A Monetary Multisectoral (Minsky) Model

Steve KeenUniversity of Western Sydney

Debunking Economicswww.debtdeflation.com/blogs

www.debunkingeconomics.com

0 1 2 3 4 5 6 7 8 9 10 11 12 1325

20

15

10

5

0

5

10

15

20

25

Great Depressionincluding GovernmentGreat Recessionincluding Government

Debt-financed demand percent of aggregate demand

Years since peak rate of growth of debt (mid-1928 & Dec. 2007 resp.)

Per

cent

0

The Bankruptcy of Neoclassical Economics

• Before the crisis…– The state of macro is good…” (Oliver

Blanchard: founding editor, AER: Macro)• After the crisis…

– It is important to start by stating the obvious, namely, that the baby should not be thrown out with the bathwater…” (Blanchard Dell'Ariccia et al. 2010; emphasis added)

• Reality– Neoclassical macroeconomics is a baby that

should never have been conceived

The Bankruptcy of Neoclassical Economics

• Neoclassical theory wrong from first principles:– Treats complex monetary exchange as barter– Assumes macroeconomy is stable– Ignores social class

• Treats entire economy a single agent– Obliterates uncertainty

• “Rational” as capacity to foresee the future; – Uses empirically falsified “money multiplier”

model of money creation; and– Ignores credit and debt.

A tentative, but not-bankrupt, alternative

• A new macroeconomics must do the exact opposite:– Economy as inherently monetary;– Model the economy dynamically;– Social classes rather than isolated agents;– Rational but not prophetic behavior;– Endogenous creation of money by banking sector;

and– Credit and Debt have pivotal roles

• Two instances– Monetary Minsky Great Moderation/Recession model– Dynamic Monetary Multisectoral model

• Base models:– Monetary Circuit Theory (Graziani 1989; Keen 2008)– Goodwin Growth Cycle (Goodwin 1967)

Monetary Circuit Theory• Basic process of endogenous money creation• Entrepreneur approaches bank for loan

• Bank grants loan & creates deposit simultaneously

• Alan Holmes, Senior Vice-President New York Fed, 1969:

• “In the real world, banks extend credit, creating deposits in the process, and look for the reserves later.” (1969, p. 73)

• New loan puts additional spending power into circulation

• Modeling this using strictly monetary framework:

Monetary Circuit Theory• Input financial relations in matrix:

M1

"Type"

"Account"

"Symbol"

"Compound Debt"

"Pay Debt"

"Record Payment"

"Debt-financed Investment"

"Wages"

"Interest"

"Consumption"

"Debt repayment"

"Record repayment"

"Lend from capital"

"Record Loan"

0

"Bank Capital"

BV t( )

0

0

0

0

0

0

0

I

0

J

0

0

"Bank P/L (B.T)"

BT t( )

0

B

0

0

0

E F( )

G

0

0

0

0

1

"Firm Loan (FL)"

FL t( )

A

0

B

C

0

0

0

0

I

0

J

1

"Firm Deposit (FD)"

FD t( )

0

B

0

C

D

E

G H

I

0

J

0

1

"Worker Deposit (WD)"

HD t( )

0

0

0

0

D

F

H

0

0

0

0

BV

System M1

tBV t( )d

dI J

tBT t( )d

dB E F G

tFL t( )d

dA B C I J

tFD t( )d

dC B D E G H I J

tHD t( )d

dD F H

• Symbolic derivation of system of coupled ordinary differential equations

Monetary Circuit Theory• Symbolic substitutions generate model

System M1

tBV t( )d

d

FL t( )

V r t( ) BV t( )

L r t( )

tBT t( )d

drL FL t( ) rD FD t( ) rD HD t( )

BT t( )

B

tFL t( )d

d

BV t( )

L r t( ) FL t( )

V r t( ) P t( ) YR t( ) Inv r t( )

tFD t( )d

drD FD t( ) rL FL t( )

BV t( )

L r t( ) FL t( )

V r t( ) BT t( )

B

HD t( )

W P t( ) YR t( ) Inv r t( )

W t( ) YR t( )

a t( )

tHD t( )d

drD HD t( )

HD t( )

W

W t( ) YR t( )

a t( )

Goodwin Growth Cycle model• Inherently cyclical growth (Goodwin 1967, Blatt 1983)

Y/

lr1

Labour Productivitya

L

dw/dt 1/SIntegrator

w++

1Initial Wage

*L

W

WY +

-Pi I dK/dt

• Closes the loop:

1Initial Capital +

+1/SIntegrator

dK/dt

K 1/3Accelerator

Y

L/

lr100

PopulationN

l

PhillipsCurve dw/dt+- *

10WageResponse

.96"NAIRU"

• Capital K determines output Y via the accelerator:

• Y determines employment L via productivity a:

• L determines employment rate l via population N:

• l determines rate of change of wages w via Phillips Curve

• Integral of w determines W (given initial value)

• Y-W determines profits P and thus Investment I…

K 1/3Accelerator

Y

/lr1

Labour Productivitya

L

/lr

1Population

Nl

PhillipsCurve dw/dt

1/SIntegrator

w++

1Initial Wage *

LW

Y +-

Pi I dK/dt

3Initial Capital +

+1/SIntegrator

+- *10

WageResponse

.96"NAIRU"

Goodwin's cyclical growth model

Time (Years)0 2 4 6 8 10

.50

.75

1.00

1.25

1.50Employment

Wages

Goodwin's cyclical growth model

Employment.9 .95 1 1.05

Wa

ge

s.7

.8

.9

1.0

1.1

1.2

1.3

Explicit Monetary Minsky Model

• Coupled with Goodwin model to yield final system

Financial Sector

tBV t( )d

d

FL t( )

V r t( ) BV t( )

L r t( )

tBT t( )d

drL FL t( ) rD FD t( ) rD HD t( )

BT t( )

B

tFL t( )d

d

BV t( )

L r t( ) FL t( )

V r t( ) P t( ) YR t( ) Inv r t( )

tFD t( )d

drD FD t( ) rL FL t( )

BV t( )

L r t( ) FL t( )

V r t( ) BT t( )

B

HD t( )

W P t( ) YR t( ) Inv r t( )

W t( ) YR t( )

a t( )

tHD t( )d

drD HD t( )

HD t( )

W

W t( ) YR t( )

a t( )

Physical output, labour and price systems

Rate of change of capital stocktKR t( )d

dKR t( ) g t( )

Level of outputYR t( )

KR t( )

v

Employment L t( )YR t( )

a t( )

Rate of Profit r t( )P t( ) YR t( ) W t( ) L t( ) rL FL t( ) rD FD t( )

P t( ) KR t( )

Rate of employmentt t( )d

d t( ) g t( ) ( )[ ]

Rate of real economic growth g t( )Inv r t( )

v

tW t( )d

dW t( )( ) Ph t( )( )

1

t( )

t t( )d

d

1

P t( ) tP t( )d

d

Rate of change of wages

Rate of change of prices

tP t( )d

d

1P

P t( )W t( )

a t( ) 1 ( )

Rates of growth of population and productivityta t( )d

d a t( )

tN t( )d

d N t( ) N 0( ) N0

Explicit Monetary Minsky Model• Single sector model (not yet calibrated to data) can

generate “Great Moderation and Great Recession”

0 20 40 60

20

10

0

10

20

InflationUnemployment

Inflation and Unemployment

Per

cent

0

0 20 40 60100

1000

1 104

Real Output

$/Y

ear

0 20 40 600

1

2

3

4

5

Debt to Output Ratio

Year

Yea

rs to

rep

ay d

ebt

0 20 40 6010

0

10

20

30

40

50

60

70

80

90

100

110

WorkersCapitalistsBankers

Income Distribution

Year

Per

cen

t of

GD

P

Multi-sectoral extension• Stylized version of monetary flows table:

  Assets     Liabilities EquityAccount Bank

ReserveSector 1

LoanSector

2 LoanSector 1

DepositSector 2

DepositWorker

DepositBank

Equity

Symbol BR(t) FL1(t) FL1(t) FD1(t) FD2(t) WD(t) BE(t)

Compound Debt   A1 A2        

Deposit Interest       B1 B2    

Wages       -C1 -C2 C1+C2  

Worker Interest           -D -D

Investment K       E -E    Intersectoral C       -F F    Intersectoral A       -G G    Intersectoral E       -H H    Consumption K       I -I    

Consumption C       -J J    Consumption A       -K K    

Consumption E       -L L    Pay Interest       -M     MRepay Loans N     -N      Recycle Reserves -O O   O      

New Money   P   P      

Multi-sectoral extension• Profit now net of intersectoral input purchases:

n

K K K K KS S L L D DS K

K K

n

C C C C CS S L L D DS C

K C

t P t Q t W t L t W t L t r K t r K t

P t K t

t P t Q t W t L t W t L t r C t r C t

P t K t

Capital Stock

1 1Output

1 1Labor

1Price Level

1

Labor Productivity

DKC C

PR C K

C C CQC C

C C CLC C

C CPC C C

C C

F tdK K tt

dt t P t

dQ t Q t K t

dt v

dL t L t Q t

dt a t

W tdP t P t

dt a t s

da t a t

dt

• Each sector modeled as Goodwin cycle

• Financial flows matrix captures intersectoral dependencies

Multi-sectoral extension• “Conjecture: The repeated development of an

unstable state of the economy is … an unavoidable consequence of, the local instability of the state of balanced growth.” (Blatt 1983, p. 161)

0 20 40 60 80 1005

0

5

10

15

Capital GoodsConsumer GoodsAgricultureEnergy

The Rate of Profit in a Monetary Multisectoral Model of Production

Years

Pro

fit/C

apita

(P

erce

nt)

Multi-sectoral extension

• “The usual image of the business cycle was of a wavelike movement, and the waves of the sea were the accepted metaphor… The reality in the nineteenth and early twentieth centuries was, in fact, much closer to the teeth of a ripsaw which go up on a gradual plane on one side and drop precipitately on the other…” (Galbraith 1975, p. 104)

20 25 30 35 402

0

2

4

6

40

60

80

100

120

Rate of GrowthDebt Ratio (RHS)

Debt Level and Economic Growth

Multi-sectoral extension• Model fundamentally monetary: physical cycles cause

and caused by cycles in finance

20 25 30 351 10

5

1 106

1 107

1 108

10000

1 105

1 106

1 107

LoansDepositsBank Reserves (RHS)

Bank Assets & Liabilities

Addendum: Reforming economic education• Making real dynamics sexy & accessible• Free prototype QED “Quesnay Economic Dynamics”• Inspired by Godley SAM approach

– Extended to continuous time• Ideally suited to financial flows

Explicit Monetary Minsky Model

• Freely available at www.debtdeflation.com/blogs/qed

• Advanced versions under development

• Mathematica version for arbitrary number of sectors available soon

• New economic dynamic monetary modeling program “Minsky” available by early 2012

Conclusion: Kuznets was correct…

• According to … modern followers [of past economists], static economics is a direct stepping stone to the dynamic system…

• According to other economists, the body of economic theory must be cardinally rebuilt, if dynamic problems are to be discussed efficiently…

• … as long as static economics will remain a strictly unified system based upon the concept of equilibrium, … its analytic part will remain of little use to any system of dynamic economics…

• the static scheme in its entirety, in the essence of its approach, is neither a basis, nor a stepping stone towards a proper discussion of dynamic problems. Kuznets, S. (1930, pp. 422-428, 435-436; emphasis added)

References• Bezemer, D. J. (2009). ““No One Saw This Coming”: Understanding Financial

Crisis Through Accounting Models.” Groningen, The Netherlands, Faculty of Economics University of Groningen.

• Blatt, J. M. (1983). Dynamic economic systems : a post-Keynesian approach. Armonk, N.Y, M.E. Sharpe.

• Bezemer, D. J. (2010). "Understanding financial crisis through accounting models." Accounting, Organizations and Society 35(7): 676-688.

• Biggs, M., T. Mayer, et al. (2010). "Credit and Economic Recovery: Demystifying Phoenix Miracles." SSRN eLibrary.

• Blanchard, O., G. Dell'Ariccia, et al. (2010). "Rethinking Macroeconomic Policy." Journal of Money, Credit, and Banking 42: 199-215.

• Goodwin, R. (1967). A growth cycle. Socialism, Capitalism and Economic Growth. C. H. Feinstein. Cambridge, Cambridge University Press: 54-58.

• Graziani, A. (1989). "The Theory of the Monetary Circuit." Thames Papers in Political Economy Spring: 1-26.

• Holmes, A. R. (1969). Operational Constraints on the Stabilization of Money Supply Growth. Controlling Monetary Aggregates. F. E. Morris. Nantucket Island, The Federal Reserve Bank of Boston: 65-77.

References

• Keen, S. (1995). "Finance and Economic Breakdown: Modeling Minsky's 'Financial Instability Hypothesis.'." Journal of Post Keynesian Economics 17(4): 607-635.

• Keen, S. (2008). Keynes’s ‘revolving fund of finance’ and transactions in the circuit. Keynes and Macroeconomics after 70 Years. R. Wray and M. Forstater. Cheltenham, Edward Elgar: 259-278.

• Kuznets, S. (1930). "Static and Dynamic Economics." The American Economic Review 20(3): 426-441.

• Kydland, F. E. and E. C. Prescott (1990). "Business Cycles: Real Facts and a Monetary Myth." Federal Reserve Bank of Minneapolis Quarterly Review 14(2): 3-18.

• Minsky, H. P. (1982). Can "it" happen again? : essays on instability and finance. Armonk, N.Y., M.E. Sharpe.

• Schumpeter, J. A. (1934). The theory of economic development : an inquiry into profits, capital, credit, interest and the business cycle. Cambridge, Massachusetts, Harvard University Press.

• Solow, R. M. (2001) “From Neoclassical Growth Theory to New Classical Macroeconomics”, in J. H. Drèze (ed.), Advances in Macroeconomic Theory. New York, Palgrave

• Solow, R. (2008). "The State of Macroeconomics." The Journal of Economic Perspectives 22(1): 243-246.