Noah Smith has another piece up taking a swipe at heterodox economics and what he calls the “Folk Theory of the Business Cycle”.  He says:

A lot of people seem to subscribe to what I call the Folk Theory of business cycles (not to be confused with the Folk Theorem of game theory). Roughly speaking, this is the idea that:

1. Debt growth is necessary for GDP growth.

2. As GDP grows, debt levels become too large, leading to an economic crash.

3. Therefore, booms cause busts, through the mechanism of debt accumulation.

He then goes into a series of arguments against this theory.  But this is nothing more than a strange misrepresentation about how some heterodox economists think about the business cycle.  Noah, as he proved in his last post, doesn’t understand heterodox economics very well and appears to be out of comfort zone here.¹

First, I am not really a “heterodox” economist.  Heck, I’m not even an economist so my views shouldn’t be taken as being representative of any/all heterodox economists.  But I am a market practitioner whose career has revolved around understanding financial statements and financial institutions.  And since heterodox economists focus a good deal on accounting I tend to find components of their views complementary to my own work.  In my opinion, if you can’t explain the financial system through financial accounting then you can’t begin to understand it.  Debt is important because it explains a balance sheet relationship between assets/liabilities and income statement “flows” so, while I might not be an adherent of the “Folk Theory”, I am not so quick to dismiss it as Noah is.²

Second, aside from being total misrepresentations, Noah’s arguments reject basic financial accounting and are, quite simply, unconvincing.  For instance, Noah says the “Folk Theory” is wrong because quality of debt matters more than quantity of debt: