managerial economics lecture economy alternative 02

8/4/2019 Managerial Economics Lecture Economy Alternative 02

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Managerial Economics

Lecture Nine:

Alternative theories ofmacroeconomic behaviour



Recap

• Last week

– Empirical data on economic cycle contradictsneoclassical economics:– Prices anti-cyclical

– Wages pro-cyclical

• No ―diminishing marginal productivity‖ – Credit leads cycle, money base follows

• Not ―quantity theory of money‖ but ―endogenouscredit & money creation‖

• Complements Blinder’s survey research

• Supports Schumpeter’s theory of cycle

• K&P conclude with fascinating statement:



Money, credit and business cycles…

• ―The fact that the transaction component of real cash

balances (M 1) moves contemporaneously with the cyclewhile the much larger nontransaction component (M2)leads the cycle suggests that credit arrangements couldplay a significant role in future business cycle theory.

• Introducing money and credit into growth theory in away that accounts for the cyclical behavior ofmonetary as well as real aggregates is an importantopen problem in economics.”

• This ―open problem‖ the focus of Hyman Minsky’s

research…



Like father, like son…

• Minsky a student of Schumpeter’s

– & influenced by Keynes … and Marx • Built on foundations of all three (but never admitted to

inspiration from Marx —worked during ―McCarthyist‖period in USA when reading Marx effectively a crime)

• Did first degree in mathematics before economics Phd• During longest period of sustained prosperity in

America’s history, developed the ―Financial InstabilityHypothesis‖

• Key proposition: ―The most significant economic event ofthe era since World War II is something that has nothappened: there has not been a deep and long-lastingdepression.‖ (Minsky 1982: xi)

• Why is this significant? Because…



Financial Instability Hypothesis

• ―As measured by the record of history, to go more than

thirtyfive years without a severe and protracteddepression is a striking success.

– Before World War II, serious depressions occurredregularly. The Great Depression of the 1930s was justa "bigger and better" example of the hard times thatoccurred so frequently. This postwar success indicatesthat something is right about the institutionalstructure and the policy interventions that werelargely created by the reforms of the 1930s..‖ (xi)

• So what were these structures & interventions?– Restrained use of debt

– Public spending to ameliorate any downturn

• Both developed in response to Great Depression:



The Great Depression

0

50

100

150

200

250

1 9 2 0

1 9 2 2

1 9 2 4

1 9 2 6

1 9 2 8

1 9 3 0

1 9 3 2

1 9 3 4

1 9 3 6

1 9 3 8

1 9 4 0

1 9 4 2

G D P

I n d e x ( 1 9 1 3 = 1

0 0 )

-20%

-15%

-10%

-5%

0%

5%

10%

15%

20%

25%

30%

G D P

C h a n g e

10 years torestore output levels

30% fall inoutput in 4 years

WWII



The Great Depression

0

5

10

15

20

25

30

A p r

- 2 9

O c t

- 2 9

A p r

- 3 0

O c t

- 3 0

A p r

- 3 1

O c t

- 3 1

A p r

- 3 2

O c t

- 3 2

A p r

- 3 3

O c t

- 3 3

A p r

- 3 4

O c t

- 3 4

A p r

- 3 5

O c t

- 3 5

A p r

- 3 6

O c t

- 3 6

A p r

- 3 7

O c t

- 3 7

A p r

- 3 8

O c t

- 3 8

A p r

- 3 9

O c t

- 3 9

A p r

- 4 0

O c t

- 4 0

A p r

- 4 1

O c t

- 4 1

A p r

- 4 2

O c t

- 4 2

U S A

U n e m p l o y m e n t R a t e

( S e a s o n a l l y A d j u s t e d )

Source: NBER data series m08292a

From effectively zero...

To 25% in 3 years WW II BringsSustained Recovery



Minskian Economic History

• Minsky’s reading of Depression:

– Final in series of financial crises in which accumulateddebt & falling prices overwhelmed system

– Deflation (prices fell by up to 10% p.a.) meant realrate of interest exceeded 15%

– Nominal debt fell but real debt (ratio nominal debt tonominal DGP) ballooned• Irving Fisher claimed debt/GDP ratio was

– 60% in 1929

– 160% by 1933– Complex price dynamics, mechanics of bankruptcy,

government public works, etc. partially reduced debts;

– World War II reduced them to trivial levels…



USA Interest Rates 1918-2000

-20

-15

-10

-5

0

5

10

15

20

25

3

0 / 0 8 / 1 8

3

0 / 0 8 / 2 0

3

0 / 0 8 / 2 2

3

0 / 0 8 / 2 4

3

0 / 0 8 / 2 6

3

0 / 0 8 / 2 8

3

0 / 0 8 / 3 0

3

0 / 0 8 / 3 2

3

0 / 0 8 / 3 4

3

0 / 0 8 / 3 6

3

0 / 0 8 / 3 8

3

0 / 0 8 / 4 0

3

0 / 0 8 / 4 2

3

0 / 0 8 / 4 4

3

0 / 0 8 / 4 6

3

0 / 0 8 / 4 8

3

0 / 0 8 / 5 0

3

0 / 0 8 / 5 2

3

0 / 0 8 / 5 4

3

0 / 0 8 / 5 6

3

0 / 0 8 / 5 8

3

0 / 0 8 / 6 0

3

0 / 0 8 / 6 2

3

0 / 0 8 / 6 4

3

0 / 0 8 / 6 6

3

0 / 0 8 / 6 8

3

0 / 0 8 / 7 0

3

0 / 0 8 / 7 2

3

0 / 0 8 / 7 4

3

0 / 0 8 / 7 6

3

0 / 0 8 / 7 8

3

0 / 0 8 / 8 0

3

0 / 0 8 / 8 2

3

0 / 0 8 / 8 4

3

0 / 0 8 / 8 6

3

0 / 0 8 / 8 8

3

0 / 0 8 / 9 0

3

0 / 0 8 / 9 2

3

0 / 0 8 / 9 4

3

0 / 0 8 / 9 6

Interbank Rate

Real Rate

Inflation Rate

Linear (Real Rate)

Poly. (Real Rate)

M a s s i v e p o s i t i v e― r e a l ‖ r a t e s d u e t o

d e f l a t i o

n i n G r e a t D e

p r e s s i o n

Negativereal

ratesduringWW II

E v e n m o r e n e g a t i v e r

e a l r a t e

d u r i n g P o s t - W a r r e c o

v e r y

Post-War stability

K o r e a n W a r I n f l a t i o n

H u g e d e f l a

t i o n c a u s e d b y

p o s t - W W I

r e t u r n t o t h e G o l d S t a n d

a r d b y U K




• Post-War success due to

– Reduction of private debt to historically low levels– Culture of prudence after WWII, Great Depression

• versus excess of ―Roaring Twenties‖ stock market boom

– ―Big government‖

• Large government spending/taxing role counterbalancedprivate sector tendencies to excess during boom,frugality during slump

• Institutions designed to attenuate excessive behaviourin borrowing, lending, investing…

• Emphasis upon income equality

– Less money for speculation by wealthy

– More for income-financed stable mass consumption




• Gradual development of problems since WWII due to

gradual– Increase in debt to income levels over many businesscycles

– Decline in fear of financial collapse as GD forgotten

– Relaxation of prudent financial arrangements• Financial fragility rising from 1950 till early 1960s

– Financial crises in USA but still highgrowth/employment

– 1973: major financial crisis in period of highemployment:

• Income distribution (high wages) and raw materials (highprices) driven inflation

• ―Stagflation‖: first major post WWII financial crisis




• To understand why we’ve had crises but not a Depression,we need– ―an economic theory which makes great depressions

one of the possible states in which our type of capitalist economy can find itself .

– We need a theory which will enable us to identify

which of the many differences between the economyof 1980 and that of 1930 are responsible for thesuccess of the postwar era.‖ (xi)

• Neoclassical & conventional ―Keynesian‖ models can’t dothis because they are timeless equilibrium models

– might explain equilibrium but• Can’t explain location of equilibrium itself • Omit time processes that are evolutionary and non-

equilibrium




• Minsky knew suitable model had to

– treat financial crises as normal events inunconstrained capitalist economy

– Explain why such events hadn’t happened in 1948-1966:• ―The first twenty years after World War II were

characterized by financial tranquility. No serious threatof a financial crisis or a debtdeflation process tookplace.

• The decade since 1966 has been characterized byfinancial turmoil. Three threats of financial crisis

occurred, during which Federal Reserve interventions inmoney and financial markets were needed to abort thepotential crises.‖ (1982: 63)

– Minsky on the historical record 1948-1978




• The lessons from this history?:– ―Since this recent financial instability is a recurrence

of phenomena that regularly characterized oureconomy before World War II, it is reasonable toview financial crises as systemic, rather thanaccidental, events.

– From this perspective, the anomaly is the twentyyears after World War II during which financialcrises were absent, which can be explained by theextremely robust financial structure that resultedfrom a Great War following hard upon a deep

depression.– Since the middle sixties the historic crisis-prone

behavior of an economy with capitalist financialinstitutions has reasserted itself…‖ (63)




1864.0 1875.5 1887.0 1898.5 1910.0

Year

-0.2

-0.1

0.0

0.1

0.2

0.3

A n n u a l C h a n g e

Manufacturing Output

Wholesale Prices

Composite Wages

The 19th Century Trade Cycle

•Procyclicalprices

•Frequentwage falls

•Financialcrises

roughly every20 years

• Minsky’s view of unbridled capitalism supported by recordof 19th century trade cycle:




• But post-1973 still differs from pre-WWII periods ofinstability:

– The past decade differs from the era before WorldWar II in that embryonic financial crises have beenaborted by a combination of support operations by theFederal Reserve and the income, employment, andfinancial effects that flow from an immensely largergovernment sector. This success has had a side effect,however; accelerating inflation has followed eachsuccess in aborting a financial crisis.‖ (63)

• So how to turn these historical insights into a theory?• Firstly, build on your antecedents…



Brief HET of Minsky

• Parents met at a Communist Party social function– No prizes for guessing early formative influences!

• Fought in US Army in WWII, decamped post-war to do adegree

• Educated during McCarthyist ―communist witch hunt‖period—no mention ever of Marx in his research, for

obvious reasons– PhD supervisor Joseph Schumpeter: the archetypal

theorist of cycles• Foundation influences thus Marx & Schumpeter—and not

Keynes• With degree in mathematics, attempted to buildmathematical model of trade cycle (based on Hicks’sdifference equation model, extended by Kalecki’s―principle of increasing risk‖)



Brief HET of Minsky

• Kalecki argued investment restrained by increasing risk

(uncertainty) as capital grows• Minsky used this at macro level in model of trade cycleModel was 1 2t t t Y Y Y

• Minsky made dependent on financial conditions

• declines as economy grows, thus giving turning pointto upward explosive movement:

• "the accelerator coefficient ... is in part based onthe productive efficiency of investment, but it isalso related to the willingness of investors to takerisks and the terms in which investors can financetheir endeavours..." (Minsky 1965: 261)



Brief HET of Minsky

• Model went nowhere, but Minsky began to exploreimplications of finance for economic behaviour

• Initially tried from conventional understanding of Keynes:

– ―If we make the Keynesian assumption thatconsumption demand is independent of interest rates,but assume that investment demand, and hence the coefficient, depends on interest rates, then a risingset of interest rates will lower the coefficient.‖(Minsky 1965, 1982: 262)

– Also went nowhere… • Then, one day, by chance, he read Keynes’s 1937 papers…

– ―My interpretations of Keynes is not the conventionalview which is mainly derived from Hicks' "Mr. Keynesand the Classics," an article which I believe misses

Keynes' point completely…‖ (Minsky 1982: 280)



There’s more than one ―Keynes‖

• Keynesian economics of IS-LM & AS-AD more due toHicks than Keynes;

• Different theme in Ch. 12 & Ch. 17:

• Rather than investment regulated by rate of interest:

– investment motivated by the desire to produce ―those

assets of which the normal supply-price is less thanthe demand price‖ (Keynes 1936: 228) • Demand price determined by prospective yields,

depreciation and liquidity preference.

• Supply price determined by costs of production

• ―Two price levels‖ in capitalism:

– Normal commodities basically ―cost plus‖

– Assets ―expectations under uncertainty‖




• Two price level analysis becomes more dominantsubsequent to General Theory :– The scale of production of capital assets ―depends, of

course, on the relation between their costs ofproduction and the prices which they are expected torealise in the market.‖ (Keynes 1937a: 217)

– ―Marginal Efficiency of Investment‖ (MEI or MEC for―Capital‖) analysis akin to view that uncertainty can bereduced ―to the same calculable status as that ofcertainty itself‖ via a ―Benthamite calculus‖, whereas

– uncertainty in investment is that about which ―there is

no scientific basis on which to form any calculableprobability whatever. We simply do not know.‖ (Keynes1937a: 213, 214)




• Three aspects to expectations formation under trueuncertainty– Presumption that ―the present is a much more

serviceable guide to the future than a candidexamination of past experience would show it to havebeen hitherto‖

– Belief that ―the existing state of opinion as expressedin prices and the character of existing output is basedon a correct summing up of future prospects‖

– Reliance on mass sentiment: ―we endeavour to fall backon the judgment of the rest of the world which is

perhaps better informed.‖ (Keynes 1936: 214) • Fragile basis for expectations formation thus affects

prices of financial assets



What is ―uncertainty‖?

• Imagine you are very attracted to someone

• This person has accepted invitations from 1 in 5 of thepeople who have asked him/her out

• Does this mean you have a 20% chance of success?

• Of course not:

– Each experience of attraction is unique– What someone has done in the past with other people

is no guide to what he/she will do with you in thefuture

– His/her response is not ―risky‖; it is uncertain .• Ditto to individual investments

• success/failure of past instances give no guide topresent ―odds‖



How to cope with relationship uncertainty?

• We try to ―find out beforehand‖

– ask friends—eliminate the uncertainty• We do nothing…

– paralysed into inaction

• We ask regardless…

– compel ourselves into action• We follow conventions

– ―follow the herd‖ of the social conventions of oursociety

– ―play the game‖ & hope for the best • So what about investors?




• In the midst of incalculable uncertainty, investors formfragile expectations about the future

• These are crystallised in the prices they place uponcapital asset

• These prices are therefore subject to sudden and violentchange

– with equally sudden and violent consequences for thepropensity to invest

• The ―marginal efficiency of capital/investment‖ is simplyratio of yield from asset to its current demand price, andtherefore there is a different ―marginal efficiency ofcapital‖ for every different level of asset prices (Keynes1937a: 222)




• In 1969, Minsky states that his own ideas aboutuncertainty "seem to be consistent with those of Keynes"(1969a, 1982: 191, footnote 6), citing Keynes 1937

• Eventually concludes

– “capitalism is inherently flawed, being prone tobooms, crises and depressions. This instability, inmy view, is due to characteristics the financialsystem must possess if it is to be consistent withfull-blown capitalism. Such a financial system willbe capable of both generating signals that induce an

accelerating desire to invest and of financing thataccelerating investment.” (Minsky 1969b: 224)

• Combines elements of Marx, Keynes & Schumpeter

• Christens his model the ―Financial Instability

Hypothesis‖:




• ―After the event it becomes apparent that the marginsof safety built into debt structures were too great.

• As a result, over a period in which the economy does well,views about acceptable debt structure change. In thedealmaking that goes on between banks, investmentbankers, and businessmen, the acceptable amount of debt

to use in financing various types of activity and positions increases .• This increase in the weight of debt financing raises the

market price of capital assets and increases investment.As this continues the economy is transformed into a boom

economy…‖ (65) • This transforms a period of tranquil growth into a period

of speculative excess:




• ―Stable growth is inconsistent with the manner in whichinvestment is determined in an economy in which debt-financed ownership of capital assets exists, and the extentto which such debt financing can be carried is marketdetermined.

• It follows that the fundamental instability of a

capitalist economy is upward. The tendency totransform doing well into a speculative investment boomis the basic instability in a capitalist economy.” (65)

• This characteristic of capitalism necessarily missed by IS-

LM/AS-AD analysis because process fundamentally non-equilibrium in nature:




• Whether neoclassical or Keynesian, IS-LM/AS-AD analysis omits time and debt

– Difference between ―Keynesian‖ (1950-1973) and―Neoclassical‖ (1973+) economic management outcomesmay reflect deterioration of economy

• but neither theory could have seen it coming

• Minsky notes Hicks also rejects IS-LM

– John R. Hicks, "Some Questions of Time in Economics,"in Evolution, Welfare and Time in Economics: Essays inHonor of Nicholas GeorgescuRoegen (Lexington, Mass.:Lexington Books, 1976), pp. 135-151. In this essay Hicks finally repudiates the potted equilibrium version of Keynes embodied in the IS-LM curves: he now views IS- LM as missing the point of Keynes and as bad economics

for an economy in time.‖ (Minsky 1982: 70)




• But both equilibrium theories missed causal factorsbehind deterioration:

– Evolution of riskier behavior & financial arrangementsas long period of tranquility changed expectations:

• ―Stability—or tranquility—in a world with a cyclical pastand capitalist financial institutions is destabilizing.‖

– Resulting cyclical/secular increase in debt levels madeeconomy more fragile, more susceptible to financialcrises

• Spelling Minsky’s model out step by step:




• Economy in historical time

• Debt-induced recession in recent past• Firms and banks conservative re debt/equity ratios, assetvaluation

• Only conservative projects are funded

• Recovery means conservative projects succeed• Firms and banks revise risk premiums

– Accepted debt/equity ratio rises

– Assets revalued upwards



The Euphoric Economy

• Self-fulfilling expectations– Decline in risk aversion causes increase in investment

• Investment expansion causes economy to grow faster

– Asset prices rise, making speculation on assetsprofitable

– Increased willingness to lend increases money supply

(endogenous money)– Riskier investments enabled, asset speculation rises

• The emergence of ―Ponzi‖ (Bondy?) financiers – Cash flow from ―investments‖ always less than debt

servicing costs– Profits made by selling assets on a rising market– Interest-rate insensitive demand for finance



The Assets Boom and Bust

• Initial profitability of asset speculation:

– reduces debt and interest rate sensitivity– drives up supply of and demand for finance

– market interest rates rise

• But eventually:

– rising interest rates make many once conservativeprojects speculative

– forces non-Ponzi investors to attempt to sell assets toservice debts

– entry of new sellers floods asset markets– rising trend of asset prices falters or reverses



Crisis and Aftermath

• Ponzi financiers go bankrupt:– can no longer sell assets for a profit– debt servicing on assets far exceeds cash flows

• Asset prices collapse, drastically increasing debt/equityratios

• Endogenous expansion of money supply reverses

• Investment evaporates; economic growth slows orreverses

• Economy enters a debt-induced recession ...• High Inflation?

– Debts repaid by rising price level– Economic growth remains low: Stagflation– Renewal of cycle once debt levels reduced



Crisis and Aftermath

• Low Inflation?

– Debts cannot be repaid– Chain of bankruptcy affects even non-speculativebusinesses

– Economic activity remains suppressed: a Depression

• Big Government?– Anti-cyclical spending and taxation of government

enables debts to be repaid

– Renewal of cycle once debt levels reduce

k E




• Since WWII

– Debt has risen in ratchet-like manner• Rise during boom

• Peak & then fall during slump

• Cycle renews with higher initial debt level

– Government spending rescued system in each slump• Massive inflation in asset prices as by-product

– Monetarist/Neoclassical policy has• reduced ―counter-vailing‖ impact of government spending

• driven down inflation rate to near-deflation levels– Debt levels now highest in history, inflation near zero…

k E H f l



Minskian Economic History of Australia

• Data fromrecent (2004)PhD thesis:

• Luke Reedman, "Asassessment of theDevelopment ofFinancial Fragilityin the Australianeconomy―

• Rise in debt toGDP from 50%

to 135% 1960-2000:

Mi ki E i Hi f li




• Interest payments peaked in 1989/90

• Corporate indebtedness decreased since 1990:

• BUT Household debt levels rising…

Mi ki E i Hi f A li




• BUT Corporate indebtedness decreased since 1990:

• BUT overall fragility higher given debt repayments:

Mi ki E i Hi t f A t li




• AND situation of Sydney households worst in history…

• Debt & financial fragility has risen as Minsky predicted…





• Household & corporate sector now more susceptible tofinancial crisis than ever before…





• Cyclical ―ratcheting up‖ of gap between expenditure and debt over last40 years

• Household & corporate sector now net borrowers – ― A positive gap means that capital expenditures exceed available

internal funds.‖ (153)

M d lli Fi i l I t bilit



Modelling Financial Instability

• Minsky’s verbal model appears confirmed by data • But (for better or worse…!) only mathematical models

―cut it‖ with economists – Vigorous methodological debates about role of

mathematics in economics• Considered in History of Economic Thought

• Whatever outcome of debate, reality is thatmathematical models are key part of ―rhetoric‖ ofeconomics

– If you can’t ―say it‖ with maths, economists won’tlisten

• Can this be modelled mathematically?– Yes but not with ―equilibrium‖ tools – Need something like what Minsky tried: mathematical

models that incorporate time





• Mathematical models that incorporate time are

– Differential equations– Difference equations

• Not taught at undergraduate level in most universities(including UWS)

• Sometimes taught at advanced (Masters/PhD) level– But frequently at inadequate level

• Modern sciences (biology, physics, maths itself) showdifferential equations only able to model real-world

processes when they are– Nonlinear

– Involve three or more variables (―third order‖)

– Most economics courses don’t go beyond linearsecond order equations





• Several attempts to model Minsky in literature

– See references in final slide• My model based on Goodwin’s trade cycle model (nextslide)

– Key component of dynamic model is ―rate of change

of x with respect to time ‖ – Mathematically shown as dx/dt: dx f x dt

• Similar to calculus you have done in Maths 1.3 etc.; BUT

• One key difference: calculus considers equations of form

dy f x dx

• Rate of change of dependent variable afunction of value of independent variable

• Differential equations ―rate of change of

dependent variable a function of its own value‖

dy

f y dx

M d lli Fi i l I st bilit




• Maths gets quite complicated (overview only here!); but

– Dividing by dependent variable puts equation in―percentage change‖ form:

dx

f x dt

• Rate of change

1 dx g x x dt

• Percentage rate of change

• % rate of change thinking therefore essentially dynamic

• Often complicated models easily expressed in ―percentage

rate of change‖ terms • Applying this to model ―a cyclical economy‖

– ―The natural starting place for analyzing the relationbetween debt and income is to take an economy with a

cyclical past that is now doing well…‖ (Minsky 1982: 65)

M d llin Fin nci l Inst bilit




• First stage: Goodwin’s model (of Marx’scyclical growth theory)

• Causal chain– Capital (K) determines Output (Y)

– Output determines employment (L)

– Employment determines wages (w)

– Wages (wL) determine profit (P)– Profit determines investment (I)

– Investment I determines capital K

– chain is closed

K

Y v

―accelerator‖

Y

L a

p r o d u c t

i v i t y

dw L w f

dt N

P h i l l i p s

c u r v e

Y w L

I k

K

dK k Y K

dt K

Investmentfunction Depreciation





• Goodwin’s model reduces to two ―% rate of change‖expressions:

1GDP

d g

dt

1 d

P dt

• ―% rate of change of employment rateequals % rate of economic growthminus % rate of population growth and

technical change‖

• ―% rate of change of wages share of

GDP equals % increase in wages(Phillips curve) minus % rate oftechnical change‖

• ―Employment will rise if the rate of economic growthexceeds the sum of population growth & technical change‖

• ―Workers share of output will rise if the increase in wages

exceeds the rate of technical change‖





• Click on graph to run it dynamically…

• Adding debt relatively easy:





• Debt finances investment

• Debt will grow if desired investment exceeds retainedearnings

• Interest is paid on outstanding debt:

dD

I

dt

Y W r D where

• Adds 3rd ―% rate of change‖ expression:

1

GDP

d I Y W d r g

d dt D

• ―The debt to output ratio willgrow if the rate of interestexceeds the rate of growth andinvestment exceeds EBIT‖





• Generatessystem whichcan be stableif starts nearequilibrium:

0 10 20 30 40 500.75

0.8

0.85

0.9

0.95

1

Wages Share EquilibriumWages Share 1% deviation

Employment Equilibrium

Employment 1% deviation

Goodwin with Debt: Stable

Years

P e r c e n t

0.955 0.96 0.965 0.97 0.975 0.980.79

0.8

0.81

0.82

0.83

0.84

0.85

Equilibrium Pair

Cycle 1% deviation


Employment

W a g e s S h a r e

0 10 20 30 40 503.8

3.75

3.7

3.65

3.6

Debt to Output Equilibrium

Debt to Output 1% deviation


Years

R a t i o t o

G D P

Debt Stabilises

1 1 d1

• But which cansuffer debt-inducedbreakdown if

far fromequilibrium…





• Exactly thesame model;

• Differentinitialconditions:

0 50 100 150 200 250 3000.4

0.6

0.8

1

1.2

1.4

1.6

Wages Share Equilibrium

Wages Share Non-equilibrium

Employment Equilibrium

Employment Non-equilibrium

Goodwin with Debt: Unstable

Years

P e r c e n t

0.6 0.7 0.8 0.9 1 1.10.4

0.6

0.8

1

1.2

1.4

1.6

Equilibrium Pair

Cycle Non-equilibrium


Employment

W a g e s S h a r e

0 50 100 150 200 250 3004

2

0

2

4

6

Debt to Output Equilibrium

Debt to Output 1% deviation


Years

R a t i o t o G

D P

Debt Explodes

2 2 d2

• Cyclical

pattern ofdebt to outputvery similar todata on US andAustralian

economies:





• Click on graph to run it dynamically…

• Model replicates Minsky’s verbal description of ―freemarket‖ (no government) capitalist economy

• What about mixed economy?





• Add in government sector with spending afunction of unemployment rate:

1 dG

g G dt

1

GDP

dg g g

g dt

• ―% rate of change of government spendingis a function of the rate of employment‖

• Results in 4th

rate of change expression:• ―The government spending to output

ratio will grow if the rate of growth ofgovernment spending exceeds the rate

of economic growth‖





• Results in model which is cyclical but not unstable:

Employment rate

Time (Years)

0 100 200 300 4000

.5

1.0

1.5

2.0Wage Share

Time (Years)

0 100 200 300 400.6

.7

.8

.9

1.0

1.1Limit Cycle

.6 .725 .85 .975 1.1.80

.85

.90

.95

1.00

1.05

Debt/Output

Time (Years)

0 100 200 300 400-2

0

2

4Government spending to output

Time (years)

0 100 200 300 400-.20

.05

.30

.55

.80





• How does model compare to reality?

– Real world a mixture of ―free market‖ & ―mixedeconomy‖ models

• Model government ―holds the line‖ on unemployment

– Real-world ones progressively reduced commitmentto employment since WWII

• Model’s investment (etc.) parameters fixed – Real world (and Minsky’s) behaviours evolve over time

• more speculation as memory of crisis recedes

• No price dynamics in model

– Real-world inflation can reduce debt burden• But deflation increases it

– Price dynamics can be added to model





• Minsky prognosis for world/Australian economies

– Debt levels now at historic highs

– Inflation now close to zero (except for oil, Chinaimpact on raw material prices—steel etc.)

– Government anti-cyclical spending weakened by 30 years of neoclassical economic policy

– Recessions inevitable (economy fundamentally cyclical)• Next one could be extended by impact of

– Substantial debt levels

– Low or falling prices• Precursor: Japan’s economic crisis 1990-2005

• Next week: A managerial look at finance

– Finale: to run Minsky models dynamically, install Vissim

viewer (on WebCT) and run Vissim models

References



References• Minsky Models

– Deleplace, G. & Nell, E.J. (eds.), 1996, Money in Motion: The Post Keynesian and Circulation Approaches , Macmillan, London.

– Deleplace, G. & Nell, E.J., 1996b ―Monetary Circulation and Effective Demand‖, in Deleplace,

G. & Nell, E.J. (1996a).– Desai, M., 1973, ―Growth Cycles and Inflation in a Model of the Class Struggle‖, Journal of

Economic Theory , Vol. 6, 527-545.– Desai, M., 1995, ―An Endogenous Growth-Cycle with Vintage Capital‖ Economics of Planning,

Vol 28, Iss 2-3, 87-91.– Jarsulic, M., 1989, ―Endogenous credit snd endogenous business cycles‖, Journal of Post

Keynesian Economics , Vol. 12, 35-48.– Keen, S., 1995. ―Finance and economic breakdown: modelling Minsky’s Financial Instability

Hypothesis‖, Journal of Post Keynesian Economics , Vol. 17, No. 4, 607-635.– Keen, S., 1996. ―The chaos of finance‖, Economies et Societes , Vol. 30, special issue Monnaie et Production No. 10, 55-82.

– Keen, S., 1997. ―From stochastics to complexity in models of economic instability‖, Nonlinear Dynamics, Psychology and Life Sciences , Vol. 1, No. 2, 151-172.

– Keen, S., 1999. ―The nonlinear dynamics of debt deflation‖, Complexity International , Volume6: http://journal-ci.csse.monash.edu.au/ci/vol06/keen/keen.html.

– Keen, S., 2000. ―The nonlinear economics of debt deflation‖, in Barnett, W., Chiarella, C.,Keen, S., Marks, R., Schnabl, H., (eds.), Commerce, Complexity and Evolution , CambridgeUniversity Press, 83-110.

– Skott, P., 1989, ―Effective Demand, Class Struggle and Cyclical Growth‖, International Economic Review , Vol. 30 No. 1, 231-247.

• Goodwin, R.M., 1950, ―A non-linear theory of the cycle‖, Review of Economics and Statistics , Vol.32, 316-320.

• Goodwin, R.M., 1967, ―A Growth Cycle‖, in Feinstein, C.H. (ed.), Socialism, Capitalism and Economic Growth, Cambridge University Press, Cambridge, 54-58. Reprinted in Goodwin, R.M., 1982, Essays in Dynamic Economics, MacMillan, London.

managerial economics lecture economy alternative 02

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