reduce the debt to zero if this rate of repayment were sustained.

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Figure 116: Using a time constant instead for the rate of debt repayment

A similar definition for the rate of new lending tells you how long this rate of lending would take to
double the debt—see Figure 117, where I’ve also copied the model’s parameters to the top of the
canvas, where they can be varied easily during a simulation.
Figure 117: Lending also with a time constant, plus copying parameters into a "control panel"

This simple model, without any physical output or price component, needs a definition of GDP as
well in terms of financial flows only. We can’t just add up consumption and investment using this
model, because the only non-financial flows in it are Wages as the income of workers, and
consumption by workers (ConsumeW) and bankers (BuyB): there’s no definition of profit as the
income of capitalists, nor is there any definition of investment—which involves capitalists buying
from other capitalists, and is therefore subsumed within the single column for the Firm sector. So,

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given how this simple model is constructed, investment—as well as profit, and consumption by
capitalists—doesn’t appear at all, and it therefore has to be inferred as a residual.

My approach in these simple models (without an integrated model of the physical economy as well)
has been to take a leaf out of Das Kapital—specifically, Volume II, Chapter 7, “The Turnover Time
and the Number of Turnovers”: 35

We have seen that the entire time of turnover of a given capital is equal to the
sum of its time of circulation and its time of production. It is the period of time
from the moment of the advance of capital-value in a definite form to the return
of the functioning capital-value in the same form. (Marx and Engels 1885)

In this model, GDP is derived from the amount of money in the Firm sector, and its turnover rate:

Firms
GDP = (44)
τF
This equation, in flowchart form, is highlighted in grey in Figure 118.
Figure 118: GDP as the turnover of money per year in the firm sector

With GDP defined this way, inter-firm spending (which in this simple model, includes investment and
consumption by capitalists, since I haven’t separated out capitalists as a different financial entity to
Firms in this model) is the residual between GDP and wages. This residual includes profits, dividends,
etc.—again, aspects of a capitalist system that you could explicitly model in a more elaborate model.

I also use a very simple assumption to determine wages: I make the distribution of income a
parameter, so that 𝜔𝜔% of GDP goes to workers and (1 − 𝜔𝜔)% goes to capitalists as gross profit,

35
https://www.marxists.org/archive/marx/works/1885-c2/ch07.htm.

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with this minus interest payments being net profit (in an integrated physical-monetary economy
model, wage determination would be driven by bargaining power, as in the Goodwin model).

This leaves consumption by workers and bankers to be defined. You could, of course, make a
“Kaleckian” assumption that workers simply consume their wages, and equivalently, that bankers
spend their interest income. For the sake of illustration, I’ll do that first (in Figure 119), and compare
the results to a model with time constants, based on the amount of money in the workers’ and
bankers’ accounts.

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Figure 119: "Kaleckian" assumptions on consumption by workers and bankers

This Kaleckian assumption effectively making workers and bankers passive parts of the system,
rather than active parts: whatever they receive as Wages ($216/Year) or Interest ($5.50/Year) goes
out as consumption. On the other hand, if you base spending upon the amounts in their bank
accounts, divided by time constants that reflect the fact that workers are living close to “hand to
mouth” whereas bankers have large buffers compared to their spending, then you have a small time
constant for Workers and a large time constant for Bankers. Changing the distribution of income
between workers and bankers will therefore change the amount turning up in the Firms account,
thus changing GDP.

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Figure 120: Consumption based on time constants

Figure 120 also shows the advantages of dividing by a time constant to define a flow, rather than
multiplying by an equivalent constant. The value for the time constant tells you how long, in
fractions of a year, that the social class could consume before running out of money: 1/25th of a year
for Workers (otherwise known as a fortnight), 2.5 years for Bankers. The size of the time constant is
readily interpreted as an indicator of the relative income and wealth of the two social classes.

Figure 121 illustrates the impact of varying the time constants in the model. If the time constant for
lending is smaller than that for repayment, then there is net debt and money creation by the
banking sector, and GDP rises. If repayment is faster than new lending, then there is net money
destruction and GDP falls. Changes in the workers’ time constant have more impact than changing
that for bankers—workers spend their accounts much more quickly than bankers, because they have
to. So though their bank accounts are the same size in Figure 121, workers generate far more
spending than do bankers ($250/Year versus $4/Year).

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Figure 121: Varying time constants for lending, repayment, worker & banker consumption

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By using the “Editor Mode” display of the Godley Table, and choosing “Godley Table Show Values”
from the Preferences form of the Options main menu (see Figure 122), you can see the amounts
passing between the accounts in this model in the Godley Table itself—see Figure 123.
Figure 122: The Preferences form from the Options menu

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Figure 123: Editor Mode display with numerical values shown in the Godley Table

The last step in putting together a comprehensive model is to show the financial system from the
point of view of Firms and Workers, as well as from the Banking sector. To do this, insert two more
Godley Tables on the canvas, label one Firms and the other Workers, and then use the down-arrow
on the columns ( ) to search for Liabilities that haven’t yet been defined as Assets, and vice versa.
The Firm sector has one Asset—its deposit account Firms—and one Liability—Loans. When these are
added to its Godley Table, Minsky automatically fills in the rows where there are already operations
on both accounts (LendF and RepayF), while leaving those where there is an operation on one but not
the other unbalanced: the sum of 𝐴𝐴 − 𝐿𝐿 − 𝐸𝐸 shows the flow that hasn’t yet been allocated to an
account—see Figure 124.

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Figure 124: The Firm sector's Godley Table with Assets & Liabilities added

To fully specify the model, you need to define an Equity column for the Table. I used FirmE as the
name for “Firm Equity” and made the matching entry needed so that 𝐴𝐴 − 𝐿𝐿 − 𝐸𝐸 = 0 on every row—
see Figure 125. In this simple model, all those entries go in the Equity column, but that isn’t
necessarily the case in a more complex model. You might, for example, have CashW as an asset of the
Workers, so that withdrawing money from the Banking sector reduced the Workers’ deposit account
(Workers) and increased their cash account CashW, without altering their Equity.
Figure 125: The model from the Firm sector's point of view

Figure 126 shows the complete model, with all accounts recorded in the respective Godley Tables.

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Figure 126: The complete model, which is still very simple, with financial dynamics only

I hope that’s enough background to enable you to use Godley Tables in your own modelling. Now
let’s use Minsky to show why, when it comes to money, Paul Krugman doesn’t know what he’s
talking about.

7.4 A Keen Rant: Using Minsky to Revisit the Keen-Krugman Debate

Almost a decade ago now, Paul Krugman gave me a birthday present, by citing me in his New York
Times column on March 27th, 2012. 36

Entitled “Minsky and Methodology (Wonkish)”, the post began as any birthday present should—it
was very nicely wrapped:

My birthday is March 28th, and since I lived in Sydney then, I first saw his column when I was alerted to it on
36

my birthday by a Facebook message.

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Figure 127: The opening to Krugman's first post

Unfortunately, once I opened the present, it was all downhill. He wrote a series of seven posts, 37
ending with “Oh My, Steve Keen Edition”, whose final line was “Nick [Rowe] uses a four-letter word
to describe this; I can’t, because this is the Times.”

In between the nice introduction and the derogatory denouement, there was something that is far
too rare in economics today, a “debate” between opposing schools of thought in economics over a
fundamental issue. I put “debate” in inverted commas because we never spoke, and while I read his
posts, he didn’t read mine. 38 But the juxtaposition of opposing views was something that rarely
happens in economics, so in that sense, it qualifies as a debate.

The topic of the debate was “Do banks, debt and money matter in macroeconomics?” Krugman’s
position was “No” back then, and it’s still “No” today: in the 2021 promotional video for his
Masterclass on economics, 39 he says “It’s about people. It’s not about money”.

37
Krugman’s posts on me https://krugman.blogs.nytimes.com/2012/03/27/minksy-and-methodology-
wonkish/; https://krugman.blogs.nytimes.com/2012/03/27/banking-mysticism/;
https://krugman.blogs.nytimes.com/2012/03/30/banking-mysticism-continued/;
https://krugman.blogs.nytimes.com/2012/04/01/tobin-brainard-1963/;
https://krugman.blogs.nytimes.com/2012/04/02/things-i-should-not-be-wasting-time-on/;
https://krugman.blogs.nytimes.com/2012/04/02/a-teachable-money-moment/;
https://krugman.blogs.nytimes.com/2012/04/02/oh-my-steve-keen-edition/.
38
My posts on Krugman http://www.debtdeflation.com/blogs/2012/03/29/krugman-on-or-maybe-off-keen/;
http://www.debtdeflation.com/blogs/2012/04/02/blog-observations-on-krugman/;
http://www.debtdeflation.com/blogs/2012/04/03/oh-my-paul-krugman/;
http://www.debtdeflation.com/blogs/2012/04/04/krugman-apologises/;
http://www.debtdeflation.com/blogs/2012/04/09/capital-account-interview-on-the-keen-krugman-brawl/.
39
https://www.masterclass.com/classes/paul-krugman-teaches-economics-and-society/. Of course, this is a
course that I don’t recommend you undertaking!

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Figure 128: Screenshots from Krugman's promotional video

Yes it is (also) about money, as I’ll now explain using Minsky. 40 Firstly, here are the substantive parts
of Krugman’s first post in 2012, where he set out very well the basic assumptions of the “Loanable
Funds” model of banking. I’ve highlighted the key passages in italics:

I always try to find the simplest representation I can of whatever story I’m trying
to tell about the economy. The goal, in particular, is to identify which
assumptions are really crucial — and in so doing to catch yourself when you’re
making implicit assumptions that can’t stand clear scrutiny.

Keen doesn’t seem to be doing that. His paper contains a number of assertions
about what is crucial, without much explanation of why these things are crucial.
And I guess I just don’t see it.

In particular, he asserts that putting banks in the story is essential. Now, I’m all
for including the banking sector in stories where it’s relevant; but why is it so
crucial to a story about debt and leverage?

Keen says that it’s because once you include banks, lending increases the money
supply. OK, but why does that matter? He seems to assume that aggregate
demand can’t increase unless the money supply rises, but that’s only true if the

40
I received the INET grant that enabled me to create Minsky in September 2011, so Minsky was in its infancy
back then, and in particular, we hadn’t yet implemented Godley Tables: all Minsky could do back then was
model simple ordinary differential equations using the flowchart paradigm of conventional system dynamics
programs—See https://www.ineteconomics.org/research/grants/extending-macroeconomics-and-developing-
a-dynamic-monetary-simulation-tool. Therefore, I couldn’t use Minsky to illustrate my argument back then
(the original version is still accessible from
https://sourceforge.net/projects/minsky/files/Windows%20Binaries/).

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velocity of money is fixed; so have we suddenly become strict monetarists while I

wasn’t looking? In the kind of model Gauti and I use, lending very much can and
does increase aggregate demand, so what is the problem?

Keen then goes on to assert that lending is, by definition (at least as I understand
it), an addition to aggregate demand. I guess I don’t get that at all. If I decide to
cut back on my spending and stash the funds in a bank, which lends them out to
someone else, this doesn’t have to represent a net increase in demand. Yes, in
some (many) cases lending is associated with higher demand, because resources
are being transferred to people with a higher propensity to spend; but Keen
seems to be saying something else, and I’m not sure what. I think it has
something to do with the notion that creating money = creating demand, but
again that isn’t right in any model I understand. (Krugman 2012b. Emphasis
added)

The key technical issue here is what do banks do? According to Krugman, banks take in deposits
from some customers, and lend them out to others:

If I decide to cut back on my spending and stash the funds in a bank, which lends
them out to someone else, this doesn’t have to represent a net increase in
demand…

This is not, of course, what banks actually do, as we now can state with the authority of the Bank of
England:

This article explains how the majority of money in the modern economy is
created by commercial banks making loans. Money creation in practice differs
from some popular misconceptions — banks do not act simply as intermediaries,
lending out deposits that savers place with them, and nor do they ‘multiply up’
central bank money to create new loans and deposits. (McLeay, Radia, and
Thomas 2014. Emphasis added)

But it’s worth putting Krugman’s misconception into Minsky to show that, if Neoclassicals were right
about what banks do, then they would also be right to ignore banks in their macroeconomic models.

Fundamentally, as the Bank of England notes, Neoclassicals believe that banks act “simply as
intermediaries”. I call it the “Ashley Madison theory of banking”—see Figure 129 if you haven’t
heard of Ashley Madison before.

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Figure 129: Ashley-Madison as an intermediary

Ashley Madison doesn’t actually provide sex: instead, it lets men who want sex find women who
want sex, and charges a fee for the introduction service. Similarly, in the Neoclassical mind, banks
don’t actually provide money: instead, they let people with more money than they need at the
moment (savers) meet people with less money than they need (borrowers). The savers lend money
to the borrowers, and the bank charges a fee for the introduction. No money is created because of
the new debt—just ask Paul Krugman:

Think of it this way: when debt is rising, it’s not the economy as a whole
borrowing more money. It is, rather, a case of less patient people—people who
for whatever reason want to spend sooner rather than later—borrowing from
more patient people. (Krugman 2012a, pp. 146-147. Emphasis added) 41

The easiest way to model what Krugman—and all Neoclassicals, with almost the sole exception of
the Bank of England economist Michael Kumhof—think banks do, is to model the literal case of
savers lending money directly to borrowers, through the deposit facilities provided by banks. Figure
130 shows the banking sector’s view of that person-to-person case, where the “less patient people”
are factories, and the “more patient people” are rentiers who both invest in and lend to factories.
The bank has only one asset—Reserves, which match the sum of the deposits of Impatient people,
Patient people and Workers, plus the Banking sector’s Equity. 42 The first four rows show financial
operations—lending, paying interest, repaying debt, and paying the bank’s “intermediation” fee.
Then we have paying wages to workers, which enables production; dividend payments to
shareholders (those “patient people” again), and finally consumption of the output of the factories
managed by the “impatient people” by “patient people”, workers and bankers.

41
I will never cease to be amused by Neoclassical protestations that their approach is “value-free”, while at the
same time they use pejorative terms all the time: “perfect” competition, Pareto “optimal”, etc. And here,
Krugman gives us “patient” versus “impatient” people…
42
In most models, for the same of simplicity, I treat Bank Equity as short-term “at call” funds, ignoring that
banks have long-term equity (which includes long-term debt). But Minsky supports multiple Equity columns, so
if you wish you can model Bank Equity as including both at-call and long-term components: just choose
“Enable multiple Equity columns” from the Preferences form on the Options menu.

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Figure 130: Patient lends to impatient via the banking system

Notice that while lending shows up in the banking sector’s Godley Table, the actual debt owed
doesn’t, because in this model, the debt is not an asset of the banking sector: instead, it’s an asset
for the “Patient” people and a liability for the “Impatient” people. So to see the debt itself (which I
labelled as “Loans” in this model), you have to create additional tables for Patient, Impatient and
Workers. Figure 131 shows all the Godley Tables in this model—as noted in the chapter on Godley
Tables, all you have to do is create a new table and then use the down-arrow on the columns ( )
to search for Liabilities that haven’t yet been defined as Assets, and vice versa.

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Figure 131: All the Godley Tables for "Patient to Impatient" lending

To complete the model, I made very similar definitions to the model developed in Figure 126—see
Figure 132. The main differences are that Krugman’s silly “Impatient” term takes the place of the
Firm sector there.

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Figure 132: The definitions of flows in the Loanable Funds model

With those definitions made, the model can be run, and the parameters that control lending and
repayment varied while the model runs, to see the impact of higher and lower levels of credit and
debt on this toy economy. While there clearly is some impact, some things don’t change: as
Krugman put it himself, “when debt is rising, it’s not the economy as a whole borrowing more
money”: changes in debt have no impact on the money supply. There are variations in GDP and
incomes as a result of the variations in the time constants for lending and repayment, but they are
both minor and transient. If this model described the real world accurately, then it would make sense
to leave banks, debt and money out of macroeconomics. To cite Krugman once more: 43

“I’m all for including the banking sector in stories where it’s relevant; but why is it
so crucial to a story about debt and leverage?” (Krugman 2012b)

Take a minute to savor this statement. If anyone scoffs at the assertion that mainstream economists
don’t understand banks, debt and money, just show them this gem.

Anyway, to answer his question, we have to take account of the real-world situation that banks lend
to non-banks, so that Loans are an asset of the Banking Sector, and not of “Patient People”. Before I
show how to do this, note one aspect of Figure 133: given the parameters in the model, a higher

43
https://krugman.blogs.nytimes.com/2012/03/27/minksy-and-methodology-wonkish/.

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debt to GDP ratio is associated with a lower GDP—see the Income and Debt/GDP plots on the right
hand side of Figure 133.
Figure 133: Dramatic changes in Debt/GDP, minor transient changes in GDP

To change this model so that Banks, rather than “Patient People”, lend to “Impatient People”, you
have to:

• Shift the Loans column from Patient’s Godley Table to the Bank’s;
• Delete the financial operations on the Patient Godley Table: the first three rows for Interest
payments, lending and repayment all go, leaving just two rows—receiving Dividends and
consuming;
• Make room for a new Asset on the Banking Sector Godley Table by clicking on the green plus
icon below the Asset label;

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• Click on the , which will show Loans as a Liability that hasn’t yet been classified as an
Asset (when you delete the Loans column from Patient’s Godley Table, Loans remains in the
model as a Liability of Impatient), and select Loans;
• Minsky then brings across the two operations that affect Loans, Lend and Repay;
• The Banking sector Godley Table will still show Interest as a transfer out of Impatient’s
account, but it doesn’t go anywhere; Type “Interest” into the BankE column, to show that
interest payments increase the (at-call) equity of the banking sector.

That’s it: strictly speaking we should also change how lending is determined, since the Loanable
Funds model shows lending as being based on amount of money in Patient’s deposit account, but
this is enough to see if this simply structural change to the model—as opposed to a behavioural
change—has any impact on the dynamics.

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Figure 134: Altering the Godley Tables of Loanable Funds to fit the real world

You bet it does: see Figure 135. Debt creates money, so the money supply rises when debt rises, and
falls when it falls; a rising debt to GDP ratio is associated with a rising GDP (and the obverse for
falling debt); credit growth, which was out of synch with GDP growth in the Loanable Funds model,
now parallels—and in fact causes—the growth of GDP. We are in a completely different world to the
Neoclassical model of loanable funds—and it happens to be the real world we actually inhabit.
Loanable Funds is a misleading fantasy.

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Figure 135: Dramatic changes in Debt/GDP, dramatic changes in GDP

So too are all the models that go with it—especially the model of “Fractional Reserve Banking”. Here
Mankiw’s Macroeconomics textbook gives a good outline of the fantasy. It starts with banks as just
warehouses for deposits:

We begin by imagining a world without banks. In such a world, all money takes
the form of currency, and the quantity of money is simply the amount of
currency that the public holds. For this discussion, suppose that there is $1,000 of
currency in the economy.

Now introduce banks. At first, suppose that banks accept deposits but do not
make loans. The only purpose of the banks is to provide a safe place for
depositors to keep their money.

The deposits that banks have received but have not lent out are called reserves.
Some reserves are held in the vaults of local banks throughout the country, but

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most are held at a central bank, such as the Federal Reserve. In our hypothetical
economy, all deposits are held as reserves: banks simply accept deposits, place
the money in reserve, and leave the money there until the depositor makes a
withdrawal or writes a check against the balance. This system is called 100–
percent–reserve banking. (Mankiw 2016, p. 89. Emphasis added)

Mankiw displays this using a T-Account:

Figure 136: Mankiw's model of Full Reserve Banking

Firstbank’s Balance Sheet

Assets Liabilities
Reserves $1,000 Deposits $1,000
When Mankiw introduces lending, it is lending from reserves:

Now imagine that banks start to use some of their deposits to make loans… The
banks must keep some reserves on hand so that reserves are available whenever
depositors want to make withdrawals. But as long as the amount of new deposits
approximately equals the amount of withdrawals, a bank need not keep all its
deposits in reserve. Thus, bankers have an incentive to make loans. When they
do so, we have fractional–reserve banking, a system under which banks keep
only a fraction of their deposits in reserve. (Mankiw 2016, pp. 89-90)

Mankiw then shows the bank as lending out 80% of its reserves:
Figure 137: Mankiw's model of Fractional Reserve Lending

Firstbank’s Balance Sheet

Assets Liabilities
Reserves $200 Deposits $1,000
Loans $800
Let’s compare this model of banks to what banks actually do, in Minsky—see Figure 138.
Figure 138: Comparing actual banking with the Fractional Reserve Banking Model

The first line shows what banks actually do to make a loan: they add an amount to the borrower’s
deposit account, and simultaneously record a debt by the borrower to the bank for precisely the
same amount. Lending creates deposits directly, which is creating money directly—there’s no need
for the iterative process alleged in the Fractional Reserve Banking model.

The second line shows the first stage of Fractional Reserve Banking model, but it is clearly
incomplete: it shows a transfer of Assets from Reserves to Loans, but where is the money for the
borrower?

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The only way to show the loan actually giving money to the borrower is if the loan is in cash: the
borrower walks out of the bank with a debt to the bank as shown in Figure 138, and an equivalent
amount of cash, as shown in Figure 139.
Figure 139: Completing the first round of Fractional Reserve Banking

This alone is enough reason to reject the model: it’s very easy to say “use some of their deposits to
make loans” as Mankiw does, but when one models what that means in strict double-entry format,
lending from reserves only works if all loans are in cash. 44 In the real world, almost all loans are
made by crediting a deposit account. 45

So why do Neoclassicals stick with an unrealistic and complicated model, in place of a realistic and
simpler one? Because with the more complicated model, they can ignore banks and money and debt
in their macroeconomics, and claim that the money supply is controlled by government policy—
government reserve creation times the “money multiplier”—rather than determined by bank
lending. In part, this is ideology disguised as science, but it’s also the standard reaction of a discipline
to a discovery that contradicts a core belief. As the physicist who discovered quantum mechanics put
it:

“a new scientific truth does not triumph by convincing its opponents and making
them see the light, but rather because its opponents eventually die, and a new
generation grows up that is familiar with it.” (Planck 1949, pp. 33-34)

Krugman’s reaction to the Bank of England report that rejected these textbook models is par for the
course here. The Bank of England paper said nothing that hadn’t been said by many non-mainstream
economists in the previous five decades (Moore 1979, 1988a; Graziani 1989; Holmes 1969), but it
said it with the authority of a body that Neoclassical economists could not ignore:

The reality of how money is created today differs from the description found in
some economics textbooks:

• Rather than banks receiving deposits when households save and then
lending them out, bank lending creates deposits.

44
Or some other negotiable instrument like a bank cheque.
45
It doesn’t have to credit the depositor’s account per se: if you use your credit card to shop, the deposit
account that will be credited will be the merchant’s, while the increased debt will be recorded against your
credit card account. But the essence of the entire process is contained in that one line in a Godley Table.

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• In normal times, the central bank does not fix the amount of money in
circulation, nor is central bank money ‘multiplied up’ into more loans and
deposits. (McLeay et al. 2014a, p. 1. Emphasis added)

Pretty definitive, right? So how did Krugman react to it? 46 See Figure 140:
Figure 140: Krugman's reaction to the Bank of England paper

That reaction can be summarized as “I’ve read it. So what?”. He did not even consider that he should
model what this meant for money creation, let alone macroeconomics as a whole. The same applies
to Mankiw, whose textbook post-dates the Bank of England paper, and yet repeats the myths that
the Bank of England debunked.

In a moment, we’ll leave these barter mystics behind, and consider the actual macroeconomics of
money. But beforehand, I want to cover one important point: though all the Minsky models I’ve
shown to date have been either pure “Godley Table” models, or pure flowchart models, it’s quite
easy to mix the two—thus letting Godley Tables handle the monetary dynamics of a model
economy, and the flowchart cover the physical dynamics.

7.5 A Mixed Godley Table-Flowchart model

In all the models to date, I’ve either used the Godley Tables to lay out the system’s dynamics, as in
Figure 131, or a flowchart, as in Figure 104. In every Figure between Figure 121 and Figure 135, the

46
https://krugman.blogs.nytimes.com/2014/04/28/a-monetary-puzzle/ .

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flowchart components were used to define variables in the Godley Table itself, while the Godley
Table generated all the differential equations that power the model.

But this is done just for convenience. It’s quite easy to combine a model of mixed monetary and
physical dynamics. I’ll illustrate this starting from a simple Godley-Table-only model, as illustrated in
Figure 141.

I’ve copped a fair bit of criticism (on YouTube and social media) for the part of this model highlighted
in Figure 141: the determination of GDP by turnover of money in the Firm sector’s bank account, and
then also profits and wages. 47
Figure 141: A pure Godley Table model with money turnover assumptions determining GDP, Profits and Wages

For the record, I don’t think this is how capitalism actually works: this is just a genuine simplifying
assumption to allow me to ignore the physical economy and concentrate on monetary dynamics,
which—thanks to the ignorance of Neoclassical economists and the fervency of other ideologues—
remains an area of great contention in economics today. Of course, Neoclassical economists get the
physical economy wrong as well, with their fetish for equilibrium, and an unrealistic “production
function” (the “Cobb-Douglas”) that is both tautological where it’s right, and delusional where it’s
wrong. 48 In practice, I want to encourage economists to build mixed monetary-physical economy

47
Capitalist consumption and investment is necessarily implicit in this model, because expenditure by
capitalists on themselves—firms buying goods off other firms, capitalists (who are subsumed into the firm
sector) buying goods off firms, etc—can’t be displayed without adding several more sectoral accounts. The
other option—which is a design ambition for Minsky, and is therefore dependent on raising more development
funds—is to enable Godley Tables to be three-dimensional. Then intra-firm monetary exchanges would occur
between slices of a Godley Cube, while inter-sectoral exchanges would occur on the front face of the cube, as
now.
48
See Forget the “Cobb-Douglas Production Function” (an optional read), starting on page 190.

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models (with ecological linkages as well—see Chapter 10, starting on page 189). So let’s see how,
using my model of Minsky’s Financial Instability Hypothesis.

Figure 142 shows this model. The physical output part of the model—the flowchart components
directly below the Godley Table—reproduce Goodwin’s model. The monetary components—
borrowing and debt repayment, interest, wages and consumption—are added via the Godley Table
for the banking sector. The key factors I added to Goodwin’s model to reproduce Minsky’s
Hypothesis were an investment function in place of Goodwin’s assumption that all profits were
invested, and debt financing investment in excess of profits. This was easily modelled by the
combined actions of the Godley Table, where the Debt column has entries +𝐵𝐵𝐵𝐵𝐵𝐵𝐵𝐵𝐵𝐵𝐵𝐵 and −𝑅𝑅𝑅𝑅𝑅𝑅𝑅𝑅𝑅𝑅:

dDebt
 Borrow  Repay (45)
dt
And some of the flowchart elements highlighted in the Figure which equate borrowing to gross
investment and profits to debt repayment:

Borrow  IG
(46)
Repay  
Done in this way, the crucial role of the endogeneity of money in Minsky’s Hypothesis is obvious:
since loans create deposits, the act of borrowing to finance investment expands both the money
supply and aggregate demand.
Figure 142: Using a Godley Table in the Keen-Minsky model

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I’ve added one tiny feature to the model as well, using a switch to make it an option in running the
model. In the original model, the role of consumption is effectively ignored, with workers’
consumption equalling wages and bank spending equalling interest. That is the default shown in
Figure 142, but if the parameter 𝜏𝜏 ? Is set to 1, consumption is instead based on the money in
Workers and Banks, divided by a time-constant:

Workers
CW =
W
(47)
Banks
CB =
B

This is to address one criticism I’ve also heard of the model, and which is surely reproduced in some
academic papers somewhere, that it is a “supply driven” model, rather than a demand driven one.

Hello? The driving force in the model is the investment function, and since when was investment not
a component of aggregate demand? The element that is missing from the original model (Keen
1995) was any model for consumption, so that consumption was the residual variable—since the
model determined both investment and output.

The capacity to base consumption on a time constant in this model is a simple step towards
modelling both investment and consumption. This necessarily means that the residual variable is
now something not modelled here: unsold stocks, since with investment, consumption and output
determined, the free variable will be unsold stocks. Price dynamics are also absent—though they can
easily be added.

Now let’s turn to the key issue for which Minsky was designed: to allow the easy analysis of
monetary dynamics in a capitalist economy.

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8 Money
My main motivation for inventing Minsky was to enable proper modelling of money. Since then,
Modern Monetary Theory (MMT) has risen to prominence, and Minsky is ideally suited to analyzing
the claims and counter-claims made about MMT. The core claim is that government spending
precedes taxation: that rather than having to tax to be able to spend, governments create money
first by spending, and tax it back later. 49

One of the best ways to illustrate this is to take a situation where there was no monetary system,
and have money introduced. As Graeber (Graeber 2011) emphasized, this was not what normally
happened in history—the assumption first enunciated by Smith that barter was the rule before
money was introduced is a myth. But there are instances where one political system has collapsed,
and the monetary system with it, followed later by the development of a new monetary system in
the context of forging a new political system. The legal scholar Christine Desan identified instances
of this in England after the collapse of the Roman Empire:

The new narrative explains how each of the capacities associated with money—
its function as a unit of account, mode of payment, and medium of exchange—is,
at base, a mode of governing. The unit of account, first, arises when a
stakeholder takes something that is not fungible—the in-kind service owed by
individuals or families—and marks it with a token. Accounts that rely on the
“convergence story” of money’s creation often simply assume the existence of a
unit of account because it is so difficult to understand how people who are
engaged only in bipolar exchanges can create a term for value that is shared
among them all. But establishing a unit of account is a critical accomplishment
that demands an explanation. The capacity of an object to furnish homogeneous
comparative terms—a unit of account—to evaluate other objects supplies the
terms for “counting” value, i.e., price. That unit is used both as the basis of
accounting systems and as the metric into which circulating coin or currency can
be converted. Once we admit the agency of a stakeholder common to those
engaged in bipolar exchanges, the accomplishment becomes intelligible.

In early medieval England, rulers chose to make the basic unit of account—the
penny—out of silver. That choice gave silver a price. For example, a weighed
pound of silver of specified fineness might be exchanged for 230 pennies at the
mint—the “mint price” received when an individual took that amount of bullion
in to be coined. The mint made perhaps 242 pennies out of the bullion, kept 12
for the moneyer and the king, and returned the remainder. The “price” of silver
was tied, by definition, to the value of the tribute or tax obligation: pennies made
by the mint were the tokens used by the king to pay for resources advanced to
him. At the time the tax was due, each penny carried value towards extinguishing
the tax obligation.

Note that without violence to that reality, observers could assume that coin
expressed the value of the silver it contained: at tax time, the arrangement itself
identified the value that a penny held for extinguishing the fiscal obligation with

49
We’ve already seen this in the Chapter Error! Reference source not found. on modelling money without
mathematics. Here I’ll replicate the models in Manifesto and introduce mathematical modelling of fiat money
dynamics as well.

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the value of silver. In fact, we might say that the silver coin had become a
material proxy for the tax obligation. (Money therefore also furnished a “store of
value,” another function often attributed to money.) It was not, however, the
content of coin that gave it a priced value, but the system that made coin into
money. (Desan 2015, p. 58)

Desan singled out the example of the 8th century King of Mercia, Offa, whose coinage was
particularly well designed—see Figure 143.
Figure 143: A silver penny from Offa's reign

The main aspect to the design wasn’t the art on the coin itself, but the role of the coin in defining
the Kingdom itself: what once were payments-in-kind to the King became payments in coin, while
the coin came to be used in person-to-person trade in the Kingdom as well:

in-kind payment of rents began to be converted in part into cash payments

during the 8th century, a trend that would continue in later centuries, and the
late 8th century Mercian king Offa extended tribute obligations to virtually
“everyone” in his territory… tokens clearly acted as a “mode of payment” to the
government when they were returned in lieu of tribute or other obligation. As we
saw above, the tokens invited use as a mode of payment in private deals as well.
(Desan 2015, pp. 57-59)

The first fully-fledged Minsky model in Manifesto simulates this “ab initio” creation of a monetary
system.

8.1 Modelling the Origins of Fiat Money in Minsky: pp. 33-39 of Manifesto

File: http://www.profstevekeen.com/wp-
content/uploads/2021/05/Figure03DesanOffaCoins-1.mky

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To create a monetary system based on coins, firstly you have to create the coins. Assuming that the
King starts with enough silver to make the initial coins, the most sensible entity to start with is the
authority he directs to make the coins, The Mint. 50

The steps in this process are:

• The Mint creates the coins;

• The Mint gives the coins to the Treasury;
• The Treasury spends the coins to procure goods from lords and peasants, where the
purchase replaced the pre-monetary practice of compulsory acquisition at the point of a
sword (the in-kind payment of rents noted by Desan above);
• The coins are then used by lords to pay peasants to produce output, which is sold to both
lords and peasants, and the government (this is a bit of a fiction: back in the 700s, peasants
were indentured to their feudal lords, but it’s for the purposes of illustration); and
• Finally, coins are taxed from the lords and peasants by the Treasury.

Figure 144 shows these steps in The Mint’s Godley Table.

Figure 144: The Mint’s view of King Offa's establishment of a monetary economy

As I note in Manifesto, Godley Tables don’t show actual coins, but are an accountant’s record of
where the coins are at some point in time (the stocks called CoinsMint, CoinsTreasury, etc. in Figure 144),
and the rate at which they’re moving from one account to another per year (the flows called
MintCoins, SpendPeasants, etc., in Figure 144):

Think of the entries as records in a spreadsheet file, rather than the things
themselves, whether these be grams of gold in a vault, penny coins in your
pocket, or electronic dollars stored in a bank database. (Keen 2021, p. 27)

This “spreadsheet” shows the distribution of coins from the Mint’s point of view. Once you have
defined it, it also tells you how many more tables you need to complete the model: three, one each
for the Liabilities of the Mint. Figure 145 shows the model after those three tables have been

50
You could start your model earlier if you wish—Desan explains how rulers acquired silver once they started
making coins—just start from the assumption that The Mint has all the silver it needs, and then later add
buying silver from the public in the manner that Desan explains. “In early medieval England, rulers chose to
make the basic unit of account—the penny—out of silver. That choice gave silver a price. For example, a
weighed pound of silver of specified fineness might be exchanged for 230 pennies at the mint—the “mint
price” received when an individual took that amount of bullion in to be coined. The mint made perhaps 242
pennies out of the bullion, kept 12 for the moneyer and the king, and returned the remainder. The “price” of
silver was tied, by definition, to the value of the tribute or tax obligation: pennies made by the mint were the
tokens used by the king to pay for resources advanced to him. At the time the tax was due, each penny carried
value towards extinguishing the tax obligation” (Desan 2015, p. 58)

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created, but before they are populated with stocks and flows by using the tool in each table to
identify Liabilities that haven’t yet been defined as Assets.
Figure 145: Introducing Godley Tables for the other 3 entities in the model

The Treasury has both the Asset of CoinsTreasury, and the Liability of CoinsMint (the Mint’s Asset has to
be a Liability for another entity in the model). If you open the Treasury Godley Table, and use the
tool on both the Asset and Liability side of its ledger, you will generate the table you see in
Figure 146:
Figure 146: The Treasury's Godley Table after allocating the Mint's assets and liabilities

The next step is matching the flows with changes to the Equity of the Treasury—which I define as
TreasuryE—see Figure 147

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Figure 147: Treasury Godley Table finalised. Peasants and Lords to go

All that is left to complete the structure of coin accounts in this model is to repeat this process for
the Peasants and Lords—see Figure 148.

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Figure 148: The complete set of Godley Tables for the King Offa model

I find this structure alone, in any model, to be very informative. We’ll see a better example with the
next model, of modern-day fiat money. But for now, it is obvious that act of minting the coins sends
the Treasury into negative equity, while the issuance of those coins to it by the Mint puts it back into
zero equity—if the coins just remained in the Treasury. But of course, the Mint and the Treasury are
two wings of the government, so the sum of their two operations is zero. In effect, the fact that the
government can do this—create liabilities and assets within itself, and then have those liabilities
accepted by other entities in the society (“Would you prefer a coin in your hand, or a sword at your
throat, in exchange for those chickens?”)—is the essence of what gives the government’s balance
sheet a unique status in a monetary economy.

To complete the model, we need to define the flows, and the initial flow here is the minting of coins.
I’m using 1000 coins to match Milton Friedman’s mythical “Optimum Quantity of Money” model, in
which

(12) All money consists of strict fiat money, i.e., pieces of paper, each labelled
"This is one dollar." (Friedman 1969, p. 3)

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The first stage of modelling the flows is to take the stocks and flows from the Godley Tables
themselves and place them on the canvas. This is done using the right-mouse menu—see Figure 149.
Figure 149: Copy stock and flow variables from Godley Tables to the canvas

In Figure 150, I’ve copied the stocks and flows from the Mint’s Godley Table, placed them on the
canvas, put the Mint’s table back in icon rather than Edit view, and turned off display of variables on
each Godley Table to save space. This is feasible now that Minsky has a “Godleys” tab that lets you
see all the Godley Tables at once. The stocks and flows overlap onscreen somewhat because when I
resized the Mint’s icon, it rescaled the layout of the variables as well. This is technically a bug—it
would be better if the symbols didn’t overlap. But it’s not fatal, so we’ll leave this bug in place until
we’re rolling in development funding.

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Figure 150: Stocks and flows extracted from the Mint's Godley Table

The first activity to define is the minting of coins, and here I use a simple but very useful feature of
Minsky, the switch. This takes a logical operator in at the top, and has two options on the left hand
side: what happens if the logical operator is false, and what happens if it is true. 51 The operation
shown in Figure 151 compares the system simulation time 𝑡𝑡 to 1, and so long as 𝑡𝑡 < 1, it outputs
1000 per year. Once 𝑡𝑡 ≥ 1 then the output drops to zero. Therefore, over the first year of the
simulation, 1000 coins are created. You could add a time lag between minting and issuing if you
wish, but for simplicity I’ve simply linked minting to issuing.
Figure 151: Using the switch to produce 1000 coins while t< 1 year

So long as the coins remain in the hands of the government, nothing of interest happens: the Equity
of the Treasury, Mint and the government as a whole remain at zero: the minting of coins (which
increases the Mint’s equity and reduces the Treasury’s) is offset by the issuing of those coins to
Treasury (which increases the Treasury’s equity and reduces the Mint’s)—see Figure 152.

51
We will add to the switch feature over time to enable it to handle multiple cases, but we haven’t got there
yet.

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Figure 152

The action commences—as MMT argues—when the Treasury spends its newly created currency into
circulation. As Desan emphasises, this practice replaced forced appropriation in these post-Roman
and pre-Norman Kingdoms. In this simple model, I assume that the rate of spending is a function of
how many coins are in the Treasury, using a time lag. One by-product of the spending is that the
Treasury’s equity turns negative: it still “owes” the Mint 1000 coins, but it has spent them all into the
economy, where they are now in the hands of the Lords and Peasants—see Figure 153.
Figure 153: Treasury spends coins into circulation

For the Treasury, this means that it goes into negative equity: it “owes” 1000 coins to the Mint, but it
has spent them into the economy, so that, with no subsequent usage of the coins, and no taxation, it
has no coins to meet its “debt” to the Mint, and no coins to continue purchasing goods from the
Lords and Peasants—see Figure 154.

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Figure 154

To continue purchasing goods from the private sector, it either has to produce more coins (which
would undermine the value of those in existence), or tax back some of those in circulation. The latter
makes far more sense, and also sets up the antagonistic relationship between the private sector,
where everyone wants to hang on to the tokens they already have, given their value in exchange,
and the state, which wants the tokens back, not because it needs them—it could, after all, just print
more—but because taxation maintains the value of those in circulation.

As Desan emphasises, the most important impact of going from paying taxes in kind, to paying in
coin, was that the first way of levying taxes simply takes resources out of the “private sector”,
leaving nothing behind. Paying in coin achieves the same physical outcome—resources produced in
the private sector are transferred to the public—but leaves the private sector with an exchangeable
token, the coins. This enables trade to expand in the private sector, if these coins are made valuable
by being a means to pay taxes in future. Therefore, the expansion in trade that Neoclassicals
attribute to using a “money commodity” in place of barter, actually occurred when an otherwise
valueless token—King Offa’s coin—was made valuable as a way to pay taxes in future. Taxes, which
mainstream and Austrian economists rail against, are essential to maintaining the value of that
commerce-enabling fiat currency.

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This creates a symbiotic relationship between the public sector and the private sector, rather than
the parasitic one emphasised by Austrian economists. 52 Yes, the government is taking resources
from the private sector; but its manner of doing it by coins rather than payment in kind creates a
token which can be—and was, as Desan explains—used to dramatically expand private sector trade.

These aspects are introduced by the flows shown in Figure 155—which does a bit of historical
violence by imagining that peasants are paid a wage rather than being indentured:
Figure 155: Coins are now used for private sector commerce

Finally, taxation is imposed to both get the coins back to the Treasury to finance future spending,
and to give the coins a value to the public: it’s worth collecting them in the course of business to be
able to pay taxes when they are levied. For reasons of historical accuracy, I show the Peasants paying
a higher rate of tax than the Lords. That taxation revenue, when subtracted from government
spending, determines the deficit—see Figure 156.
Figure 156: Taxation and the deficit

Finally, we have the full model shown in Manifesto—see Figure 157.

52
It also inverts where the “parasitic” behaviour occurs: by spending the coin it has created, the government
gets private-sector-created resources “for free” (the sword-wielding tax collector can now be assigned to other
activities, such as invading the neighbouring kingdom); taxing is merely the government taking back that
otherwise worthless token it created.

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Figure 157: The model that produced Figures 2-3 and 2-4 in Manifesto

The Godleys Tab, with display of values turned on via the Options/Preferences menu, provides a nice
overview of the flows in the model—see Figure 158. Notice that the Mint has zero equity, while the
Treasury has negative equity of 952 coins—and this is precisely equal to the positive equity of the
private sector, which is 11 for the Peasants and 941 for the Lords.
Figure 158: The Godley Tables in the Offa example, with display of values turned on

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8.1.1 Check the equations

One thing Minsky does which is almost unique in the system dynamics space is generate the
equations of the model in mathematical format—I’m pretty certain Mathematica’s System Modeler
does the same, but Vensim, Stella, etc., do not. It’s an option under “Export Canvas”—see Figure
159, where LaTeX is the relevant option).
Figure 159: The options under "Export Canvas")

One of the advantages of this capacity is that things you might have missed in the flowchart model
can be more obvious in the equations (if reading equations is “your thing”, as it is mine). The clear
flaw, in stock-flow consistency terms, in this model is that I have the Lords consuming their “Profits”,
but also paying taxes on their profits. I missed that in laying out the flowchart, but it was obvious
when I checked the equations—see Equation (48), where I’ve highlighted the inconsistent equations
in red.

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Differential Equations
dCoinsMInt
 MintCoins
dt
dCoins Treasury
 IssueCoins  TaxPeasants  TaxLords  SpendPeasants  SpendLords 
dt
dCoinsLords
 ConsumePeasants  SpendLords  Wages  TaxLords 
dt
dCoinsPeasants
 Wages  SpendPeasants  ConsumePeasants  TaxPeasants 
dt
dLordsEquity
 ConsumePeasants  SpendLords  Wages  TaxLords 
dt
dPeasantsEquity
 Wages  SpendPeasants  ConsumePeasants  TaxPeasants 
dt
dMintEquity
 MintCoins  IssueCoins
dt
dTreasuryEquity
 IssueCoins  TaxLords  TaxPeasants  MintCoins  SpendLords  SpendPeasants 
dt
Equations
MintCoins   1   1  t  0  1   1   1  t 1000
IssueCoins  MintCoins
Coins Treasury
Spend  ;SpendLords  SpendLPRatio ; SpendPeasants  Spend  SpendLords
 Spend
CoinsLords
GDP  ;Wages  GDP WageShare ;Profits  GDP  Wages (48)
GDP
CoinsPeasants
ConsumePeasants  ; ConsumeLords  Profits;Consumption  ConsumePeasants  ConsumeLords
Consume
TaxLords  Profits  TaxrateLords ; TaxPeasants  Wages  TaxratePeasants ; Tax  TaxPeasants  TaxLords
Deficit  Spend  Tax
PublicEquity  MintEquity  TreasuryEquity
PrivateEquity  LordsEquity  PeasantsEquity
Parameters
 Spend  0.1; GDP  0.5; Consume  0.01;WageShare  0.7;TaxratePeasants  0.3;TaxrateLords  0.25; LPRatio  0.65

This error was easily edited—see Figure 160—and it didn’t have any impact on the model anyway,
but it shows what can go wrong when you use the flowchart logic for monetary flows rather than the
Godley Tables, since the flowchart paradigm doesn’t automatically enforce stock-flow consistency,
whereas the Godley Tables do.
Figure 160: Lords consumption now shown net of taxes

A Godley Table would have captured this error, but since I was assuming that, to consume, the Lords
were buying from other Lords (there was plenty of inter-estate trade in the feudal epoch: some fiefs
were almost entirely devoted to one industry, such as ship-making), this intra-class trade couldn’t be
entered into a Godley Table (yet). 53

53
One practice I follow when building serious models is to force all transactions to be monetary—including
those between the same social classes (Lords) or in the same sector (Manufacturing)—otherwise, at the heart

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One critical insight into the role of government spending in any economy—or rather, any economy
where the government issues its own currency—can be garnered by adding together the equity of
the Mint and the Treasury to define the equity of the government sector in this model, and the
equity of the Lords and Peasants to define the change in equity of the private sector. The insight, as
shown in Equation (49), is that an increase in equity for one sector is necessarily a decrease in equity
of the other. 54 I’ve colour-coded transactions that net out within different sectors: minting of coins
increases the Mint’s equity and reduces the Treasury’s; issuing of coins does the opposite, leaving
taxation and spending the only actions that alter aggregate government equity. Conversely, Wages
and consumption by peasants net out in the private sector, leaving taxation and spending the only
actions that alter aggregate private equity. A deficit for the government sector (spending exceeding
taxation) causes a surplus for the private sector:
Differential Equations
dMintEquity
 MintCoins  IssueCoins
dt
dTreasuryEquity
 IssueCoins  TaxLords  TaxPeasants  MintCoins  SpendLords  SpendPeasants 
dt
(49)
dGovernmentEquity
 TaxLords  TaxPeasants  SpendLords  SpendPeasants 
dt
dLordsEquity
 ConsumePeasants  SpendLords  Wages  TaxLords 
dt
dPeasantsEquity
 Wages  SpendPeasants  ConsumePeasants  TaxPeasants 
dt
dPrivateEquity
 SpendLords  TaxLords   SpendPeasants  TaxPeasants 
dt

This is the basic insight of MMT: the government deficit is the private sector surplus.

We can also integrate these rates of change to derive the result that the equity of one sector is the
negative of the equity of the other:

GovernmentEquity   TaxLords  TaxPeasants  SpendLords  SpendPeasants 

(50)
PrivateEquity   SpendLords  TaxLords   SpendPeasants  TaxPeasants 

There’s no debt of any sort in this model, so I can’t yet derive the other fundamental insight of MMT,
that the outstanding government debt is simply the record of government money creation. But
that’s an obvious deduction from the next model.

of your monetary model is the fiction that intra-class or intra-sectoral trade is barter. So in a 4-sector model I
built for a research project for UNEP (the United Nations Environment Program), I split each of my 4 sectors
(manufacturing, services, agriculture, energy) into 2 halves, and had one half buy its sector-specific inputs off
the other. At some point, we’ll add the same facility to the Godley Tables—so that they effectively become 3-
dimensional. Then an intra-sectoral transaction would occur in the 3rd dimension, and the sum of the “slice”
of the cube would be zero, rather than the sum of a row in the table.
54
I emphasise that this is focusing on the claims one sector has on another, and not the value of physical
assets which are not a liability to someone else. The sum of all claims is necessarily zero in these models.

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8.2 Modelling Modern Fiat Money in Minsky: pp. 39-50 of Manifesto

Notice that all the accounting in the King Offa model is shown on the Mint’s Godley Table (see
Figure 144 on page 127), because what is circulating in the economy is its combination asset-and-
liability, the coin, which was created by Offa’s Mint. The Mint doesn’t actually facilitate the
exchange of coin between Peasant and Lord, or Lord and Treasury; but because the Peasants and
Lords tables record these transactions—where they are exchanging assets—the exchange turns
up on the Mint’s Godley Table as well, as a record of the movement of its liabilities (this is a
feature of Minsky).

When we move on to a modern monetary economy, the private banks and their liabilities of
deposit accounts enter the picture as well, because private banks do facilitate the transfer (when
the transaction is a transfer from one deposit account to another), and what is being transferred
are liabilities of the private banking system, not of the Central Bank itself. They are also the
conduit for government spending and tax payments

This necessitates a much more convoluted path for government spending: to actually get money
to the public, it has to turn up in people’s deposit accounts, which are liabilities of the private
banks. So the assets of the private banks have to be increased as well, which means that net
government spending creates both deposits and reserves.

Therefore, net government spending creates both assets and liabilities at the level of the private
banking system: the assets and liabilities of the banking sector rise because of a government
deficit, leaving its net position unchanged: its aggregate equity position remains at zero (in this
model, at this stage of its development).

For the private sector non-bank public however (where did we develop this contradictory usage
of the words “private” and “public”?), the deficit increases their assets—the Deposit accounts—
without changing their liabilities. This is the key MMT point that government deficits create “net
financial assets” for the public.

At the next level of the financial system, the Central Bank, there is no creation of net financial
assets: instead, there is a transfer of Central Bank liabilities from one account to another. The
reserves, as well as being an asset of the private banks, are a liability of the central bank.
Reserves are increased by government spending and reduced by taxation. Simultaneously,
government spending reduces the Treasury’s deposit account and taxation increases it. At this
level therefore, the deficit is a liability swap: a transfer from one Central Bank liability account—
the Treasury—to another—Reserves. 55 Neither deficits nor surpluses alter the assets of the
Central Bank.

At this stage of the development of the model, the Treasury only has the asset of its deposit
account at the central bank, and no liabilities, so spending decreases the Treasury’s assets while
taxation increases them. Overall, the Treasury’s capacity and willingness to go into negative
equity is what drives the creation of money at the level of the private banking sector and the
public.

55
Of course, in the real world, there are multiple reserve accounts—one (at least) per private bank. This model
focuses on the aggregate of reserves. A model covering possible liquidity default risks would use multiple
reserves accounts for multiple banks.

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Therefore at the minimum, four Godley Tables are needed to show the overall monetary
mechanics: the Treasury, the Central Bank, the Private Banks, and the (confusingly named) Public,
or non-bank private sector—see Figure 161.
Figure 161: Government spending and taxation in a modern monetary economy

This basic situation for a modern monetary economy confirms the point made by the model of King
Offa’s coins, which is the fundamental insight of MMT: the government sector deficit is the private
sector surplus, and vice versa. Focusing just on the Treasury, Bank Deposits and Bank Reserves, a
government deficit creates both Deposits, which are an asset of the non-Bank private sector, and
Reserves, which are an asset of the Banking sector—see Equation (51).

dTreasury
 Tax  Spend
dt
dDeposits
 Spend  Tax (51)
dt
dReserves
 Spend  Tax
dt

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This immediately shows that government surpluses are a bad idea, unless you actually want to
reduce the amount of money in the economy; and that whatever they might do to future
generations—which we’ll tackle shortly—government deficits enrich the current generation, by
creating net equity for it (see Equation (52)).

dBankE
0
dt
(52)
dPrivateENB
 Spend  Tax
dt
Figure 162 adds the account TBondsB to the model. This records the value of Treasury Bonds that
have been sold, so it is an asset for the private banking system and a liability for the Treasury.

You can see that if government spending exceeds taxation, the net equity of the private sector rises,
and is identical in magnitude to the negative equity of the government, which at this stage is entirely
reflected in a negative value for its account at the Central Bank—effectively, the government’s
Treasury runs an overdraft account with the government’s Central Bank.

Also, Reserves and the Treasury’s account at the Central Bank move in opposite directions: if the
government runs a deficit, Reserves are created; if it runs a surplus, Reserves are destroyed. The
Reserves are identical in value to the negative of the equity of the government sector.

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Figure 162: Bond sales enabled but not yet simulated

I haven’t defined flows for bond sales as yet however, so the simulation shown in Figure 162 is
effectively of the model in Figure 161. Now let’s introduce government debt by having the Treasury
issue bonds, which are sold to the private banks—see Figure 163. This could be made much more
complicated—bond sales could be modeled as based on forward forecasts of the deficit,
extrapolating existing trends—but the simplest case will do here.
Figure 163: Bonds are sold to cover the Deficit

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Figure 164 introduces bond sales by Treasury to the private banks. Bond sales are made equal to the
deficit. The impact of this change to the model is that bank Reserves remain at zero, the Treasury’s
account at the Central Bank also remains at zero—whereas it went negative in the simulation
without bond sales in Figure 162—and that the money in the economy is identical to the level of
government debt.

It also introduces money as the sum of the amounts in deposit accounts plus (short-term) bank
equity. Now we can see that—in this model—the money in existence is identical to the Treasury
Bonds in existence. So the sale of bonds has had no role in the creation of money—that was done by
the deficit itself—but it has enabled the banking sector to exchange a non-tradeable, non-income-
earning asset (Reserves) for a tradeable, income-earning asset (Treasury Bonds).

This confirms the crucial points made by MMT, that the “debt” itself doesn’t create the money, nor
does the government need to sell the bonds in order to finance its deficit. If the Treasury didn’t sell
the bonds, then it would be in the same situation as the Treasury in the King Offa model: it would be
in debt to the Central Bank (as King Offa’s Treasury was to his Mint), with an overdraft taking the
place of a deficiency of coins in its possession. The bond sales let the Treasury maintain its account
at the Central Bank at zero (in this model—in the real world, a positive level could be maintained as
well), because the bond sales bring in revenue equivalent to the deficit.

To illustrate an important feature of this model, I’ve enabled display of numbers on the Godley
Tables, via the Options/Preferences dialog box.

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Figure 164: Bond sales, but no interest on bonds

The government does, of course, pay interest on Treasury Bonds. I assume that it then borrows the
funds needed to pay the interest from the Central Bank—see Figure 165.
Figure 165: Interest on Bonds

Introducing this fact has a dramatic effect on the model: compare Figure 166 to Figure 164, and you
will see that private bank equity, which remained at zero with no interest on bonds, turns positive
when interest is paid, because the interest on bonds adds to bank reserves, without also adding to
liabilities. So it increases bank equity, which has been zero through all the previous models. Notice
also that the amount of money in existence exceeds the amount of bonds—otherwise known as
government debt to the private sector. The difference is made up by the Treasury’s debt to the
Central Bank, which is equivalent to the total interest paid on Treasury bonds.

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Figure 166: Interest on bonds creates positive equity for the banking sector

What this shows is that a government deficit can actually “kick-start” a private banking system, by
creating positive net equity for the banking sector, which is necessary for real-world lending: a bank
with negative equity is bankrupt, while to start operation as a bank, a private corporation needs to
raise share capital so that it can start with its activities as a bank with positive equity.

Before writing Manifesto, I had primarily used Minsky to model the dynamics of private credit—
largely because that’s the topic that mainstreamers like Krugman get so badly wrong. One puzzle,
when working with models of a pure credit economy, was how did banks accumulate the positive
equity needed to operate: in a pure credit system, positive equity for the banking sector means
identical negative equity for the non-banking sectors.

This model shows that, arguably, interest on government bonds enables the banking sector to have
positive equity, without driving the non-banking sector into negative equity, because the bonds
create positive equity for the non-banking sector (notice that the equity of the public in Figure 166 is
294, which is identical to the value of bonds on issue), while the interest on those bonds creates
positive equity for the banking sector (the positive equity of the banking sector, of 486, is identical to
the debt of the Treasury to the Central Bank, which is identical to the sum of interest paid on bonds).

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One personal opportunity cost of all the time I waste reading Neoclassical literature is that I am not
up to date on the literature of MMT. That said, I am not aware of any MMT authors making this
same case—that interest paid on Treasury bonds creates positive equity for the banking sector. If
any reader knows of papers making that case, please let me know and I’ll read them and cite them
here. That said, this may be a novel discovery—and a good reason for the rate of interest on
Treasury Bonds to be positive.

This model can obviously be extended to include private bank lending, and financial transactions
between subsectors of the non-bank public.

8.3 An integrated view of deficits and credit: pp. 59-65 of Manifesto

This section of the Manifesto covers a vital episode in America and the world’s economic history: the
boom of the 1920s and the bust of the 1930s. These events should be the focus on economic
analysis, but instead, Neoclassical economists prefer to ignore them as “outlier events”. The Great
Depression, according to them, shouldn’t have happened; and nor should the Stock Market reach
such ridiculous heights and then crashed. But of course they did happen.

Before I use Minsky to explain why this boom and bust happened, I’m going to take the opportunity
here to go more deeply into the data than I had space for in Manifesto. The first thing to note is that
this was a time of extreme volatility, compared to the relative stability of the post-WWII economy—
a point that was fundamental to Hyman Minsky’s analysis of capitalism:

The most significant economic event of the era since World War II is something
that has not happened: there has not been a deep and long-lasting depression.

As measured by the record of history, to go more than thirty-five years without a

severe and protracted depression is a striking success. Before World War II,
serious depressions occurred regularly. The Great Depression of the 1930s was
just a “bigger and better” example of the hard times that occurred so frequently.
This postwar success indicates that something is right about the institutional
structure and the policy interventions that were largely created by the reforms of
the 1930s.

Can “It”—a Great Depression—happen again? And if “It” can happen, why didn’t
“It” occur in the years since World War II? These are questions that naturally
follow from both the historical record and the comparative success of the past
thirty-five years. To answer these questions it is necessary to have an economic
theory which makes great depressions one of the possible states in which our
type of capitalist economy can find itself. We need a theory which will enable us
to identify which of the many differences between the economy of 1980 and that
of 1930 are responsible for the success of the postwar era. (Minsky 1982, p. xix)

The volatility of the pre-WWII period is striking, which we, embedded in out post-WWII “Baby
Boomer”/Gen X/ Gen Y reality, can fail to fully appreciate. Table 2 and Figure 172 show that not only
was real growth higher in the pre-WWII period (averaging 3.7% per year versus 2.5% since 1945), it
was also much more volatile: the ratio of the standard deviation of growth to the rate of growth was
2.2 for 1850-1945 versus 1.17 for 1945-2021.
Table 2:Growth and Volatility 1850-2030

Nominal Growth Real Growth

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Period Mean Standard Deviation Ratio Mean Standard Deviation Ratio

1850-1945 5.3% 9.6% 1.83 3.7% 8.2% 2.21
1945-2021 6.2% 3.2% 0.52 2.5% 3.0% 1.17
Figure 167: Pre-WWII Volatility & Post-WWII Stability of growth

Change in Nominal and Real GDP 1850-2030

35
WWIIEnd

30

25

20

15
Percent per year

10

0 0

−5

− 10

− 15

− 20 Nominal GDP
Real GDP
− 25
1850 1860 1870 1880 1890 1900 1910 1920 1930 1940 1950 1960 1970 1980 1990 2000 2010 2020 2030

Rescaled US Census, BIS & OECD data

The same applies to the unemployment and inflation rates: both were lower on average before the
end of WWII than in the post-War period, but the volatility was far higher in the pre-War period than
after
Table 3: Unemployment and Inflation Volatility 1850-2030

Unemployment Inflation
Period Mean Standard Deviation Ratio Mean Standard Deviation Ratio
1850-1945 4.2% 6.5% 1.5 1.0% 6.4% 6.1
1945-2021 5.7% 1.7% 0.3 3.7% 3.3% 0.9

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Figure 168: Unemployment and Inflation Volatility 1850-2030

Unemployment and Inflation 1850-2030

30
WWIIEnd

25

20

15
Percent & percent per year

10

0 0

−5

− 10

− 15 Unemployment
Inflation
− 20
1850 1862 1874 1886 1898 1910 1922 1934 1946 1958 1970 1982 1994 2006 2018 2030

Rescaled US Census, BIS & OECD Data

Minsky was obviously right that there was a significant change in the nature of American capitalism
after WWII, which he identified as the evolution of “Big Government”:

Whereas in the small government economy of the 1920s profits were well nigh
exclusively dependent on the pace of investment, the increase in direct and
indirect state employment along with the explosion of transfer payments since
World War II means that the dependence of profits on investment has been
greatly reduced.

With the rise of big government, the reaction of tax receipts and transfer
payments to income changes implies that any decline in income will lead to an
explosion of the government deficit. Since it can be shown that profits are equal
to investment plus the government’s deficit, profit flows are sustained whenever
a fall in investment leads to a rise in the government’s deficit.

A cumulative debt deflation process that depends on a fall of profits for its
realization is quickly halted when government is so big that the deficit explodes
when income falls. The combination of refinancing by lender-of-last-resort
interventions and the stabilizing effect of deficits upon profits explain why we
have not had a deep depression since World War II. The downside vulnerability

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of the economy is significantly reduced by the combination of these types of

“interventions.” (Minsky 1982, p. xxviii. Emphasis added)

As Figure 169 shows, the transition from small to Big Government is emphatically a product of the
Great Depression and World War II. World War I caused a sharp spike in government spending as a
percentage of GDP, but the post-War period saw a rapid return to small government—the pre-WWI
period had, from today’s perspective, an unthinkably low level of government spending of just 2% of
GDP. World War I saw that rise to almost 25%, but it fell rapidly back to below 5% of GDP in the early
1920s. It then continued to fall during that decade, as Coolidge used the prosperity of the era to
reduce government debt by running a surplus that, across much of the decade, was equivalent to 1%
of GDP.
Figure 169: From small to Big Government between the Great Depression and the end of WWII

Government Spending USA

45
GreatDepression WWIIEnd

40

35

30
Percent of GDP

25

20

15

10

0
1900 1910 1920 1930 1940 1950 1960 1970 1980 1990 2000 2010 2020 2030

https://www.whitehouse.gov/wp-content/uploads/2021/05/hist01z1_fy22.xlsx

This is what Calvin Coolidge thought was responsible for the apparent prosperity of The Roaring
Twenties. To repeat, at much greater length than in Manifesto, the quote from Coolidge’s State of
the Union address, he attributed the prosperity of the 1920s to his policy of running a sustained
government surplus, and using it to pay down government debt:

No Congress of the United States ever assembled, on surveying the state of the
Union, has met with a more pleasing prospect than that which appears at the
present time. In the domestic field there is tranquility and contentment,
harmonious relations between management and wage earner, freedom from

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industrial strife, and the highest record of years of prosperity… The country can
regard the present with satisfaction and anticipate the future with optimism.

The main source of these unexampled blessings lies in the integrity and character
of the American people… Yet these remarkable powers would have been exerted
almost in vain without the constant cooperation and careful administration of
the Federal Government…

Wastefulness in public business and private enterprise has been displaced by

constructive economy… We have substituted for the vicious circle of increasing
expenditures, increasing tax rates, and diminishing profits the charmed circle of
diminishing expenditures, diminishing tax rates, and increasing profits…

One-third of the national debt has been paid … the national income has
increased nearly 50 per cent, until it is estimated to stand well over
$90,000,000,000. It has been a method which has performed the seeming
miracle of leaving a much greater percentage of earnings in the hands of the
taxpayers with scarcely any diminution of the Government revenue. That is
constructive economy in the highest degree. It is the corner stone of prosperity.
It should not fail to be continued…

Last June the estimates showed a threatened deficit for the current fiscal year of
$94,000,000. Under my direction the departments began saving all they could
out of their present appropriations… The combination of economy and good
times now indicates a surplus of about $37,000,000. This is a margin of less than
1 percent on our expenditures and makes it obvious that the Treasury is in no
condition to undertake increases in expenditures to be made before June 30. It is
necessary therefore during the present session to refrain from new
appropriations for immediate outlay, or if such are absolutely required to provide
for them by new revenue; otherwise, we shall reach the end of the year with the
unthinkable result of an unbalanced budget. (Coolidge 1928, December 4 1928.
Emphasis added)

The June to which Coolidge referred was June, 1929. The “unthinkable result” at the end of that year
was not “an unbalanced budget”, but America’s second Great Depression (the first, as I note in
Manifesto, was “The Panic of 1837”).

Coolidge was acutely aware of the declining government debt of his time. However, he, like his
successors one century later, had no idea of what was happening with private debt. As he applauded
halving government debt, from $30 to roughly $15 billion, private debt rose from $45 to $80
billion—see Figure 170. He was, as Clinton and Bush did in the 1990s and early 2000s, conducting an
unwitting experiment into how long credit-based money creation could counter the destruction of
fiat-based money, without causing a crisis.

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Figure 170: GDP, Private and Government Debt 1910-1940

Debt and Nominal GDP 1910-1940

120
1920 GreatDepression
Private Debt
110 Government Debt
Nominal GDP
100

90

80

70
US $ Billion

60

50

40

30

20

10

0
1910 1912 1914 1916 1918 1920 1922 1924 1926 1928 1930 1932 1934 1936 1938 1940

Census Data, rescaled to fit post-1952 Federal Reserve Data

In Coolidge’s time, the answer turned out to be “about 8 years”. Between 1921 and 1929, the
government surplus of roughly $1 billion a year was more than counterbalanced by credit of
between $1 billion and $8 billion per year—see Figure 171.

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Figure 171: Private Credit and the Government Deficit 1910-1940

Credit and Government Deficit 1910-1940

18
1920 GreatDepression

16

14

12

10
US $ per year

0 0
−1
−2

−4 Private Credit
Government Deficit
−6
1910 1912 1914 1916 1918 1920 1922 1924 1926 1928 1930 1932 1934 1936 1938 1940

Census Data, rescaled to fit post-1952 Federal Reserve Data

While that situation endured, GDP rose from a low of $71 billion in 1921 to a maximum of $104
billion at the start of 1929—see the dotted plot in Figure 170. It was a volatile performance, as
Figure 172 indicates—inflation-adjusted growth ranged from as low as minus 21% in 1921 to a high
of 23% in 1922—but the average was still a very high 5.8% real growth per year. Coolidge’s rhetoric
extrapolated this rate of growth forward thanks to his good budget management, but that’s not
what transpired: the average real growth rate from the high of 1929 till the 1930s low in 1933 was
minus 9% per year. Nominal GDP in 1933 was $16 billion lower than in 1921.

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Figure 172: Volatile GDP

Change in Nominal and Real GDP 1910-1940

30
1920 GreatDepression

25

20

15

10
Percent per year

0 0

−5

− 10

− 15

− 20

− 25 Nominal GDP
Real GDP
− 30
1910 1912 1914 1916 1918 1920 1922 1924 1926 1928 1930 1932 1934 1936 1938 1940

Rescaled US Census data

The core feature of the Great Depression that, even today, is seared into people’s minds, is the huge
increase and then sustained level of unemployment. Unemployment data wasn’t as systematic back
then—much of it was recorded by trade unions—but nor was it as corrupted as is has become in the
last fifty years: back then you were recorded as unemployed if you had registered as unemployed,
either with your union or an employment office. The boom of the 1920s was so extreme at its end
that the percentage rate of unemployment in October 1929 was zero. Three years later, it was an
unprecedented 25%, and it remained at elevated levels throughout the 1930s.
Figure 173: Unemployment and Inflation 1910-1940

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There is much more to the story of the 1920s and 1930s than just government money destruction
and private money creation. But since that part of the story has never been properly told—because
the mainstream, as well as misunderstanding the role of fiat money creation in a well-functioning
capitalist economy, also continues to deny the role of credit in aggregate demand—I’m going to
attempt to use Minsky to reproduce the effects of government surpluses and private credit across
the boom period of the 1920s. I’ll define this as starting at the nadir for nominal GDP in the 1920s—
mid 1921, when the USA’s nominal GDP was US$72.25 billion—and ending at its apogee in 1929,
when it peaked at $104.6 billion. Across almost all of that time, the government surplus was 1% of
GDP, while credit began at 1% of GDP and peaked at 8% in mid-1927—see Figure 174. I’m showing
the deficit rather than the surplus, since a deficit has the same impact on the economy as positive
credit. So, for most of the 1920s, the government deficit was minus 1% of GDP. Though it fluctuated
much more than the government surplus, the average value of credit between 1921 and 1929 was
5% of GDP.
Figure 174: Government deficits and private credit 1910-1940

Credit and Government Deficit 1910-1940

20
GDP Min GDP Max

17.5

15

12.5

10
Percent of GDP

7.5

2.5

0 0
−1
− 2.5

−5

− 7.5 Government Deficit

Private Credit
− 10
1910 1912 1914 1916 1918 1920 1922 1924 1926 1928 1930 1932 1934 1936 1938 1940

Whitehouse and Census

The data that I wish to emulate in a Minsky model are the following:
Table 4: Historical data to emulate in the Minsky model

Parameters % of GDP Date GDP Government Debt Private Debt

Deficit -1% 1921.5 $ 71.26 $ 23.87 $ 46.66
Credit 5% 1929 $ 104.60 $ 17.20 $ 82.07

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I have created a very simplified model here, because I want as few complications as possible to get
in the way of the three basic questions that I want to pose: what would have happened to the
economy had the private sector not gone on a borrowing binge; and what would have happened had
Coolidge run either a deficit, or a balanced budget during that private sector borrowing binge; and
what would have happened had Coolidge run a deficit while the private sector’s debt remained
constant?
Table 5: Godley Table for the banking sector in the model

The model came pretty close to fitting the data (see Table 6), even though the time path of credit
was much simpler—a constant 5% of GDP throughout, rather than the range from 1 to 7.5%—than
the actual data.
Table 6: Simulation results

Simulation % of GDP Simulation Years GDP Government Debt Private Debt

Deficit -1% 0 $ 70.00 $ 23.87 $ 46.66
Credit 5% 7.5 $ 100.00 $ 17.40 $ 79.20
The full model is shown in Figure 175. It is, as noted, extremely simple: there are no government
bonds for example, all the government debt is owed by the Treasury to the Central Bank. But as the
previous model showed, bonds don’t finance government spending: instead, they are a way of
creating reserves for the private banks. They could be added here, and quite possibly could improve
the accuracy of the simulation; but this is a sufficient structure to disentangle the causal factors
behind the boom of the 1920s.

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Figure 175: Simulating Coolidge's Golden Years

With the model constructed, we can now use it to answer those “what if?” questions:

• What if the private sector had not increased its debt?;

• What if Coolidge had run a balanced budget or deficit, while the private sector borrowed?;
• What if Coolidge had run a deficit while the private sector’s debt remained constant?;
• What if Coolidge had run a deficit while the private sector borrowed; and
• How large a deficit would have been needed to reproduce the prosperity of the 1920s
without increasing private debt?

All the subsequent plots of this model export the Canvas from the Plots tab.

8.3.1 The actual event: Coolidge Surplus and private sector credit binge

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8.3.2 Coolidge Surplus with no private sector borrowing

This first simulation indicates that, without the rise in private debt, there would have been no
boom—no growth even—during the 1920s.
Figure 176: No credit: the Roaring Twenties loses its Roar

8.3.3 Coolidge Balanced Budget with the credit binge

This simulation indicates that the impact of Coolidge’s surplus was to reduce the level of economic
growth, compared to what it would have been with the credit binge alone.
Figure 177

8.3.4 Coolidge runs a Deficit with the credit binge

This generates higher growth and a lower private sector debt ratio.

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Figure 178

8.3.5 Coolidge runs a Deficit with no credit

This is with the 1% of GDP surplus converted into a deficit: the economy grows rather than shrinks.
Figure 179

8.3.6 Coolidge runs a Deficit to reproduce the 1920s boom without credit
A deficit of 4% of GDP is sufficient to reproduce the boom of the 1920s, without any growth in
private debt.

8.3.7 Disentangling cause and effect

This simple model shows the advantages of the monetary, system dynamics approach to modelling.
But it would be nothing without including the key causal factors, which Neoclassical economics omit
by assumption: private debt and credit. In the next chapter I’ll explain my “Keen” model of Minsky’s
Financial Instability Hypothesis, which shows that capitalism can be overwhelmed by excessive
private debt, and plunged into a deep and lasting downturn as credit turns substantially negative.

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This has now happened three times in the history of American capitalism: during “The Panic of
1837”, the Great Depression, and the Great Recession. The unifying factor in each of these crises has
been a prolonged period of negative credit, as noted in Table 2.5 in Manifesto (reproduced here as
Table 7).
Table 7: Magnitude of Credit and duration of negative credit in the USA's major economic crises

Credit (annual change in private debt)

Credit as percent of GDP Years
Crisis Maximum Minimum Change Negative Duration 56
Panic of 1837 12.2 -8.9 21.1 6.2
Great Depression 9.1 -9.1 18.2 8.2
Great Recession 15.4 -5.3 20.7 2.6
The next four figures illustrate this, along with the rising level of private debt associated with each
boom and bust, and the correlation of credit to the rate of economic growth (nominal in these plots,
since I’m focusing here on the impact of credit on the monetary level of output: changes in the price
level—but do not eliminate—the impact).
Figure 180: USA Debt and Credit since 1834

USA Debt and Credit from 1834 till 2021

200 20
1837 1930
190 18
180 16
170 14
160 12
150 10
140 8

Credit as percent of GDP

Debt as percent of GDP

130 6
120 4
110 2
100 0 0
90 −2
80 −4
70 −6
60 −8
50 − 10 − 10
40 − 12
30 − 14
Debt
20 Credit − 16
10 2008 − 18
0 − 20
1830 1840 1850 1860 1870 1880 1890 1900 1910 1920 1930 1940 1950 1960 1970 1980 1990 2000 2010 2020 2030

Census Data Rescaled to fit Federal Reserve Data post-1952

The major crises in America’s economic history were all negative credit events, and Richard Vague’s
magisterial survey of global credit crises, A Brief History of Doom (Vague 2019), shows that this rule
applies to all of global capitalism’s roughly 150 crises in the last 150 years. The next three charts

56
This is measured from the first negative month to the last, but includes some periods of positive credit (most
of 1839, and late 1935 till late 1936).

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focus on America and its three major crises: the “Panic of 1837, the Great Depression, and the Great
Recession. Though the levels of private debt were substantially different, the scale of the negative
credit events were quite similar: as shown by Table 7, each crisis was preceded by a credit boom,
with credit-based demand reaching between 9% and 15% of GDP, while the plunge from this peak
was roughly 20% of GDP in each case.
Figure 181: The Panic of 1837

USA Debt and Credit before, during & after a crisis

200 20
190 18
180 16

Credit as percent of GDP & Growth percent per Year

170 14
160 12
150 10
140 8
Debt as percent of GDP

130 6
120 4
110 2
100 0 0
90 −2
80 −4
70 −6
60 −8
50 − 10 − 10
40 − 12
30 − 14
Debt
20 Credit − 16
10 Growth Rate − 18
0 − 20
1830 1832 1834 1836 1838 1840 1842 1844 1846 1848 1850 1852 1854 1856 1858 1860

Census Data Rescaled to fit Federal Reserve Data post-1952

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Figure 182: The Great Depression

USA Debt and Credit before, during & after a crisis

200 20
GDP Min GDP Max
190 18
180 16

Credit as percent of GDP & Growth percent per Year

170 14
160 12
150 10
140 8
Debt as percent of GDP

130 6
120 4
110 2
100 0 0
90 −2
80 −4
70 −6
60 −8
50 − 10 − 10
40 − 12
30 − 14
Debt
20 Credit − 16
10 Growth Rate − 18
0 − 20
1910 1912 1914 1916 1918 1920 1922 1924 1926 1928 1930 1932 1934 1936 1938 1940

Census Data Rescaled to fit Federal Reserve Data post-1952

Figure 183: The Great Recession

USA Debt and Credit before, during & after a crisis

200 20
190 18
180 16
Credit as percent of GDP & Growth percent per Year
170 14
160 12
150 10
140 8
Debt as percent of GDP

130 6
120 4
110 2
100 0 0
90 −2
80 −4
70 −6
60 −8
50 − 10 − 10
40 − 12
30 − 14
Debt
20 Credit − 16
10 Growth Rate − 18
0 − 20
1990 1992 1994 1996 1998 2000 2002 2004 2006 2008 2010 2012 2014 2016 2018 2020

Census Data Rescaled to fit Federal Reserve Data post-1952

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8.4 A Modern Debt Jubilee: pp. 65-68 of Manifesto

The end result of almost two centuries of widespread misunderstandings about how money is
created, developed and maintained by the false beliefs of mainstream economists, is a global
economy terminally indebted to the private creators of money. The previous charts show this
phenomenon in the home of modern capitalism, America. The next chart--Figure 184—shows that
this is a global phenomenon.

Here I have to thank the Bank of International Settlements for assembling an excellent database on
debt across over 40 countries. 57 When I started warning that a global financial crisis was imminent
back in December 2005, the only data I could get easily was on America from the Federal Reserve
Flow of Funds, 58 and Australia from the Reserve Bank of Australia’s statistical tables. 59 Today, thanks
to Bill White 60—who, as Research Director for the Bank of International Settlements, was the only
person in an official position to warn that a financial crisis was likely (Borio and White 2004)—the
Bank of International Settlements publishes a database with standardized measures of private and
public debt from over 40 countries. That data shows unequivocally that the level of private debt,
relative to GDP, is the highest it has been in the post-WWII period, which, by reference to long term
data series for the USA and UK, is also the highest it has been in the history of capitalism—see Figure
184.

This has numerous deleterious effects on the economy, which I discuss with respect to my model of
Minsky’s Financial Instability Hypothesis in the next chapter. Here, I want to model something that I
first proposed in 2012 (on January 1st, as it happens): 61 a “Modern Debt Jubilee”, as a means of
escaping from this debt trap, by effectively replacing credit-based money with fiat-based money in a
way that does not discriminate between those who had joined the 2000s speculative bubble and
those who did not.

57
https://www.bis.org/statistics/totcredit.htm.
58
https://www.federalreserve.gov/apps/fof/FOFTables.aspx.
59
https://www.rba.gov.au/statistics/.
60
https://williamwhite.ca/.
61
http://www.debtdeflation.com/blogs/manifesto/.

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Figure 184: Record private debt levels afflict almost all economies

Though I thought of the idea a decade ago, I didn’t subsequently develop it, because I believed that
it had a snowflake’s chance in Hell of actually being implemented. And then along came Hell, in the
form of Covid. In 2020, private debt in the USA rose faster than it had even done.

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Figure 185: Covid and its impact upon private debt and credit

Private Debt and Credit from 2005

100 12
2020

95 10

90 8

Credit as Percent of GDP

Debt as Percent of GDP

85 6

80 4

75 2

70 0 0

Corporate Debt
65 Household Debt −2
Corporate Credit
Household Credit
60 −4
2004 2005.8 2007.6 2009.4 2011.2 2013 2014.8 2016.6 2018.4 2020.2 2022

BIS Data

All previous instances of rapidly rising private debt have occurred during a speculative binge. This
one is occurring because the corporate sector in particular can’t meet its financial obligations during
Covid, and so has rolled over existing debt that would otherwise have been retired, and taken on
new debt in order to meet financial commitments that were ordinarily covered from cash flow. So
there will not be the typical economic boom from private sector borrowing—but there could well be
the typical bust after Covid, if there is ever an after, especially if the welcome if insufficient
government supports are removed too quickly.

This meant that it was time to actually model how a Modern Debt Jubilee could be undertaken, and
the results surprised even me. The model in Manifesto was extremely simple—I just covered the
accounting involved and showed that it was consistent: see Figure 186. I’ll include the simulation
model for this at the end of this chapter, just for the sake of completeness, but what I want to do
now is develop a much more comprehensive model of a Modern Debt Jubilee, to show how it might
be used to reduce America’s private and government debt levels.
Figure 186: The basic mechanics of a Modern Debt Jubilee

This is the first moderately large Minsky model that I’ve developed here, so it will take quite a while
to explain its structure and dynamics. The basic structure of the Jubilee, and outcomes of the model,
are as follows:

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(1) The Jubilee is used to convert Jubilee % of existing private sector debt into government debt,
thus converting credit-backed money into fiat-backed. Fiat-money increases, credit-money
decreases.
(2) The Jubilee is distributed on a per capita basis, so every adult (person over 18) receives the
same amount. If the per capita amount exceeds a person's debt, the excess is used to buy
newly-issued corporate debt, which must be used to pay down corporate debt.
(3) The Jubilee creates money, but the allocation of it to debt repayment cancels precisely as
much, so there is no net creation of money by the Jubilee itself.
(4) Treasury issues Jubilee Bonds, which are sold to the Banking sector. The Banking sector gets
the funds to buy these bonds from the Jubilee itself, which creates excess Reserves equal in
magnitude to the fiat money created by the Jubilee.
(5) Interest payments by Treasury on the Jubilee bonds then compensate the Banking sector for
the fall in its income from interest on private debt
(6) Side-effects of the Jubilee include a fall in inequality and an increase in GDP from dramatic
rise in the velocity of money. These occur because the Jubilee increases the money held by
workers, whose higher propensity to spend also boosts the economy.
(7) If interest is paid on Jubilee Bonds, this creates money over time, thus expanding GDP.

Though the model is the most complicated to date, the monetary model is essentially a combination
of the endogenous money model of Figure 126 with the Jubilee components of Figure 186. I have
divided the non-bank private sector into three sectors—Firms, where output is produced, Capitalists,
who own the Firms, and Workers, who work in the Firms. The first eight rows of Figure 187 are the
basic financial operations of the private sector: interest and dividend payments, wages, and
consumption. I have omitted bank lending and debt repayment here, just to simplify the model—
they could easily be added.

The remaining rows implement the mechanics of the Jubilee:

• Jubilee payments to workers and capitalists;

• Debt repayment by workers and capitalists;
• Share purchases by those workers and capitalists whose debts were less than the value of
the per-capita Jubilee payment (set at 60% of aggregate private debt in this simulation,
which is roughly equal to 100% of GDP in this simulation, and equal to the debt level of the
US private sector);
• Firms using these share sales to pay down corporate debt;
• Bond sales by the Treasury, of a value equal to the Jubilee itself—which has created the
excess Reserves that banks will use to buy the bonds; and
• Interest payments on those bonds by Treasury to the Banks.

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Figure 187: Banking sector Godley Table for a Modern Debt Jubilee

The Jubilee component of the model is shown in Figure 188. The top left-hand corner determines
the Jubilee itself. The switch means that the Jubilee doesn’t commence until Start year, after which
it lasts for one year. 62 The other logic switches determine that, if debt is paid down to zero, the
payments are used to purchase “Jubilee shares” instead—shares newly issued by companies (so that
they receive the revenue, rather than a trader), the revenue from which must be used to pay down
corporate debt.
Figure 188: Mechanics of the Jubilee

62
At the moment, it’s not possible to select a set of icons from Minsky and export those as an SVG file, so I had
to copy these elements to a blank canvas, which reset the parameters and variable values. Hopefully by the
time this book is published, we’ll add support for exporting a selection of icons on the canvas. This is the sort
of thing that continued funding of Minsky enables, so please consider signing up to its Patreon page
https://www.patreon.com/HPCODER.

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The scale of the Jubilee is based on current US private debt data, which totalled US$29.5 trillion in
2021. This is broken into corporate debt of $17.5 trillion and household debt of $12 trillion. I made
an arbitrary division of initial household debt into ¼ as debt of capitalists 𝐷𝐷0𝐾𝐾 and ¾ as debt of
workers 𝐷𝐷0𝑊𝑊 , since the Flow of Funds doesn’t provide that information. 63 The Jubilee equals 60% of
this outstanding debt, or $17.7 trillion.

The division of the population into workers and capitalists is somewhat arbitrary as well: I assume
that 5% of the population earns its income primarily from ownership, and 95% primarily from wages.
Since the Jubilee is on a per capita basis (which works out to US$100,000 per adult American in this
simulation), 95% of the Jubilee goes to workers and 5% to capitalists. This is hardly unfair to
capitalists as individuals—everyone gets the same amount, regardless of social class—and it goes
some way to redressing the impact of Quantitative Easing, which had the express objective of
increasing share prices, and therefore overwhelmingly favoured capitalists over workers. 64

There are some complicated issues as a result of the change in share ownership, which are handled
by the component shown in Figure 189: the new shares dilute existing shareholdings, so there has to
be a change in where the dividends go.

63
The variables 𝐷𝐷0𝐾𝐾 and 𝐷𝐷0𝑊𝑊 and the constants that determine them replicate details of the Godley Table in
Figure 187, because at the moment Godley Tables only take numbers as the initial conditions (the first row in
the table). At some point we’ll add the capability to take parameters as the inputs, which would remove the
need for this separate definition of 𝐷𝐷𝐾𝐾0 and 𝐷𝐷𝑊𝑊
0 .
64
The Atlantic Council asserts that cumulatively QE in America has totalled $7.6 trillion as of 2021: see
https://www.atlanticcouncil.org/blogs/econographics/global-qe-tracker/.

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Figure 189: Share ownership and dividend effects of the Jubilee

This doesn’t make existing shareholders worse off however, because the fall in interest payments by
firms is partly passed on to all shareholders via a rise in dividend payments—see Figure 190, and
Equation (53), which I think is easier to read than the flowchart. 65
Figure 190: Firms pass on the fall in interest payments in the form of dividends

 LoansF 
rLoans D F 0 1   (53)
 D F 0 

Equation (53) cover the variable part of dividend payments by firms because of the Jubilee. When
the simulation starts and before the Jubilee, Equation (53) equals zero, and the dividend payout is
11% of profits, as specified by PayoutRatio. When the debt level of firms LoansF falls because of the
Jubilee, this becomes positive, and is added to the dividend payout ratio. In this way, the reduction
in firm interest payments is passed back to the owners of shares—who also change in social
composition, because, with 95% of the Jubilee going to workers, their debt of $12 trillion is
extinguished, and they buy $7 trillion of Jubilee Shares.

65
This is another planned enhancement of Minsky: make it possible to show a flowchart as an equation, where
an equation is easier to read.

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In the first simulation shown below in Figure 191, the interest rate on Jubilee Bonds is set to zero, to
illustrate what the Jubilee does if the amount of money in the economy remains constant—with
interest payments, the amount of money increases. The effects include a large increase in GDP—
which surprised even me when I first ran the model.

The reason for this is the impact of the Jubilee on the distribution of money, with initially more of it
turning up in workers’ bank accounts, but then—because workers have a much higher rate of
spending than capitalists or bankers—most of that money ends up in the firm sector, rather than in
the bank accounts of capitalists and bankers. The firm sector’s turnover of money determines
private sector GDP (I have omitted normal government spending and taxation from this model), and
its rate of turnover is lower than that of workers, but much higher than bankers and capitalists. So
the impact of the redistribution of money via the Jubilee is a much higher level of GDP via an
increased rate at which money turns over in the economy.

This modelling phenomenon is the obverse of a real-world phenomenon that I have long observed
and attributed to the impact of higher private debt levels on people’s willingness to spend: the fall in
the velocity of money since the peak inflationary period of the early 1980s—see Figure 192. This
explanation still has legs as an inadvertent macro effect of a micro phenomenon: the higher average
debt to income ratio today makes people “hoard” money to be able to pay their interest and
principal commitments, but at the aggregate level hoarding merely reduces the rate of turnover of
money. This leads to lower incomes, defeating the micro objective people have of saving more.

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Figure 191: Simulation with no interest on Jubilee Bonds

However, this model has constant turnover rates for each social class (workers, capitalists and
bankers) and the firm sector, so the rise in velocity it generates comes from the redistribution of
existing money (and the fall in indebtedness, which reduces interest payments on existing debt, thus
enabling that money to be used for commodity purchases instead).

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Figure 192: Velocity of money of zero maturity (https://fred.stlouisfed.org/series/MZMV)

The next simulation has interest paid on Jubilee bonds at the same rate as private debt, of 6% per
year. The outcome is that bank income does not fall because of the Jubilee, while the payment of
interest also creates new money. The banks don’t lose income out of the Jubilee—the interest they
used to receive from private debtors is now provided by the government. As with MMT’s insight in
general, the negative equity of the Treasury enables the positive equity of the private sector—see
Figure 193.
Figure 193: The Treasury's Godley Table for the Modern Debt Jubilee

Rather than this leading to an increase in the government’s debt to GDP ratio however, over time, it
leads to a fall—see the second plot in Figure 194, which shows the debt to GDP ratios for the private
sector, public sector, and the sum of the two. The government debt to GDP ratio rises as a direct
consequence of the Jubilee initially, as government debt replaces private debt; but the growth in the
economy triggered by the Jubilee means that the government debt ratio falls over time. After a
decade, the government debt ratio is lower than it was before the Jubilee. The aggregate debt ratio
also falls: the economy transitions from a private sector based on debt to one based on share equity.

This is because the stimulatory effect of the Jubilee on private sector activity more than outweighs
the increased debt the government takes on in Jubilee Bonds. Direct attempts to reduce the
government debt to GDP ratio by austerity have the opposite effect on the real economy—
depressing GDP and counteracting the attempt to reduce the debt ratio by reducing government
debt.

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Figure 194: A Modern Debt Jubilee with interest on Jubilee Bonds

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Figure 195: Modern Debt Jubilee Godley Tables

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Figure 196: The full Modern Debt Jubilee model

This completes the models showcased in Manifesto. As time goes on, I’ll add new models here,
developed by myself and others, to show what Minsky can do.

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9 Complexity

Lotka’s model was easily derived, simply by acknowledging that sharks eat fish, and by using the
simplest possible mathematical operation to link the two species together. 66 It’s also easily analyzed,
since with just two dimensions, its dynamic properties depend on a simple quadratic, as I’ll explain
later in Chapter 11. The next model, which is the first simulated model in the history of complex
systems analysis, is an entirely different … kettle of fish.

9.1 Lorenz model

The derivation of Lorenz’s model of turbulent flow 67 required mathematical skills well in advance of
those possessed by the vast majority of economists—including me—so don’t let the simplicity of the
equations in (54) fool you. Superficially, they are only slightly more complicated than the Lotka
predator prey model: rather than 2 variables and 4 parameters (Lotka), there are 3 variables and 3
parameters:

dx
 a y  x 
dt
dy
 x b  z   y
dt (54)
dz
 x y  c z
dt
a  10, b  28, c  2.67
However, the behavior of the model is from another planet: Planet Complexity—see Figure 197.
Unfortunately for mainstream economists, this happens to be the planet on which we actually live.

66
Things get far more complicated when 3 or more species are considered: with 3 dimensions, as I explain in
Manifesto, you enter the realm of chaotic dynamics—which we’ll explore using Lorenz’s model.
67
https://www.scribd.com/document/395983652/lorenzderivation-pdf.

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Figure 197: Lorenz's model with its chaotic behavior and "strange attractors"

What is worth repeating is the exercise of deriving the equilibrium of the model, by setting all the
differential equations in (54) to zero:

dx
 a y  x   0
dt
dy
 x b  z   y  0 (55)
dt
dz
 x y  c z  0
dt

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One obvious solution here is where 𝑥𝑥 = 𝑦𝑦 = 𝑧𝑧 = 0. The non-zero solutions to (55) give us these
three conditions for the equilibrium values, which I identify using the subscript E:

yE  xE
yE  x E b  zE  (56)
xE  yE
zE 
c
A bit of algebraic manipulation yields:

zE  b  1
(57)
yE  xE   c  b  1

There are thus 3 equilibria for this model:

   
 xE   0  c  b  1  c  b  1
       
 yE    0 ,  c  b  1 ,  c  b  1 (58)
       
 z   0  b 1   b 1 
 E      
   
One reason I love this model, as a non-mainstream economist, is that it makes a mockery of the
Neoclassical obsession with equilibrium modelling, because it has three equilibria, all of which are
unstable. The equilibria are the colored dots on the phase plots of z against x & y, and y against x.
The simulation starts at the values (0.1,0.1,0.1), just a slight displacement from the (0,0,0)
equilibrium. Because the simulation starts so close to this equilibrium, the system is rapidly pushed
away from it: this equilibrium is stable on two of its three eigenvalues, but unstable on one.

The system is then attracted towards one of the other two equilibria, but they are “strange
attractors”: they attract the system from a distance but repel it—in a cyclical fashion—when it gets
closer to them. We’ll get into the detail of how to analyze this instability in Chapter 11, but for now
its primary characteristics are that the system will never converge to any of its equilibria, and yet the
system will also never return values that are unrealistic. Its dynamics are therefore necessarily far-
from-equilibrium dynamics: the very idea of “equilibrium dynamics”—as ensconced in Neoclassical
“Dynamic Stochastic General Equilibrium” modeling—is an oxymoron.

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Figure 198: Lorenz model with equilibria. Simulation starting from (0.1,0.1,0.1)

My model of Minsky’s Financial Instability Hypothesis, which we’ll develop in the next section, has
related, though not quite so complex, far-from-equilibrium dynamics.

9.2 A complex systems model of economic instability

On page 80, I introduced Richard Goodwin’s model of cyclical growth, which reduced to the
following two equations for the employment rate 𝜆𝜆 and the wages share of output 𝜔𝜔68.

d   1− ω  
λ = λ ⋅ −δK  −α − β 
dt  v   (59)
d
ω =ω ⋅ ( Sλ ⋅ ( λ − Z λ ) − α )
dt
The model generated everlasting cycles, like those generated by Lotka’s Predator-Prey model:

68
The model’s parameters are 𝛼𝛼, 𝛽𝛽, 𝛿𝛿𝐾𝐾 , 𝑣𝑣, 𝑆𝑆𝜆𝜆 , 𝑍𝑍𝜆𝜆 , where 𝛼𝛼 is the rate of technical progress, 𝛽𝛽 the rate of
population growth, 𝛿𝛿𝐾𝐾 the depreciation rate, 𝑣𝑣 the capital to output ratio, 𝑆𝑆𝜆𝜆 the slope of a linear “Phillips
Curve”, and 𝑍𝑍𝜆𝜆 the employment rate at which the rate of change of wages is zero.

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Figure 199: Reduced Form Goodwin Model

Since that derivation was some time back(!), and I don’t have to worry about my publisher’s
constraints on word length, I’ll repeat the derivation here, along with the third factor I introduced
when I constructed my model of Minsky’s Financial Instability Hypothesis in 1992 (Keen 1995): the
private debt to GDP ratio 𝑑𝑑𝑟𝑟 ≡ 𝐷𝐷⁄𝑌𝑌. I’ll derive the model using the basic rules of calculus that:

 1 dx
x 
x dt
x
x y (60)
y
x y x y

The three definitions that we will turn into a simple model that extends Goodwin’s model to include
the role of finance in capitalism, are the employment rate, the wages share of GDP, and the private
debt to GDP ratio:

L
λ≡
N
W
ω≡ (61)
Y
D
dr ≡
Y
Two ancillary definitions are needed: the output to labor ratio 𝑎𝑎, and the capital to output ratio 𝑣𝑣:

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Y
a
L
(62)
K
v
Y
The first step is to apply the rules in (60) to the definitions in (61)—and to save time I’ll use the
definitions in (62) to extend the equations as far as possible without introducing any assumptions:

 
   L   
 L    Y N
N   Y   
a N
 N  a

  W   W
   Y (63)
 
Y
 D  
dr     D Y
 Y 

To proceed any further, we need to introduce some simplifying assumptions. Most of the
assumptions Goodwin made are shown in Equation (64): exponential growth of the output to labor
ratio and of population, a constant capital to output ratio, and a uniform wage:

1 da
 
a dt
1 dN
  (64)
N dt
v  const
W  w L
When we feed these assumptions into the definitions, we get a final and very simple expression for
the rate of change of the workers’ share of output 𝜔𝜔, but we still have further to go with the
employment rate and the debt ratio. Both contain an expression for the rate of change of the capital
stock 𝐾𝐾, and the debt ratio equation includes the rate of change of private debt 𝐷𝐷:

  Y    

 w
   L  Y  w
 
L  Y  w
  Y  
a  Y  w
  (65)
  Y
dr  D

𝑌𝑌� is better known as the rate of economic growth, so let’s use 𝑔𝑔𝑟𝑟 = 𝑌𝑌� to simplify the appearance of
these equations. I’ll also replace 𝑤𝑤
� with 𝑃𝑃𝑐𝑐 (“Phillips curve”) :

  g  
 r


  P  (66)
c

dr  D
 g
r

At this point, we have three mathematical statements that are easily interpreted verbally: the
employment rate will rise if economic growth exceeds the sum of the growth rates of the output to
labor ratio and population; the wages share of GDP will rise if wage demands exceed the growth rate

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of the output to labor ratio; and the debt ratio will rise if debt rises faster than the rate of economic
growth.

We now need to define the rate of economic growth and the rate of growth of private debt to arrive
at a final model. Given the assumption that the capital to output ratio 𝑣𝑣 is a constant, the rate of
economic growth is the same as the rate of change in the capital stock:

K
Y
v
1 dY 1 d  K 
gr      
Y dt K dt  v 
v (67)
v 1d
  K
K v dt
1 d
 K
K dt
Now we need to define the rate of change of the capital stock. 69 The obvious starting point is that
the rate of change of capital equals investment minus depreciation, which is normally assumed to be
a linear function of the amount of capital. Using 𝐼𝐼𝐺𝐺 for gross investment , 𝛿𝛿𝐾𝐾 for the depreciation
rate, and 𝑖𝑖𝐺𝐺 = 𝐼𝐼𝐺𝐺 ⁄𝑌𝑌 for the ratio of gross investment to output, this yields:

dK
 IG  K  K
dt
1 dK  IG
  K   K
K dt K
(68)
  IG  
K K
v Y
  iG  
K K
v
This leaves just the rate of change of private debt to be defined:

  g  
 r

 
  w  (69)
dr  D
 g
r

� , we need a realistic simplifying assumption. The simplest—which is far too kind to

To determine 𝐷𝐷
the finance sector, since it omits the modern finance sector’s main business model of Ponzi

69
The very issue of an aggregate measure of capital is a fraught one, given the Cambridge Controversies.
However the import of this was much greater for Neoclassical economics than Post Keynesian, because in
Neoclassical Economics, the rate of return on capital is its marginal product. This leads to the circularity in the
theory that Sraffa exposed. In Post Keynesian economics, this link does not exist: the rate of return is a
function of class struggle over the distribution of income. So the concept of an aggregate quantity of capital is
less problematic for Post Keynesian modelling, even though this issue of how one aggregates disparate types
of capital equipment still exists. In the next chapter on energy, I make a novel suggestion as to how to do this,
though at a highly abstract level.

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finance 70— is that capitalists invest more than profits during a boom, and less than profits during a
slump—and that they have to borrow money 71 to enable this. Borrowing thus finances investment,
so that the rate of change of private debt 𝐷𝐷 was equal to gross investment minus profits:

d
D= I G − Π
dt (70)
≡ 1 d D=
D
IG − Π
D dt D
This appears to be an impasse, since the denominator is D, rather than something we can work with
like Y. But there’s a handy trick for situations like this, taught to me by the wonderful (if irascible)
mathematics lecturer Professor Williams when I was studying first year undergraduate mathematics
at Sydney University in 1971. To quote Williams:

There are 3 rules of mathematics: (1) what have you got that you don’t want?
Get rid of it; (2) what haven’t you got that you do want? Put it in (3) Keep it
balanced.

We can bring in Y by multiplying the right hand side of 𝑌𝑌/𝑌𝑌, and then rearranging terms:

 = Y IG − Π
D
Y D
Y IG − Π
= (71)
D Y
1
= ( iG − π s )
dr

Here 𝜋𝜋𝑠𝑠 stands for the profit share of income: 𝜋𝜋𝑠𝑠 = Π⁄𝑌𝑌. This now gives us three fairly simple
equations:

  g  
 r


  P  (72)
c

i  s
dr  G  gr
dr

To proceed, we need to add functional forms for the rate of change of wages 𝑤𝑤 � and the investment
share of output 𝑖𝑖𝐺𝐺 . For the former, I use the same linear “Phillips curve” function used by Goodwin.
For the latter, though a common practice in Post Keynesian economics is to model investment as
driven by a target level of capacity utilisation, I base investment on the rate of profit, using exactly
the same form as the wage change function, with the rate of profit taking the place of the
employment rate:

 = S ⋅ (λ − Z )
w λ λ
(73)
IG
iG = =Sπ ⋅ (π r − Zπ )
Y

70
Ponzi finance can easily be added by including debt that doesn’t create new productive capacity. See (Giraud
and Grasselli 2019).
71
“Money” at this point in developing the model is effectively “real”—there is no inflationary mechanism.

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Profit in the original Goodwin model was just output minus wages. The introduction of private debt
means that profit now equals output minus wages minus interest payments on outstanding debt:

Π= Y − W − r ⋅ D (74)

The rate of profit is profit Π divided by capital 𝐾𝐾. It is easily related to the profit share 𝜋𝜋𝑠𝑠 , where this
is now 1 − 𝜔𝜔 − 𝑟𝑟 ∙ 𝑑𝑑𝑟𝑟 :

Π
πr =
K
Y −W − r ⋅ D
=
v ⋅Y
(75)
1 − ω − r ⋅ dr
=
v
πs
=
v
This gives us a 3-dimensional model which, as I explain in Manifesto, reproduces the essence of
Minsky’s Financial Instability Hypothesis:

  g  
 r


  P  (76)
c

i  s
dr  G  gr
dr

Where I’ve used the abbreviations:

iG
gr   K
v
PC  S    Z 
(77)
 
iG  S   s  Z  
 v 
s  1    r  dr
𝑑𝑑𝑑𝑑
To simulate and analyze this model, we need to express it in terms of differential equations— —
𝑑𝑑𝑑𝑑
1 𝑑𝑑𝑑𝑑
rather than rates of change—𝑥𝑥� = ∙ . This just involves multiplying both sides of Equation (76) by
𝑥𝑥 𝑑𝑑𝑑𝑑
the relevant variables 𝜆𝜆, 𝜔𝜔, 𝑑𝑑𝑟𝑟 :

d
λ = λ ⋅ ( gr − α − β )
dt
d
ω =ω ⋅ ( PC − α ) (78)
dt
d
d r = iG − π s − d r ⋅ g r
dt
These equations are easily entered into Minsky—see Figure 200.

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Figure 200: Reduced form version of Minsky's Financial Instability model

The peculiar dynamics in this model—the initially falling and then rising cycles in the growth rate and
employment, the rising private debt to GDP ratio, and the decline in the workers’ share of GDP, even
though they do no borrowing in this model—turn out to be a particular subset of the dynamics of
the Lorenz model, known as the “Intermittent Route to Chaos” (Pomeau and Manneville 1980). 72

We’ll check this behavior out analytically in Chapter 11—and the linear form of the model, shown
here, is essential to that task. But I’ve also heard comments from Neoclassicals that this model
generates unrealistic cycles—look at how large the fluctuations are in wages share, employment,
and the growth rate! Therefore, this is a useful point at which to discuss the proper role of nonlinear
functions in complex systems models.

9.3 Nonlinear Functions in Nonlinear Models

Figure 201 adds two nonlinear functions to the previous model, one for the “Phillips Curve” and the
other for the investment function. You will note that the cycles in this model are much smaller in
scale than for the previous model with linear behavioral functions.

This is because the nonlinear functions themselves curtail a model’s behavior to realistic bounds, in a
way that linear functions do not. They do not generate the cycles themselves in the model shown

72
The unrealistic values of some variables—in particular, the debt ratio—are largely a consequence of the use
of linear behavioural functions. More realistic nonlinear functions result in more realistic variable values, which
indicate that the role of nonlinear functions is not to generate the cyclical behaviour (which results from the
intrinsic nonlinearities in the model itself) but to constrain the behaviour within realistic bounds.

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here, since those cycles are intrinsic to the model itself via the nonlinear interaction of system
states.

The actual cyclical behavior of the model is due to the several points in it in which one variable (say,
the debt ratio) is multiplied by another (say, the wages share of GDP). 73 For example, as the
employment rate rises, it increases the rate of growth of the wages share of GDP because the
variables are multiplied together in the equation for the rate of growth of the wages share.

With a linear “Phillips Curve” function, this intrinsic nonlinearity is multiplied by a constant slope of
the Phillips Curve, whether the model economy is close to an equilibrium or far away from it. This
applies whether the employment rate is well below or well above its equilibrium value, and a
constant slope means that it shows wages fall with low employment as easily as they rise with high
employment.

But with a nonlinear Phillips Curve, the intrinsic nonlinearity is increased much more when it is a
significant distance above the equilibrium than it is when closer to it, while an employment rate well
below the equilibrium leads to only a small fall in wages, rather than a very large one.

Nonlinear functions also let you use much more subdued assumptions about the magnitude of a
system’s response to an imbalance. The functions used here are both exponentials, and are entered
using a generalized formula that takes an (x,y) coordinate, the slope at that coordinate, and a
minimum value as inputs: 74
Var x
s
GenExp  x , y , s , m,Var   y  me y m
m (79)

The slope of both these functions at their (x,y) points—the employment level where wage change
equals zero for the wages function, the profit level at which all profits are invested for the
investment function—is 2, versus a slope of 10 for both of their linear counterparts. An extreme
slope is needed for the linear functions because, with a more gradual slope, nonsense values could
be returned—such as an employment rate of more than 100%, for example. With a nonlinear
function, the slope near the equilibrium can be quite modest, while the nonlinearity of the function
itself makes this slope steeper further away from the equilibrium. This is realistic, and serves the
purpose of constraining system outcomes to realistic bounds.

73
This isn’t apparent in the equations in this section, since they use abbreviations to make the equations more
compact. The full nonlinear interactions in this model are shown in Equation (209) in section 11.4, which starts
on page 235.
74
This function is, I hope, much easier to read than the flowchart renditions of it on the canvas. One thing we
hope to enable one day is direct entry of equations onto the canvas, rather than requiring the use of a
flowchart format. But as with all things computing, implementing this will require funding.

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Figure 201: Nonlinear behavioral functions generate more realistic cycles

9.4 The switch function

Figure 201 makes use of Minsky’s switch function to enable the model to switch from using linear to
nonlinear functions easily.

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Figure 202: The switch functions used in Figure 201

The switch function takes an input which can be zero or non-zero, and returns the first input if its
value is zero, or the second if it is non-zero. The parameter 𝐿𝐿𝐿𝐿𝐿𝐿𝐿𝐿𝐿𝐿𝐿𝐿 has an initial value of 0, a
maximum of 1, and a step-size of 1, so it acts as the on-off switch. To make it easier to see what is
happening, the indicator wire within the switch block will switch from one input to the other when
the input condition is altered.

Now let’s turn our attention to the essential missing ingredient in economic models of production:
energy.

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10 Energy
The work in this chapter is the most technically demanding in this book, and also the area most
needing follow-up work … by people like you! As I note in Manifesto, the fact that economics has
persisted for almost a century (Cobb and Douglas 1928; Leontief 1944, 1946b; Leontief 1946a;
Leontief 1936) with models of production in which energy plays no role is, arguably, the Original Sin
of Economics that has resulted in it being the misleading miasma that it is today. But escaping from
that miasma is difficult, as I found as I worked with Matheus Grasselli and Tim Garrett to derive the
models outlined here.

The starting point, though, was simple enough. Both Neoclassical and Post Keynesian mathematical
models of production functions treated output as a function of inputs of Labor and Capital:

Y  F L, K  (80)

However, nothing can be produced without energy and matter inputs as well. The input-output
approach to modelling production, pioneered by Leontief (Leontief 1936), did explicitly include
inputs of both energy and raw materials (as well as other commodities) to produce output, but in
practice, this method was generally implemented in an equilibrium framework in “Computable
General Equilibrium” (CGE) models, when the equilibrium of an input-output matrix is unstable. 75
After the “Rational Expectations Revolution”, Neoclassicals largely abandoned CGE modeling in
favour of single commodity modeling, based on the Ramsey growth model (Ramsey 1928). The
Cobb-Douglas Production Function (CDPF) ruled supreme in these models, and portrayed output as
being produced by combining technology 𝐴𝐴, labour 𝐿𝐿 and capital 𝐾𝐾:

Y  A  L1  K  (81)

Post-Keynesian aggregate production form of the Leontief input-output model, which Goodwin
used in his cyclical growth model (Goodwin 1967), and I used in my model of Minsky’s Financial
Instability Hypothesis, is:

K 
Y  min , a  L (82)
 v 
Here 𝑣𝑣 is normally described as the “Capital to Output ratio” (see Figure 69 on page 47), while 𝑎𝑎 is
called “Labor Productivity”—though I challenge both these labels later.

Neither aggregate production function explicitly include either matter or energy, something which
mainstream economists largely ignored until the publication of the Limits to Growth (Meadows,
Randers, and Meadows 1972). Then, faced with a rival technology—system dynamics—they tried to
develop a Neoclassical riposte. Stiglitz (Stiglitz 1974a; Stiglitz 1974b) and Solow (Solow 1974a) both
proposed modified Cobb-Douglas functions of the form (Solow 1974a, p. 35, Equation 6):

Q  emgt  Lg  R h  K 1gh (83)

75
See (Blatt 1983) for an excellent explanation of this.

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Here R stood for “Resources”, which include energy. 76 It is treated as a third input on equal footing
with Labor and Capital.

This didn’t make sense to me, for two reasons. Firstly, it implied that energy could be added to a
production process independently of labor and capital—say, by hitting a factory with a bolt of
lightning—and thus producing output. But this was more likely to turn the factory into a smouldering
ruin. Secondly, it implied that Labor and Capital could both function without energy—which of
course they can’t. Figure 203 both portrays and satirizes this approach.

Even far superior attempts to engage with the role of energy in production, like the work of Kümmel
and Ayres (Kümmel, Ayres, and Lindenberger 2010; Kummel 2011; Lindenberger and Kümmel 2011;
Kümmel, Lindenberger, and Weiser 2015), used a similar formulation where Capital, Labor and
Energy were put on an equal footing. One step in the derivation of their LinEx production function
was the introduction of a dimensionless specification of a production function, which again put
Labor, Capital and Energy on an equal footing. Equation (84) shows equations 39 and 50 from
(Kümmel, Ayres, and Lindenberger 2010, pp. 162,166)

y k , l , e; t   Y  k  K o , l  Lo , e  E o ; t  Y0
(84)
yCDE  y0  k 0  l 0  e10 0

What was needed was a formulation which made energy absolutely essential to the production
process, and didn’t pretend that it could be added independently of both labour and machinery.
Figure 203: Treating energy as an equivalent independent input to labour and capital

I was cogitating over this dilemma one evening while walking through Bob Ayres’s apartment in
Paris—which was full of statues—when the quip “Capital without energy is a sculpture; labor
without energy is a corpse” flashed into my mind. This insight revealed that the correct form for
incorporating energy in production wasn’t Equation (84) and Figure 203, but equation (85) and
Figure 204. Energy is an input to both machinery and labour, without which they can’t do useful
work:

Q  F K E  , LE  (85)

76
Though the word appeared only once in the text of these three papers: “The proposition that limited natural
resources provide a limit to growth and to the sustainable size of population is an old one. The natural
resource that was the centre of the discussion in Malthus' day was land; more recently, some concern has
been expressed over the limitations imposed by the supplies of oil, or more generally, energy sources, of
phosphorus, and of other materials required for production.” (Stiglitz 1974a, p. 123), and unlike Limits to
Growth, no attempt was made to quantify either resources in general or energy in particular.

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In doing useful work, waste is also necessarily generated—an application, in a very limited sense, of
the Second Law of Thermodynamics. So the inputs to Labour and Capital are (different forms of)
energy, and the outputs are materials transformed from non-usable inputs to usable commodities,
plus waste.
Figure 204: Labour and capital both need energy inputs to produce output (which inevitably produces waste)

The easiest way to develop a mathematical model of production out of this insight was to treat both
𝐾𝐾 (𝐸𝐸 ) and 𝐿𝐿(𝐸𝐸 ) as being equal to the product of the units of each (𝐾𝐾 and 𝐿𝐿), times the annual energy
consumption of each (𝐸𝐸𝐾𝐾 and 𝐸𝐸𝐿𝐿 ), times how efficiently those inputs were turned into useful work
(𝑒𝑒𝐾𝐾 and 𝑒𝑒𝐿𝐿 ):

K E   K  EK  eK
(86)
LE   L  EL  eL

I fed this into the Capital and Labour components of the Cobb-Douglas Production Function (minus
what soon transpired to be the superfluous 𝐴𝐴):

Y (t ) K (t ) ⋅ L (t )
α 1−α
=
(87)
( K ⋅ EK ⋅ eK ) ⋅ ( L ⋅ EL ⋅ eL )
α 1−α
=
Rearranging this led to the expression in Equation (88), where the last two components are the
standard expressions for capital and labour in the CDPF:

Y ( t ) = ( EL ⋅ eL ) ⋅ ( EK ⋅ eK ) ⋅ K α ⋅ L1−α
1−α α
(88)

The first component—the energy consumption of the typical worker, times how much of that energy
is turned into useful work in production—can be treated as a constant: the capacity for a worker to
put energy into useful work hasn’t varied since humans evolved, and is roughly 100 Watts. The
second is the energy input to the “representative machine” at a given time, multiplied by how much
of that energy is turned into useful work. The energy consumption of the “representative machine”

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has risen from the tonnes of fuel per day that powered James Watt’s steam engine to the tonnes per
second that fuel Elon Musk’s rockets. The efficiency with which machines turn energy into useful
work is an unknown scalar bounded by (0,1). Treat the product (𝐸𝐸𝐿𝐿 ∙ 𝑒𝑒𝐿𝐿 )1−𝛼𝛼 ∙ 𝑒𝑒𝐾𝐾 𝛼𝛼 as a constant 𝐶𝐶𝐿𝐿
and reserve the exponents for factors that actually change over time: 𝐸𝐸𝐾𝐾 , 𝐾𝐾, 𝐿𝐿 . Then our energy-
modified Cobb-Douglas Production Function is equation (89):

Y ( t ) =CL ⋅ ( EK ⋅ K ) ⋅ L1−α ; or
α

(89)
Y ( t ) = CL ⋅ EK α ⋅ K α ⋅ L1−α
Derived this way, the “total factor productivity” term 𝐴𝐴 is actually a constant times the energy input
to the “representative machine” of a given time.

This is the form in which I published this work (with Bob Ayres and Russell Standish) in “A Note on
the Role of Energy in Production” (Keen, Ayres, and Standish 2019, p. 44). But we only used the
Cobb-Douglas Production Function in the probably forlorn hope that some Neoclassicals might
therefore read the paper. The real basis for modelling the role of energy in production properly is
the “Leontief Production Function” used by Post Keynesians (equation (90)):

K  K
Y ( t ) =min  , a ⋅ L  =u ⋅ =a ⋅ L (90)
v  v
On the other hand, the Cobb-Douglas Production Function belongs in the dustbin of the history of
economic thought.

10.1 Forget the “Cobb-Douglas Production Function” (an optional read)

Neoclassicals take great solace in the fact that their preferred aggregate production function fits the
national data so well:

I have always found the high R2 reassuring when I teach the Solow growth model.
Surely, a low R2 in this regression would have shaken my faith. (Mankiw 1997, p.
104)

This is doubly so, because the model also encapsulates the Neoclassical belief that the real wage is
the marginal productivity of labor, and the rate of profit is the marginal productivity of capital. The
fact that the empirically measured Cobb-Douglas exponents are very close to the national income
shares of labour and capital played a major role in the acceptance of the Cobb Douglas by
Neoclassical economists:

aggregate production functions apparently work nevertheless and do so in a way

which is prima facie not easy to explain. It is easy enough to understand why, in
economies in which things move more or less together, a relationship giving an
aggregate measure of output as dependent on aggregate measures of capital and
labor should give a good fit when applied to the data. What is not so easy to
explain is the fact that the marginal product of labor in such an estimated
relationship ap- pears to give a reasonably good explanation of wages as well. In
its simplest form, this puzzle is set by a remark which Solow once made to me
that, had Douglas found labor's share to be 25 per cent and capital's 75 per cent
instead of the other way around, we would not now be discussing aggregate
production functions. (Fisher 1971, p. 305)

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Tragically, in one of the most insightful and witty papers in the history of economics, 77 “The Humbug
Production Function”, Anwar Shaikh (Shaikh 1974) gave the explanation that Fisher craved—and it
wasn’t one that Fisher would have enjoyed. The Cobb-Douglas Production Function is just a
tautology. It simply restates, in exponential rather than additive form, the identity that “Income
equals Wages plus Profits” under conditions of relatively constant income shares:

Shaikh demonstrated that the Cobb–Douglas is simply an (anti-)logarithmic

transformation of the income identity under the assumption that relative income
shares are constant. (Carter 2011, p. 259)

Therefore, regressing the Cobb-Douglas Production Function against national income data is like
regressing Y against Y: of course you’ll get a high correlation. That correlation falls below 100% only
to the extent to which its assumptions—such as a uniform wage rate and constancy of income
shares—deviate from actual conditions.

I’ll repeat Shaikh’s proof here to explain why the Cobb-Douglas function should be rejected as a
basis for economic modelling. Start with the identity that income 𝑌𝑌 equals wages 𝑊𝑊 plus profits Π:

Y W   (91)

Assume a uniform real wage rate 𝑤𝑤 and a uniform rate of profit 𝑟𝑟, applied respectively to a labour
force 𝐿𝐿 and stock of capital 𝐾𝐾:

Y  w L  r K (92)

Differentiate both sides and divide by 𝑌𝑌:

1 d 1 d
 Y   w  L  r  K 
Y dt Y dt
1  d d d d 
  w L  L  w  r  K  K  r  (93)
Y  dt dt dt dt 
w d L d r d K d
  L  w  K   r
Y dt Y dt Y dt Y dt
Bring in income shares—the proportion of income going to workers and capitalists respectively—by
multiplying each fraction by the “missing ingredient”: multiply the first term by 𝐿𝐿⁄𝐿𝐿, the second by
𝑤𝑤 ⁄𝑤𝑤 and so on:

1 d Lw d w L d K r d rK d
 Y  L  w  K  r (94)
Y dt L Y dt w Y dt K Y dt r Y dt
Group the terms so that income shares multiply each differential:

1 d 1  L w  d 1  w L d 1  K  r  d 1  r K  d
 Y     L     w     K    r (95)
Y dt L  Y  dt w  Y  dt K  Y  dt r  Y  dt
𝐾𝐾∙𝑟𝑟 𝑤𝑤∙𝐿𝐿
Call the profit share of GDP 𝛼𝛼 = , and the wages share 1 − 𝛼𝛼 =
𝑌𝑌 𝑌𝑌

77
Given the ignorant and humourless state of economics in general, this isn’t a high bar: it’s more of a hurdle
for sausage dogs. But Anwar cleared that bar by a large margin. Read the paper!

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1 d 1 d 1 d 1 d 1 d
 Y  1      L  1      w    K    r (96)
Y dt L dt w dt K dt r dt
“Percentage” rates of change can be expressed as the differential of the logs, so that

1 d d
 Y  lnY  (97)
Y dt dt
And likewise for the other differentials in (96):

d d d d d
lnY   1     lnw   1     lnL    lnK     lnr  (98)
dt dt dt dt dt
At this point, we assume that income shares 𝛼𝛼 and 1 − 𝛼𝛼 are constant. They do change over time—
that was the basis of the Goodwin model 78—but relatively slowly compared to employment, wages,
capital and the rate of return on capital, as codified in Kaldor’s stylized facts:

the share of wages and the share of profits in the national income has shown a
remarkable constancy in " developed " capitalist economies of the United States
and the United Kingdom since the second half of the nineteenth century. (Kaldor
1957, pp. 591-92)

Neoclassical modelers also treat 𝛼𝛼 as a constant in their models. So we can do the same, and then
integrate both sides, with integration being the inverse of differentiation:

d  d d d d 
 dt lnY    1   dt lnw  1   dt lnL    dt lnK     dt lnr  (99)
lnY   1    lnw   1    lnL   lnK    lnr 

A constant multiplying the logarithm of a variable is the same as the logarithm of the variable raised
to the power of that constant: 𝛼𝛼 ∙ 𝑙𝑙𝑙𝑙(𝑤𝑤) = 𝑙𝑙𝑙𝑙(𝑤𝑤 𝛼𝛼 ) and so on, so that

lnY   lnw 1   lnL1   lnK    lnr   (100)

Take exponentials of both sides:

       
ln w1 ln L1 ln K  ln r 
Y e
(101)
 w 1  r   L1  K 
This is almost the “Cobb-Douglas Production Function”: the only difference is that Cobb and Douglas
began with a constant in the place of 𝑤𝑤 1−𝛼𝛼 ∙ 𝑟𝑟 𝛼𝛼 , while later Neoclassicals use a time-varying 𝐴𝐴(𝑡𝑡),
which they call “total factor productivity”—and which, as explained previously, is actually the energy
consumption level of the “representative machine”:

Y  A  L1  K  (102)

78
The Goodwin model’s empirically exaggerated variation in wages share is dramatically reduced when
nonlinear behavioural functions, and monetary and price dynamics, are included in the model.

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It’s no wonder, therefore, that the “Cobb Douglas Production Function” fits the empirical data on
output and income distribution, since it can be derived from that data, under the not entirely false
assumption that income shares are relatively constant.

Neoclassicals estimate 𝐴𝐴 as a residual from the time series for Labour and Capital—since the vast
majority of them are not aware of Shaikh’s proof, and in typical Neoclassical fashion, those that are
think that Solow’s rejoinder to Shaikh (Solow 1974b) settled the dispute in their favour. But it didn’t
(Shaikh 1980, 2005; Labini 1995).

There is a further weakness, pointed out by Mankiw and noted in Manifesto, that while the CDPF fits
national data well with its exponent conforming to national income distribution data, this value for 𝛼𝛼
also results in predictions of relative economic performance that are disastrously bad:

Because poor countries have about one-tenth the income of rich countries, they
should have returns to capital that are about one hundred times as large. In
particular, since the profit rate is about 10 percent per year in rich countries, it
should be about 1,000 percent per year in poor countries. (Mankiw, Phelps, and
Romer 1995, p. 287)

Another good reason to reject the CDPF is its assumed easy substitution of one input for another.
This in itself is a dubious assumption—you can’t easily vary the labour and capital inputs into a
production process—but in the context of energy, it is simply false. Energy can be used more or less
efficiently, but there is no substituting for it. If you don’t have energy, you don’t have output, period.
On this basis, the fixed coefficient formulation of the Leontief is more sensible. And, as the next
section shows, it is easy to interpret the capital output ratio in the Leontief function as the efficiency
with which energy is turned into useful work. The Leontief function has therefore implicitly
contained the role of energy all along.

10.2 Generalizing the Leontief Production Function

Superficially, the Leontief Production Function has the same weakness as the Cobb-Douglas when it
comes to the role of energy of energy in production—there isn’t one. Stating the Leontief in terms of
a utilization of capital rate 𝑢𝑢, a capital to output ratio 𝑣𝑣, and an output to labour ratio 𝑎𝑎, it is:

K
Y ( t ) =u ⋅ =a ⋅ L (103)
v
In fact, it’s relatively easy to show that the capital to output ratio v, which has been treated simply as
an empirical regularity with a fairly constant value of between 2 and 4 for most economies, is
actually the inverse of 𝑒𝑒𝐾𝐾 : the efficiency with which machines turn energy into useful work.

We have to start by defining what aggregate output 𝑌𝑌 actually is, mathematically, in a

macroeconomic model. Economists treat it as just a number—a scalar—but the real question is “a
number of what?”. It is not a pure number, but a dimensioned number: it is a number of identical
“things”. These “things” are stylized universal commodities, which in the models can be consumed
by workers as consumption items 𝐶𝐶, or used as investment items 𝐼𝐼, which are inputs to make
machines, or “Capital” 𝐾𝐾. The term for this (highly unrealistic) universal commodity is a “widget”. So
𝑌𝑌 in an aggregate macroeconomic model is the number of widgets produced per year.

In this same sense, we—my collaborators Matheus Grasselli (Grasselli and Costa Lima 2012; Grasselli
and Maheshwari 2017; Grasselli and Nguyen-Huu 2018; Giraud and Grasselli 2019) and Tim Garrett
(Garrett 2011, 2012a, 2012b, 2014, 2015) and I—introduced 𝑄𝑄 as the energy equivalent of 𝑌𝑌: it was

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the amount of energy (measured in joules) 𝐸𝐸𝑌𝑌 contained in a widget, multiplied by the number of
widgets produced per year 𝑌𝑌.

Q
= EY ⋅ Y (104)

We then equated Q to the energy converted into useful work by machinery, using equation (86):

Q  u  K  EK  eK (105)

We can now show the relationship between Q and Y, using equation (103):

K
u  K  EK  eK  EY  u 
v (106)
E
EK  eK  Y
v

If we now equate terms with the same dimensions—energy per year in the cases of 𝐸𝐸𝑌𝑌 , 𝐸𝐸𝐾𝐾 and
scalars in the cases of 𝑒𝑒𝐾𝐾 , 𝑣𝑣, we get, firstly, that 𝑒𝑒𝐾𝐾 is the inverse of 𝑣𝑣:

1
eK  (107)
v
Secondly, the conversion factor between output in widgets and output in terms of energy (useful
work) at any given time in this single-commodity world is the energy consumption level of the typical
machine of that time:

EK  EY (108)

The first finding was a surprise, but one that made intuitive sense once we realized it: the
empirically-observed rough proportionality between output Y and capital stock K, which is an
essential aspect of the Leontief model, actually represents the efficiency with which machines turn
their energy inputs into useful work. In this sense, the Leontief model has always included a role for
energy—it just wasn’t explicit. This then turns on its head the standard rendition of the capital to
output ratio. This has been declining over time, somewhat inexplicably—see Figure 205:
Figure 205: Capital output ratio from https://fred.stlouisfed.org/series/RKNANPUSA666NRUG#0

However, from this energy-based perspective, what this actually shows is a rise over time in the
efficiency with which machinery turns energy into useful work—or, also quite feasibly, an increase in

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the amount of GDP which is virtual or non-physical (neither commodities nor directly consumed
energy, though of course virtual products—such as video games—require physical resources,
including file servers and electricity). Though there is an increasing trend right from the start of the
data, it becomes much stronger and more pronounced in the early 1980s, which coincides with the
development of the computer and the “virtual” economy it allows, the financialization of capitalism
and the rise in what Marx would call “fictitious output” from “fictitious capital”, 79 and the start of US
capital outsourcing production to China.
Figure 206: The efficiency with which energy is turned into useful work (GDP, or Y)

The rise in the ratio also supports to some degree the “decoupling” argument, that over time less
and less of GDP is dependent on physical and energetic output—though it’s also important to put
this in context: the dependence at the global level of output on energy remains extremely high (the
data in Figure 206 comes solely from the USA). When one looks at the long-run global data (Figure
207), and especially data for the last half-century (Figure 208), the correlation between GDP and
energy is extremely tight.

79
If the latter explanation for the rising ratio is more valid, then we should expect to see this ratio fall in the
future if the dominance of the finance sector ever comes to an end.

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Figure 207: Global GDP and energy consumption since 1800 80

Pre-1960 https://themasites.pbl.nl/tridion/en/themasites/hyde/consumptiondata/totalenergy/index-2.html
100000 100000
World Energy (annual data from 1970)
Post 1970 Energy https://data.oecd.org/energy/primary-energy-supply.htm

Post 1960 GDP https://data.worldbank.org/indicator/NY.GDP.MKTP.KD

World GDP (annual data from 1960)

10000 10000

1000 1000

100 100

10 10
1800 1820 1840 1860 1880 1900 1920 1940 1960 1980 2000 2020

Pre-1960 https://www.rug.nl/ggdc/historicaldevelopment/maddison/releases/maddison-database-2010

80
Data sources Pre-1960:
Energy https://themasites.pbl.nl/tridion/en/themasites/hyde/consumptiondata/totalenergy/index-2.html
GDP https://www.rug.nl/ggdc/historicaldevelopment/maddison/releases/maddison-database-2010

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Figure 208: Global GDP and Energy data since 1970 81

World Energy and GDP since 1970

15000 100000
World Energy
14000 World GDP 90000
Energy MTOE (Million Tons of Oil Equivalent)

13000 80000

12000 70000

GDP US$ 2010 Billion

11000 60000

10000 50000

9000 40000

8000 30000

7000 20000

6000 10000

5000 0
1970 1975 1980 1985 1990 1995 2000 2005 2010 2015 2020

Year

These are both rising trends which generates a spurious correlation of course, but the annual change
data is also extremely tightly correlated, and almost 1 for 1—see Figure 209.

81
Data sources Post 1970:
Energy https://data.oecd.org/energy/primary-energy-supply.htm
GDP https://data.worldbank.org/indicator/NY.GDP.MKTP.KD

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Figure 209: Annual change in GDP against change in energy (Correlation 0.83)

Annual Change in World Energy and GDP

OPEC II GFC
Energy
GDP
6
Percent change per year

0 0

−2
1970 1980 1990 2000 2010 2020

Years

However, the rise in the GDP to energy ratio is also apparent at the global level since the 1970s—see
Figure 210.

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Figure 210: GDP in constant US$ divided by Energy in BTU

Units of GDP per Unit of Energy

6

3
1960 1970 1980 1990 2000 2010 2020

However, the long-term data shows that this is a reversal of the trend since the start of the industrial
age—see Figure 211.

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Figure 211: GDP to Energy since 1800

Units of GDP per Unit of Energy

70

60

50

40

30

20

10

0
1800 1820 1840 1860 1880 1900 1920 1940 1960 1980 2000 2020

Interpretation of this long term trend in GDP to Energy is an open question—it quite possibly
represents the change from non-fossil to fossil-fuel driven industry over the course of the 19th
century. That said, the very tight fit between energy and GDP from the 20th century on, and
especially for the period from 1970 till 2017, provides another strong argument for the Leontief
Production Function as the proper tool to model the close to linear relationship between energy
consumption and GDP.

10.3 A Goodwin model with Energy

One key element in the previous section was using dimensional analysis to unravel an equation—
equation (106), where the first term on the left was dimensioned in units of energy per year, and the
next term was a scalar. It therefore made sense to equate components in the equation with the
same dimensions:

EY
EK  eK 
v
EK  EY (109)
1
eK 
v
Dimensional analysis is an important technique in science and engineering to check the validity of a
model, and it should be in economics too:

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The consistent and correct use of dimensions is essential to scientific work

involving mathematics. Their very existence creates the potential for errors:
omitting them when they should be included, misusing them when they are
included, and others. However, their existence also makes possible dimensional
analysis, which can be a significant factor in avoiding error. In the equation 𝑦𝑦 =
𝑓𝑓(. ), if y should have dimensions then so also should 𝑓𝑓(. ), and they should be
identical to those of y. If y should not have them then neither should 𝑓𝑓(. ) have
them… An error revealed by a correctly performed dimensional analysis indicates
a fundamental problem. Therefore, the importance of dimensions for science can
hardly be overstated. (Barnett II 2004, p. 95).

Economics has ignored dimensional analysis, as is obvious enough in the Cobb Douglas Production
function itself. As Barnett points out, the dimensions of the function can only be made reasonable by
ascribing a ludicrous set of dimensions to the 𝐴𝐴(𝑡𝑡) term:

A typical CD function is given by 𝑄𝑄 = 𝐴𝐴 ∙ 𝐾𝐾 𝛼𝛼 ∙ 𝐿𝐿𝛽𝛽 , in which: Q is the output

variable; K and L are the capital and labor input variables, respectively; A, may be
a constant or a variable; and, 𝛼𝛼 and 𝛽𝛽 are the elasticity of output with respect to
capital and with respect to labor, respectively…

If dimensions are used correctly, output, capital, and labor each must have both
magnitude and dimension(s), while 𝛼𝛼 and 𝛽𝛽 are pure numbers. Assume, for
example, that:

(1) Q is measured in widgets/elapsed time (wid/yr);

(2) K is measured in units of machine-hours/elapsed time (caphr/yr); and,

(3) L is measured in man-hours/elapsed time (manhr/yr). (Barnett II 2004, p.

96)

The only way to balance this equation in dimensional terms is for the A term to have crazy
dimensions for something that Neoclassicals, not knowing of Shaikh’s critique, describe as “Total
Factor Productivity”:

Q  A  K   L1
 1
Widgets K  L 
 ADimensions  Hours    Hours 
Year  Year  Year 
Widgets 1
 ADimensions  K Hours   LHours1  (110)
Year Year
1
Widgets  ADimensions  KHours  LHours


Widgets
ADimensions 
K Hours   LHours1

The “Cobb Douglas Production Function”, as well as being based on a tautology, is also dimensionally
weird. What we need instead is a model of the biophysical processes by which inputs of energy, raw

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materials and intermediate products are turned into usable physical products. 82 This chapter will
take the first tentative steps towards this, in models in which energy plays a fundamental role. Our
first pass was a model in which the inputs are energy, and the outputs are energy: the production
process turns energy in a form that can’t be consumed by humans—say, coal—into one in which it
can—say, electricity.

We started from the points established earlier about the Leontief Production Function (LPF), that by
using the redefinition of K and L as means by which energy is used to perform useful work:

K E   K  EK  eK
(111)
LE   L  EL  eL

We can recast the standard LPF:

K
Y =u ⋅ =a ⋅ L (112)
v
In terms of energy, so that output 𝑄𝑄, in terms of useful energy per year, equals capacity utilization 𝑢𝑢
(a scalar) times the number of machines 𝐾𝐾, times energy per machine per year 𝐸𝐸𝐾𝐾 , times the
efficiency with which that energy input is turned into useful work 𝑒𝑒𝐾𝐾 :

Q  u  K  EK  eK (113)

This is dimensionally consistent:

Energy Energy
 Scalar  Machine   Scalar
Year Year
Machine (114)
Energy Energy

Year Year
The Leontief Production Function in terms of energy per year is mapped across to the standard
measure of GDP in Widgets per year by dividing 𝑄𝑄 by 𝐸𝐸𝐾𝐾 , where 𝐸𝐸𝐾𝐾 = 𝐸𝐸𝑌𝑌 , the energy content of a
widget:

Q Q
Y= = =u ⋅ K ⋅ eK (115)
EY EK
For simplicity, I’ll work with 𝑢𝑢 = 1 as in Goodwin’s original model. 83

We start from the definition of 𝑄𝑄 in terms of 𝐾𝐾:

Q  K  EK  eK (116)

82
This did exist, to some degree, in the “Computable General Equilibrium” models, but in mainstream
economics these have largely been supplanted by Ramsey growth models, most of which use a Cobb-Douglas
“production function”.
83
A worthwhile and highly publishable task for a motivated reader is to generalize this and make capacity
utilization an endogenous variable of the model. This will create an (at least) 3-dimensional model, whose
behaviour will be far more complex than that shown here.

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Labour’s input also has to be converted into energy terms, where we treat the energy output of the
representative worker as a constant: 84

L ⋅ EL ⋅ eL =L ⋅ El
(117)
El = constant

Labour is a derived demand in the Goodwin model: it is equal to the number of workers needed to
operate the machines used to produce output. We therefore need to define a machine to worker
ratio:

K
kL ≡ (118)
L
In the original Goodwin model, Goodwin used an output to labour ratio 𝑎𝑎, which he assumed rose
over time at a constant rate 𝛼𝛼, and this was the same as the rate of growth of the capital to labour
ratio (since there was a linear relationship between output and capital). 𝑘𝑘𝐿𝐿 is therefore equivalent to
𝑎𝑎 in (Goodwin 1967). As with Goodwin, we assume that this ratio rises exogenously over time, but as
well as giving it a less androgynous term (𝑘𝑘𝐿𝐿 rather than 𝑎𝑎), we use a less androgynous Greek letter
kappa (𝜅𝜅𝐿𝐿 ) for its rate of growth:

kL = κ L (119)

The output to labour ratio in this model is more complicated, since it relates the useful energy from
production to the energy input from labour. It therefore includes the dynamics of energy as well as
of those of the capital to labour ratio: 85

Q
aE =
L ⋅ El
K ⋅ EK ⋅ eK
= (120)
L ⋅ El
EK
=k L ⋅ ⋅ eK
El
𝐸𝐸𝐾𝐾 , the energy input to the representative machine at time t, is assumed to grow at an exogenously
given rate of 𝜅𝜅𝐸𝐸 :

 =κ
E (121)
K E

So that the rate of growth of 𝑎𝑎𝐸𝐸 is:

a
=E κL + κE (122)

We can now derive 𝐿𝐿 by rearranging the first line of equation (120):

84
The capacity for work for the average human is of the order of 100 Watts.
85
From this point on we omit capacity utilization 𝑢𝑢, as discussed in footnote 33. See
https://fred.stlouisfed.org/series/TCU for the US data.

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Q
L= (123)
aE ⋅ El
Once 𝐿𝐿 is defined, the rest of the model follows logically.

The employment rate 𝜆𝜆 is employment 𝐿𝐿 divided by population 𝑁𝑁, which is assumed to grow at an
exogenously given rate. Goodwin used 𝛽𝛽 for this rate; in keeping with our eponymous renaming of
the capital to labour ratio, we use 𝜈𝜈 (the Greek equivalent of n) instead:

L
λ=
N (124)
 =ν
N
The employment rate determines the rate of change of wages:

 = S ⋅ (λ − Z )
w (125)
λ λ

The wage times Labour determines the wage bill, which determines profit:

Π= Q − w ⋅ L (126)

Investment is profit minus depreciation:

dK
I= = Π −δK ⋅ K (127)
dt
Capital times the energy output of capital determines output Q in units of energy per year, closing
the causal chain of the model:

Q =K ⋅ EK ⋅ eK (128)

10.3.1 Derivation
We start from the same system states as in the original Goodwin model, and then expand them out
with the new definitions from equations (116) to (128).

Firstly the derivation of 𝜆𝜆̂:

L
λ=
N
(129)
1 Q
=
N aE ⋅ El

Therefore the “percentage rate of change of 𝜆𝜆“ is:

λ = Q
−N
 − a
E
(130)
 − (ν + (κ + κ ) )
=Q L E

The derivation of 𝑄𝑄� starts from the definition of 𝑄𝑄:

Q =K ⋅ EK ⋅ eK (131)

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Therefore

= K
Q +E

K

IG − δ K ⋅ K
= + κE (132)
K
I
= G + κE −δK
K
IG
The derivation of :
K

IG Π
=
K K
Y − w⋅ L
=
K
 w⋅ L 
Y ⋅ 1 − 
Y 
= 
K (133)
Q
⋅ (1 − ω )
EK
=
K
K ⋅ EK ⋅ eK ⋅ (1 − ω )
=
K ⋅ EK
= eK ⋅ (1 − ω )

Therefore:

λ = eK ⋅ (1 − ω ) − (ν + κ L + δ K ) (134)

This is identical to the original Goodwin model (with depreciation) with 𝑒𝑒𝐾𝐾 , the efficiency with which
machinery turns its input energy into useful work, taking the place of the capital to output ratio.

Secondly, the derivation of 𝜔𝜔

�:

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
w⋅ L
=
ω
Y
 Q
w⋅
aE ⋅ El
=
Q
EK
 w (135)
EK
aE
=
El
= E+w  − a
K E

 − (κ + κ )
= κE + w L E

= Sλ ⋅ ( λ − Z λ ) − κ L

This is strictly identical to the original Goodwin model form:

λ = eK ⋅ (1 − ω ) − (ν + κ L + δ K )
(136)
 = S ⋅ (λ − Z ) − κ
ω λ λ L

At this stage the inclusion of energy might look like “much ado about nothing”—see Figure 212.

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Figure 212: Goodwin with energy in system state form

However, there are three ways in which this is an advance:

1. The previous empirical regularity of a reasonably constant capital to output ratio is now
explained as the efficiency with which energy is converted into useful work;
2. The fact that no quantitative change occurs by introducing energy into the Leontief
production function, whereas a significant change occurs when doing the same with the
Cobb-Douglas production function, indicates that the Leontief form was effectively correct,
though based on a statistical regularity (the relatively constant capital to output ratio) rather
than on energy; and
3. The explicit use of energy in the derivation allows both waste production (consistent with
the 2nd Law of Thermodynamics) and resource depletion to be added to the basic Goodwin
model.

Point 3 above is covered by firstly defining waste energy as the complement to useful energy in
Equation (128):

WE = K ⋅ EK ⋅ (1 − eK ) (137)

Secondly, to simulate resource depletion, we revise Equation (128) to include a factor based on the
fraction of remaining fossil fuel reserves:

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F0 − Depletion
Q = K ⋅ EK ⋅ eK ⋅
F0 (138)
Depletion
= ∫ (( K + ω ⋅Y ) ⋅ E ) K

Depletion includes the use of energy in production, and the energy consumed by workers.

This extension is best shown in an absolute values model of Goodwin with energy. This model is
shown in Equation (139) and simulated in Minsky in Figure 213 (the Minsky model includes a
conversion of waste energy into waste matter, which can be degraded over time—we’re thinking of
𝐶𝐶𝐶𝐶2 here obviously).

d
N= ν ⋅ N
dt
d
aE = ( κ L + κ E ) ⋅ aE
dt
d
E=K κ E ⋅ EK
dt
F − Depletion
Q = K ⋅ EK ⋅ eK ⋅ 0
F0
Q
Y=
EK
1 − eK
WE= Q ⋅
ek
d
K = IG − δ K ⋅ K
dt
IG = Π
Π= Y − w ⋅ L
Y
L=
aE ⋅ El
w⋅ L
ω=
Y
d (139)
w =w ⋅ ( Sλ ⋅ ( λ − Z λ ) )
dt
d
FE =− EK ⋅ ( K + ω ⋅ Y )
dt
d
Depletion = ( K + ω ⋅ Y ) ⋅ EK
dt

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Figure 213: A Minsky system dynamics model of energy in production and resource depletion

This explains the final figure in Manifesto, but it only scratches the surface of properly incorporating
inputs from Nature into economic modelling. Though the previous model does introduce energy into
the production function, its treatment of matter is too simplistic, with all the “heavy lifting” between
matter and energy done by the conversion factor 𝐸𝐸𝐾𝐾 . A model of production entirely in terms of
energy is also an extreme simplification. More realistically, energy is used in production to transform
matter from less useful forms (raw materials) to more useful (finished products). The next section
develops a model with both energy and matter inputs used to produce useful matter output. This
model was derived in collaboration with my friends and research colleagues Tim Garrett, an
atmospheric physicist, and Matheus Grasselli, a financial mathematician.

10.4 A Goodwin model with matter and energy

Our inspiration here was Hicks’s noble but unsuccessful attempt to build a dynamic model of a
production economy in the paper "Wages and Interest: The Dynamic Problem" (Hicks 1935), where
the output was bread—a consumer good. Though poorly known today, this paper was in fact the
real origin of the IS-LM model, as Hicks admitted in 1981 in "IS-LM: An Explanation" (Hicks 1981). 86

86
“I must begin with the old story. "Mr. Keynes and the Classics" was actually the fourth of the relevant papers
which I wrote during those years. The third was the review of The General Theory that I wrote for the
Economic Journal, a first impression which had to be written under pressure of time, almost at once on first
reading of the book. But there were two others that I had written before I saw The General Theory. One is well
known, my "Suggestion for Simplifying the Theory of Money" (1935a), which was written before the end of
1934. The other, much less well known, is even more relevant. "Wages and Interest: the Dynamic Problem"'
was a first sketch of what was to become the "dynamic" model of Value and Capital (1939). It is important
here, because it shows (I think quite conclusively) that that model [IS-LM] was already in my mind before I
wrote even the first of my papers on Keynes.” (Hicks 1981, p. 140. Emphasis added).
The key evidence to which Hicks alluded was the section of the 1935 paper that used equilibrium in two
markets to mean that equilibrium in a third could be assumed—and therefore the analysis could be simplified
by omitting that market entirely: “An obvious result, so it would appear! But it conveys the less obvious
message, that in order to determine the rate of interest, we need not examine that elusive thing, the "capital

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In this paper, Hicks attempted to develop a dynamic theory of economics by reconciling the
treatment of capital as a “factor of production” by J.B. Clark with its treatment as a produced means
of production by Wicksell:

Most modern theories of capital fall into one or two classes. On the one hand,
there is the "timeless" type of theory, which treats capital as a factor of
production like any other. Such a theory is that of J. B. Clark. In practice, it
assimilates capital to land, treating it as the inexhaustible provider of a regular
stream of resources. On the other hand, there is the "period of production"
theory of Bohm-Bawerk and Wicksell. This treats capital as "stored-up labour"—
labour stored up in the past. (Hicks 1935, p. 456)

Hicks characterised both theories as “stationary”, and “quite satisfactory under that hypothesis, but
incapable of extension to meet other hypotheses, and consequently incapable of application” (Hicks
1935, p. 456), because both theories assumed equalities that applied in a stationary state but could
not be assumed in a changing one. Hicks warned that assuming such equalities where they did not
exist was dangerous:

To found a theory upon an assumed equality, which is not a real equality, is a

most dangerous thing to do; for the more complex the theory becomes, the
more specialised it becomes. The blinkers grow, until they shut out nearly all the
landscape. One distinction blurred over breeds another, until we have in the end
only a special case of a special case of a special case. (Hicks 1935, p. 457)

Hicks therefore attempted to abandon the assumption of stationarity and develop a dynamic model.
After advocating period analysis over the use of continuous time, Hicks set out his simplifying
assumptions, which commenced with:

(1) We shall assume a community which is wholly engaged in the production of a

single homogeneous good, which we shall call Bread.

(2) Bread is made by the co-operation of labour (assumed homogeneous) with

capital goods (not homogeneous) which we shall call Equipment. Equipment may
include land, buildings, machinery, raw materials, and half-finished goods. (Hicks
1935, p. 458)

These assumptions, in the context of a dynamic theory, require a model in which both bread and
Equipment are produced—and in which raw materials, including energy, are exploited, as we model
here. Had Hicks actually built this model, it would have been a true tour de force. Unfortunately, he
did not. Instead, at a later stage in the paper, he reduced Equipment to dated bread:

A production plan can be regarded, on the basis of our simplifying assumptions,

as a series of outputs of bread in successive weeks, together with the series of
inputs of labour necessary to obtain those outputs. For the entrepreneur has
actually to determine, not only how much labour he will employ in the first week,
but how he will employ that labour, whether in the production of bread for the
next market day, or in the production of bread for the more distant future

market"; for if the market for labour is in equilibrium, and if the market for bread is in equilibrium, the market
for loans must be in equilibrium too.” (Hicks 1935, pp. 465-67. Emphasis added)

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(activity which, a week after, will only have resulted in the production of
equipment). (Hicks 1935, p. 460)

Hicks’s conceptual apparatus thus reduced to a model in which bread is produced using bread and
labour alone, and in which bread functions as a consumer good if used this week, and a capital good
if not used this week. 87

When we first attempted to build a model which did achieve what Hicks set out to do, we felt
genuine sympathy for his plight, since our attempt to build a model with the same conceptual
foundation—an economy producing a single commodity, which functions as both a consumer and an
investment good (which is a common feature of the vast majority of economic models, both
Neoclassical and Post Keynesian)—led to a similar intellectual impasse. It is very easy to imagine a
world in which consumers consume bread, but very difficult to imagine a world in which bread
functions as machinery. In the end, Hicks’s sketch of a model described a passingly realistic scenario
of consumption, but a trivial and unrealistic scenario for investment.

Our solution was to reverse this dilemma, and to consider a world with a far-fetched model of
consumption, but a passingly realistic scenario for investment. What commodity can take the place

87
Hicks’s time period in "Wages and Interest: The Dynamic Problem" was a week, something which he later
admitted made the Walrasian assumptions he made in 1935 inappropriate for the macroeconomic analysis of
Keynes’s 1936 General Theory, which in 1937 he purported to capture with the IS-LM model. While it was
appropriate in a week to consider expectations to be constant, it was not appropriate to consider the same
when the time period is a year, because it implies constancy of expectations, which means the absence of
surprises:

“Applying these notions to the IS-LM construction, it is only the point of

intersection of the curves which makes any claim to representing what actually
happened (in our "1975"). Other points on either of the curves—say, the IS
curve—surely do not represent, make no claim to represent, what actually
happened. They are theoretical constructions, which are supposed to indicate
what would have happened if the rate of interest had been different. It does not
seem farfetched to suppose that these positions are equilibrium positions,
representing the equilibrium which corresponds to a different rate of interest. If
we cannot take them to be equilibrium positions, we cannot say much about
them. But, as the diagram is drawn, the IS curve passes through the point of
intersection; so the point of intersection appears to be a point on the curve; thus
it also is an equilibrium position. That, surely, is quite hard to take. We know that
in 1975 the system was not in equilibrium. There were plans which failed to be
carried through as intended; there were surprises. We have to suppose that, for
the purpose of the analysis on which we are engaged, these things do not matter.
It is sufficient to treat the economy, as it actually was in the year in question, as if
it were in equilibrium. Or, what is perhaps equivalent, it is permissible to regard
the departures from equilibrium, which we admit to have existed, as being
random. There are plenty of instances in applied economics, not only in the
application of IS-LM analysis, where we are accustomed to permitting ourselves
this way out. But it is dangerous. Though there may well have been some periods
of history, some "years," for which it is quite acceptable, it is just at the turning
points, at the most interesting "years," where it is hardest to accept it.” (Hicks
1981, pp. 149-50)

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of bread, and enable a reasonably realistic model of production—including the use of raw materials
and energy, and the production of machinery using that commodity as an input—at the probable
expense of a rather unrealistic consumption good?

Fiction provided an answer with the cult animated movie The Iron Giant. 88 The deuteragonist of that
movie was made of iron—see Figure 214. We therefore imagined a “Planet of the Iron Giants”, in
which Iron Giants were the consumers and workers (and capitalists), iron was used to make the
capital goods (blast furnace/rolling mill, iron ore and coal mining machines), energy was essential to
all three processes, iron was consumed by the workers as their real wage, and physical waste (slag)
was necessarily generated by production, as well as waste energy as in our previous model.

Figure 214: The "Iron Giant"

10.5 Derivation: constant technology and population

This was more easily said than done. To produce a model in which one commodity—iron—was the
final output, we needed to model three sectors: the energy-mining sector (most easily thought of as
coal mining, since coal—as coke—is also an input to iron manufacturing, and not solely an energy
source); the iron-ore-mining sector; and a factory sector which took inputs of coal and iron ore to
produce iron and slag. Each sector needed labour, and specialized capital—made of iron. Our mental
framework was that everything was made of sheet iron, which could be shaped in the factory sector
into shapes specific for each sector, and also as consumption for our Iron Giant workforce.

We needed three production relations, each with a different type of output, but each of which
required energy (and capital and labour) as inputs. The outputs were respectively energy (best
thought of as coal), iron ore, and iron plus slag.

88
https://www.imdb.com/title/tt0129167/.

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In keeping with Keen Ayres & Standish 2019, we treat machinery (“Capital”) as the means to channel
energy to perform useful work. The output of an industry per year is the product of the number of
machines K, times the energy per machine per year E, times the efficiency of conversion of energy
into useful work ε, times the yield of product per unit of energy input y—this is the key extension
over the previous model, where all internal processes in the model were in terms of energy only.

EnergyOutput
yE 
EnergyInput
OreOutput
yM  (140)
EnergyInput
MatterOutput
yF  ; MatterOutput  Iron  Slag
EnergyInput

With three sectors (E for mining energy, M for mining iron ore, and F for factory), we have five
equations: one for the output of each sector in units of energy per year (Joules/Year), units of iron
ore per year (Kilograms/Year), units of physical output consisting of both iron and slag
(Kilograms/Year), iron itself Y (our single commodity GDP), and slag YW (physical waste):

Equation Units
E = K E ⋅ EE ⋅ ε E ⋅ y E Energy/Year
M = K M ⋅ EM ⋅ ε M ⋅ y M Mass/Year (Iron ore)
(141)
F = K F ⋅ EF ⋅ ε F ⋅ y F Mass/Year (Iron plus Slag)
Y= µ ⋅ F Mass/Year (Iron)
YW =(1 − µ ) ⋅ F Mass/Year (Slag)

Output 𝑌𝑌 that is used for investment adds to the stock of machines 𝐾𝐾, which is denominated in
terms of mass: kilograms of iron. This gives us a novel solution to the measurement of capital
problem: rather than ignoring the issue entirely as in standard Neoclassical models—despite
Samuelson’s concession of defeat in the Cambridge Controversies (Sraffa 1960; Samuelson 1966;
Pasinetti et al. 2003; Harcourt 1972)—or measuring capital in terms of dated labour as did Sraffa
(Sraffa 1960), we measure capital in terms of kilograms of iron. 89 Using 𝐾𝐾 to signify the number of
machines, and 𝑘𝑘 to signify the weight of each machine, we have:

K = K E ⋅ kE + K M ⋅ kM + K F ⋅ kF (142)

We therefore define 𝜅𝜅 as the proportion of capital invested in each industry:

K K E ⋅ kE K M ⋅ kM K F ⋅ kF
= + +
K K K K
1 =κE + κM + κF (143)
K K K
κ E ⋅ , KM =
KE = κM ⋅ , KF =
κF ⋅
kE kM kF

89
Conceptually, the machines are rolled iron sheets molded into different shapes.

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Employment 𝐿𝐿 is proportional to the number of machines in each sector. There is a workers per
machine ratio 𝜆𝜆 such that employment in each industry equals this ratio times K:

L=
E λE ⋅ K E
κE ⋅ K (144)
= λE ⋅
kE

Matching equations apply for employment in mining 𝑀𝑀 and fabrication 𝐹𝐹.

We then define 𝜆𝜆𝐾𝐾 as the aggregate ratio of labour to capital:

 κE κM κF  (145)
λK =  λ E ⋅ + λM ⋅ + λF ⋅ 
 kE kM kF 

This enables us to define aggregate employment 𝐿𝐿 and the employment rate 𝜆𝜆. For simplicity in the
first pass, we worked with a constant population 𝑁𝑁0 , and a constant labour to capital ratio 𝜆𝜆𝐾𝐾 : 90

L K
λ
= = λK ⋅ (146)
N0 N0
This in turn enabled us to use the same wage change relation as in the previous models, based on
the aggregate level of employment:

1 d
⋅ w = Sλ ⋅ ( λ − Z λ ) (147)
w dt
Three output equations are now needed, in contrast to earlier models with just one. A full, multi-
commodity-model would require price relations for each of the energy, iron mining and fabrication
sectors, as well as stocks of unsold units of output. To generate a less complex single commodity
model, we instead assumed proportionality between each sector, with excess capacity in energy and
iron ore mining so that their yields adjust to meet the energy needs of the entire economy. 91 This
means that the output of the energy sector equals to energy input needs of all three sectors: itself,
mining, and fabrication:

K E ⋅ E E ⋅ ε E ⋅ y E = K E ⋅ E E + K M ⋅ EM + K F ⋅ E F (148)

This requires that the yield of the energy sector adjusts to the needs of all three sectors:

K E ⋅ E E + K M ⋅ EM + K F ⋅ E F
yE = (149)
K E ⋅ EE ⋅ ε E
Solving for 𝑦𝑦𝐸𝐸 yields:

1  k 1  EM ⋅ κ M EF ⋅ (1 − κ E − κ M )  
yE = ⋅ 1 + E ⋅ ⋅ +  
εE  κ E EE  k M kF
(150)
  

90
When the derivation of this model succeeded, we added a growing population 𝑁𝑁 and a falling labour to
capital ratio in the final version, which is detailed in the next section.
91
This assumption is not a bad approximation to reality during a pre-ecological crisis period. It will be relaxed
in later extensions to allow analysis of falling EROEI or fossil to renewable energy switching.

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The same assumption for mining, that the yield adjusts to fit the needs of the fabrication sector for
material (iron ore) inputs, enables us to link the total output of the two sectors. Since the factory
sector converts iron ore to rolled iron sheeting plus slag, then by the conservation of matter, the
gross output of the factory 𝐹𝐹 in kilograms of iron plus slag equals the input 𝑀𝑀 in kilograms of iron
ore. Therefore:

K M ⋅ EM ⋅ ε M ⋅ y M = K F ⋅ E F ⋅ ε F ⋅ y F (151)

From this we can derive the yield (in kilograms per joule) of the factory sector:

κ M ⋅ k F ⋅ EM ⋅ ε M
=yF ⋅ yM (152)
κ F ⋅ k M ⋅ EF ⋅ ε F
Output from the factory sector can now be defined:

κ M ⋅ k F ⋅ EM ⋅ ε M
F = K F ⋅ EF ⋅ ε F ⋅
⋅y
κ F ⋅ k M ⋅ EF ⋅ ε F M
(153)
κ ⋅ E ⋅ε ⋅ y
= M M M M ⋅K
kM

Define 𝜙𝜙𝐾𝐾 :

κ M ⋅ EM ⋅ ε M ⋅ y M
φK = (154)
kM
Then output 𝑌𝑌 and waste 𝑌𝑌𝑊𝑊 are:

Y =µ ⋅ φ K ⋅ K
(155)
YW = (1 − µ ) ⋅ φK ⋅ K

With output, labour and wages defined, it is now possible to derive the model in terms of the wages
share of GDP and the employment rate. The rate of change of the wages share of GDP is a linear
transformation of the rate of change of wages in this model without technical change or growth in
population:

κ M ⋅ EM ⋅ ε M ⋅ y M
φK = (156)
kM
Therefore, the rate of change of wages share is a linear transformation of the wage change function:

d λK d
ω
= ⋅ w
dt ψ dt
λK
= ⋅ w ⋅ ( Sλ ⋅ ( λ − Z λ ) )
ψ (157)
λ ψ
= K ⋅ ⋅ω ⋅ ( Sλ ⋅ ( λ − Z λ ) )
ψ λK
=ω ⋅ ( S λ ⋅ ( λ − Z λ ) )

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The employment rate is a linear transformation of capital stock:

L
λ=
N0
(158)
λ
= K ⋅K
N0

Hence

d λK d
λ
= ⋅ K
dt N 0 dt
λK
= ⋅ (ψ K ⋅ (1 − ω ) ⋅ K − δ K ⋅ K )
N0 (159)
λK N0
= ⋅ (ψ K ⋅ (1 − ω ) − δ K ) ⋅ ⋅λ
N0 λK
= λ ⋅ (ψ K ⋅ (1 − ω ) − δ K )

This results in the classic Goodwin model, with 𝜓𝜓𝐾𝐾 taking the place of 1⁄𝑣𝑣 :

d
ω =ω ⋅ ( Sλ ⋅ ( λ − Z λ ) )
dt
(160)
d
λ = λ ⋅ (ψ K ⋅ (1 − ω ) − δ K )
dt
The final step in this process was to introduce a growing population and changing technology,
manifest as a falling ratio of workers to machines. This in turn provides the scaffolding on which to
add the accumulation of waste in the biosphere.

10.6 Growth and pollution

We replace a constant population with a growing one, and a constant labour to capital ratio with a
falling one:

d
N= ν ⋅ N ,ν > 0
dt
(161)
d
λK =⋅
λκ λK , λκ < 0
dt
A variable 𝑁𝑁 thus replaces 𝑁𝑁0 in (158) while 𝜆𝜆𝐾𝐾 becomes a variable in (156). The state space
equation for 𝜔𝜔 thus becomes:

d 1 d
= ω ( w ⋅ λK )
dt ψ dt (162)
=ω ⋅ ( Sλ ⋅ ( λ − Z λ ) + λκ )

That for 𝜆𝜆 becomes:

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d d λK ⋅ K
λ=
dt dt N (163)
= λ ⋅ (ψ K ⋅ (1 − ω ) − δ K + λκ −ν )

This is once more the classic Goodwin model:

d
ω =ω ⋅( Sλ ⋅ ( λ − Z λ ) + λκ )
dt
(164)
d
λ = λ ⋅(ψ K ⋅ (1 − ω ) − δ K + λκ −ν )
dt
The strengths of this model over the previous versions are:

• The introduction of the concept of an “energy return on energy invested” in the yield from
the energy mining sector, 𝑦𝑦𝐸𝐸 , since the input and the output are both energy. This is a
critical concept in biophysical economics (Hall 2011), but, to our knowledge, has not
previously been incorporated in a macroeconomic model.
o In this initial model, this is a constant derived from the requirement of the other two
sectors. Our ambition is to make this an empirically derived quantity in future
extensions, and to consider the extent to which this determines and constrains
economic performance.
• It is now possible to link this model directly to the generation of waste matter 𝑌𝑌𝑊𝑊 using
equation (155):

λ ( t ) ⋅ N 0 ⋅ eν ⋅t
Y (=
t) ψK ⋅
λK ( t )
(165)
1− µ
(t )
YW= ⋅Y (t )
µ
Figure 215 shows a simulation of this model in Minsky, including both output and waste derived
from Equation (165).

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Figure 215

This model thus achieves what Hicks attempted in "Wages and Interest: The Dynamic Problem"
(Hicks 1935) in the context of a single commodity model of production. Future extensions will
address the unrealism of this foundational model by introducing multiple commodities, and multiple
forms of waste as well.

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11 Analyzing a Model
This should not be is a difficult chapter, because it is telling you how to do something that you
should already know how to do: to work out the qualitative properties of a dynamic system.

However, if you have done a degree in economics—even a PhD—you probably don’t know how to
do that. This is regardless of whether you’re a Neoclassical, Austrian, Sraffian, Marxist or Post
Keynesian, because most (not all!) modelers in these disparate traditions have one thing in common:
they model the economy using equilibrium-oriented methods. 92 This implicitly assumes that the
equilibrium of their model—and by implication, the economy itself—is necessarily stable. It’s not, as
this chapter will explain.

If you’ve got this far into this book, I am assuming that you know the basics of linear algebra—
specifically, what a determinant is and how to work it out. I also assume that you don’t know how
they’re applied in dynamic analysis—basically, in working out the stability or otherwise of a dynamic
system using “eigenvalues” and “eigenvectors”.

It was also difficult for me to write this chapter, since, though this material used to be second nature
to me, after dedicating most of the last two decades to debunking Neoclassical economics (Keen
2001, 2002, 2003e, 2003c, 2003a, 2003d, 2003b, 2004b, 2004a; Lee and Keen 2004; Standish and
Keen 2004; Keen 2005; Keen and Standish 2005; Gallegati et al. 2006; Keen and Standish 2006; Keen
and Ormerod 2007; Keen 2009; Keen and Standish 2010; Keen 2011a, 2011b, 2011c, 2015; Keen and
Standish 2015), I’ve barely used these techniques myself this century. With mathematics, like sports,
if you don’t use it, you lose it.

Finally, large scale dynamic systems—and that means anything with more than two dimensions—are
extremely hard to analyze qualitatively, and there is a hard limit: the mathematical prodigy Galois
proved in 1830 that almost all 5th order and above polynomials do not have a symbolic solution. 93
This matters for analyzing dynamic systems because, as you’ll see below, the qualitative properties
of a dynamic model can be reduced to the properties of a polynomial of the same order.

Why is this a problem? Here, what economists do know has led to delusions about what they don’t
know.

Virtually all schoolchildren learn the solution to a quadratic, a “second order polynomial”. Figure 216
shows the formulas, using the symbolic engine of the mathematics program Mathcad.
Figure 216: The well-known solutions to a quadratic equation

 b + b 2 − 4⋅ a⋅ c 
−
2 solve , x  2⋅ c 
a + b ⋅ x + c⋅ x 0 → 
simplify
 b − b 2 − 4⋅ a⋅ c 
− 
 2⋅ c 
Pretty simple, right? Most of us learn this by rote at school: “the roots of a + b ∙ x + c ∙ x 2 = 0 are
minus b, plus and minus the square root of b squared minus 4ac, all divided by 2 times c”. If you
don’t study mathematics to an advanced level (say, 2nd year undergraduate), it’s not unusual to think

92
To evolutionary and complex systems economists, this chapter should be old hat.
93
Here I had to pause in my writing to look up the name of the mathematician who proved this—which is a
sign of how much I’ve forgotten. I thought it was Galois (it was, though he had predecessors), but I was no
longer sure.

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there must be equivalent formulas for higher order polynomials—and that there’s no limit to how
high you can go.

So what’s the equivalent line for a cubic? Figure 217 shows the three formulas: you can forget
learning them by rote!
Figure 217: The symbolic solutions to 𝑎𝑎 + 𝑏𝑏 ∙ 𝑥𝑥 + 𝑐𝑐 ∙ 𝑥𝑥 2 + 𝑑𝑑 ∙ 𝑥𝑥 3 = 0
1 2
b c
3 −
 a2 b
3
a⋅ c
3 2 2
b ⋅c a⋅ b ⋅ c c
3
a

b⋅ c 
3⋅ d
9⋅ d
2
c
Cubic →  + + − − − − + − −
0  2 3 4 4 3 3 2⋅ d 2 1 3⋅ d
 4⋅ d 27⋅ d 27⋅ d 108⋅ d 6⋅ d 27⋅ d 6⋅ d 
3
 a2 b
3
a⋅ c
3 2 2
b ⋅c a⋅ b ⋅ c c
3
a

b⋅ c 
 + + − − − − +
 2 3 4 4 3 3 2⋅ d 2
 4⋅ d 27⋅ d 27⋅ d 108⋅ d 6⋅ d 27⋅ d 6⋅ d 

 b c
2 1
 − 3
 3⋅ d
9⋅ d
2  a2 b
3
a⋅ c
3 2 2
b ⋅c a⋅ b ⋅ c c
3
a

b⋅ c  
3⋅  +  + + − − − − +  ⋅i
1  1  2 3 4 4 3 3 2⋅ d 2 
 4⋅ d 27⋅ d 27⋅ d 108⋅ d 6⋅ d 27⋅ d 6⋅ d 
3  3 
b c
2  a2 b
3
a⋅ c
3 2 2
b ⋅c a⋅ b ⋅ c c
3
a

b⋅ c    a2 b
3
a⋅ c
3 2 2
b ⋅c a⋅ b ⋅ c c
3
a

b⋅ c  
−  + + − − − − + + + − − − − +
3⋅ d 2  2 3 4 4 3 3 2⋅ d 2  2 3 4 4 3 3 2⋅ d 2 
Cubic →
9⋅ d
−
c
−
 4⋅ d 27⋅ d 27⋅ d 108⋅ d 6⋅ d 27⋅ d 6⋅ d 
+
  4⋅ d 27⋅ d 27⋅ d 108⋅ d 6⋅ d 27⋅ d 6⋅ d  
1 1 3⋅ d 2 2
3
 a
2
b
3
a⋅ c
3 2 2
b ⋅c a⋅ b ⋅ c c
3
a b⋅ c

2⋅  + + − − − − + 
 2 3 4 4 3 3 2⋅ d 2
 4⋅ d 27⋅ d 27⋅ d 108⋅ d 6⋅ d 27⋅ d 6⋅ d 

 b c
2 1
 − 3
 3⋅ d
9⋅ d
2  a2 b
3
a⋅ c
3 2 2
b ⋅c a⋅ b ⋅ c c
3
a

b⋅ c  
3⋅  +  + + − − − − +  ⋅i
1  1  2 3 4 4 3 3 2⋅ d 2 
 4⋅ d 27⋅ d 27⋅ d 108⋅ d 6⋅ d 27⋅ d 6⋅ d 
3  3 
b c
2  a2 b
3
a⋅ c
3 2 2
b ⋅c a⋅ b ⋅ c c
3
a

b⋅ c    a2 b
3
a⋅ c
3 2 2
b ⋅c a⋅ b ⋅ c c
3
a

b⋅ c  
−  + + − − − − + + + − − − − +
3⋅ d 2  2 3 4 4 3 3 2⋅ d 2  2 3 4 4 3 3 2⋅ d 2 
Cubic →
9⋅ d
−
c
−
 4⋅ d 27⋅ d 27⋅ d 108⋅ d 6⋅ d 27⋅ d 6⋅ d 
−
  4⋅ d 27⋅ d 27⋅ d 108⋅ d 6⋅ d 27⋅ d 6⋅ d  
2 1 3⋅ d 2 2
3
 a2 b
3
a⋅ c
3 2 2
b ⋅c a⋅ b ⋅ c c
3
a

b⋅ c 
2⋅  + + − − − − +
 2 3 4 4 3 3 2⋅ d 2
 4⋅ d 27⋅ d 27⋅ d 108⋅ d 6⋅ d 27⋅ d 6⋅ d 

At the next level, a quartic, the equation for even one of the four formulas wouldn’t fit on a single
page, and there is no formula—there cannot be a general formula, as Galois proved almost two
centuries ago—for a quintic or above.

That’s the bad news. The good news is twofold. Firstly, advances in computing power have meant
that the numerical analysis of the properties of a dynamic model are possible. Secondly, the actual
number of fundamental dimensions to a model is often below five, even for a very complicated
model—for example, even the government-based extension of my model of Minsky, which has six
equations (Keen 1995, pp. 625-632), is actually a 3-dimensional model, because its fundamental
dimensions are the wages share of GDP, the employment rate, and the private debt to GDP ratio.

However, as is often the case with mathematical analysis, the good news comes with bad news (and
so on ad infinitum).

In numerical analysis, the number of dimensions is based not on the fundamental variables in a
model, but on its parameters: so a model with 3 variables and ten parameters is ten-dimensional
when you wish to work out how the model’s behavior changes with different parameters. If each
parameter can take fifteen different values, you have one million billion possible combinations.
That’s just too many even for a modern computer to analyze, so mathematicians and computer
programmers have worked out ways to explore the parameter space—genetic algorithms, simulated
annealing, etc.—without having to check every possible combination of parameters.

In symbolic analysis, while the dimensionality depends on the number of fundamental variables, the
task of converting a model into a form where its equations are strictly in terms of the fundamental
variables can be extremely difficult. Using my model of Minsky’s Financial Instability Hypothesis as
an example again, it had three fundamental dimensions—the wages share of GDP, the employment

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rate and the private debt to GDP ratio. The mathematician Bernardo Costa-Lima’s devoted his entire
PhD thesis to analyzing its properties. 94

Despite those discouraging remarks, its worth knowing at least the basics of the qualitative
interpretation of complex dynamical models. It will, for a start, disavow you of the notion that
equilibrium modelling is sufficient. And it will allow you to appreciate the processes that give rise to
the complex dynamics of systems like Lorenz’s butterfly effect, and my own models of financial
instability.

It will also help you appreciate that the instability of input-output dynamics—something that I think
played a large role in Neoclassical economists finally abandoning CGE (“Computable General
Equilibrium”) modeling—wasn’t at all due to the fixed proportions involved in an input-output
matrix. Even with variable input proportions, these equilibrium models would still have been
unstable, because ironically, the linear components of a model determine the stability of its
equilibrium, while the nonlinear bits only come into play far from equilibrium. Neoclassicals should
not have abandoned Computable General Equilibrium modelling for Dynamic Stochastic General
Equilibrium modelling, which was a backward step (Romer 2016): instead, they should have
abandoned their fetish for equilibrium, and embraced far from equilibrium dynamics.

11.1 Of linearity and nonlinearity

One of the quirks of nonlinear models is that the stability of their equilibrium points is determined by
their linear components—so that if the equilibrium of a nonlinear model is unstable, it’s because of
its linear bits, not the nonlinear ones. Therefore, if the equilibrium of some dynamic process is
unstable—as is the case for Computable General Equilibrium models —then adding nonlinear bits to
it (say, replacing a Leontief input-output matrix with a different production model that allows for
substitution between inputs) won’t help one zot: the equilibrium will remain unstable.

The easiest way to illustrate this is with a Taylor series expansion for a periodic function, like 𝑠𝑠𝑠𝑠𝑠𝑠(𝑥𝑥).
Imagine a model where the equilibrium is given by 𝑠𝑠𝑠𝑠𝑠𝑠(𝑥𝑥). Then, if you’re a long way from this
equilibrium—say at 2𝜋𝜋—the behavior of the model is dominated by its nonlinear bits, and the linear
component is effectively irrelevant: see Figure 218. The linear approximation to 𝑠𝑠𝑠𝑠𝑠𝑠(2𝜋𝜋) is 2𝜋𝜋, or
about 6.3, which is hopelessly wrong, since the actual value is zero. The full 17th order polynomial
approximation is 0.011, which is only wrong by 1%.

94
http://cms.dm.uba.ar/actividades/seminarios/sanlsd/PhD_Thesis_Bernardo_R_C_Costa_Lima_Final_Submiss
ion.pdf.

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Figure 218: sin(x) and its approximations out to 10

sin(x) and its first nine Taylor series approximations

1.2 π ⋅ 2 π
4
1

0.8

0.6
Value of sin and approximations

0.4

0.2

0 0

sin(x)
− 0.2
1 term (x)
− 0.4
2 terms (x^3)
3 terms (x^5)
− 0.6 4 terms (x^7)
5 terms (x^9)
− 0.8 6 terms (x^11)
7 terms (x^13)
−1 8 terms (x^15)
9 terms (x^17)
− 1.2
0 1 2 3 4 5 6 7 8 9 10

Figure 219 shows the same functions, but for values less than 1. Here, the nonlinear terms add very
little to the accuracy of the approximation: the linear approximation to sin(0.1) is 0.1; the actual
value of 𝑠𝑠𝑠𝑠𝑠𝑠(0.1) = 0.099833. The higher order terms improve the accuracy of the linear
approximation by less than 0.02%. Near the equilibrium, the linear term rules.

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Figure 219: sin(x) and its approximations out to 1

sin(x) and its first nine Taylor series approximations

1.2
0.1

1.1

0.9
Value of sin and approximations

0.8

0.7

0.6

sin(x)
0.5
1 term (x)
2 terms (x^3)
0.4
3 terms (x^5)
0.3
4 terms (x^7)
5 terms (x^9)
0.2 6 terms (x^11)
7 terms (x^13)
0.1 8 terms (x^15)
9 terms (x^17)
0 0
0 0.1 0.2 0.3 0.4 0.5 0.6 0.7 0.8 0.9 1

This is because the nonlinear components are the divergence from equilibrium, raised to a power of
2 or more. When you’re a large distance from the equilibrium, these numbers dominate the linear
component, since 𝑥𝑥 5 > 𝑥𝑥 4 > 𝑥𝑥 3 > 𝑥𝑥 2 > 𝑥𝑥 1 𝑓𝑓𝑓𝑓𝑓𝑓 𝑥𝑥 > 1. But when you’re close to the equilibrium,
the order is reversed: 𝑥𝑥1 > 𝑥𝑥 2 > 𝑥𝑥 3 > 𝑥𝑥 4 > 𝑥𝑥 5 𝑓𝑓𝑓𝑓𝑓𝑓 𝑥𝑥 < 1.

This enables a simple way of analyzing the stability of a nonlinear dynamic model: convert it into a
polynomial approximation; drop all but the linear terms to generate a linearized model; and work
out whether its rates of change are negative near the equilibrium—which means the system will
converge to the equilibrium—or positive—which means the system will diverge. It’s slightly more
complicated than this, but that’s the gist.

11.2 The absolute basics of stability analysis

Let’s give it a try with the simplest complex model we consider in this book, Lotka’s predator-prey
model—see Figure 220 (which reproduces Figure 85 on page 64). This generated, to Lotka’s surprise,
everlasting cycles, rather than the convergence to equilibrium that he expected:

It was, therefore, with considerable surprise that the writer, on applying his
method to certain special cases, found these to lead to undamped, and hence
indefinitely continued, oscillations. (Lotka 1920,p. 410)

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Figure 220: Lotka's predator-prey model: everlasting cycles

Equation (166) expresses this as a differential equation, in a way that illustrates that Lotka’s model is
the simplest possible extension of a model of exponential growth. If there were no Sharks, the
number of fish would grow exponentially, while if there were no Fish, Shark numbers would fall
exponentially. But the existence of sharks linearly decreases the growth rate of fish, while also
linearly decreasing the death rate of sharks:

d
F  a  b  S  F
dt
(166)
d
S  c  d  F  S
dt
The first step in working out why this model generates everlasting cycles is to express it as a vector
equation:

d F   a  F  b  S  F  (167)

dt  S  c  S  d  S  F 

Next we create a matrix from this vector, where the entries are the differentials of the equations
with respect to F and S. This is known as the Jacobian matrix (I’ll explain why this is needed later):

   
 a  F  b  S  F  a  F  b  S  F   a  b  S b  F 
 F S    (168)
 
    d  S c  d  F 
 c  S  d  S  F  c  S  d  S  F 
 F S 

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𝑑𝑑𝑑𝑑 𝑎𝑎 𝑑𝑑𝑑𝑑
Then we replace F and S with their equilibrium values. From Equation (166), = 0 if 𝑆𝑆 = and =
𝑑𝑑𝑑𝑑 𝑏𝑏 𝑑𝑑𝑑𝑑
𝑐𝑐 95
0 if 𝐹𝐹 = :
𝑑𝑑

 a c   b  c 
a  b  b    0 
 b d   d  (169)
  
 a c  d a 
 d c  d    0 
 b d   b 

This is now the linear component of the predator-prey model, which, in the vicinity of the
equilibrium, dominates the nonlinear components. So, to work out whether the model converges to
the equilibrium or diverges from it, we have to analyze Equation (170)—where I’ve used the
subscript L to indicate that this is a linearized model:

 b  c 
   0 
F
d  L 
 d    FL  (170)

dt  SL   d  a   SL 
 0 
 b 
Before we do, it’s easy to add this to the Minsky model of the full nonlinear model, so that we can
see how it behaves:

d b  c
FL   SL
dt d
(171)
d d a
SL   FL
dt b
This is a linear model of the deviation of the full system from its equilibrium values (hence the
positive and negative values that it generates), and you can see that it reproduces the same closed
cycle as the full nonlinear model (though it’s circular in shape, as opposed to the egg-like shape of
the full nonlinear model). So the model neither converges to the equilibrium, nor moves away from
it.

95
There’s another equilibrium, when 𝐹𝐹 = 𝑆𝑆 = 0. The same technique used here shows that this equilibrium is
unstable.

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Figure 221: The Predator-Prey model and its linearized deviation from equilibrium 96

We can now use some algebra to show why this model generates the same magnitude cycles
forever. The logic starts from the nature of a single ordinary differential equation, and simply works
out how to apply that to a system of equations.

A linear Ordinary Differential Equation is an equation of the form:

dy t 
 a  y t  (172)
dt
Here 𝑎𝑎 is a constant and 𝑦𝑦 is a variable, and what we’re trying to find is the correct functional form
for 𝑦𝑦. This might be a model of population growth, or radioactive decay. So the general solution for
𝑦𝑦 as a function of time is that 𝑦𝑦(𝑡𝑡) must be some function whose rate of change equals itself times a
constant. The exponential function is the only candidate, since the differential of an exponential
function is the coefficient for the exponent times the function. A exponential is of the form:

96
Notice that the text on the y-axis for the second graph spills outside the graph? This is obviously a bug. It has
been there for some time as we’ve focused on improving other aspects of Minsky. This one, I hope, will be
eliminated with the remaining funds from the Friends Provident grant.

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y t   c  et (173)

Its differential is the exponent times the function itself:

d d
y t   c  et
dt dt
d
c  et  c    et (174)
dt
   y t 

We then feed this “guess” 97 into Equation (172)

dy t 
 a  y t 
dt (175)
  y t   a  y t 

It’s obvious that our “guess” answer is correct if 𝑎𝑎 = 𝜆𝜆, but I’m going to labor the point a bit here by
rearranging the last line of Equation (175):

  y t   a  y t 
  y t   a  y t   0 (176)
  a y t   0

Equation (176) is only true for non-zero values of 𝑦𝑦(𝑡𝑡) if 𝜆𝜆 = 𝑎𝑎. Therefore the solution to Equation
(172) is:

y t   c  eat (177) 98

The value of 𝑎𝑎 tells you whether a system tends towards zero over time—if 𝑎𝑎 < 0—or explodes—if
𝑎𝑎 > 0—or doesn’t change—if 𝑎𝑎 = 0.

Have I bored you with this exposition? I hope so, because the process for working out the same
results for a system of equations like Equation (170) is much more demanding, but it is essentially
the same process—only following the rules of matrix mathematics, since we’re working with a pair
of equations rather than a single equation.

We start with the linear component of the predator-prey model in Equation (170)—reproduced
here:

 b  c 
 0 
d  FL   d    FL 
  (178)
dt  SL   d  a   SL 
 0 
 b 

We presume that the differential of the vector is 𝜆𝜆 times the vector:

97
This is called the “ansatz” in mathematics (see https://en.wikipedia.org/wiki/Ansatz).
98
This defines not just one solution to the equation, but a whole family of solutions, each with a different
initial condition 𝑐𝑐.

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d  FL  F 
(179)
 L 
dt  SL   SL 
 

We equate this to the matrix equation in (178):

 b  c 
 FL   0 
d    FL 
     (180)
 SL   d  a   SL 
   0 
 b 
Next we rearrange the equation so that the zero vector is on the right hand side:

 b  c 
 FL   0 
d    FL    0
        (181)
 SL   d  a  S 0
   0   L  
 b 

To process this according to the rules of matrix mathematics, we need to multiply the first term by
the identity matrix:

 b  c 
 1 0  FL   0 
d   FL   0
             (182)
 0 1  SL   d  a  S 0
     0   L  
 b 
We can now multiply the Identity Matrix by 𝜆𝜆, and group terms on the Left Hand Side (LHS):

  b  c  
  0 
  0  
  d    FL   0 (183)
         
  0    d  a  S
0    L   
0
 
 b  
We subtract the second matrix from the first to yield:

 b c 
  
 d    FL    0 (184)
     
 d a  S 0
    L  
 b 

For this equation to allow for non-zero values of 𝐹𝐹𝐿𝐿 and 𝑆𝑆𝐿𝐿 over time, the matrix in (184) must
somehow be like (𝜆𝜆 − 𝑎𝑎) in Equation (176): it must have a magnitude of zero. Then the equation can
be solved for non-zero values of 𝐹𝐹𝐿𝐿 and 𝑆𝑆𝐿𝐿 . This will be the case if the determinant of the matrix is
zero. The determinant is a quadratic in 𝜆𝜆:

 b c 
  
 d   2   b  c  d  a  (185)
    
 d a   d b 
  
 b 

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So the roots of this polynomial give us the values of 𝜆𝜆 that both solve Equation (184), and tell us
whether this linear system will converge to the equilibrium—if the roots are both negative—or
diverge from it—if they are both positive:

2  a  c  0 (186)

However, the roots of this equation are pure complex numbers—numbers including the square root
of −1, symbolized by the letter 𝑖𝑖:

 2  a  c
(187)
   a c i

They therefore they describe purely cyclical behavior, as we’ve already seen in the simulation.

In general, there are 4 major classes of behavior:

• a stable fixed point: both roots—called eigenvalues—are real and negative;

• an unstable fixed point: both eigenvalues are real and positive;
• a saddle, which is also unstable: one positive real eigenvalue and one negative; and
• a cyclical system, where both are complex numbers—which can have positive, negative, or
zero real parts.

In a way, this is all rather ho-hum: the behavior is relatively simple, and with computers, we can see
the model’s behavior in the simulation anyway. But the behavior isn’t simple when we get to what
are called complex systems: systems of three or more nonlinear ordinary differential equations. 99

11.3 Analyzing a complex model

As a warmup to analyzing my model of Minsky’s Financial Instability Hypothesis, we’ll analyze the
first such system to be numerically simulated: Lorenz’s “butterfly” model of turbulent flow (Lorenz
1963). We simulated—but did not analyze—this in section 9.1 on 176. Its deceptively simple
equations in 3 variables 𝑥𝑥, 𝑦𝑦, 𝑧𝑧 with three parameters 𝑎𝑎, 𝑏𝑏, 𝑐𝑐 are: 100

dx
 a y  x 
dt
dy
 x b  z   y (188)
dt
dz
 x y  c z
dt
The first step is to work out the equilibria of this model, which is relatively easy to do. We set the
differentials in Equation (188) to zero, and then solve for these specific values of 𝑥𝑥, 𝑦𝑦, 𝑧𝑧:

99
This can be confusing, because the word “complex” is also used to describe numbers involving the square
root of minus one: “Complex numbers”. Complex systems analysis uses complex numbers, but the two areas
are different topics.
100
The treatment here is only the very first step in analyzing this model, whose properties are still an active
field in mathematics research today—see for example (Chen 2018) and (Kudryashov 2015); for a teaching-level
exposition on this model, see https://core.ac.uk/download/pdf/236407976.pdf.

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a y  x   0
x b  z   y  0 (189)
x y  c z  0

The obvious solution is that all three are zero. 101 One obvious element of the non-zero solutions is
that 𝑦𝑦 = 𝑥𝑥, which is easily derived from the first equation. Feed this into the second and third
equations, and you get:

x b  z   x  0
(190)
x x  cz  0
This gives you one value for 𝑧𝑧, and 2 for 𝑥𝑥—which is also the value for 𝑦𝑦:

z  b  1
(191)
x   cz

So the three equilibria of this system are:

 x1E  0
   
 y E    0 ,
 1  
 z E   0
 1   
 
 x2E   c  b  1
   
 y E    c  b  1 , (192)
 2  
 zE   
 2   b  1 
 
 
 x3E   c  b  1
   
 y E    c  b  1
 3  
 zE   
 3   b  1 
 
We calculate the “Jacobian” matrix—so called because it was first developed by Carl Gustav Jacob
Jacobi—which is a matrix formed by differentiating each function with respect to each variable in
the system (I’ll explain why it’s used later):

    
 a y  x  a y  x  a y  x  
 x y z 
   a a 0
     
 x b  z   y x b  z   y x b  z   y    b  z 1 x  (193)
 x y z   
   y x c 
      
 x y  c z x y  c z x y  c z 
 x y z 

Now we substitute the values of 𝑥𝑥, 𝑦𝑦, 𝑧𝑧 at the equilibria. Starting with the zero equilibrium, this
generates the linear component of the model in the vicinity of (0,0,0). Using the subscript L to
emphasize that this is linearized rather than the full model, we get this model:

101
𝐹𝐹 = 𝑆𝑆 = 0 is also an equilibrium of the predator prey model, and it is unstable.

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 xL  a a 0   xL 
d      
(194)
y L  b 1 0    y L 
dt      
 z 
z
  
L 0 0 c   L

We make the same “ansatz” that the solution is of the form:

 xL   xL 
d    
(195)
yL     yL 
dt    
z 
 zL   L

Substituting this into (194) gives us an algebraic equation to solve:

 xL  a a 0   xL 
     
  y L  b 1 0    y L 
   (196)
     
z   0 0 c   
 L     zL 

Rearrange it using the rules of matrix algebra:

  0 0  a a 0    xL   0
        
  0  0    b 1 0    y    0 (197)

      L   
  0 0    0 0 c    zL   0

We’re now looking for values of 𝜆𝜆 that allow the variabes 𝑥𝑥𝐿𝐿 , 𝑦𝑦𝐿𝐿 , 𝑧𝑧𝐿𝐿 to take non-zero values. This is
revealed by the roots of the polynomial in 𝜆𝜆 generated by this determinant:

  a a 0 
 
 b   1 0     c   2  1  a   a  b  1 (198)
 
 0 0   c 
 

So one root of (198) is obviously −𝑐𝑐, while the quadratic formula is needed to identify the other two:

c ,
a  1  a  a  4  b  2  1
  , (199)
2
a  1  a  a  4  b  2  1

2
There’s a lot more grunt work to express this fully, but the key point for stability is that, for the
equilibrium to be stable, the biggest “real” part (that is, the part that doesn’t involve the square root
of minus one) of these numbers—known as the “dominant eigenvalue”—must be negative. We
know that −𝑐𝑐 is negative, since 𝑎𝑎, 𝑏𝑏, 𝑐𝑐 are all positive numbers; but the value of the other two
depends on the magnitude of the square root term. Here we have to plug in numerical values for
𝑎𝑎, 𝑏𝑏, 𝑐𝑐, which are parameters in fluid mechanics. The realistic values that Lorenz first used were:
a  10
b  28 (200)
8
c
3

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When we plug those into Equation (199) we get:

8
 ,
3
  22.8, (201)
11.8

What this means that this equilibrium is stable along two of its three “eigenvectors”, but unstable
along the third. So the zero equilibrium is a “saddle node repeller”: it attracts the system along two
axes, but repels along the third.

The other two equilibria are symmetric, so we can just consider the second. We feed the values for
𝑥𝑥2𝐸𝐸 , 𝑦𝑦2𝐸𝐸 , 𝑧𝑧2𝐸𝐸 into the Jacobian:

 
 a a 0   a a 0 
   
b  z2E 1 x2E    1 1  c  b  1 (202)
   
 yE x2E c   c  b  1 
 2
 c  b  1 c 

The linear component of the dynamic system near this second equilibrium is thus:

 
 xL   a a 0   xL 
d      
yL   1 1  c  b  1   yL  (203)
dt      
   zL 
 zL   c  b  1 c  b  1 c  
 
We assume that this is equivalent to:

 xL   xL 
d    
yL     yL  (204)
dt    
z 
 zL   L
Substitution yields:

 
 xL   a a 0   xL 
     
   yL    1 1  c  b  1   yL  (205)
     
     zL 
 zL   c  b  1 c  b  1 c  
 
Grouping via the rules of linear algebra yields:

  
  0 0   a a 0   xL   0

        
  0  0    1 1  c  b  1   yL    0 (206)
     
  0 0       zL   0
    c  b  1 c  b  1 c    
  
This is true if the determinant of the matrix is zero, which yields this third order polynomial:

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 3  1  a  c   2  c  a  b   2  c  a  b  1 (207)

Remember the formula for the roots of a cubic equation in Figure 217? Feed this into that, and you
get a nightmare expression that would fill several pages. It’s much easier to fill in the values for the
parameters—see Equation (200). Feed these into Equation (207) and you get one real root (the
negative number on its own) and a pair of “imaginary” numbers—numbers involving 𝑖𝑖 = √−1:

13.855,
  0.094  10.195 i , (208) 102
0.094  10.195 i

The first root shows that this equilibrium is a strong attractor along one of its dimensions
(eigenvectors). But the next two show that it is cyclical (the two complex numbers generate cyclical
behavior) and that it is a repeller: the real part of the pair of complex roots is greater than zero. This
means that as the system approaches this equilibrium, it is repelled from it in a cyclical fashion—
which is what we saw in the simulation.

The whole model has one equilibrium which attracts along two dimensions and repels along a third,
and two equilibria which attract along one dimension and repel cyclically on a plane. Figure 222
shows its three equilibria, and the dynamics of the Lorenz model, projected onto the 𝑥𝑥, 𝑦𝑦 and 𝑧𝑧
planes. This behavior had never been seen in a mathematical model before Lorenz, and the
equilibria were dubbed “strange attractors” as a result.

102
Since it is symmetric, the other non-zero equilibrium has the same roots.

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Figure 222: The dynamic behavior of the Lorenz model projected onto the x,y and z planes

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This also illustrates why equilibrium modelling is a waste of time if the underlying system is
complex—and that is true when the system in question has three or more dimensions that interact
with each other in nonlinear ways (Li and Yorke 1975). A complex system will almost certainly never
be in any of its feasible equilibrium states: if you want to model it, you have to use modelling
techniques that can handle far-from-equilibrium behavior.

This discovery convinced meteorologists of Lorenz’s point, that weather forecasting should not use
equilibrium techniques. If his simple model, which was derived from the complicated equations that
describe fluid flow, generated chaotic behavior, then the weather—where the fluid is air—must also
be chaotic. Equilibrium models of the weather were therefore useless.

This was not the only factor involved, but there then ensued a revolution in meteorology which has
led to the advanced capacity meteorologists have to predict the weather today—within limits also
determined by the properties of complex systems. This is why the disaster of Cyclone Sandy had
such a tiny impact on human life: meteorologists were able to predict where it would make landfall
to a far higher degree of accuracy than was possible before Lorenz, and therefore people could be
advised to evacuate before the disaster hit. 103

But in economics? In 2007, economists advised that politicians that the economy would sail
smoothly into 2008, since their equilibrium-based economic models predicted it would be a year of
tranquil economic growth.

11.4 Analyzing the Keen model of Minsky’s Financial Instability Hypothesis

I predicted something different—a financial crisis—because I was informed by the non-equilibrium
model I had built of Minsky’s Financial Instability Hypothesis, way back in August of 1992 (Keen
1995). That model used a nonlinear Phillips curve function devised by John Blatt (Blatt 1983, p. 213)
for the express purpose of avoiding nonsense outcomes like an employment rate of more than 1; in
this book, I have used a linear Phillips curve, not because I believe it is linear—anything but, as I
explain in Section 5.2.1, starting on page 49—but because it’s easier to mathematically analyze a
model with linear rather than nonlinear functions.

It also means, as Carl Chiarella emphasized (Chiarella and Flaschel 2000; Chiarella 2005; Asada et al.
2006), that if you use linear behavioral functions in an otherwise nonlinear model, the nonlinearities
in the model itself arise not from the functions (which inevitably involve assumptions by the
modeler) but from the structure of the model itself: they are intrinsic. Once these are identified and
analyzed, nonlinear functions can be added at a later stage when you are attempting to fit your
model to data.

My solution to the problem Blatt identified with linear functions—that they can give you a
employment rate of more than 100%--was to use the employment to population ratio (which is
about 60%) rather than the employment to workforce ratio (which is about 90-95%). That way, the
countervailing intrinsic nonlinearities in the model will kick in well before the model reaches an
employment to population ratio of 100%, even with an unrealistic linear Phillips curve.

The model—which as I show in Section 9.2 on page 179, can be derived directly from the
macroeconomic definitions for the employment rate, the wages share of GDP, and the private debt

103
This wasn’t the case for Cyclone Ida in August 2021, because, with the additional heat in the Caribbean
from global warming, Ida grew too quickly for most people to be able to evacuate in time. It was just luck that
Ida didn’t hit a major population centre, as did Sandy.

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ratio—is reproduced in Equation (209), with the intrinsic nonlinearities, generated when one
variable is multiplied by another, highlighted in red.

  1 − ω − r ⋅ dr   
  Sπ ⋅  − Zπ   
d  v  −δ  −α − β 
λ = λ ⋅ K
dt  v  
  
  
d
ω =ω ⋅ ( Sλ ⋅ ( λ − Z λ ) − α ) (209)
dt
  1 − ω − r ⋅ dr  
d  1 − ω − r ⋅ dr   Sπ ⋅
v
− Zπ  
d r = Sπ ⋅  − Zπ  − (1 − ω − r ⋅ d r ) − d r ⋅    −δ 
K
dt  v   v 
 
 
The full analysis of this model’s stability properties is in (Grasselli and Costa Lima 2012). I won’t
attempt that level of detail here, because it would just be too lengthy, and also because examining
just one equilibrium is hard enough on its own—so hard in fact, that I debated whether or not I
should include this section at all.

In the end, I decided to keep it, because it reveals the role of symbolic analysis in explaining why
some phenomena that can be seen in a simulation actually occur. The two specific features of my
model that cannot be explained by the equations themselves, nor understood simply by looking at a
simulation, are that:

• The crisis is preceded by a period of diminishing volatility in the rate of economic growth—a
“Great Moderation”; and
• Before it collapses in a final crisis, the capitalist share of income fluctuates around a constant
level, while the workers’ share of GDP falls as the debt ratio rises.

Both these phenomena are apparent in Figure 223. But neither were either predictions by Minsky in
his Financial Instability Hypothesis, nor assumptions built into the model itself.

Minsky did say “stability … is destabilizing”, but this was with reference to a single cycle—that a
period of tranquil growth would lead to rising and eventually euphoric expectations, leading to a
boom which changed the distribution of income, and caused a bust. However, he did not predict
that the scale of cycles would get smaller before they got larger: that was something that was first
seen in the simulations for my 1995 paper. The phenomenon was so striking that I ended the paper
with a rhetorical flourish about it:

The chaotic dynamics explored in this paper should warn us against accepting a
period of relative tranquility in a capitalist economy as anything other than a lull
before the storm. (Keen 1995, p. 634)

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Figure 223: The Keen-Minsky model (same equations as (209) but with compact functions to save space)

The fact that the profit share was stable (before it collapsed at the end of the simulation), while the
wages share fell as the debt level rose, was also an enigma: how come workers’ share of GDP falls as
debt rises, even though—in this model—workers did not borrow?

The solution to this enigma became obvious when I first tried to work out the model’s equilibria in
terms of its three system states: the wages share 𝜔𝜔, the employment rate 𝜆𝜆, and the debt ratio 𝑑𝑑𝑟𝑟 .
An equilibrium will be defined in terms of the model’s parameters, which was easy to do for the
employment rate. But the “equilibrium” wages share included the “equilibrium” debt ratio as one of
its arguments: try as I might, I either couldn’t eliminate a variable from the solution, or I got
something too complicated to work with. So I decided to work with the profit share instead: 104

π s = 1 − ω − r ⋅ dr (210)

That results in a much more compact set of equations:

104
Substitutions like this are often necessary with complex systems models. Grasselli and Costa-Lima found
that they had to substitute the debt ratio with the inverse of the debt ratio to analyze what the called the
“bad” equilibrium, with zero wages share and zero employment but an infinite debt ratio. (Grasselli and Costa
Lima 2012, p. 199)

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  πs   
  Sπ ⋅  − Zπ   
d  v  −δ  −α − β 
λ = λ ⋅ K
dt  v  
  
  
d
ω =ω ⋅ ( Sλ ⋅ ( λ − Z λ ) − α ) (211)
dt
 π  
 Sπ ⋅  s − Zπ  
d π   v  −δ 
d r = Sπ ⋅  s − Zπ  − π s − d r ⋅  K
dt  v   v 
 
 
Given that 𝜆𝜆 and 𝜔𝜔 are both positive, we can simplify finding the equilibrium to solving the following
equations:

π 
Sπ ⋅  s − Zπ 
 v  −δ −α − β = 0
K
v
Sλ ⋅ ( λ − Z λ ) − α =
0 (212)

 π  
 πs  Sπ ⋅  s − Zπ  

Sπ ⋅  − Zπ  − π s − d r ⋅   v  −δ  =0
K
 v   v 
 
 
The first two are relatively easy to work out, while the third, for the debt ratio, is quite involved.
Equation (213) shows the equations using the substitution of the profit share, which allows us to
express both the equilibrium profit share and equilibrium employment rate in terms of the model’s
parameters:

 v ⋅ (δ K + α + β ) 
πs =
v ⋅ + Zπ 
 Sπ 
α
=λ + Zλ (213)
Sλ
π 
Sπ ⋅  s − Zπ  − π s
dr =  v 
  πs  
 Sπ ⋅  v − Zπ  
   −δ 
K
 v 
 
 
We have to go further to express the debt ratio in terms of the model’s parameters only though,
since the profit share itself is part of the debt ratio. Making this substitution yields the unholy mess
in Equation (214):

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  v ⋅ (δ K + α + β )  
 v ⋅ + Zπ  
  Sπ   v ⋅ (δ K + α + β ) 
Sπ ⋅ − Zπ  − v ⋅  + Zπ 
 v   Sπ 
 
dr =  
   v ⋅ (δ K + α + β )   
  v ⋅ + Zπ   
 S ⋅  Sπ  −Z  
 π  v
π
 
   
   −δ 
 v
K 
 
 
 
  (214)
 
 
This complicated expression simplifies drastically once you realize that part of it is the expression for
the equilibrium rate of profit from Equation (213) . Using superscripted 𝐸𝐸 (as in 𝑑𝑑𝑟𝑟𝐸𝐸 ) to emphasize
that these are equilibrium values, we have:

 v        
sE  v   K
 Z  
 S 
 (215)
E 
S  Z
E v      K   sE
d 
r


Even this isn’t the end of the process, because the differential equations in Equation (211) are in
terms of the wages share, not the profit share. We either have to derive the equilibrium wages
share, or convert the wages share differential equation into a profit share equation. The easier route
is the former, and it also reveals something interesting. Firstly, we define the equilibrium wages
share in terms of the equilibrium profit rate and debt ratio:

ωsE = 1 − π sE − r ⋅ d rE (216)

Remember that this model was derived from strictly true macroeconomic definitions? Since the
equilibrium profit share is a constant, then a higher rate of interest means a lower wages share of
GDP. In the dynamic model as well as in this equilibrium calculation, the higher the debt level, the
lower the workers’ share of GDP. This explains the phenomenon we can see in the dynamic path of
the model as well: as the debt level rises, the wages share falls. A higher interest rate also leads to a
lower wages share. The real class struggle in capitalism is not between workers and capitalists, but
between workers and bankers.

That fun observation aside, we still need to substitute the expressions for the equilibrium profit
share and debt ratio from Equation (215) into (216) to generate equilibrium values for the wages
share, employment ratio and debt ratio. Using the expression for 𝜋𝜋𝑠𝑠𝐸𝐸 yields this relatively compact
statement of the values of the “good” equilibrium:

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sE  1  sE  r  drE


 E   Z
S
v      K   sE
E
d  (217)
r

where
 v        
sE  v   K
 Z  
 S 


 r  
  v      K    v      K 
sE  1  v    Z     v      K   v    Z  
  S       S 
 (218)
E 
S  Z
1   v      K  
drE   v      K   v    Z  
     S 

These equilibrium values have to be substituted into the Jacobian—which is just too big to show in
full form here, so I’ll represent what it is instead: the partial derivatives of each of the functions in
the system (Equation (211)) with respect to each of the variables 𝜆𝜆, 𝜔𝜔, 𝑑𝑑𝑟𝑟

 ∂ d  ∂ d  ∂  d 
  λ  λ  λ
 ∂λ  dt  ∂ω  dt  ∂d r  dt  
 ∂ d  ∂ d  ∂  d 
  ω  ω  ω (219)
 ∂λ  dt  ∂ω  dt  ∂d r  dt  
∂ d  ∂ d  ∂  d 
  dr   dr   dr 
 ∂λ  dt  ∂ω  dt  ∂d r  dt  

Fortunately a fair degree of cancellation occurs, so that the Jacobian isn’t quite as horrific as it could
have been—but it’s still pretty horrific:
 
 S   1    r  d  Z  
   v

 
      K    S 0 
 v 
  (220)
 S   S  d  
  2 S    Z       1 
 v v v 
  
 
 1    r  d  
 S   
 Z   
 S    r  v  r  S  d  
  0 K       1
 v2 v v  v 

We’re not home and hosed yet: this is the linear component of the model in the vicinity of this
equilibrium, and to know whether this linear model will converge to the equilibrium, we need to
calculate the roots of the polynomial that results from the same process as shown for the Lorenz
model. These roots are just too complicated to calculate symbolically, so—as is often the case in
complex systems analysis—we are forced to numerical means: we calculate the polynomial for given
parameter values.

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The key parameters that shape the system’s behavior are the interest rate, the slope of the
investment function 𝑆𝑆𝜋𝜋 , and the point at which investment equals profits (and therefore, firms don’t
borrow) 𝑍𝑍𝜋𝜋 . The key behavior of the model—a flip from a stable to an unstable equilibrium—can be
seen in the equations below: where the slope of the function 𝑆𝑆𝜋𝜋 , is 8.4, 8.5 and 8.6 respectively: 105

 0.025, 
 
S  8.4  0.0008  1.98i ,
 
 0.0008  1.98i 
0.025,
 
S  8.5   1.99i ,  (221)
 
 1.99i 
 0.025, 
 
S  8.6  0.0008  2i ,
 
 0.0008  2i 

Each set of eigenvalues includes a negative real value, which attracts the system towards it. Each
also contains a pair of complex eigenvalues, which makes the system cycle. The key difference is
that, in the first case, the “real part of the complex eigenvalues” is negative—which means the
system will converge to the equilibrium; in the second, the real part is zero—so it will repeat the
same cycle indefinitely, neither converging on the equilibrium, nor diverging from it; in the third
however, we get “strange attractor” behavior, because the real part is positive—it repels the system
from the equilibrium. So the system is attracted along one axis and cyclically repelled along another.

This doesn’t mean that the value of 8.5 is a critical one for the system—the behavior of this
linearized model only properly characterizes the full nonlinear model in the immediate vicinity of the
equilibrium, so if you start much further away, as do the simulations I’ve done of it in this book, then
instability can apply at a lower value for the slope of the investment function. But it does indicate
that there are conditions under which the model can be stable, and others under which it can be
unstable, so the model “bifurcates” when the parameters change across this critical value.

Figure 224 shows a simulation with a low value (𝜋𝜋𝑆𝑆 = 5) for the slope of the investment function,
and you can see the model converging to the equilibrium values over time.

105
The other parameters are the same: 𝛼𝛼 = 1.5%, 𝛽𝛽 = 1%, 𝛿𝛿𝐾𝐾 = 6%, 𝑣𝑣 = 3, 𝑟𝑟 = 4%, 𝑆𝑆𝜆𝜆 = 10, 𝑍𝑍𝜆𝜆 =
60%, 𝑆𝑆𝜋𝜋 = 10, 𝑍𝑍𝜋𝜋 = 3%.

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Figure 224: Linear Keen-Minsky model with a low value for the slope of the investment function

Figure 225 shows what happens with a higher value (7.5), and starting from a long way from the
equilibrium position (the debt ratio I start the simulation with is zero, while the equilibrium debt
ratio is 252%). The model starts to converge on the equilibrium, but then diverges—and ultimately it
will collapse onto the “bad” equilibrium of zero employment, zero wages share, and an infinite
private debt to GDP ratio. This is the stylized equivalent of a debt-deflation, which implies a total
breakdown of society—and it’s why “Big Government” is needed, according to Hyman Minsky,
because the government’s counter-cyclical spending can prevent this collapse from occurring.

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Figure 225: Linear Keen-Minsky model with a high value for the slope of the investment function

This simple model emphasizes a key point from a genuine dynamic model, as opposed to fake
dynamics of “Dynamic Stochastic General Equilibrium” modelling: you can’t reduce the behavior of a
complex system to the properties of its equilibrium.

11.5 Why the Jacobian?

The easiest way to explain why the Jacobian matrix—a matrix formed by differentiating each
function with respect to each variable—is needed as part of this process is by analogy to what
happens when you try to approximate a function like 𝑠𝑠𝑠𝑠𝑠𝑠(𝑡𝑡) using a polynomial.

What you are doing in that instance is declaring that the numerical value of 𝑠𝑠𝑠𝑠𝑠𝑠(𝑡𝑡) is equal to the
numerical value of an infinite sum of polynomials, which is an infinite sum of terms of a constant,
plus another constant times t, plus another constant times t squared, and so on:

sint   a0  a1  t  a2  t 2  a3  t 3    an  t n   (222)

The unknowns here are just the coefficients 𝑎𝑎0 , 𝑎𝑎1 , 𝑎𝑎2 𝑎𝑎3 and so on. If we take the simplest case,
where 𝑡𝑡 = 0, we know that 𝑠𝑠𝑠𝑠𝑠𝑠(0) = 0. With 𝑡𝑡 = 0, all the terms on the right hand side are zero,
except for the first constant 𝑎𝑎0 . So we know therefore that 𝑎𝑎0 = 0. That’s easy, but how do we
work out what 𝑎𝑎1 is? English mathematician Brook Taylor 106 realized that these could be found

106
https://en.wikipedia.org/wiki/Brook_Taylor.

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using differentiation. If you differentiate 𝑠𝑠𝑠𝑠𝑠𝑠(𝑡𝑡), you get 𝑐𝑐𝑐𝑐𝑐𝑐(𝑡𝑡). Differentiating the right hand side—
the polynomial—gets rid of the first constant (the differential of a constant is zero), leaves the
second constant 𝑎𝑎1 standing on its own, while the other terms are all multiplied by powers of t:

d
sint   cos t   a1  2  a2  t  3  a3  t 2    n  an  t n1   (223)
dt
Use 𝑡𝑡 = 0 again, we know that 𝑐𝑐𝑐𝑐𝑐𝑐(0) = 1, while all the subsequent terms are zero. So we know
that 𝑎𝑎1 = 1. There’s more to know about this process itself, but this is enough for our needs: we
have worked out that the linear approximation to 𝑠𝑠𝑠𝑠𝑠𝑠(𝑡𝑡) is just 𝑡𝑡 itself:

sint   t  (224)

It’s a reasonable approximation for 𝑡𝑡 between −1 and +1:

sin(t) and its first order approximation

1
0
sin(t)
0.8
t

0.6

0.4

0.2
sin(t) and t

0 0

− 0.2

− 0.4

− 0.6

− 0.8

−1
−1 − 0.8 − 0.6 − 0.4 − 0.2 0 0.2 0.4 0.6 0.8 1

t between -1 and +1

This is already “too much information” for what you need to know here (were you feeling that way?
Sorry!), which is that the linear term in this whole process is the first differential of the function. This
rule for a “scalar function”—a function of just one variable, in this case, t—is the first differential of
the function with respect to 𝑡𝑡.

The Jacobian just generalizes this to a “vector function”—a function of more than one variable, in
the case of the Keen-Minsky model, the variables of 𝜆𝜆, 𝜔𝜔, 𝑑𝑑𝑟𝑟 . The Jacobian is the first differential of
every function with respect to every variable. So by deriving it, we build a linear approximation of

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the system, and the properties of this linear approximation dominate the system’s behavior around
its equilibrium.

If this linear system is stable—if it converges to the equilibrium—then so will be the full nonlinear
system, but only if it starts “close enough” to the equilibrium that the linear forces can “do their
thing”. It is possible to have a system whose equilibria are stable, but only if you start close to those
equilibria where the linear components dominate. If you start further away, then the nonlinear
terms dominate—which can be seen in the simulation shown in Figure 225, since the value of 𝑆𝑆𝜋𝜋 is
below the critical level for stability of the equilibrium, and yet the simulation still diverges from it.

This behavior of a complex system leads to the concept of a “basin of attraction”: a region around an
equilibrium where the system will converge to the equilibrium—or remain within a finite distance of
it that is less than the overall phase space of the system—if the initial conditions lie within this basin.
Other concepts that turn up at this level of analysis include the Lyapunov exponent, to determine
whether a system is chaotic or not (a system can generate aperiodic cycles, but not actually be
chaotic). Were I twenty years younger, and that much closer to my own mathematical education, I’d
attempt an explanation here. But having wasted so much time fighting Neoclassical economists, I’ve
forgotten much of what would be needed to give a decent explanation. So, if you want to
understand these concepts—and they are worth understanding if you wish to really contribute to
nonequilibrium economics—then I suggest either doing a course in complex systems at your local
University mathematics department, or undertaking self-tuition via online resources like The Chaos
Book (https://chaosbook.org/).

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12 Model fitting notes from a non-statistician

The science fiction author Ray Cummings once wrote 107 that “time is what keeps everything from
happening at once”. Time, or the lack of it, is also what keeps some things from happening at all. In
my case, the lack of time has meant that statistical analysis is the least developed part of my
personal intellectual portfolio.

It is also, for reasons of lack of funding, the least developed aspect of Minsky. We hope to be able to
extend Minsky at some stage to implement some methods for parameter estimation in complex
systems, but for the moment, if you wish to fit a Minsky model to data, you’re going to have to do
that by exporting the model to another program. Minsky currently supports model exporting to
Matlab (it’s an option in the “Export Canvas” command on the File menu) for that purpose; it should
soon support export to Vensim; at some stage we will add model exporting to R; and you can export
the data from a Minsky simulation to a CSV file, which can be loaded into any data analysis program.

Fitting models to data is, of course, a large part of conventional economics, with its own sub-
discipline of econometrics—and its own intellectual problems. Fitting a complex systems model to
data opens yet more cans of worms, fundamentally because a complex systems model necessarily
violates the conditions for linear regression (which is the mainstay of econometrics) that elements of
a model predominantly interact additively. The inherent nonlinearity of complex systems models,
along with the far-from-equilibrium behavior that most models generate, means that the values of
parameters also interact with each other in nonlinear ways—normally multiplicatively, as in my
model. This creates a “fitness landscape” for those parameters with numerous mountains and
valleys (in terms of the model’s deviation from real world data) that can trap a standard least
squares parameter fitting process in a local minima which is close to the initial guess values, but far
removed from the model’s actual minimum deviation from real-world data.

This weakness of standard techniques cannot be addressed by a “brute force” approach of

examining every permutation of the parameters, because the number of permutations is
overwhelming. For example, the Keen-Minsky model shown in Figure 225 has nine parameters. If we
try just twenty different values for each parameter, then there are 920 , or over 12 million trillion,
different combinations of parameters to consider. This is simply too large a number of possibilities to
test, so mathematicians and computer scientists have developed a range of techniques to sample a
subset of possible combinations, and have reasonable confidence that your eventual choice of
parameters is a global minimum, rather than a local one.

These techniques include genetic algorithms, simulated annealing, neural networks, plus a range of
variations on least squares techniques—such as the Adam Optimization Algorithm 108 (the name is
derived from “adaptive moment estimation”)—all of which are designed to overcome the problem
of the parameter estimation technique getting locked onto a local minimum (deviation of the model
from the data) which is not the global minimum.

My main interest in fitting models is not finding the best parameter values to enable a given model
to replicate real world data, but in seeing whether or not the empirical data qualitatively conforms
to a given model. If there are qualitative similarities, then the model, while it might not be able to
replicate the empirical data precisely—or even closely—can provide insights into the real-world
system.

107
https://quotes.yourdictionary.com/author/quote/592234.
108
The site https://www.geeksforgeeks.org/intuition-of-adam-optimizer/ gives a reasonably accessible
explanation of the algorithm.

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This was the point of Lorenz’s model, which was constructed by stripping down an extremely
accurate high-dimensional model of fluid turbulence to an extremely simple model with just 3
variables and 3 parameters. Lorenz didn’t construct this model to fit the data on turbulence, but to
show the underlying factors causing that turbulence were the interaction of aspects of the
weather—wind speed, temperature, humidity, pressure gradients, etc.—in highly nonlinear ways. In
doing so, he “discovered” chaos (though it had first been identified logically by Poincare at the end
of the 19th century), and a whole new way of modelling the weather was born.

I had a similar ambition for my model of Minsky’s Financial Instability Hypothesis. I wanted to do
what Minsky had not managed to do, to produce a mathematical model of his verbal intuitions
about the role of private debt and credit in causing both cycles and crises in capitalism. 109 I did that
with a model in which I made a range of simplifying assumptions that removed other possible
sources of instability apart from the nonlinear interactions of the model’s system states—the rate of
employment, the oncldistribution of income, and the private debt to GDP ratio.

Some obvious sources of cyclical behavior in capitalism are variations in the rate of interest, changes
in the capital to output ratio, intersectoral production and monetary dynamics, changes in the rate
of population growth and technological change… All these were effectively held constant in my basic
model. All that was left were the interactions of those three system states, and out of them arose
two unexpected properties—in the sense that neither of them were predictions of Minsky’s verbal
model.

The Keen-Minsky model shown in Figure 225 has four key qualitative features:

• A rising level of private debt to GDP over time;

• An eventual debt-deflationary crisis—which in technical terms is convergence of the model
onto the “bad equilibrium” of zero employment, zero wages, and an infinite debt to GDP
ratio;
• Cycles in the rate of economic growth diminishing and then rising before a crisis; and
• The shift in the distribution of income over time, with a rising private debt ratio causing a
declining workers’ share of income, while the profit share of income is cyclical but
unaffected by the rising debt ratio.

Only the first two characteristics that Minsky had described in his hypothesis, and that I had
expected to emanate from the model. The latter two were what are known in complex systems as
“emergent properties”: behaviors of a model that are not built into it by its designer, but result from
the nonlinear interactions of the components. 110

109
Minsky did try to do that, in his PhD thesis, and it led to two of the only three papers by Minsky that were
published in leading mainstream journals (Minsky 1957, 1959). He failed, because he used as his underlying
model the Hicks-Hansen-Samuelson second-order difference equation known as the “Multiplier-accelerator
model” (https://en.wikipedia.org/wiki/Multiplier-accelerator_model). As soon as I read the introduction to
that paper, I knew that Minsky wouldn’t succeed, because I had already worked out that this model was based
on an economic fallacy of equating actual savings to desired investment, both of which were functions of
income. It was therefore asking “what level of GDP ensures that actual savings equals desired investment,
when both are lagged functions of income”, to which the only answer was “zero GDP”. I explain why in more
detail in the paper “Burying Samuelson’s Multiplier-Accelerator and resurrecting Goodwin’s Growth Cycle in
Minsky” (Keen 2020a).
110
People often think that emergent properties can only be found in multi-agent models, where the macro
behavior can’t be derived from the micro, but this isn’t the case. Lorenz’s butterfly is the perfect instance of

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The second property in particular was striking. Though Minsky had famously stated that “Stability—
or tranquility—in a world with a cyclical past and capitalist financial institutions is destabilizing”
(Minsky 1982, p. 101), this was in relation to the process within one cycle, where a period of tranquil
growth would lead to rising expectations, turning a period of tranquil growth into a credit-fuelled
boom. Minsky also expected that, in the absence of “Big Government”, there debt to GDP ratio
would increase over a series of booms and busts, until a level of debt was accumulated that
overwhelmed the economy and caused a Depression.

But he did not expect that these booms and busts would get smaller in magnitude for a while, and
then get larger—which was the first emergent property of my model. Nor did he think that the rising
debt ratio, and rising debt servicing costs, would come at the expense of workers and not capitalists
(until the final crisis occurred). 111 These predictions were a direct product of the mathematical
model, which I first developed in August of 1992.

behavior which wasn’t pre-programmed by the modeler, but arose from the nonlinear interactions of the
model’s system states.
111
I explain the second phenomenon in Manifesto on pages 87-88, and the first on pages 88-93.

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13 Conclusion
I hope that the preceding chapters give you a reasonable introduction to modelling in Minsky, as
well as an explanation of why continuous time system dynamics modelling is an excellent foundation
for a monetary, far-from-equilibrium, biophysical approach to modelling capitalism.

There are some features of Minsky that I haven’t discussed, mainly because their implementation at
present is incomplete. One obvious such feature is grouping: as noted on section 6.2 on page 67,
grouping still has significant bugs which make it advisable not to use this feature at present. We have
also enabled unit analysis in Minsky, which is a powerful means of checking the logic of a model, but
the implementation doesn’t as yet work smoothly enough to recommend its use. I’ve probably spent
too much time in theoretical digressions rather than simply explaining how to build a model as well.
I’ll try to return to this manual/book and improve those aspects of it as time permits.

For now, I would be delighted if you started using Minsky to build Post Keynesian oriented dynamic
models of capitalism, and biophysical models of the dependence of the economy on the biosphere.
One positive-negative of the current state of development of Post Keynesian economics is that, since
most Post Keynesian models use “time periods”, there is a lot of low-hanging fruit in re-
implementing these models in continuous time. A second positive-negative is that the field of
dynamic integrated biophysical monetary modelling is virtually pristine: there is so much to be done.
If you do embark upon modelling with Minsky, you won’t run out of research projects any time
soon—and the existence of relatively easily solved “puzzles”, Kuhn notes, is an important part of the
development of a “Normal Science” after a period of revolutionary upheaval:

The scientific enterprise as a whole does from time to time prove useful, open up
new territory, display order, and test long-accepted belief. Nevertheless, the
individual engaged on a normal research problem is almost never doing any one
of these things. Once engaged, his motivation is of a rather different sort. What
then challenges him is the conviction that, if only he is skilful enough, he will
succeed in solving a puzzle that no one before has solved or solved so well. Many
of the greatest scientific minds have devoted all of their professional attention to
demanding puzzles of this sort. (Kuhn 1970)

As I argued in Manifesto, economics has been locked in a pre-scientific state ever since Walras,
Jevons and Menger in the 1870s, and arguably, ever since Smith distorted the empirically sound
foundations of the Physiocrats with the argument that the division of labour—and not the “free gift
of nature”—was the basis on which the economy and economic growth were built. Even progressive
rival schools of thought like Post Keynesian economics and MMT have remained either based on
Neoclassical modelling foundations that they should have abandoned—primarily, equilibrium-
oriented modelling and the use of “time periods” rather than continuous time—or they have not
developed a widespread practice of dynamic modelling because the technology to do it properly was
accessible only to a tiny cohort of suitably trained non-mainstream economists.

Minsky is far from perfect, and far from finished, but I believe it is sufficiently well designed and
sufficiently complete to enable a community of modelers to grow around it, to share models, and to
illustrate how much more fruitful and realistic a dynamic, non-equilibrium, monetary, energy-aware
approach to economics is when compared to the stale, equilibrium-fixated, barter-based, energy-
ignorant work of Neoclassicals.

Please help turn this belief into reality.

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14 Appendix: the credit dynamics of house prices

(0.225)

This is an extract from an as yet unpublished paper undertaken with Paul Ormerod and Nyman
Rickard.

Arguments over whether there is or is not a bubble in housing are endless and seemingly futile.
Proponents of the bubble hypothesis point to various metrics when they exceed historic norms, such
as house prices relative to rents or household income. Opponents argue that such divergences
simply reflect the balance of the forces of supply and demand, or propose reasons why these price
to income ratios should in fact rise over time. Bubble proponents slate the blame for the perceived
bubble to the banking sector; opponents of the bubble hypothesis blame inflexible supply for any
perceived deviation of prices from affordability metrics.

The current state of this debate is thus akin to the irresolvable question of “which came first: the
chicken or the egg”? Given the importance of housing both socially and economically, this is an
unsatisfactory state of affairs.

Clearly there are causal factors working in multiple directions: is it possible to disentangle them to
work out what is the predominant factor, and thus determine whether housing is or is not in a
bubble? In this paper we propose a causal analysis, and apply a well-known—if limited by its linear
assumptions—statistical test to resolve this dispute.

14.1 The argument

We commence with an argument couched in terms of supply and demand. The supply of housing
has two major components: the turnover of existing properties (whether for speculative,
demographic or social reasons), and additions to the stock of properties by construction. We can
therefore specify the physical flow of supply onto the market at a point in time 𝑆𝑆𝐻𝐻 (𝑡𝑡) as having one
factor relating to the fraction 𝛼𝛼 (𝑡𝑡) of existing stock 𝑄𝑄𝐻𝐻 (𝑡𝑡) supplied to the market each year, and
another consisting of construction or the change in stock:

d
SH ( t ) =α ( t ) ⋅ QH ( t ) + QH ( t ) (0.226)
dt
The monetary demand for housing has two components as well: the deposits needed by prospective
purchasers, and the flow of new mortgage debt 𝑀𝑀(𝑡𝑡). Given that, even in the 1960s, the typical loan
to deposit ratio was 2.5:1, and today the ratio is closer to 10:1, we neglect deposits here and treat
𝑑𝑑
the monetary demand for housing as being equivalent to the flow of new mortgages 𝑀𝑀(𝑡𝑡). This
𝑑𝑑𝑑𝑑
flow, divided by the price level ruling at the time of purchase 𝑃𝑃𝐻𝐻 (𝑡𝑡), determines the physical
demand for housing 𝐷𝐷𝐻𝐻 (𝑡𝑡):

d
M( t )
DH ( t ) = dt (0.227)
PH ( t )

The market demand and supply factors thus have monetary forces on one side (change in mortgage
debt and the house price level) and physical supply on the other, with numerous potential causal
channels: rising mortgage debt might drive house prices; rising house prices might encourage people
to take on mortgage debt; rigid supply meeting flexible demand may push house prices up; rising
house prices might encourage more circulation of existing stock, and new construction, and so on.

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Stating the causal dynamics in an agnostic way, and dropping the time argument for notational
simplicity, we start with the relation between demand and supply shown in equation (0.228):

d
M
dt  S (0.228)
H
PH

Restating this in terms of the house price index yields:

d
M
PH  dt (0.229)
SH

We are interested in the change in house prices—which immediately suggests that one factor in the
change in house prices is not the rate of change of mortgage debt, but its acceleration:

 d 
M
d d  dt 
PH    (0.230)
dt dt  SH 
 
Expanding this out yields:

 d 
M
d 1  d2 d 
PH   2 M − dt ⋅ SH  (0.231)
dt SH  dt SH dt 
 
A simplification makes this relation more tractable: we note that equation (0.229) suggests that 𝑃𝑃𝐻𝐻
𝑑𝑑
can be substituted for 𝑀𝑀�𝑆𝑆𝐻𝐻 :
𝑑𝑑𝑑𝑑

d 1  d2 d 
PH   2 M − PH ⋅ SH  (0.232)
dt SH  dt dt 

If we now divide by 𝑃𝑃𝐻𝐻 to derive the percentage rate of change of prices, we get:

d2
M
1 d 2 1 d
PH  dt − SH (0.233)
PH dt PH ⋅ SH SH dt

Equation (0.233) expresses the rate of change of house prices as a function of supply and demand,
as participants in this debate all agree. However, what may be unexpected is that this relationship
includes acceleration terms for both mortgage debt and housing supply. Substituting (0.226) into
((0.233) yields:

d2
M d 
1 d 2 1 d2
PH  dt − ⋅  (α ⋅ QH ) + 2 QH  (0.234)
PH dt PH ⋅ SH SH  dt dt 

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This implies that for house prices to rise, the acceleration of mortgage debt must be positive, and
greater (when deflated by the current monetary value of transactions on the housing market) than
the supply-deflated sum of the rate of change of the physical housing stock times its turnover rate,
plus the rate of change of new construction (and thus the acceleration of the housing stock).

We have revealed a potential relationship between the rate of change of house prices and the
acceleration of mortgage debt: but which causes which? Do rising house prices cause people to
decide to take on mortgage debt, or does accelerating mortgage debt cause house prices to rise?

If the former, then the supply “chicken” leads the demand “egg”, and those who argue that there is
no bubble have a case. If there is a policy desire to reduce the rate of growth of house prices, then
that policy must focus on the supply of housing. There is also no reason why sustained price rises
cannot continue.

But if it is the latter, then the demand “egg” leads the supply “chicken”, and the argument that there
is a debt-financed bubble driving house prices has legs: limits on the capacity of banks to create
mortgages would impact upon house price growth. There is also a very good reason why house price
rises must ultimately stop: they depend on the acceleration of mortgage debt being not merely
permanently positive but substantially greater than zero, to counter the impact of the two supply
factors. This is impossible, since nothing, not even mortgage debt, can accelerate forever.

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