The 2009 Financial Crisis

A Neo-Keynesian Diagnostic and Policy Response

Geoff Crocker, Technology Market Strategies, Bristol, UK
March 2009

(download pdf)


The current crisis is not caused by banks lending too much credit. If this were the case substantial inflation would have resulted which it has not. Rather the crisis has been caused by a substantial long term increase in productivity in the real economy which means that wages have become insufficient to buy the output of goods and services, or to repay the credit used to buy them. This process occurs gradually over time if productivity gains are not fully fed into real wages but partially into increased business profit, and if that increased profit is not fully channelled into dividend income and consumer expenditure. This appears to have been the case in 2005-2007. Credit has therefore been excessive against household income but not against GDP output. Without the credit, GDP would go into recession. The only policy corrective for this is to fund aggregate demand by alternative instruments such as a citizen’s income. This would be funded by a government bank with a flexible credit ratio to achieve the aggregate citizen’s income required. Current policy instruments have been exhausted.  This is because they are based on the initial false diagnosis of excessive credit.


The following graphs for the UK economy show that particularly between 2005 and 2007

• GDP and consumption continued to grow but household disposable income remained flat

• in 2007 real household disposable income grew by only 0.1% whilst GDP grew by 3%

• household disposable income reduced as a percentage of consumption from 78.2% to 74.7%

• the gap was met by increased household credit which grew from £17bn to £55bn

The dramatic increase in household credit is less apparent in the scale of the above GDP diagrams but is evident when graphed alone in the following diagram

£50bn new consumer debt each year has become essential to fund the purchase of GDP.  Without it GDP would fall due to decreased effective demand, and employment, wages and income would fall as a consequence. 

The system is faced with two alternative vicious circles - one where increased productivity reduces the wage and household income element of GDP and this demand drop leads to a GDP recession, or one where the demand gap is filled by increased credit which becomes un-repayable from next period wages. Neither is sustainable.

Diagnostic and policy

From this data a diagnostic of the current global credit crisis is based on the following logic

• the real supply side of the economy (factories, restaurants, transport, communications, infrastructure etc) has full operational potential and is highly efficient

• the real demand side of the global economy has equal potential – aspirations for higher standards of living in the developing world represent huge potential demand growth

• the current crisis derives from a failure of the financial system to fund real demand, specifically consumer expenditure

• the fact that recent growth has been non-inflationary (the NICE decade) means that banks have not lent too much credit – in fact non-inflationary growth suggests that banks have lent exactly the right amount of credit

• Keynes demonstrated that real demand potential needs effective funding – in his day, wages were the main funding mechanism of this demand and not just as the neo-classical school thought, a cost of production which needed to be minimised

• as technology has progressed since Keynes, the huge increase in labour productivity means that wages are now a smaller component of final output value and of effective consumer demand and have had to be supplemented by credit to fully fund consumption of the available output – this is why household debt/earnings ratios have risen substantially

• this process does not occur completely and instantaneously but over time if productivity gains are not fully fed into real wages and if the increased corporate profitability then resulting is not fully fed into dividend income and if that increased dividend income is not as fully channelled into consumer expenditure as the wages it has displaced would have been

• the ultimate hypothetical case of this is a fully automated economy with no employees and therefore no wages in the macro economy – in this case the product would have to be allocated by government voucher or citizen’s income

• in such a fully automated hypothesis if all workers had become shareholders then the income and demand flows might be fully restored and recession avoided but this is a comparative static analysis between two end states – a dynamic analysis shows that the immediate step of a reduction in wage led consumer expenditure immediately generates recession effects before any counterbalancing dividend income generated consumer expenditure can compensate

• just as wages reached their limit in funding effective demand of ever increasing output, so credit has now reached its limit since it ultimately has to be repaid out of future wages – pensions and dividends are insufficient to fill the demand funding gap

• there is therefore a case for a non-repayable form of credit to be developed to fund consumer demand sufficient to sustain the levels of output and employment required – this is best developed as some form of citizen’s income

• as well as its macroeconomic function in funding effective demand, a citizen’s income would have potential social benefits in enhancing concepts of mutually responsible citizenship

• in all the above diagnostic and policy response money is properly treated as a virtual rather than a real commodity – again this accords with Keynes’s exposition of money and is already recognised in bank multipliers which create loans as multiples of money deposits – a government budget for a citizen’s income is proposed as a creation of virtual money, not some budget which has to be raised or some debt which has to be paid back

• the citizen’s income would therefore be funded by a government bank with a flexible credit ratio set to fully fund the gap between supply side output and the total of wages, pensions, dividends, and credit consumer funds

Geoff Crocker
March 2009

Note on the author
Geoff Crocker holds a first class honours degree from Durham university UK and has extensive work experience in industrial strategy for major international corporate clients.


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