Transcript Post-Keynesian Economics – II

Post-Keynesian
Economics - II
D. Allen Dalton
ECON 325 – Radical Economics
Boise State University
Fall 2011
Post-Keynesian
Growth Economics
Solow Growth Model
• The basic neoclassical growth model
was developed by Robert Solow in
1956, extending a model developed
earlier by Roy Harrod (1939) and
Evsey Domar (1946) - the HarrodDomar Model.
– “A Contribution to the Theory of
Economic Growth,” QJE, 70 (1):65-94.
Solow Growth Model
• Five basic equations
– Macro production function
• Y/L = F (K/L) with diminishing returns to K and L
– GDP equation
• Y = C + I + G + NX
– Savings function
• I = sY; s is the marginal propensity to save out
of income
– Change in Capital equation
• ∆K = sY – dK; d is the rate of depreciation
– Change in Workforce equation
• Lt+1 = Lt(1 +gL); g is the growth rate of labor
Solow Model Graphical Presentation
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y = f(k); where y = Y/L, k = K/L
n = labor force growth rate
δ = depreciation
k = capital per worker (K/L)
y = output (income) per worker (Y/L)
L = labor force
s = saving rate
k is determined by three variables
– Investment (saving) per worker
– Population growth (increasing population reduces k)
– Depreciation (K declines as it depreciates)
Solow Model Graphical Presentation
• Production
function
showing
diminishing
returns to K
• Saving
function
• Capital
function
Solow Model Graphical Presentation
• When the savings
rate (sy) is greater
than the sum of
the labor force
growth rate and
the depreciation
rate [(n+d)k], then
capital per worker
is increasing;
output per worker
is increasing.
Solow Model Graphical Presentation
• When sy < (n+d)k,
then capital per
worker is
decreasing; output
per worker is
decreasing.
Solow Model Graphical Presentation
• When sy = (n+d)k,
then capital per
worker is constant,
output per worker
is constant, and
output is growing
at the rate of n
(labor force
growth rate).
Effects of Changes in Saving
• Suppose that
savings rate
increases (shift of
saving function
from sy to s1y.
• Saving now
exceeds labor
force growth and
depreciation.
• Capital
accumulation
occurs; k grows.
• Output per worker
grows.
Effects of Changes in Saving
• The economy
initially has a
higher growth rate
but ultimately
returns to the
steady-state
growth rate (n+d)
but capital per
worker and output
per worker is
permanently
higher.
Kaldor-Robinson Growth Model
• The basic Post-Keynesian growth model
was developed independently by
Nicholas Kaldor and Joan Robinson in
the 1950s, especially their respective
1956 writings.
– Kaldor
• "The Relation of Economic Growth and Cyclical
Fluctuations", 1954 EJ
• "Alternative Theories of Distribution", 1956, RES
• "A Model of Economic Growth", 1957, EJ .
– Robinson, The Accumulation of Capital, 1956.
Kaldor-Robinson Growth Model
• Classical division of world into
capitalists and workers, earning
profits and wages.
• Capitalists control rate of
investment; workers control rate of
consumption.
•Y=W+P=C+I
• S = swY + (sp-sw)P
• I = swY + (sp-sw)P
Kaldor-Robinson Growth Model
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•
I = swY + (sp-sw)P
I/Y = swY/Y + (sp-sw)P/Y
P/Y = [1/(sp-sw)][I/Y] – [sw/(sp-sw)]
Classical assumptions
– sw = 0 and sp = 1
• P/Y = I/Y
– The greater the rate of investment and
therefore economic growth, the greater
the share of the national income going to
capitalists!
Kaldor-Robinson Growth Model
• Relax Classical assumptions
– sw = 0 and sp < 1 (so some income from
profits spent on C)
• P/Y = (1/sp)(I/Y)
– The profit share of national income
for a given ratio of investment to
output will be higher the smaller is
the marginal propensity to save out of
profit income!
Post-Keynesian
Microeconomics
Individual Choice
Seven Principles of Consumer Choice
(1) Consumers follow habits & rules; they
satisfice rather than maximize.
(2) Beyond a threshold, once a need is met,
additional units of good bring no additional
satisfaction.
•
Exists at a positive price and finite income.
•
Changes in relative prices only affect choices within a
subgroup; all prices within a subgroup must change to
affect choices outside the subgroup.
(3) Consumers divide expenditures into
categories and subcategories.
Individual Choice
Seven Principles of Consumer Choice
(4) Needs are hierarchically ranked.
•
Essential needs financed first; then if discretionary
income remains, it is allocated to other subgroups by
priority. Not all goods can be substituted for others.
(5) Time and increases in income allow
movement from one need to another on the
hierarchy of needs.
•
People make way up their pyramid as their income
grows.
(6) Needs are non-independent.
(7) Past choices influence current choices.
Characteristics of Firms
• Imperfectly competitive markets
the rule; firms are price-setters.
• Firm decision-making is
interdependent; strategy is
essential behavioral attribute.
• Divorce of ownership and control
means other goals (market share,
firm survival) take precedence over
profit-maximization.
Costs of Production
• Input ratios are technologically
fixed within a production process.
– Very little substitution between
inputs
– Fixed technical coefficients
• Practical capacity is engineer-rated
Costs of Production
• The unit direct costs (≈AVC) and
marginal costs of a plant are
approximately constant up to practical
capacity.
• Unit cost (≈ATC) is generally decreasing
until practical capacity is reached
• Production beyond practical capacity
entails rapidly increasing marginal costs
• Cost curves do not include opportunity
costs
Costs of Production
• Firms usually
operate with
excess capacity
(average costs are
constant).
• Excess capacity
plays a role for
firms similar to
the role liquidity
plays for
households flexibility.
• Firms have other
sources of
flexibility – e.g.,
inventories and
overtime.
Price-Setting
• All Post-Keynesian price-setting models are
versions of cost-plus pricing.
• Mark-up pricing
– Prices depend on UDC. A gross-costing margin is
added (covering overhead costs and desired
profits) to arrive at price.
• Normal-cost pricing
– Takes advantage of accounting practices to assign
a part of general costs to each manufactured
product.
– Firms calculate a normal unit cost (includes both
direct and attributed overhead costs) at the
normal level of production, to which they add a net
costing margin covering profits. The normal unit
cost is independent of demand.
Price-Setting
• Under cost-plus pricing, changes in
demand lead neither to an increase in
unit costs nor to an increase in prices.
• Inventories buffer the changes in
demand, rather than prices.
• Cost-plus pricing reflects behavior of
leading firms in the industry; other
firms must decide whether to follow.
• What ultimately determines the size of
the costing margin?
Price-Setting
• What ultimately determines the size of the
costing margin?
– The target rate of return.
• What determines the target rate of return?
– What determines the normal profit rate?
– Following the growth models of Kaldor and
Robinson, what determines the macroeconomic
profit rate is the macroeconomic growth rate!
– Sraffian’s argue that the normal profit rate
depends upon the rate of interest.
– Marxian-influenced Post-Keynesians argue the
normal profit rate is determined by class struggle
and (Kaleckians) the degree of monopoly power.
Post-Keynesian
Macroeconomics
Monetary Theory
• Endogenous Money
– Supply of money determined by the demand
for bank credit and the public’s
preferences.
– Creation of loans and hence deposits is ex
nihilo – without previous reserves - all that
is needed is a credible borrower.
– Banks obtain cash and required reserves
from the central bank as a consequence of
loan-creation.
Monetary Theory
All money
(reserves, currency, deposits)
is endogenous
and demand-determined!
Monetary Theory
• All interest rates are tied to the
“benchmark rate” that is administered
by the central bank.
• The rate chosen by the central bank is
described by a reaction function,
specifying the policy goals the central
bank has.
– e.g., raise interest rates when the inflation
is rising, unemployment falling, capacity
utilization is high.
Monetary Theory
• At any given point
in time, the supply
of money is
perfectly elastic
at the benchmark
rate.
• The demand for
money is
determined by
the loan rate of
interest, the
growth rate of
output, the growth
rate of prices and
the rate of
investment.
i
R
St2
St1
St0
D
High-powered Money
Financial Instability Hypothesis
• Focus on “capital development of
economy” rather than “allocation of
resources”
• Capital development is accompanied by
exchanges of present money for future
money
– “Present money” pays for resources into
production of investment output; “Future
money” is the profits accruing to capitalasset owning firms
– Control over capital stock is financed by
liabilities
Financial Instability Hypothesis
• Liability Structures: the balance sheet of
firms determine a time-series of payment
commitments and time-series of
conjectured cash receipts
– Money flows are from depositors to banks to
firms, and then from firms to banks to depositors
– Flow of money to firms is response to expected
future profits; Flow of money from firms is result
of realized profits
• Consumers, governments and international
agents also have liability structures
Financial Instability Hypothesis
• The key determinant of system
behavior is the level of profits
• FIH incorporates the Kaleckian view of
profits – structure of AD determines
profits
– Simplest model, the aggregate level of
profits equals the aggregate level of
investment each period (P/Y = I/Y).
• FIH is a theory of the impact of debt
on system behavior.
Financial Instability Hypothesis
• Banks are innovative profit-seekers
– Seek to innovate new profitable assets
they acquire and liabilities they market
• Three distinct income-debt relations
for economic agents
– Hedge-financing
– Speculative -financing
– Ponzi-financing
Financial Instability Hypothesis
• Hedge finance: agents which can fulfill
all of their payment obligations from
cash flows
• Speculative finance: agents which can
fulfill their payment obligations from
their income account, even though cash
flow can not repay principle on
contractual debt (such units must “roll
over” debt)
Financial Instability Hypothesis
• Ponzi finance: cash flows are not
sufficient to fulfill either repayment of
principle or interest due on outstanding
debt; such agents must either sell
assets or increase borrowing
– Borrowing or selling assets lowers the
equity of these agents
Financial Instability Hypothesis
• First Theorem
– “The economy has financing regimes under
which it is stable, and financing regimes
under which it is unstable.”
If hedge-financing dominates, the economy is an
equilibrium-seeking and containing system. The
greater the weight of speculative and Ponzi
financing, the greater the likelihood the
economy is a deviation-amplifying system.
Source: Hyman Minsky, “The Financial Instability Hypothesis”, Handbook of Radical Political Economy, 1993.
Financial Instability Hypothesis
• Second Theorem
– “Over periods of prolonged prosperity, the
economy transits from financial relations
that make for a stable system to financial
relations that make for an unstable
system.”
If an unstable economy occurs during a period
of inflation, an attempt to reduce inflation via
monetary constraint will push speculative units
into Ponzi units and Ponzi units will see their
asset values collapse.
Source: Hyman Minsky, “The Financial Instability Hypothesis”, Handbook of Radical Political Economy, 1993.
FIH: The Central Question
Why does speculative
and Ponzi financing
become more prevalent
in times of prolonged
prosperity?
Monetary Circuit Theory
• Monetary Circuit Theory
• Two matrices; balance-sheet matrix and a
transactions-flow matrix.
• Balance sheets deal with stocks
• Each stock associated with a given flow
– Simple Model
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Banks do not make profits
Households don’t borrow
Firms don’t hold money balances
Flows must balance
Positive signs represent sources of funds,
negative signs represent use of funds
Monetary Circuit Theory
Source: Marc Lavoie, Introduction to Post-Keynesian Economics, p. 77.
Monetary Circuit Theory
• Monetary Circuit Theory
– Firms borrow funds needed to pay wages to
households
– When wages are paid, they become income for
households
– When received as income, before consumption,
these funds become savings
– Savings become a deposit for banks in their capital
account
– As income is consumed, it becomes a source of
funds for firms
– Any unsold product become inventories
Aggregate Demand Theory
• Keynes’ General Theory
– Kaleckian alternative
• Aggregate Supply Function
– Relationship of firms’ expected sales
receipts to level of employment hired
• Aggregate Demand Function
– Relationship of households’ expected
purchases to level of employment
• Interaction produces Macreconomic
equilibrium
Aggregate Supply and Demand
• Keynes
viewed Say’s
Law as
requiring a
coincidence
between the
Z and D
functions
Source: Paul Davidson, “Reviving Keynes’ Revolution,” Why Economists Disagree, p. 70.
Keynes and Say’s Law
• Whether Keynes accurately portrayed
Say’s Law has been a subject of a
prolonged and ongoing debate.
• Leijonhufvud argues that what Say had
in mind was a “constraint on reasoning,”
and that therefore Say’s Law is really a
relationship between plans and not the
fruition of plans.
We won’t enter into that debate here (take my
Macroeconomics class in the spring if you want
to understand the debate and its importance).
Aggregate Supply and Demand
• Keynes argued
that involuntary
unemployment
is due to a lack
of effective
demand (Given
D at D’,
equilibrium
sales are E and
employment is
N1 rather than
full employment
Nf
Source: Paul Davidson, “Reviving Keynes’ Revolution,” Why Economists Disagree, p. 70.
‘
Aggregate Demand Theory
• The primary determinant of the level of
effective demand is investment, which
does not require saving.
• Rather investment only depends upon
the willingness to borrow (tied to
expected sales) and the willingness to
lend (tied to expected sales).
• Thus the importance of consumer
demand in molding the expectations of
firms and banks to enter into loan
contracts to finance investment.
Post-Keynesian
Political Economy
Normative Criteria and Policy
Espousal
• Success at full employment and fair
distribution of income rather than
success at allocating resources
• Government Management
• Price and income policies can do
good
• Socialist to corporate liberalism