IDEAS home Printed from
   My bibliography  Save this article

Circuit theory extended: The role of speculation in crises


  • Lancastle, Neil


This paper asks why modern finance theory and the efficient market hypothesis have failed to explain long-term carry trades; persistent asset bubbles or zero lower bounds; and financial crises. It extends Godley and Lavoie (Monetary Economics: An Integrated Approach to Credit, Money, Income, Production and Wealth, 2007) and the Theory of the Monetary Circuit to give a mathematical representation of Minsky's Financial Instability Hypothesis. In the extended circuit, the central bank rate is not neutral and the path is non-ergodic. The extended circuit has survival constraints that include a living wage, a zero interest rate and an upper interest rate. Inflation is everywhere. The possibility of stable carry trades emerges. In high interest rate, hedge economies, powerful banks invest surplus loan interest. With speculation, banks lobby to enter investment markets and the system is precariously liquid/illiquid. In a Ponzi economy, where loans never get repaid, solvency is a balance between increasing reserves, reducing interest rates and rebuilding banks' balance sheets during systemic crises. Simulating bank bailouts, household bailouts and a Keynesian boost suggests that bank bailouts are the least effective intervention, exerting downward pressure on wages and household spending: austerity.

Suggested Citation

  • Lancastle, Neil, 2012. "Circuit theory extended: The role of speculation in crises," Economics - The Open-Access, Open-Assessment E-Journal, Kiel Institute for the World Economy (IfW), vol. 6, pages =1-27.
  • Handle: RePEc:zbw:ifweej:201234

    Download full text from publisher

    File URL:
    Download Restriction: no

    File URL:
    Download Restriction: no

    Other versions of this item:

    References listed on IDEAS

    1. Péter Karádi & Miklós Koren, 2008. "A Spatial Explanation for the Balassa-Samuelson Effect," CeFiG Working Papers 4, Center for Firms in the Global Economy, revised 01 Oct 2008.
    2. Marco Veronese Passarella & Malcolm Sawyer, 2014. "Financialisation in the circuit," Working papers wpaper18, Financialisation, Economy, Society & Sustainable Development (FESSUD) Project.
    3. Christian Hellwig & Guido Lorenzoni, 2009. "Bubbles and Self-Enforcing Debt," Econometrica, Econometric Society, vol. 77(4), pages 1137-1164, July.
    4. Bela Balassa, 1964. "The Purchasing-Power Parity Doctrine: A Reappraisal," Journal of Political Economy, University of Chicago Press, vol. 72, pages 584-584.
    5. Christoph Fischer, 2004. "Real currency appreciation in accession countries: Balassa-Samuelson and investment demand," Review of World Economics (Weltwirtschaftliches Archiv), Springer;Institut für Weltwirtschaft (Kiel Institute for the World Economy), vol. 140(2), pages 179-210, June.
    6. Schulmeister, Stephan, 2006. "The interaction between technical currency trading and exchange rate fluctuations," Finance Research Letters, Elsevier, vol. 3(3), pages 212-233, September.
    7. Alvaro Angeriz & Philip Arestis, 2007. "Monetary policy in the UK," Cambridge Journal of Economics, Oxford University Press, vol. 31(6), pages 863-884, November.
    8. Hyman P. Minsky, 1992. "The Financial Instability Hypothesis," Economics Working Paper Archive wp_74, Levy Economics Institute.
    9. Keen, Steve, 2010. "Solving the paradox of monetary profits," Economics - The Open-Access, Open-Assessment E-Journal, Kiel Institute for the World Economy (IfW), vol. 4, pages 1-32.
    10. Philip Arestis, 2009. "New Consensus Macroeconomics: A Critical Appraisal," Economics Working Paper Archive wp_564, Levy Economics Institute.
    11. Fama, Eugene F, 1991. " Efficient Capital Markets: II," Journal of Finance, American Finance Association, vol. 46(5), pages 1575-1617, December.
    Full references (including those not matched with items on IDEAS)


    Citations are extracted by the CitEc Project, subscribe to its RSS feed for this item.

    Cited by:

    1. Hamid Raza & Bjorn Gudmundsson & Stephen Kinsella & Gylfi Zoega, 2015. "Experiencing financialisation in small open economies: An empirical investigation of Ireland and Iceland," Working papers wpaper84, Financialisation, Economy, Society & Sustainable Development (FESSUD) Project.

    More about this item


    circuit theory; macroeconomic simulation; carry trade; austerity; banking regulation; interest rate policy;

    JEL classification:

    • E10 - Macroeconomics and Monetary Economics - - General Aggregative Models - - - General
    • E27 - Macroeconomics and Monetary Economics - - Consumption, Saving, Production, Employment, and Investment - - - Forecasting and Simulation: Models and Applications
    • E43 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Interest Rates: Determination, Term Structure, and Effects
    • E58 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Central Banks and Their Policies
    • E60 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - General


    Access and download statistics


    All material on this site has been provided by the respective publishers and authors. You can help correct errors and omissions. When requesting a correction, please mention this item's handle: RePEc:zbw:ifweej:201234. See general information about how to correct material in RePEc.

    For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: (ZBW - German National Library of Economics). General contact details of provider: .

    If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.

    If CitEc recognized a reference but did not link an item in RePEc to it, you can help with this form .

    If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your RePEc Author Service profile, as there may be some citations waiting for confirmation.

    Please note that corrections may take a couple of weeks to filter through the various RePEc services.

    IDEAS is a RePEc service hosted by the Research Division of the Federal Reserve Bank of St. Louis . RePEc uses bibliographic data supplied by the respective publishers.