Financialisation issues
in a stock-flow
consistent approach:
Minsky and Godley
Marc Lavoie
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 PostKeynesian economists did integrate financial
relations in their real models.
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
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 »!
Outline
• Godley’s view of financial Keynesianism and
the SFC approach
• Minsky and the SFC approach
• Some results arising from a SFC model that
integrates real and financial features
GODLEY’S VIEWS AND SFC
Some views taken from chapters 1 and 2
Standard flow accounting matrix in
macro: elementary NIPA
+ Sources of funds; – Uses of funds
Drawbacks of standard macro
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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 (SNA).
• But there has been a fully integrated SNA version
since 1968 (revised in 1993)!
Transactions matrix:
NIPA with flow-of-funds accounts
Features of the transaction matrix
• All rows sum to zero (counterparties)
• All columns sum to zero (budget constraint)
• Everything comes from somewhere and everything goes
somewhere:
• There should be no « black holes ».
• We have NIPA, flows of financial payments, flow
changes in assets and liabilities.
• The matrix can be made as complicated as needed.
• The flow matrix, along with a revaluation matrix (capital
gains and losses) must be linked to the stock matrix, to
find the evolution of stocks.
A more realistic balance sheet
+ = Assets;
─ = Liabilities
The revaluation matrix
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.
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).
THE SFC APPROACH III
• Two strands of research linking stocks and flows:
– Godley and Cripps (1983) at Cambridge,
•
Cambridge Economic Policy Group,
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New Cambridge school (1970’s).
– Tobin (1982) and his associates at Yale,
•
the ‘pitfalls approach’ (1969)
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the New Haven school.
• Godley (1996, 1999) manages to combine elements of the two
strands, mixing the portfolio adding-up conditions of Tobin to
Keynesian behavioural equations. In particular, Godley has
endogenous outputs.
MINSKY AND SFC
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)
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.
Simplest example of the quadruple
entry principle: a bank loan to firms
Other PK authors and flow-of-funds
analysis: Eichner 1987 textbook
• Eichner (1987, pp. 810-838) 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-of-funds
analysis.
• Eichner “almost alone among economists – recognized
that the flow-of-funds approach provides a much more
useful analytical tool for explaining economic processes
than the national income accounts”. Davidson (1992, p.
189)
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 ».
An early interpretation of Minsky
in terms of a SFC framework
•
It is interesting to note that the possible links
between flow-of-funds 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, EJ).
• 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.
SOME FINANCIALISATION
ISSUES IN A SFC MODEL
(G&L 2007, CH. 11)
PK models that mix the real and the
financial sides
• Minsky-Kaleckian models (Taylor and O’Connell
1985; Semmler and Franke 1991), with a difference
equation and portfolio equations
• Non-linear Minsky models (Delli Gatti and Gallegati
1990s; Jarsulic, Charles 2006, 2008)
• Skott’s early SFC model 1981, 1988, 1989
• Palley’s model with consumer debt 1991, 1994
• Flaschel, Chiarella, Semmler 1990s, 2000s
Drawbacks of many previous models:
Sometimes ….
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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
SFC models and financialization
• Besides Lavoie and Godley (2001-2) and Godley and
Lavoie (2007, ch. 11), there are many more models,
that can give rise to many other configurations
• With government (Zezza and Dos Santos 2004, Dos
Santos and Zezza 2008)
• With different behavioural equations (Van Treeck
2009, Skott and Ryoo 2008, Clévenot 2007, Firmin
2008)
• With the focus on banks (Le Héron and Mouakil
2008)
Main behavioural equations of the
model the matrices of which was
shown before: Households
• Consumption on the basis of
– past real wealth
– current disposable income net of interest
payments on loans, plus net additions to
outstanding loans
• Gross new loans is a fraction of personal income
• Standard portfolio equations with adding-up
conditions
Commercial banks
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Banks have own funds (net worth)
Banks have retained earnings
Banks make loans to firms and to consumers
Have a bank liquidity ratio target range
(bills/deposits)
– Banks raise the deposit rate relative to the bills
rate when the actual ratio is too low
• Face a capital adequacy ratio requirement (BIS)
– Banks raise the lending rate relative to the deposit
rate when actual ratio is too low
Effect on the stock of personal loans of a one-time increase in
the flow of gross household loans to personal income ratio
G&L 2007
Effect of a one-time increase in the flow of gross household
loans to personal income G&L 2007 (relative to baseline)
Evolution of the bank capital adequacy ratio and of
the bank liquidity ratio, relative to the base line
solution, following an increase in the gross new loans
to personal income ratio
Evolution of the government deficit to GDP ratio and of the
government debt to GDP ratio, relative to the base line
solution, following an increase in the gross new loans to
personal income ratio