Minsky and Godley and financial Keynesianism. Marc Lavoie University of Ottawa

Transcription

1 Minsky and Godley and financial Keynesianism Marc Lavoie University of Ottawa

2 Problem statement The current financial crisis, which started to unfold in August 2007, is a reminder that macroeconomics cannot ignore financial relations, otherwise financial crises cannot be explained. Old Keynesians, with the exception of James Tobin and his followers, paid little attention to financial relations, besides the standard IS/LM model. It was not always clear how Cambridge or Post- Keynesian economists did integrate financial relations in their real models.

3 American PK vs Cambridge PK American PK (Minsky): Money, debt, liquidity, interest rates, cash flows Fundamentalist PK Financial Keynesianism Wall Street Keynesianism Cambridge PK: Real economy, actual and normal profit rates, pricing, rates of utilization Robinsonians/Kaleckians Kaldorians (Godley) Sraffians

4 Minsky and Godley, 1970s and 1980s Both authors wanted to go beyond standard Keynesianism, as represented either by the old neoclassical synthesis or represented by Cambridge PKs (also P. Davidson 1972). We could say, as pointed out by Chick (1995, p. 33), that they both offered a response to the Monetarist critique, which claimed that Keynesianism concentrates too much on flows (except when discussing liquidity preference) and «did not properly incorporate money and financial variables» (Godley and Cripps 1983, p. 15). They both wished to deny the claim, made by Kalecki (circa 1936), that «I have found what economics is; it is the science of confusing stocks with flows»!

5 Outline Godley s view of financial Keynesianism and the SFC approach Minsky and the SFC approach Previous attempts at modelling Minsky s views

6 GODLEY S VIEWS AND SFC

7 Simulating current changes in financial flows

8 Standard accounting matrix in macro

9 Drawbacks of standard macro What form does personal saving take? Where does personal saving go? Where does the finance for investment come from? How are government budget deficits financed? Which sector provides the counterparty to every transaction in assets? Standard macro relies on the 1953 presentation of the UN system of national accounts. But there has been a fully integrated version since 1968 (and 1993)!

10 A (partial) transaction-flow matrix: NIPA with flow-of-funds accounts +

11 Features of the transaction matrix All rows sum to zero (counterparties) All columns sum to zero (budget constraint) Here interest payments were omitted Everything comes from somewhere and everything goes somewhere. There should be no «black holes». The matrix can be made as complicated as needed. The flow matrix, along with a revaluation matrix (capital gains and losses, not shown here) must be linked to the stock matrix, to find the evolution of stocks.

12 A (stock) balance-sheet matrix

13 THE SFC APPROACH I The three matrices (flows, stocks, revaluation) and their links (the stock-flow coherent (SFC) approach) help pin down the evolution of whole economic systems, which is what macroeconomics is. The claim here is that stock-flow consistent models (SFC models), inspired in particular by the work of Wynne Godley, are the likely locus of some form of post-keynesian consensus in macroeconomics, as it allows to entertain both monetary and real issues within a single model, by dealing both with tangible and financial capital.

14 THE SFC APPROACH II The SFC approach is a response to the critics who, as reported by Chick (1995, p. 20), believe that PKE is «not coherent, not scientific, not formal, not logical» «The fact that money stocks and flows must satisfy accounting identities in individual budgets and in an economy as a whole provide a fundamental law of macroeconomics, analogous to the principle of conservation of energy in physics» (Godley and Cripps 1983, p. 18). SFC restrictions «remove many degrees of freedom from possible configurations of patterns of payments at the macro level, making tractable the task of constructing theories to close the accounts into complete models» (L. Taylor 2004, p. 2).

15 MINSKY AND SFC

16 Minsky and SFC models I One way every economic unit can be characterized is by its portfolio: the set of tangible and financial assets it owns and the financial liabilities on which it owes (Minsky 1975, p. 70). «Inasmuch as the effective demand for current output by a sector is determined not only by the current income flows and current external finance but also by the sector s cash-payment commitments due to past debt, the alternative interpretation can be summarized by a theory of the determination of the effective budget constraints. The economics of the determination of the budget constraints logically precedes and sets the stage for the economics of the selection of particular items of investment and consumption» (Minsky 1975, p. 132)

17 Minsky and SFC models II An ultimate reality in a capitalist economy is the set of interrelated balance sheets among the various units. Items in the balance sheet set up cash flows (Minsky 1975, p. 118). To analyze how financial commitments affect the economy it is necessary to look at economic units in terms of their cash flows. The cash-flow approach looks at all units be they households, corporations, state, and municipal governments, or even national governments as if they were banks (Minsky 1986, p. 221). The structure of an economic model that is relevant for a capitalist economy needs to include the interrelated balance sheets and income statements of the units of the economy. The principle of double entry bookeeping, where financial assets and liabilities on a balance sheet and where every entry on a balance sheet has a dual in another balance sheet, means that every transaction in assets requires four entries (Minsky 1996, p. 77). This is Morris Copeland s (1949) quadruple entry principle.

18 Other PK authors and flow-of-funds analysis: Eichner 1987 textbook Eichner (1987, pp ) devotes nearly 30 pages to flow-of-funds analysis in the chapter on money and credit of his main book, with more than a dozen tables reproducing flow of funds consequences of various decisions by economic agents. The very first of these tables (Eichner 1987, p. 811) illustrates the quadruple accounting entry principle first put forth by Copeland, the US creator of flow-offunds analysis.

19 Godley, Eichner and Minsky: Differences Eichner thought that the monetary and financial systems were sufficiently resililient as long as the central bank did not pull the switch (Guttman 2010, Lavoie 2010). Godley focused on a conditional theory based on a fair degree of stability in stock-flow norms. He argued that actual stock-flow ratios could not rise forever and that rising stock-flow norms would eventually lead to unsustainable processes, thus leading to required structural changes. Minsky focused on the inherent instability of some stock-flow norms or of some liquidity and leverage norms, arguing that long periods of tranquillity would lead economic actors, and in particular banks, to let these norms deteriorate. However, Minsky (1982, p. 30) also wrote that «consumer and housing debt can amplify but cannot initiate a downturn in income and employment».

20 An early interpretation of Minsky within an SFC model It is interesting to note that the possible links between flow-offunds analysis and balance sheet accounts on the one hand, and the Minskyan view of Wall Street economics on the other hand, were already underlined by Alan Roe (1973). Roe argued that individuals and institutions generally follow stock-flow norms, but that during expansion they may agree to let standards deteriorate. He was also concerned with sudden shifts in portfolio holdings. Roe explicitly refers to the work of Minsky on financial fragility, showing that a stock-flow consistent framework is certainly an ideal method to analyze the merits and the possible consequences of Minsky s financial fragility hypothesis.

21 PREVIOUS ATTEMPTS AT MODELLING MINSKY

22 Minsky-Cambridge models Models based on an investment function, a saving function and a pricing function, with endogenous rates of capacity utilization The Taylor and O Connell (1985) model The Semmler and Franke (1991) model Both have portfolio choice (deposits, equities) Both have an investment function that depends on confidence Both have a differential equation determining confidence (spread profit-interest rates for Taylor- O Connell; the leverage ratio for Semmler-Franke) and producing business cycles.

23 Minsky-Cambridge models II The Delli Gatti and Gallegati (1990s) models. Investment is a function of q ratio and a multiple of retained earnings, this multiple changing procyclically (Minsky 2-price diagram). The Jarsulic 1988, early 1990s models Charles (2006, 2008) Ad hoc non-linearities, effect of debt ratios, chaos, bifurcations Click View then Header and Footer to change this footer

24 Minsky-Cambridge models III Skott s models (1981, 1988, 1989) An earlier forgotten effort at synthesis, which is stock-flow consistent Palley (1991, 1994) models Introduce loans to consumers. An extension of Minky s FIH to the consumer sector. initially, the higher debt taken on by borrowers leads to higher economic activity; but then, as more interest payments must be made, this slows down economic activity. Click View then Header and Footer to change this footer

25 Effect on the stock of personal loans of a one-time increase in the flow of gross household loans to personal income G&L 2007

26 Effect of a one-time increase in the flow of gross household loans to personal income G&L 2007

27 Drawbacks of many previous models: Sometimes. Models are not fully stock-flow consistent Models do not incorporate growth Money is exogenous, or set by the government deficit The leverage ratio is not considered explictly There is no stock market, or, The stock market value of equities is determined by fundamentals, and not by market supply and demand

28 Exemplar of the usefulness of SFC It is sometimes claimed that there is a positive relationship between booming economies and the debt ratio of firms. This belief is sometimes attributed to Minsky s financial fragility hypothesis. However, a SFC model shows that this need not be necessarily the case.

29 The simple Lavoie and Godley ( ) balance sheet

30 Relative evolution of the rate of accumulation g and the debt ratio l, during the transition, following a change in one of the parameters. Impact on the growth to debt ratio, dg/dl Increase in right after the shock Near the steady-state the propensity to consume _ + interest rates _ + the desire to hold shares _ + the pricing markup _ + the proportion of investment financed by new share issues the fraction of profits kept as retained earnings + + _ + autonomous investment _ +

31 Relative evolution of the rate of accumulation g and the debt ratio l, measured in new steady-state positions, following a change in one of the parameters Impact on the growth to debt ratio, dg/dl Increase in Normal regime Puzzling regime the propensity to consume _ + interest rates _ + the desire to hold shares the pricing markup + + the proportion of investment financed by new share issues the fraction of profits kept as retained earnings autonomous investment

32 Conclusion Minsky had two key insights: Banks and other economic actors get euphoric after a period of prolonged stability, thus giving rise to worsening stock-flow norms or reduced liquidity; this can be represented by a differential equation. Balance sheets are interrelated and give rise to cash commitments; this can best be represented within an explicit SFC framework.