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Steve Keen: rebel economist with a cause

Patrick Commins

Steve Keen can only roll his eyes when you mention, as he puts it, "that bloody bet".

On a balmy Sydney summer day, Keen reflects on taking and then losing a wager that house prices would plunge 40 per cent in the wake of the GFC. That bet resulted in Keen undertaking in 2010 a well-publicised 224 kilometre hike from Canberra to Mount Kosciuszko.

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As widely expected, the RBA has left rates steady for December.

"What I realised was how savage the property lobby here is to defend the idea that house prices always rise, the viciousness they've got," says Keen, who now teaches at London's Kingston University but was back in Sydney over the Christmas break.

It's this emotional investment "which is the psychological backbone that causes a bubble", he notes. And yes, he still believes there is a bubble. Keen appears completely undaunted and shows no signs of bitterness. Eventually, he believes, he will be proved right. And he enjoyed that hike.

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That bet remains the thing most Australians remember about Keen. Which is a shame.

Keen's views and policy prescriptions remain firmly and proudly unconventional – unworkable even. But as somebody who saw the GFC coming when most did not, and as a long-time disciple of the now in-vogue economist Hyman Minsky, it may be that Keen's economic views are finally entering mainstream thought.

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In a sign of the times, none other than the new chief economist of the World Bank, Paul Romer, has admitted that "for more than three decades, macroeconomic theory has gone backwards".

In a piece titled The trouble with macroeconomics, Romer in September wrote that "theorists dismiss mere facts by feigning an obtuse ignorance about such simple assertions as 'tight monetary policy can cause a recession'."

Fresh ideas needed

And there is a strong need for fresh remedies. There is more debt in the world now than before the GFC – a crisis precipitated by excess borrowing.

Low and zero interest rates and unconventional monetary policies such as quantitative easing (QE) have pumped up asset prices but done little to spark productivity gains or business investment in advanced economies.

Private debt in Australia is now equivalent to around 210 per cent of GDP, from 180 per cent in 2007. Australian households are more indebted than ever, the RBA says.

Keen is perhaps most critical of central bankers' unwillingness to incorporate the link between credit growth and financial stability into their decision making.

These guys are making money by creating Ponzi schemes.

"Conventional economic thinking completely ignores where money comes from," Keen says. "All this theory is effectively based on the idea that money is like nuts that chipmunks drop from trees and you can run out of it and if you don't have enough of it you are going to starve over winter, and it's a completely naive view of a monetary economy."

While he acknowledges that RBA governor Philip Lowe has signalled a greater emphasis on "financial stability", household indebtedness still continues to climb.

"The Reserve Bank were so backward in their thinking. Their argument was, 'oh well, the level of debt doesn't matter because the households that have the debt are wealthy and they can continue servicing it'. But the real problem is demand for the economy comes out of turnover of the existing money plus credit.

"Now, if you are relying on credit growth being equivalent to 15 per cent of GDP, which is where it was in Australia just over six months ago, you've got to continue borrowing that 15 per cent of GDP every year to maintain that trajectory.

"If you simply stabilise, then, bang!, 15 per cent of demand disappears. And that's what we face and what I think will happen [in 2017]."

Debt reset

So how do modern, monetary economies escape the spiral of ever higher debt? Keen believes there needs to be a reset of private debt levels via a "people's quantitative easing" – effectively, a government bailout of households – to something more in the order of 50-100 per cent of GDP, from around 120 per cent now.

Under the plan, the banks would be instructed to use the government cash injections to pay down the account holders' existing debt. If a person had no debt, then they would simply receive the cash.

He says the initial instalment should be larger than, say, the $1000 Rudd stimulus package, but not by much. "In anything like this, which hasn't been tried before, I would want to do it in small doses," Keen says.

What is then needed involves radical but simple regulatory reform of the banking sector.

"What I want to do is bring in a range of bank rules which would limit the amount of lending you can give against an asset to some multiple of the income-earning capacity of the asset."

Keen gives the example of a property with an estimated or actual annual rental income of $50,000, in which case the loan limit could be $500,000. Now the bidder for a house ready and nominally capable to take on the most debt wins.

Under Keen's prescription, both are limited to how much they can borrow, which means the bidder with the most savings is the one who wins.

"I want to cut off the asset bubble lending. When you look at the empirical data overwhelmingly it's leverage that determines asset prices. You have this positive feedback loop between lending and asset prices and that's how you get the bubbles we've got. These guys are making money by creating Ponzi schemes."

While Keen believes his radical policy prescriptions should happen, he has little illusions that they necessarily will. But the fault lines of years of conventional policymaking has brought the developed world to an impasse of high debt and low growth. Something may have to give.

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