Circular Flow: Drawing Further Inspiration from William Harvey

paper by Keith Rankin

Dept. of Accounting and Finance Unitec Institute of Technology

for the 2012 Conference of the New Zealand Association of Economists

Palmerston North 27-29 June 2012

IntroductionEconomics is about both flows and prices– Flow models convey balance and unbalance through time– Price models convey unbalance converging into balance

in timeCircular flow models are under-done in both

education and analysis– Initial inspiration goes back to William Harvey (and

others) who demonstrated the circular flow of blood from the body's centre to its sectors (nodes), and its return• Harvey analogy dates to Thomas Hobbes (1650s)

– "Hydraulic Keynesianism" has become a pejorative term (Laidler) [ref. AWH Phillips]

Global Economy in 'Normal' State

Abstract "normal" (a kind of template)– just as perfect competition is an abstract 'normal'

• real-world phenomena can only approximate 'normal'Three Sectors– Saving Class (S); analogous to the head

• capitalist and other 'middle-class' households• includes business 'companies' and financial system

– Low Income Class (L); analogous to left-hand, labour– Governments (G); analogous to right-handProduction Centre (P)– analogous to heart, lungs, stomach

'Normal' State (continued)Sectors run balanced budgets– saving is confined to S, balanced by investing within SFactors of production are owned by S, L, G;

reside in P– materials (oxygen, food, water) combine with all available

factor inputs to produce goods and services ('nutrients')– nutrients are conveyed via the monetary arteries to the

consuming sectors; information conveyed with return flow• money [currency] is the circulating medium• nutrients represent output (outflow) and income• 'economic cake' divided into three sectoral portions

– the division of income is based on market and government rules

Figure 3

Circular Flow in 'Normal' stateL and C consume their incomes (nutrients)– G demands collective consumer and investment goods– L demands wage goods – S demands wage and non-wage consumer goods;

plus, through their companies, investment goods• investment equals saving through interest rate• income-maximising sector

Textbook 2-sector circular flow– contained within S (Figure 4)– most saving goes to other households (Life-Cycle)– remaining income (nutrients) is Capital

• capital is invested: company purchases (equity / debt)

Imbalance; departure from 'normal' stateif S cannot fully allocate its capital, internally– private sector surpluses may be endemic (Figure 2)

• especially but not only when paying down debt– unemployment results from unallocated capitalS may allocate its capital externally– inter-sectoral intertemporal exchange (inter-nodal arteries)

• S markets unallocated nutrients (capital) to L, as debt• L contracts to send nutrients to S in the future• enables L to maintain/grow purchases of wage goods

– wage goods are central to industrial capitalism– if S-L intertemporal 'return journey' falters [eg sub-prime]

• S sends unallocated capital to G; accommodating G-deficits

Figure 5

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Inter-sectoral Mercantilism ?

Mercantilism: pursuit of indefinite surpluses– consider S=Switzerland; G=Greece; L=Lithuania– S builds up credits indefinitely; L, G enjoy 'free' nutrientsWhen nutrients flow from S, as debt– S accumulates claims on L and/or G

• financial wealth including non-circulating money– such claims are widely understood as wealth– postulate that S is a wealth-maximising sector

(in this sense of 'wealth') as well as income-maximising– S is uninterested in consuming return nutrients from L,G– S actors need to ensure their "investments" not defaulted

ConclusionIf S is wealth-maximising in this mercantilist sense– financial and economic crisis becomes chronicSolutions ?– negative real interest rates; (need not require inflation?)– system of government bankruptcy; debt forgiveness– philanthropy (more than charity)– changing the income distribution rules

• public equity approach• public equity benefits payable to L and S equally

– use average L incomes as measure of systemic success• a successful economy raises living standards;

not unsustainable accumulation of financial credits

End

Figure 5

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Figure 4

Figure 1: Google NGram

use in books of expressions:– "saving class" (blue)– "saving classes" (red)

1930 199019601900

Figure 2 UK & France

UK Balances

UK Corporate Balances

From"Splashing Out" The Economist19 May 2011

France Balances

Japan

Japan Balances

Switzerland Balances