There’s been a lot of discussion recently about Steve Keen‘s work on debt, presented (among other places) in this paper for the Centre for Policy Development last year. I made some comments at the time, as follows:
I’m generally in sympathy with the arguments presented here. However, having made similar arguments for a long time and having been continually surprised by the durability of the asset price boom/bubble let me offer a couple of counterarguments/cautions:
(1) The increase in house prices can be partially explained (on the supply side) by the increase in the size/quality of the average/median house and, particularly in the last decade, by increases in the cost of labour and materials
(2) On the demand side, given the above and the fixity of land, some increase in prices would be expected as a result of population growth and income growth. If you suppose that housing is a superior good, this would imply that the value of houses should grow faster than GDP, and probably that debt would also rise relative to GDP.
(3) Looking at the big picture of the rise in debt, it has gone on for so long (40+ years) that it must cast some doubt on arguments based on the claim that bubbles always burst. I still think the arguments are valid, but the objection can’t just be dismissed
(4) A fuller version of the optimistic story would say that credit markets have become steadily more efficient with the result that households are able to manage much larger volumes of debt. A plausible version of this story might include the concession that the debt growth of the past decade has outrun the capacity of households and markets to manage it, implying the need for a painful correction as is now happening in the US, but also allowing for a continued upward trend in, or stabilisation of, debt/income ratios.
On balance, having thought through all this, I still think the story in Steve Keen’s piece is the right one. But it’s important to confront the opposing argument in its strongest possible form.
Obviously, the opposing arguments I wanted Keen to respond to look a lot weaker now. Whatever qualifications I might still want to make, Keen got the basic points right, and those who are criticising him now should concede this.