https://criticalfinance.org/2016/09/08/consistent-modelling-and-inconsistent-terminology/
Jo Michell has a nice reply to Simon-Wren Lewis’ critique of stock-flow coherent models.
[the title of this post is the link]
Look for links to models around the world which use the SFC methodology.
This mini-post is more intended for my own reference, so that I remember this and don’t forget.
After all these years, Mario Draghi has finally said it. After repeatedly insisting Euro Area governments do “structural reforms”, Draghi has conceded that Germany should do a fiscal expansion.
Draghi: Counties that have fiscal space should use it. Germany has fiscal space
— European Central Bank (@ecb) September 8, 2016
Post-Keynesians have always maintained that “surplus” countries put a burden on “deficit” countries. Since Germany has a high positive current account balance, and sells its product abroad, it isn’t unfair to ask its government to expand domestic demand via fiscal policy and reduce imbalances.
In my opinion, what Kaldor calls the principle of circular and cumulative causation (originally ascribed to Gunnar Myrdal) is as much an important principle in economics as is the Keynesian principle of effective demand. The former is built on top of the latter and so we could just have one most important Keynesian principle.
In an article Foundations And Implications Of Free Trade Theory, written in 📚 Unemployment In Western Countries – Proceedings Of A Conference Held By The International Economics Association At Bischenberg, France, Kaldor says:
Owing to increasing returns in processing activities (in manufactures) success breeds further success and failure begets more failure. Another Swedish economist, Gunnar Myrdal called this’the principle of circular and cumulative causation’.
It is as a result of this that free trade in the field of manfactured goods led to the concentration of manufacturing production in certain areas – to a ‘polarization process’ which inhibits the growth of such activities in some areas and concentrates them on others.
In a recent paper titled The debate Over ‘Thirlwall’s Law’: Balance-Of-Payments Constrained Growth Reconsidered, Robert Blecker says:
Another key empirical question is the direction of causality between export growth and capital accumulation: does the former cause the latter (as assumed implicitly in Thirlwall’s Law), or does the latter cause the former (as in some of the newer small-country models)? Perhaps this is a case of truly ‘circular and cumulative causation’, in which investment is required to promote exports and success in exporting in turn induces further investment.
I have always thought—ever since I have read Kaldor—that this is the case. When Kaldor says success creates more success, what he is really saying is that a rise in a success of a nation makes it more competitive and increases its exports and so on.
In Kaldorian models, however, elasticity of imports/exports is taken to be constant. Rise in production leads to a rise in productivity and hence price competitiveness. But there is no way in which there is a causation to non-price competitiveness (propensity to import, or income elasticities).
A more general modeling plus empirical work should actually study the impact on non-price competitiveness. Personally, my guess is that only this will explain the vast divergence in nations’ fortunes, empirically speaking. Without it, won’t be sufficient. Interestingly, I believe the dynamics could be complex and rich and even lead to convergence in some cases, although will remain just a theoretical curiosity.
This is a continuation of my post Simon Wren-Lewis On Wynne Godley’s Models. I was comparing stock-flow coherent models to DSGE models implicitly (didn’t mention the ‘DSGE’).
One of the things I spoke of was behaviour: firms deciding how much to produce. In stock-flow consistent models, it is decided by trends in sales. So if entrepreneurs see a fall in their inventory-to-sales ratio, they’ll produce more typically. This can be made more accurate. See Wynne Godley and Marc Lavoie’s text Monetary Economics for more details.
Here I want to concentrate on models such as DSGE or any other model used by institutions such as the UK Treasury for the case of production. In these models, there is a production function describing how much firms will produce. This is incorrect to begin with. It says nothing about behaviour. If households start borrowing a lot, in DSGE models, producers are still producing the same because production is governed by the production function. In stock-flow consistent models, simple modeling assumptions about how much firms produce are far superior. So in this case, in SFC, more borrowing leads to more sales and a change in sales trends, inventory/sales ratio and hence affecting how much will be produced.
The DSGE production function is thus inconsistent with the Keynesian principle of effective demand. DSGE is not even Keynesian. It’s thus ridiculous how economists defending DSGE models and its ancestors accuse SFC modelers of not paying attention to behaviour.
There is no branch of economics in which there is a wider gap between orthodox doctrine and actual problems than in the theory of international trade.
– Joan Robinson, The Need For A Reconsideration Of The Theory Of International Trade, 1973
Orthodox trade theory tells us that the “market mechanism” should work to resolve imbalances in the current account of balance of international payments. Although, the economics profession has conceded that Keynesianism is correct, it is still far from thinking clearly about international trade.
So it is a bit surprising that The Economist would say something unorthodox about this. In a recent article it complains about Germany:
This is the Post-Keynesian idea that surplus economies put a burden on deficit economies.
A fiscal expansion by the German government has the effect of raising domestic demand and imports and reducing the German current account balance of payments. This allows the rest of the world to grow both because of German imports and also because they are less “balance-of-payments constraint”.
Second, Brad Setser has a blog post on the current account surplus of the Republic of Korea (South Korea).
It’s impressive to see Setser get the causality right:
Fiscal policy alone doesn’t determine the current account (even if tends to be the biggest factor in the IMF’s own model). A boom in domestic demand, for example, would improve the fiscal balance and lower the current account surplus, just as a fall in private demand improves the current account balance while raising the fiscal deficit.
The current account balance, government’s budget balance and the private sector financial balance are related by an identity and sum to zero. But the identity itself shouldn’t be confused with causation.
The correct causation between the balances is between domestic demand and output at home versus abroad. This causality has been highlighted by Wynne Godley in the past. See more on this blog post by me here.
New Bank Of England Paper On The Financial Balances Model For The United Kingdom
Stephen Kinsella is out with a new paper with co-authors Stephen Burgess, Oliver Burrows, Antoine Godin, and Stephen Millard published by the Bank of England.
From the paper:
Our paper makes two contributions to the literature. First, we develop, estimate, and calibrate the model itself from first principles as well as describing the stock-flow consistent database we construct to validate the model; as far as we know, we are the first to develop such a sophisticated SFC model of the UK economy in recent years.4 And second, we impose several scenarios on the model to test its usefulness as a medium-term scenario analysis tool. The approach we propose to use links decisions about real variables to credit creation in the financial sector and decisions about asset allocation among investors. It was developed in the 1980s and 1990s by James Tobin on the one hand, and Wynne Godley and co-authors on the other, and is known as the ‘stock-flow consistent’ (SFC) approach. The approach is best described in Godley and Lavoie (2012) and Caverzasi and Godin (2015) and underpins the models of Barwell and Burrows (2011), Greiff et al. (2011), and Caiani et al. (2014a,b). Dos Santos (2006) describes how SFC models incorporate detailed accounting constraints typically found in systems of national accounts. SFC models allow us to build a framework for the model where every flow comes from somewhere in the economy and goes somewhere, and sectoral savings/borrowings and capital gains/losses add or subtract from stocks of wealth/debt, following Copeland (1949). Accounting constraints allow us to identify relationships between sectoral transactions in the short and long run. The addition of accounting constraints is crucial, as one aspect of the economy we would like to model is the way it might react differently when policies such as fiscal consolidations are imposed slowly or quickly
4 Such models were popular in the past; for example Davis (1987a, 1987b) developed a rudimentary stock flow consistent model of the UK economy.
[The title of this page is the link]