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Title: Money, Credit and Finance


1
Money, Credit and Finance
  • Marc Lavoie
  • University of Ottawa

2
Outline
  • 1. The main claims of the post-Keynesian views on
    money, credit and finance
  • 2. PK monetary theory in historical perspective.
  • 3. The horizontalist and structuralist
    controversies.
  • 4. New developments in monetary policy
    implementation.
  • 5. Open-economy monetary economics.
  • 6. The integration of PK monetary economics into
    PK macroeconomics

3
Part I
  • The main claims

4
Post-Keynesian monetary sub-schools
5
Neoclassical monetary sub-schools
6
i
Ms
Ms
Ms
M
Monetarists IS/LM Verticalists
Structuralists (New Paradigm)
Horizontalists (New Consensus)
A simplified overview of endogenous money
7
Endogenous money supply A PK claim now accepted
by many schools
  • Post-Keynesians
  • Neo-Austrians
  • New Keynesians
  • (New consensus authors), Woodford, Taylor,
    Roemer, Meyer
  • (New Paradigm Keynesians, focus on credit)
    Stiglitz, Greenwald, Bernanke
  • Real business cycle theorists
  • Barro, McCallum
  • Goodhart

8
Main features in monetary economics
Features PK school Neoclassical
Money Has counterpart entries Falls from an helicopter
Money is seen As a flow and as a stock A stock
Money is tied to Production Exchange
The supply of money is Endogenous Exogenous
Main concern with Debts, credits Assets, money
Causality Reversed credits make deposits Reserves allow deposits
Credit rationing due to Lack of confidence Asymetric information
9
Main features, interest rates
Features PK School Neoclassical
Interest rates Are distribution variables Arise from market laws
Liquidity preference Determines the differential relative to base rate Determines the interest rate
Base rates Are set by the central bank Are influenced by market forces
The natural rate Takes multiple values or does not exist Is unique, based on thrift and productivity
10
Main features, macro implications
Features PK School Neoclassical
A restrictive monetary policy Has negative effects in short and long run Has negative effects only in the short run
Schumpeters distinction Monetary analysis (monetized production economy) Real analysis (money neutrality, inessential veil)
Macro causality Investment determines saving Saving determines investment
Inflation The growth in money stock aggregates is caused by the growth in output and prices Price inflation is caused by an excess supply of money
11
Two kinds of financial systems, according to
Hicks 1974
  • The overdraft financial system
  • Firms are in debt towards commercial banks
  • Commercial banks are in debt towards the central
    bank
  • The auto or asset-based financial system
  • Firms finance investment with retained earnings
  • Commercial banks have large amounts of T-bills in
    assets

12
Overdraft vs Asset-based systems
  • Overdraft systems
  • 90 or more of the world financial systems
    (including the pre-euro Bundesbank)
  • Ignored by textbooks
  • No control on HPM, except through credit control
  • Clarifies how the monetary system functions
  • In a sense, all systems are of the overdraft
    type no central bank controls directly the
    supply of money
  • Asset-based systems
  • Only in some anglo-saxon countries
  • Described by mainstream textbooks
  • Based on open-market operations is said to be
    efficient in controlling the money stock
  • Puts a veil on the operating procedures of
    monetary systems

13
Simplified neoclassical view
Central bank balance sheet Central bank balance sheet
Assets Liabilities
Foreign reserves Banknotes
Domestic T-bills Reserves of commercial banks
14
Simplified PK view
Central bank balance sheet Central bank balance sheet
Assets Liabilities
Foreign reserves Banknotes
Domestic T-bills Reserves of commercial banks
Loans to domestic banks Government deposits
(Central bank bills)
15
Part II
  • PK monetary theory
  • in historical perspective

16
Cambridge proverbs
  •  Highbrow opinion is like a hunted hare if you
    stand in the same place or nearly in the same
    place it can be relied upon to come round to you
    in circle.  (D.H. Robertson 1956)
  •  Economic ideas move in circles stand in one
    place long enough, and you will see discarded
    ideas come round again. (A.B. Cramp 1970)

17
1844 Currency school vs Banking school
  • Ricardo and Currency school
  • Only coins and Bank of England notes are money
  • The stock of money determines aggregate demand
  • Aggregate demand determines prices
  • Tooke and the Banking School
  • The definition of money is more complicated
  • Aggregate demand determines the stock of money
  • If controls are needed to influence prices,
    control credit

18
Most of modern monetary controversies can be
brought back to the Currency school and Banking
school debates
  • Definitions of money
  • Stability of the velocity of money
  • Stability of the deposit multiplier
  • Money versus credit
  • The operational target the supply of high
    powered money or interest rates?
  • Endogenous or exogenous money (reversed
    causality)
  • Inflation through excess money growth or excess
    wage growth

19
An additional complexity
  • An author can be found in two different camps at
    a time. This is often the case of creative
    authors.
  • Wicksell (who pretends to support the Quantity
    Theory, while throwing it back into question)
  • Keynes (who pretends to attack the Quantity
    Theory, while barely modifying it)
  • Hence it is difficult or even impossible to
    classify some authors

20
Keynes, a proto Monetarist?
  •  We are all Keynesians now, says Friedman, at
    the height of the IS/LM frenzy.
  • This can be better understood by reading Kaldor
    (1982), according to whom Keyness 1936 monetary
    theory is  a modification of the quantity
    theory of money, not its abandomnent.
  • Keynes 1930 (The Treatise on Money), despite some
    of its innovations and some indications about
    money endogeneity, is still very much in the
    Quantity tradition
  • He objects to those who believe that interest
    rate ought to be the main operational target of
    central banks
  • He approves of the money multiplier (Phillips
    1920)
  • He supports the use of quantitative instruments
    for the conduct of monetary policy open market
    operations and changes in reserve coefficients,
    which, at that time, were only advocated by
    Americans and the Fed.

21
Two different viewpoints, already well identified
in 1959
  •  There are two opposing viewpoints concerning
    the relationship between the supply of and the
    demand for money. On the one hand for the
    quantity theorists and Keynes the quantity
    theory of money is believed to be fixed
    independently by the banking system. The
    opposing view held by the Banking school and
    Wicksell is that the banks set not a quantity
    but a price. The banking system fixes a rate (or
    a set of rates) for the money market and then
    lends however much borrowers ask for, provided
    that they can offer satisfactory collaterals.
    Jacques Le Bourva 1959 (1992).

22
Back to the future?
  •  The quantity theory of money is dying. The most
    banal criticisms lodged against it, and long
    since accepted as truths by all, concern the
    instability of the velocity of circulation of
    money . The principal criticism of the theory,
    however, rests on the determination of the money
    supply. It is essential to the validity of the
    quantity theory that the quantity of money be a
    variable that is independent of national income
    and the current economic situation. This implies
    tha the bankers fix the amount of the money
    supply by some sovereign act dictated from the
    heights of their own secret Olympus. This is
    precisely the premise of the quantity theory that
    is no longer accepted in France today, and so the
    Banking school and Wicksell prevail. Le Bourva
    1962 (1992)

23
Quantity theory of money (Academics) vs the
Radcliffe Commission 1959 (Central bankers and
Kaldor and Kahn)
  • Quantity theory
  • Control of the money supply, in particular
    reserves, by central banks
  • The velocity of money and the money multiplier
    are quasi constants
  • Causality runs from money to prices
  • Radcliffe Commission
  • The central bank controls interest rates, but
    very indirectly only money aggregates
  • The velocity of money is unstable (many
    substitutes)  general liquidity  concept
  • Monetary policy only has a moderate effect on
    inflation, which depends on many other factors
  • Credit controls?

24
The 1960s and 1970s
  • The quantity theory and Monetarism gradually take
    over..
  • The Radcliffe view is strongly criticized by Old
    Keynesians, who consider it dépassé
  •  There still do exist in England men whose minds
    were fromed in 1939, and who havent changed a
    thought since that time, and who say money
    doesnt matter. They have embalmed their views in
    the Radcliffe Committee, one of the most sterile
    operations of all time Samuelson 1969
  • With the oil shocks of the 1970s and the
    productivity slowdown, inflation rises.
  • Monetarism and monetary targets flourish.

25
The scourge of monetarism induces a
post-Keynesian reaction
  • Until 1970, even 1980, the PK monetary theory is
    unclear. Its best exposition can be found in Joan
    Robinsons 1956 book, The Accumulation of
    Capital, but it is towards the end of the book,
    after a complex exposition of growth theory and
    value theory, so that hardly anybody pays
    attention to her monetary theory.
  • Before 1970, the main criticisms against the
    quantity theory are based on the instability of
    the velocity of money or that of the money
    multiplier (Kaldor 1958, Minsky 1957). Only
    Robinson and Kahn have a proper understanding of
    the crucial issue
  • Starting in 1970, the more essential issue of
    reversed causality is brought to the forefront by
    a number of authors.

26
Reverse causality three groups of authors
  • Researchers at the Fed (Holmes 1969, Lombra,
    Torto, Kaufman, FeigeMcGee)
  • Post-Keynesians
  • Cramp 1970, Kaldor 1970 and 1980, Robinson 1970
  • Davidson and Weintraub 1973, Moore 1979)
  • Iconoclasts Le Bourva 1959 and 1962, F.A. Lutz
    1971
  • The supply of money is not independent it is
    determined by demand.
  • Credits make deposits deposits make reserves.
  • Short-term interest rates are the exogenous
    variable.
  • The money/price causality is reversed.
  • We are back to the Banking School and current PKE!

27
Part III
  • The Structuralist vs Horizontalist PK
    controversies

28
A storm in a tea cup (Moore 2001) ?
  • The first exponents of money endogeneity were
    mainly horizontalists Robinson, Kahn, Le
    Bourva, Kaldor, Moore, and the French
    circuitists.
  • The main structuralist critics were Le Héron,
    Dow, Wray, Howells, Pollin, and Palley, many of
    which got their inspiration from Minsky.
  • As Fontana (2003) puts it, structuralists took
    over where the accommodationists had
    stopped.They brought some clarifications and
    provided new details. For instance, they insisted
    that spreads between interest rates could quickly
    vary, due to assessed default risks or changes in
    liquidity confidence. Sometimes, however, they
    constructed a horizontal strawman in an effort
    to highlight the originality of their
    contributions.
  • To a large extent, the controversy has petered
    out, for reasons that will soon be given
    (although Rochon has rekinkled some excitement by
    editing a forthcoming book on the topic!).

29
The horizontalist claims
  • 1. The supply curve of money (or high powered
    money) can best be represented as a flat curve,
    at a given interest rate. The short-term interest
    rate can be viewed as exogenous, under the
    control of the central bank, within a reasonable
    range.
  • 2. There can never be an excess supply of money.
  • 3. The supply curve curve of credit can best be
    represented as flat curves, at a given interest
    rate (or set of interest rates).
  • 4. Central banks cannot exert quantity
    constraints on the reserves of banks.

30
The structuralist points
  • 1a. What about the reaction function of the
    central bank? Chick 1977, Rousseas 1986, Palley
    1991, Musella and Panico 1995
  • 1b. Long-term and other market-determined rates
    cause the overnight rate Pollin 1991
  • 2. If loans create deposits, how do we know that
    households wish to hold these deposits? Howells
    1995
  • 3a. What about credit rationing (shape of credit
    supply curve)? Dow2 1989
  • 3b. What about borrowers risk? Minsky 1975, Dow
    and Earl 1982
  • 3c. and lenders risk (liquidity preference of
    banks)? Dow2, Wray 1989, Chick and Dow
  • 4a. Surely the central bank does not always
    accommodate and hence exerts quantity
    constraints on bank reserves. Pollin 1991
  • 4b. What about changes in the velocity of money
    and liability management, which are the main
    sources of money endogeneity Pollin 1991, Palley
    1994

31
The horizontalist answers I
  • 1. On the horizontal supply of HPM
  • New operating procedures, based on a target
    overnight rate, show clearly that central banks
    control the overnight rate and can set it at
    will recent events also show that the central
    bank reaction function has a large discretionary
    component. Thus, we can still see the target
    overnight rate as an exogenous variable, under
    the full control of the central bank.
  • Of course, if, in general, higher economic
    activity is accompanied by higher inflation
    rates, then, through the central bank reaction
    function, higher interest rates are likely to
    accompany higher economic activity, and thus the
    supply of money or HPM will appear to be
    upward-sloping through time.

32
Horizontalist answers II
  • 2. On the impossibility of excess money
  • The main argument is the reflux principle.
  • The stock-flow consistent models of Godley have
    shown that, despite the presence of an apparently
    independent money demand function and the
    presence of a supply of money function based on
    the supply of loans, flow-of-funds accounting is
    such that deposits must equate loans despite no
    such condition being inserted into the model.
  • In more sophisticated models, changes in
    liquidity preference by households will induce
    changes in relative rates but this was never
    denied by Horizontalists.

33
Horizontalist answers III
  • 3. On the horizontal supply of credit
  • It has been shown by Wolfson (1996) that there is
    no incompatibility between credit rationing and
    horizontalism.
  • It is now clearly established that higher
    economic activity does not necessarily entail
    higher debt ratio for firms (contradicting the
    essence of Minskys financial fragility
    hypothesis). This is now recognized by Wray, a
    student of Minsky.
  • But of course, as firms move from one risk class
    to another, they will trigger higher interest
    rates.
  • The remaining issue is lenders risk recent
    events have shown that banks have no clue what
    their lenders risk is, and so it cannot be
    ascertained that banks will raise interest rates
    if their balance sheet expands.

34
Credit rationing when there is a reduction in
bank confidence (Credit-worthy demand demand
with appropriate collateral Cf. De Soto, and
Heinsohn and Steiger)
Interest rate
Notional demand
Credit- worthy demand
?
i2
A
A
N
i1
?
?
Loans
35
Horizontalist answers IV
  • 4. On quantity restraints on bank reserves
  • There is no incompatibility between horizontalism
    and bank innovations or liability management.
  • New central bank operating procedures clearly
    show what was hidden before central banks
    passively try to provide the reserves being
    demanded by the banking system.

36
Conclusion
  • The original horizontalist depiction, that of
    Kaldor and Moore, is the most appropriate.
    Structuralists have helped to fill in some
    details. As Wray (2006) concludes
  • There cannot be any automatic and necessary
    impact of spending on interest rates because
    loans and deposits can and normally do increase
    as spending rises. The overnight rate will change
    only if and when the central bank decides to
    allow it to do so. Short-term loan and deposit
    retail rates can be taken as a somewhat variable
    mark-up and mark-down from the overnight rate.

37
Part IV
  • New developments in monetary policy
    implementation by central banks

38
New operationg procedures and horizontalism
  • Central banks have new operating procedures,
    although they are not that much different from
    what they used to be. They bring central banks
    closer to the  overdraft economy, and further
    away from the asset-based econonomy as defined
    by Hicks.
  • The procedures of some central banks are more
    transparent (than they were and than those of
    other central banks), so the horizontalist story
    is more obvious Canada, Australia, Sweden
  • The procedures of other central banks are less
    transparent but when interpreted in light of
    horizontalism, we can see that their operational
    logic is identical to that of the more
    transparent central banks (like the Fed).

39
The new operating procedures put in place in
Canada and other such countries are fully
compatible with the PK monetary theory
  • Central banks set a target overnight rate, and a
    band around it
  • Commercial banks can borrow as much as they can
    at the discount rate
  • There are no compulsory reserves and no free
    reserves (zero net settlement balances)
  • The target rate is (nearly) achieved every day
  • Central banks only pursue defensive operations,
    trying to achieve zero net balances.
  • When there are tensions, as during the recent
    subprime financial crisis, they try their best to
    supply the extra amount of balances demanded by
    direct clearers (mainly banks)

40
The Bank of Canada channel system
Overnight rate
Bank rate TR25pts
Target rate TR
Rate on positive balances TR-25pts
Settlement balances
- (overdraft)
(surplus)
0
41
Two different justifications for the current
interest rate procedures ?
  • New Consensus
  • Based on the 1970 Poole article
  • A macroeconomic justification
  • If the IS curve is the most unstable, use
    monetary targeting
  • If the LM curve is unstable (money demand is
    unstable), use interest rate targets
  • Post-Keynesians
  • Based on a microeconomic justification
  • Tied to the inner functioning of the clearing and
    settlement system
  • Linked to the day-by-day, hour-per-hour,
    operations of central banks

42
Poole 1970
Interest rate
LM
LM
IS
IT
IT
IS
A IT
Output
MT
A
MT
IT
Demand for money is unstable Use interest rate
targeting No variability in output
Investment is unstable Use monetary targeting
MT Less variability in output
43
The microeconomic justification for interest rate
targeting
  • Central bank interventions are essentially
     defensive . Their purpose is to compensate the
    flows of payments between the central bank and
    the banking sector.
  • These flows arise from a) collected taxes and
    government expenditures b) interventions on
    foreign exchange markets c) purchases or sales
    of government securities, or repurchase of
    securities arrriving at maturity d) provision of
    banknotes to private banks by the central bank.
  • Without these defensive interventions, bank
    reserves or clearing balances would fluctuate
    enormously from day to day, or even within an
    hour. The overnight rate would fluctuate wildly.

44
Authors who support the microeconomic explanation
  • Several central bank economists
  • Bindseil 2004 ECB, Clinton 1991 BofC, Lombra 1974
    and Whitesell 2003 Fed
  • Some post-Keynesian authors
  • Eichner 1985, Mosler 1997-98, Wray 1998 and
    neo-chartalists in general
  • Institutionalists
  • Fullwiler 2003 et 2006

45
Bank of Sweden overdraft system
  •  Lending to the banking system currently
    comprises a significant part of the Riksbanks
    assets.
  • Stage 1 involves a forecast of how much
    liquidity needs to be supplied or absorbed for
    the banks to be able to avoid using the deposit
    and lending facilities during the coming week .
    Stage 3 involves executing open market operations
    to parry the daily fluctuations in the banking
    systems current payments so the banking system
    will not need to utilise the facilities
  • Mitlind and Vesterlund, Bank of Sweden Economic
    Review, 2001

46
The Fed never tried to constaint reserves !
  • The primary objective of the Desks open market
    operations has never been to increase/decrease
    reserves to provide for expansion/contraction of
    the money supply but rather to maintain the
    integrity of the payments system through
    provision of sufficient quantities of Fed
    balances such that the targeted funds rate is
    achieved. Fullwiler (2003)

47
This was understood a long time ago by some PK
economists
  • The Feds purchases or sales of government
    securities are intended primarily to offset the
    flows into or out of the domestic
    monetary-financial system (Eichner, 1987, p.
    849).
  • Fed actions with regards to quantities of
    reserves are necessarily defensive. The only
    discretion the Fed has is in interest rate
    determination Wray (1998, p. 115).

48
There is no relationship between open market
operations and bank reserves
  • No matter what additional variables were
    included in the estimated equation, or how the
    equation was specified (e.g., first differences,
    growth rates, etc.), it proved impossible to
    obtain an R2 greater than zero when regressing
    the change in the commercial banking systems
    nonborrowed reserves against the change in the
    Federal Reserve Systems holdings of government
    securities ....(Eichner, 1985, pp. 100, 111).

49
Cf Poole in 1982, JMCB
  • The old procedures before 1979-1982 are best
    characterized as an adjustable federal funds rate
    peg system .The new system 1979-1982 is
    qualitatively similar to the old .The vast bulk
    of speculation about Fed intentions by money
    market participants concerns Fed attitudes toward
    interest rates. The issue is always one of when
    and how hard the Fed will push rates .

50
Why is the federal funds rate sometimes different
from the target rate ?
  • In Canada, the Bank is able to know with perfect
    certainty the demand for settlement (clearing)
    balances.
  • In the States, the Fed forecasts the net demand.
    Without reserve averaging, the federal funds rate
    would fluctuate widely between zero and the
    discount rate, as the set daily supply would be
    different from the given demand (two vertical
    curves).
  • With reserve averaging, banks can speculate on
    future values of the federal funds rate, and get
    extra reserves when the rate turns out to be low.
    The daily supply is still fixed, but the demand
    is interest elastic.

51
Problems with no tunnel and a not so credible
target central bank needs to be very precise in
its daily forecast of reserves demand (Whitesell
2003)
S
S
Lending rate
Target Fed rate
Expected Fed funds rate
Demand for reserves
Deposit rate
Reserves
52
And it is the same for the ECB !
  • The logic of the ECBs liquidity management ...
    can be summarised very roughly as follows The
    ECB attempts to provide liquidity through its
    open market operations in a way that, after
    taking into account the effects of autonomous
    liquidity factors, counter-parties can fulfil
    their reserve requirements as an average over the
    reserve maintenance period. If the ECB provides
    more (less) liquidity than this benchmark,
    counterparties will use on aggregate the deposit
    (marginal lending) facility Bindseil and Seitz
    2001

53
The case of the ECB reserve averaging with a
tunnel/corridor
S
S
Lending rate
Target rate
Demand for reserves
Deposit rate
Reserves
54
The Cambridgian hare!
  •  Todays views and practice on monetary policy
    implementation and in particular on the choice of
    the operational target have returned to what
    economists considered adequate 100 years ago,
    namely to target short-term interest rates 
    Ulrich Bindseil 2004, ECB, formerly from the
    Bundesbank

55
Part V
  • Open-economy monetary economics

56
Exogenous interest rates in open economies?
  • Wray 2006 argues that interest rates are clearly
    exogenous in flexible exchange regimes and
    endogenous in fixed exchange regimes, because the
    central bank must protect its reserves but what
    about China!)
  • My position and that of Godley (The PK
    horizontalist position ?) is that interest rates
    are exogenous both in flexible and in fixed
    exchange rate regimes.
  • By contrast sophisticated neoclassical authors
    argue that interest rates are exogenous in
    neither flexible nor fixed exchange rate regimes.
  • Or, within the Mundell-Fleming model, IS/LM
    neoclassical authors argue that monetary policy
    is effective in a flexible exchange rate regime,
    but powerless in a fixed exchange rate regime,
    because the supply of money is then endogenous,
    as it varies in line with the balance of
    payments.

57
A critique of the Mundell-Fleming model in fixed
exchange regime
  • In the Mundell-Fleming model, the supply of money
    is endogenous, but still supply-led demand must
    adjust to it.
  • In PKE, the supply of money is endogenous, but it
    is demand-led, as in a close economy. Any
    increase in foreign reserves will be compensated
    by a decrease in another asset of the central
    bank, or will be compensated by an increase in
    some liability of the central bank.
  • This is the compensation thesis, or the thesis of
    endogenous sterilization (Godley and Lavoie
    2005-06).

58
Simplified PK view
Central bank balance sheet Central bank balance sheet
Assets Liabilities
Foreign reserves Banknotes
Domestic T-bills Reserves of commercial banks
Loans to domestic banks Government deposits
(Central bank bills)
59
A critique of the sophisticated neoclassical
model in flexible exchange regimes
  • The neoclassical argument is that changes in
    expected future spot exchange rates determine the
    forward rate relative to the spot rate.
  • This differential, through the covered interest
    parity condition, which is known to hold at all
    times, determines the domestic interest rate
    relative to world rates.
  • The answer to this claim is, once again, reverse
    causality (Smithin 1994, Lavoie 2000). It is the
    differential between domestic and world interest
    rates that determines, nearly as an identity, the
    differential between the forward and the spot
    exchange rates. The forward rate has nothing to
    do with the expected spot rate. Forward rates in
    no way predict future spot rates (Moosa 2004).

60
Part V
  • The integration of PK monetary economics into PK
    macroeconomics

61
The integration of PK monetary economics into PK
macroeconomics
  • (a) in PK models competing with New Consensus
    models, Rochon and Setterfield 2007, Hein and
    Stockhammer (see lecture on Friday)
  • (b) in PK growth and distribution models
  • (c) through the stock-flow consistent approach
    (SFC) tied to flow-of-funds analysis.

62
The integration of PK monetary economics into PK
models of growth and distribution
  • Very early on, it was pointed out that
    neo-Keynesian models of growth were neglecting
    monetary factors (Kregel 1985, Hamlet without
    the Prince).
  • For instance, Davidson (1972) pointed out that
    the famous neo-Pasinetti model of Kaldor (1966),
    which, in a very astute way, introduced stock
    market equities in a neo-Keynesian model, was
    omitting money balances.
  • The same drawback hurt early Kaleckian growth
    models.
  • The situation started to change only in the early
    1990s, when the impact of interest rates was
    considered explicity, and when debt ratios also
    got introduced, along with cash-flow issues or
    interest payments relative to profits.

63
The case of the Kaleckian model
  • The canonical Kaleckian growth model is made up
    of three equations an investment function, a
    saving function, and a pricing function.
  • Obviously the interest rate can be introduced
    into the investment function.
  • Should it be the real interest rate (higher
    opportunity costs) or the nominal interest rate
    (lower cash flow, lower retained earnings)?
  • But if so, an increase in the interest rate also
    has an impact on the saving function (reducing
    the overall saving rate).
  • And the interest rate may also have an impact on
    the normal profit rate (the Banking School
    argument, picked up by Sraffians), thus having an
    impact on the markup.
  • And all these will have an impact on the debt
    ratio, and hence may have a feedback effect on
    the investment function.
  • Things quickly get more complicated. Despite
    assuming short-run stability, there may not be
    long-run stability (the debt ratio may explode in
    the long run).
  • What if we introduce inflation and unemployment.
    More complications! See Heins book 2008

64
The Stock-flow consistent approach
  • The Holy Grail of PKE has always been the full
    integration of monetary and real macroeconomic
    analysis, i.e., provide a true Monetary
    analysis in the Schumpeter sense.
  • Until recently, this seemed like a rather
    impossible task.
  • Godley (1996, 1999) has now done it, under the
    name of SFC. Other authors, around W. Semmler,
    also achieve something nearly similar
  • Portfolio and liquidity preference issues, along
    with banking and financial stocks of assets and
    liabilities, are now tied with flows of
    production, income, and expenditures. Deflated
    and monetary variables can also be carefully
    distinguished.
  • The method is presented in Godley and Lavoie
    (2007).
  • In my view, the method is particularly
    appropriate to model the interaction between
    (Minsky) financial crises and real crises.
  • The lecture this evening will give a simple
    example of SFC.
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