Thomas Palley's latest paper looks at Steve Keen's efforts to link aggregate demand with changes in debt levels.
I think this is a good paper. Much of what Palley has to say is in line with observations I have made before about the direction Keen seems to be going in. He identifies that Keen's ideas on the causal relationship between money and spending are little different from old-school monetarism. He also discusses how this simplistic approach overlooks many of the complexities of the relationship between debt and spending. He includes a simple model that illustrates the way that debt can have an impact both through its absolute level and through the rate of change.
Palley makes some observations on how different types of debt might have different impact on spending. This is an important issue. However, I'm not sure I buy into the way he has reflected this in his model.
This model is based on two types of households: borrowers and lenders; and two types of lending: bank lending and direct finance. Borrowers then spend the full amount of their new borrowings, regardless of the source of the loans, banks or otherwise. I think this is a fairly reasonable assumption, for a model which does not include borrowing for asset purchase.
I'm less convinced though by what he says about the spending of lenders. His function for lenders' consumption (his equation 18) is equivalent to:
C = α1 + α2 . ( YD - DL ) + α3 . W
where C is consumption spending, YD is lenders disposable income (share of GDP plus financial income), DL is direct lending in the period and W is wealth, which includes financial assets arising from both bank lending and direct finance.
The key point where Palley distinguishes between bank lending and direct finance is in the inclusion of DL in this equation. What Palley is saying is that " ...[lenders'] income is reduced by lending via direct (loanable funds) credit markets."
Here's a story I've used before. I want to buy a car. I go to the bank and ask for a loan for $10,000. The bank decides I'm not credit-worthy and declines. So, I go to my rich uncle and ask if he will lend me the money. He knows me well enough to believe that I will actually repay, so he agrees to the loan.
Now, I'm prepared to accept that this may have some impact on my uncle's own consumption spending. But, on the whole I don't think it has that much. I certainly don't think my uncle would equate this with a fall in income of $10,000. Most of the time, he's just going to see it as another way of investing. He's probably just going to take some money out of the bank and give me that. If he thought that lending me the money meant he couldn't himself buy the car he meant to buy, I don't think he'd make the loan.
On the other hand, maybe you don't like this sort of story and prefer micro-founded argument. In which case, lenders' consumption will be based on some kind of permanent income measure. How they invest their savings should have no bearing on this. So the decision to make a direct loan is not going to change consumption expenditure. Personally, I have mixed feelings on this kind of analysis, but I do think that households engage in some kind of consumption smoothing and I find it implausible that they would vary their consumption pattern on the basis of their investment choices.
What makes this point even more important, I think, is that in practice the distinction for the end investor between bank lending and other lending is a blurred one. The non-bank sector can generate and finance itself with instruments which are very close substitutes for claims on banks. Where do you draw the line between those where the household treats acquisition as a loss of income and those where it does not?
What Palley has done here (as he acknowledges) is to retain some element of loanable funds within his model. I think it would be better without it, but otherwise there are some good insights in this paper into the complex way debt impacts on demand.