Stock-flow Consistent Framework Research Articles

Functional income distribution, effective demand and wealth in Denmark – insights from an empirical stock-flow consistent model

With the important contribution of Marglin and Bhaduri different demand and growth regimes were identified, which inspired a strand of empirical research aiming to uncover the type of growth regime. Most of these studies can be framed into two methodological approaches: (i) a structural, and (ii) an aggregative approach. In this paper, we use a third approach where we exploit the advantages of the stock-flow consistent framework. We argue that using an empirical SFC model retains the advantages of the two more widely used approaches, while adding some novel features: (i) the endogenization of income distribution, which allows for a two-way relationship between demand and income shares, (ii) the consistent incorporation of stock variables in the estimation of the equations of aggregate demand components, and (iii) the inclusion of endogenous labor market dynamics in the analysis. To introduce these features, we build an empirical stock-flow consistent model for Denmark for the period 2005q1–2020q1. Our analysis suggests that demand can neither be categorically defined as wage-led nor profit-led, as the effects of a change in income distribution on the aggregate demand components cancel each other out. Results are more conclusive for capital accumulation, which is found to be profit-led.

Interbank Decisions and Margins of Stability: an Agent-Based Stock-Flow Consistent Approach

This study investigates the functioning of modern payment systems through the lens of banks' maturity mismatch practices, and it examines the effects of banks' refusal to roll over short-term interbank liabilities on financial stability. Within an agent-based stock-flow consistent framework, banks can engage in two segments of the interbank market that differ in maturity, overnight and term. We compare two interbank matching scenarios to assess how bank-specific maturity targets, dependent on the dictates of the Net Stable Funding Ratio, impact the dynamics of the interbank market and the effectiveness of conventional monetary policies. The findings reveal that maturity misalignment between deficit and surplus banks compromises the interbank market's efficiency and increases reliance on the central bank's standing facilities. Monetary policy interest-rate steering practices also become less effective. The study also uncovers a dual stability-based configuration in the banking sector, resembling the segmented European interbank structure. This paper suggests that heterogeneous maturity mismatches between surplus and deficit banks may result in asymmetric funding frictions that might precede credit- and sovereign-risk explanations of interbank tensions. Also, a combined examination of macroprudential tools and rollover-based interbank dynamics can enhance our understanding of how regulatory changes impact the stability of heterogeneous banking sectors.

Balance Sheet Effects in a Financialized Environment: A Stock-Flow Consistent Framework for Mexico

ABSTRACT Exchange rate volatility, growing foreign corporate debt, and decreasing private investment ratio are among the consequences of financialization experienced by developing countries such as Mexico. The present work analyses the combined effect of these three factors using a Stock Flow Consistent (SFC) model. It analytically explores the balance sheet effect in the non-financial corporate sector; higher foreign debt would affect private investment after episodes of real currency depreciation. To explore such mechanisms, we simulate the commodity price cycle of the early 2000s alongside the shifts in the stance of the FED in the aftermath of the Global Financial Crisis. The scenario analysis points to a hysteresis of the Real Exchange Rate (RER) and an increase in foreign debt level.

Beyond normative system boundaries in life cycle assessment: The environmental effect of income redistribution

The current practice for assessing the environmental life cycle impacts of a product system is limited to the activities that respond directly to a change in demand. The revenue resulting from this change in demand is then used to pay for primary factors, such as wages and taxes, while the redistribution of that money is left outside the system boundaries. The aim of this paper is to address this limitation by providing a method in which the second order effects, i.e., the effects of re-spending that money, are included. For that, an income distribution model based on a simplified stock-flow consistent framework was developed. The method is applied in a closed economy consisting of six industries, banks and three household income groups. The dynamics of the income redistribution effects are studied throughout the rounds of (re)distribution, showing that the perturbation has a permanent effect on the economy, from environmental and social perspectives, and major changes occur in the first period of distribution. In addition, the paper also provides insights on the next steps for developing a full-scale model and discussions on the relationship between income distribution and productivity growth.

Household debt: The missing link between inequality and secular stagnation

Abstract How do inequality and growth evolve in the long run and why? We address this question by analyzing the interplay between household debt, growth and inequality within a monetary, stock-flow consistent framework. We first consider a Goodwin–Keen model where household consumption, rather than investment by firms, is the key behavioural driver for the dynamics of the economy. Whenever consumption exceeds current income, households can borrow from the banking sector. The resulting three dimensional dynamical system for wage share, employment rate, and household debt exhibits the characteristic asymptotic equilibria of the original Keen model, namely the analogue of Solow’s balanced-growth path, where all state variables converge to an interior point, in addition to deflationary equilibria with explosive debt and collapsing employment. We then extend this set-up by separating the household sector into workers and investors, obtaining a four-dimensional system with analogous types of asymptotic behaviour. Our main result is that long-run increasing inequality between these two classes of households occurs if and only if the system approaches one of the equilibria with unbounded debt ratios. More specifically, we find that one essential channel of increased inequality is the wealth transfer from workers to investors due to interest paid on debt from the former to the latter. Finally, when properly rewritten, the celebrated inequality r > g turns out to be a necessary condition for the asymptotic stability of long-run debt-deflation. Our findings shed new light on the relationships between fairness and efficiency, and have implications for public economic policy.

A Keynesian contribution to the theory of equity yields

This paper offers a Keynesian theory, in a Stock-Flow Consistent framework, to understand equity returns and their links with economic growth and consumption decisions from a long-run perspective. The main features of such a theory can be summarised as follows. First, there is a negative relationship between Tobin’s q and economic growth. Second, the effect of economic growth on dividend yields and earnings growth is positive, but its effect on the growth in the number of shares is negative (i.e. a ‘dilution effect’), which makes the relationship between equity returns and economic growth undetermined a priori. Third, consumption decisions emerge as crucial drivers for shareholder profitability in the long-run. And fourth, in the post-Keynesian theory the equity yield is determined by aggregate demand, and no theory of risk is needed. Finally, the post-Keynesian theory will be compared against the mainstream financial theory, which features the famous risk-return nexus where asset returns are given by the volatility of the asset respect to consumption. It will be claimed that the use of risk for determining equity returns at the macroeconomic level is problematic, and that depending on the risk definition assumed, the risk-return relationship can be either positive or negative – being thus such a nexus of little theoretical significance and posing serious problems for mainstream finance.

Quantitative Easing and Asset Bubbles in a Stock-Flow Consistent Framework

Ever since the Great Recession, central banks have supplemented their traditional policy tool of setting the short-term interest rate with massive buyouts of assets to extend lines of credit and jolt flagging demand. As with many new policies, there have been a range of reactions from economists, with some extolling quantitative easing's expansionary virtues and others fearing it might invariably lead to overvaluation of assets, instigating economic instability and bubble behavior. To investigate these theories, we combine elements of the models in chapters 5, 10, and 11 of Godley and Lavoie's (2007) Monetary Economics with equations for quantitative easing and endogenous bubbles in a new model. By running the model under a variety of parameters, we study the causal links between quantitative easing, asset overvaluation, and macroeconomic performance. Preliminary results suggest that rather than being pro- or countercyclical, quantitative easing acts as a sort of phase shift with respect to time.

Sovereign ratings, macroeconomic dynamics, and fiscal policy. Interactions within a stock flow consistent framework

AbstractOperating in the context of deregulated financial markets, credit rating agencies do not only ‘provide an opinion’, but also affect macroeconomic dynamics. By utilizing a two‐country stock flow consistent model that provides a representation of the Eurozone, the paper connects the movements of sovereign ratings with the dynamics of the financial market and the constraints on fiscal policy. With endogenous fiscal expenditure and an endogenous credit rating mechanism the model shows how following a recessionary shock, a rating downgrade can influence the financial constraints that surround a government, pushing it toward fiscal austerity and thereby deepening the already ongoing recession.

A Stock Flow Consistent Model of a Closed Economy with Defaults of Firms

Sequentially examining the full chain of events starting from the default of firms through the fire-sale of goods towards write-offs of bad loans, a new matrix of financial transactions was developed. It was shown that if firms have no equities, the cost of default of those firms is equal zero. Indeed, firms suffer from losses on fire-sales but at the same time, they have a benefit from write-offs of their loans. Whereas, banks incur only the losses on bad loans. This situation may restrain lending to the economy. The considered matrix of financial transactions was incorporated in the transactions-flows matrix of the closed economy consisting of households, firms, and banks. The obtained matrix significantly differs from Goodley’s and Lavoie’s matrix that the flows caused by write-offs of bad loans were taken to flows of incomes and expenses, not to the flows generated by changes in operating assets and liabilities. On the basis of the balance sheet and transactions-flows matrices, a mathematical model of the economy was developed. The used stock-flow consistent framework allows us to be sure that nothing will be lost neither in stocks nor in flows. The model allows studying how such the key parameters as the probability of default, the rate of fire-sales (new injected parameter), recovery rate, interest rates on loans and deposits affect the performance of banks and firms, observing economic dynamics in time under different macroprudential policy rules. Numerical simulation of the model was carried out. Under chosen parameters of the models, the net wealth of firms rises due to the cost of default is zero, while both the net wealth of banks and households at the beginning run high and then falls. Reasons for such behavior of the net wealth are significantly different. The net wealth of banks begins to fall due to the accumulation of credit losses. Whereas, the net wealth of households does begin to fall due to profit paradox, when workers of households have no sufficient money in order to buy out all produced goods, due to there is price markup.

Uneven Economic Development between Two Regions in a Stock-flow Consistent Framework

Uneven Economic Development between Two Regions in a Stock-flow Consistent Framework

A two-sector model with target-return pricing in a stock-flow consistent framework

ABSTRACTIn this paper, we build a generalized two-sector Kaleckian growth model and explore the dynamics towards long-run positions. The model incorporates conflicting claims of labour and firms over income distribution and endogenous labour-saving technical progress. Adopting a stock-flow consistent framework, our simulation experiments yield the following results. First, the ‘paradox of thrift’ and the ‘paradox of costs’ hold, meaning that lower saving rates generate higher growth rates while higher real wages generate higher profit rates, but the magnitude of the impact depends on the initial status of income distribution and monetary policy. Second, changes in autonomous labour-saving innovations might explain the phenomenon of the ‘New Economy’ of the second half of the 1990s within an alternative framework. Our simulations with a two-sector model retrieve the analytical results achieved with a one-sector Kaleckian model, with the addition of path dependence.

Does credit create a ‘growth imperative’? A quasi-stationary economy with interest-bearing debt

This paper addresses the question of whether a capitalist economy can ever sustain a ‘stationary’ (or non-growing) state, or whether, as often claimed, capitalism has an inherent ‘growth imperative’ arising from the charging of interest on debt. We outline the development of a dedicated system dynamics macro-economic model for describing Financial Assets and Liabilities in a Stock-Flow consistent Framework (FALSTAFF) and use this model to explore the potential for stationary state outcomes in an economy with balanced trade, credit creation by banks, and private equity. Contrary to claims in the literature, we find that neither credit creation nor the charging of interest on debt creates a ‘growth imperative’ in and of themselves. This finding remains true even when capital adequacy and liquidity requirements are imposed on banks. We test the robustness of our results in the face of random variations and one-off shocks. We show further that it is possible to move from a growth path towards a stationary state without either crashing the economy or dismantling the system. Nonetheless, there remain several good reasons to support the reform of the monetary system. Our model also supports critiques of austerity and underlines the value of countercyclical spending by government.

The Political Economy of Shadow Banking: Debt, Finance, and Distributive Politics Under a Kalecki-Goodwin-Minsky SFC Framework

This paper describes the political economy of shadow banking and how it relates to the dramatic institutional changes experienced by global capitalism over past 100 years. We suggest that the dynamics of shadow banking rest on the distributive tension between workers and firms. Politics wedge the operation of the shadow financial system as government policy internalizes, guides, and participates in dealings mediated by financial intermediaries. We propose a broad theoretical overview to formalize a stock-flow consistent (SFC) political economy model of shadow banking (stylized around the operation of money market mutual funds, or MMMFs). Preliminary simulations suggest that distributive dynamics indeed drive and provide a nest for the dynamics of shadow banking.

Fiscal Policy in a Stock-Flow Consistent (SFC) Model

This paper deploys a simple stock-flow consistent (SFC) model in order to examine various contentions regarding fiscal and monetary policy. It follows from the model that if the fiscal stance is not set in the appropriate fashion that is, at a well-defined level and growth rate - then full employment and low inflation will not be achieved in a sustainable way. We also show that fiscal policy on its own could achieve both full employment and a target rate of inflation. Finally, we arrive at two unconventional conclusions: first, that an economy (described within an SFC framework) with a real rate of interest net of taxes that exceeds the real growth rate will not generate explosive interest flows, even when the government is not targeting primary surpluses; and, second, that it cannot be assumed that a debtor country requires a trade surplus if interest payments on debt are not to explode.