Transcript Managerial Economics - Amazon Web Services

Managerial Economics
Lecture Nine:
Alternative theories of
macroeconomic behaviour
Recap
• Last week
– Empirical data on economic cycle contradicts
neoclassical economics:
– Prices anti-cyclical
– Wages pro-cyclical
• No “diminishing marginal productivity”
– Credit leads cycle, money base follows
• Not “quantity theory of money” but “endogenous
credit & 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 cycle
while the much larger nontransaction component (M2)
leads the cycle suggests that credit arrangements could
play a significant role in future business cycle theory.
• Introducing money and credit into growth theory in a
way that accounts for the cyclical behavior of
monetary as well as real aggregates is an important
open 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 Instability
Hypothesis”
• Key proposition: “The most significant economic event of
the era since World War II is something that has not
happened: there has not been a deep and long-lasting
depression.” (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 protracted
depression is a striking success.
– Before World War II, serious depressions occurred
regularly. The Great Depression of the 1930s was just
a "bigger and better" example of the hard times that
occurred so frequently. This postwar success indicates
that something is right about the institutional
structure and the policy interventions that were
largely 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
250
10 years to
restore output levels
GDP Index (1913=100)
200
150
30%
25%
20%
15%
WW
10%
II
5%
50
0%
GDP Change
100
30% fall in
output in 4 years
-5%
-10%
-15%
1942
1940
1938
1936
1934
1932
1930
1928
1926
1924
1922
-20%
1920
0
pr
9
-2
ct
-2
A 9
pr
-3
O 0
ct
-3
A 0
pr
-3
O 1
ct
-3
A 1
pr
-3
O 2
ct
-3
A 2
pr
-3
O 3
ct
-3
A 3
pr
-3
O 4
ct
-3
A 4
pr
-3
O 5
ct
-3
A 5
pr
-3
O 6
ct
-3
A 6
pr
-3
O 7
ct
-3
A 7
pr
-3
O 8
ct
-3
A 8
pr
-3
O 9
ct
-3
A 9
pr
-4
O 0
ct
-4
A 0
pr
-4
O 1
ct
-4
A 1
pr
-4
O 2
ct
-4
2
O
A
USA Unemployment Rate (Seasonally Adjusted)
The Great Depression
30
To 25% in 3 years
25
From effectively zero...
WW II Brings
Sustained Recovery
20
15
10
5
Source: NBER data series m08292a
0
Minskian Economic History
• Minsky’s reading of Depression:
– Final in series of financial crises in which accumulated
debt & falling prices overwhelmed system
– Deflation (prices fell by up to 10% p.a.) meant real
rate of interest exceeded 15%
– Nominal debt fell but real debt (ratio nominal debt to
nominal 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…
30/08/96
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30/08/36
Korean War Inflation
Even more negative real rate
during Post-War recovery
30/08/34
-20
30/08/32
-15
Massive positive “real” rates due to
deflation in Great Depression
25
30/08/30
-10
30/08/28
-5
30/08/26
0
30/08/24
5
30/08/22
10
30/08/20
15
Huge deflation caused by post-WWI
return to the Gold Standard by UK
20
30/08/18
USA Interest Rates 1918-2000
Interbank Rate
Real Rate
Inflation Rate
Linear (Real Rate)
Poly. (Real Rate)
Negative
real
rates Post-War stability
during
WW II
Minskian Economic History
• 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 counterbalanced
private sector tendencies to excess during boom,
frugality during slump
• Institutions designed to attenuate excessive behaviour
in borrowing, lending, investing…
• Emphasis upon income equality
– Less money for speculation by wealthy
– More for income-financed stable mass consumption
Minskian Economic History
• Gradual development of problems since WWII due to
gradual
– Increase in debt to income levels over many business
cycles
– 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 high
growth/employment
– 1973: major financial crisis in period of high
employment:
• Income distribution (high wages) and raw materials (high
prices) driven inflation
• “Stagflation”: first major post WWII financial crisis
Financial Instability Hypothesis
• 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 economy
of 1980 and that of 1930 are responsible for the
success of the postwar era.” (xi)
• Neoclassical & conventional “Keynesian” models can’t do
this because they are timeless equilibrium models
– might explain equilibrium but
• Can’t explain location of equilibrium itself
• Omit time processes that are evolutionary and nonequilibrium
Financial Instability Hypothesis
• Minsky knew suitable model had to
– treat financial crises as normal events in
unconstrained 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 threat
of a financial crisis or a debtdeflation process took
place.
• The decade since 1966 has been characterized by
financial turmoil. Three threats of financial crisis
occurred, during which Federal Reserve interventions in
money and financial markets were needed to abort the
potential crises.” (1982: 63)
– Minsky on the historical record 1948-1978
Financial Instability Hypothesis
• “The first post-World War II threat of a financial crisis
that required Federal Reserve special intervention was
the so-called "credit crunch" of 1966. This episode
centered around a "run" on bank-negotiable certificates
of deposit.
• The second occurred in 1970, and the immediate focus of
the difficulties was a "run" on the commercial paper
market following the failure of the PennCentral Railroad.
• The third threat of a crisis in the decade occurred in
1974-75 … can be best identified as centering around the
speculative activities of the giant banks. In this third
episode the Franklin National Bank of New York, with
assets of $5 billion as of December 1973, failed after a
"run" on its overseas branch.” (63)
Financial Instability Hypothesis
• The lessons from this history?:
– “Since this recent financial instability is a recurrence
of phenomena that regularly characterized our
economy before World War II, it is reasonable to
view financial crises as systemic, rather than
accidental, events.
– From this perspective, the anomaly is the twenty
years after World War II during which financial
crises were absent, which can be explained by the
extremely robust financial structure that resulted
from a Great War following hard upon a deep
depression.
– Since the middle sixties the historic crisis-prone
behavior of an economy with capitalist financial
institutions has reasserted itself…” (63)
Financial Instability Hypothesis
• Minsky’s view of unbridled capitalism supported by record
of 19th century trade cycle:
The 19th Century Trade Cycle
•Procyclical
prices
•Financial
crises
roughly every
20 years
0.2
Annual Change
•Frequent
wage falls
Manufacturing Output
Wholesale Prices
Composite Wages
0.3
0.1
0.0
-0.1
-0.2
1864.0
1875.5
1887.0
Year
1898.5
1910.0
Financial Instability Hypothesis
• But post-1973 still differs from pre-WWII periods of
instability:
– The past decade differs from the era before World
War II in that embryonic financial crises have been
aborted by a combination of support operations by the
Federal Reserve and the income, employment, and
financial effects that flow from an immensely larger
government sector. This success has had a side effect,
however; accelerating inflation has followed each
success 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 a
degree
• 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 build
mathematical model of trade cycle (based on Hicks’s
difference 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 cycle
Model was
Yt      Yt 1   Yt 2
• Minsky made  dependent on financial conditions
•  declines as economy grows, thus giving turning point
to upward explosive movement:
• "the accelerator coefficient ... is in part based on
the productive efficiency of investment, but it is
also related to the willingness of investors to take
risks and the terms in which investors can finance
their endeavours..." (Minsky 1965: 261)
Brief HET of Minsky
• Model went nowhere, but Minsky began to explore
implications of finance for economic behaviour
• Initially tried from conventional understanding of Keynes:
– “If we make the Keynesian assumption that
consumption demand is independent of interest rates,
but assume that investment demand, and hence the 
coefficient, depends on interest rates, then a rising
set 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 conventional
view which is mainly derived from Hicks' "Mr. Keynes
and 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 to
Hicks 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 than
the 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”
There’s more than one “Keynes”
• Two price level analysis becomes more dominant
subsequent to General Theory:
– The scale of production of capital assets “depends, of
course, on the relation between their costs of
production and the prices which they are expected to
realise in the market.” (Keynes 1937a: 217)
– “Marginal Efficiency of Investment” (MEI or MEC for
“Capital”) analysis akin to view that uncertainty can be
reduced “to the same calculable status as that of
certainty itself” via a “Benthamite calculus”, whereas
– uncertainty in investment is that about which “there is
no scientific basis on which to form any calculable
probability whatever. We simply do not know.” (Keynes
1937a: 213, 214)
There’s more than one “Keynes”
• Three aspects to expectations formation under true
uncertainty
– Presumption that “the present is a much more
serviceable guide to the future than a candid
examination of past experience would show it to have
been hitherto”
– Belief that “the existing state of opinion as expressed
in prices and the character of existing output is based
on a correct summing up of future prospects”
– Reliance on mass sentiment: “we endeavour to fall back
on 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 the
people 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 the
future
– His/her response is not “risky”; it is uncertain.
• Ditto to individual investments
• success/failure of past instances give no guide to
present “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 our
society
– “play the game” & hope for the best
• So what about investors?
There’s more than one “Keynes”
• In the midst of incalculable uncertainty, investors form
fragile expectations about the future
• These are crystallised in the prices they place upon
capital asset
• These prices are therefore subject to sudden and violent
change
– with equally sudden and violent consequences for the
propensity to invest
• The “marginal efficiency of capital/investment” is simply
ratio of yield from asset to its current demand price, and
therefore there is a different “marginal efficiency of
capital” for every different level of asset prices (Keynes
1937a: 222)
There’s more than one “Keynes”
• In 1969, Minsky states that his own ideas about
uncertainty "seem to be consistent with those of Keynes"
(1969a, 1982: 191, footnote 6), citing Keynes 1937
• Eventually concludes
– “capitalism is inherently flawed, being prone to
booms, crises and depressions. This instability, in
my view, is due to characteristics the financial
system must possess if it is to be consistent with
full-blown capitalism. Such a financial system will
be capable of both generating signals that induce an
accelerating desire to invest and of financing that
accelerating investment.” (Minsky 1969b: 224)
• Combines elements of Marx, Keynes & Schumpeter
• Christens his model the “Financial Instability
Hypothesis”:
Financial Instability Hypothesis
• “The natural starting place for analyzing the relation
between debt and income is to take an economy with a
cyclical past that is now doing well.
• The inherited debt reflects the history of the economy,
which includes a period in the not too distant past in
which the economy did not do well.
• Acceptable liability structures are based upon some
margin of safety so that expected cash flows, even in
periods when the economy is not doing well, will cover
contractual debt payments.
• As the period over which the economy does well
lengthens, two things become evident in board rooms.
Existing debts are easily validated and units that were
heavily in debt prospered; it paid to lever.” (65)
Financial Instability Hypothesis
• “After the event it becomes apparent that the margins
of 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 the
dealmaking that goes on between banks, investment
bankers, 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:
Financial Instability Hypothesis
• “Stable growth is inconsistent with the manner in which
investment is determined in an economy in which debtfinanced ownership of capital assets exists, and the extent
to which such debt financing can be carried is market
determined.
• It follows that the fundamental instability of a
capitalist economy is upward. The tendency to
transform doing well into a speculative investment boom
is the basic instability in a capitalist economy.” (65)
• This characteristic of capitalism necessarily missed by ISLM/AS-AD analysis because process fundamentally nonequilibrium in nature:
Financial Instability Hypothesis
• Whether neoclassical or Keynesian, IS-LM/AS-AD analysis
omits time and debt
– Difference between “Keynesian” (1950-1973) and
“Neoclassical” (1973+) economic management outcomes
may 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 in
Honor 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 ISLM as missing the point of Keynes and as bad economics
for an economy in time.” (Minsky 1982: 70)
Financial Instability Hypothesis
• But both equilibrium theories missed causal factors
behind deterioration:
– Evolution of riskier behavior & financial arrangements
as long period of tranquility changed expectations:
• “Stability—or tranquility—in a world with a cyclical past
and capitalist financial institutions is destabilizing.”
– Resulting cyclical/secular increase in debt levels made
economy more fragile, more susceptible to financial
crises
• Spelling Minsky’s model out step by step:
Financial Instability Hypothesis
• Economy in historical time
• Debt-induced recession in recent past
• Firms and banks conservative re debt/equity ratios, asset
valuation
• 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 assets
profitable
– 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 conservative
projects speculative
– forces non-Ponzi investors to attempt to sell assets to
service 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/equity
ratios
• Endogenous expansion of money supply reverses
• Investment evaporates; economic growth slows or
reverses
• 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-speculative
businesses
– 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
Minskian Economic History
• 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…
Minskian Economic History of Australia
• Data from
recent (2004)
PhD thesis:
• Luke Reedman, "As
assessment of the
Development of
Financial Fragility
in the Australian
economy“
• Rise in debt to
GDP from 50%
to 135% 19602000:
Minskian Economic History of Australia
• Interest payments peaked in 1989/90
• Corporate indebtedness decreased since 1990:
• BUT Household debt levels rising…
Minskian Economic History of Australia
• BUT Corporate indebtedness decreased since 1990:
• BUT overall fragility higher given debt repayments:
Minskian Economic History of Australia
• AND situation of Sydney households worst in history…
• Debt & financial fragility has risen as Minsky predicted…
Minskian Economic History of Australia
• Household & corporate sector now more susceptible to
financial crisis than ever before…
Minskian Economic History of Australia
• Cyclical “ratcheting up” of gap between expenditure and debt over last
40 years
• Household & corporate sector now net borrowers
– “A positive gap means that capital expenditures exceed available
internal funds.” (153)
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 that
mathematical models are key part of “rhetoric” of
economics
– If you can’t “say it” with maths, economists won’t
listen
• Can this be modelled mathematically?
– Yes but not with “equilibrium” tools
– Need something like what Minsky tried: mathematical
models that incorporate time
Modelling Financial Instability
• 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) show
differential 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 linear
second order equations
Modelling Financial Instability
• Several attempts to model Minsky in literature
– See references in final slide
• My model based on Goodwin’s trade cycle model (next
slide)
– Key component of dynamic model is “rate of change
of x with respect to time”
dx
 f x 
– Mathematically shown as dx/dt:
dt
• Similar to calculus you have done in Maths 1.3 etc.; BUT
• One key difference: calculus considers equations of form
dy
 f  x  • Rate of change of dependent variable a
dx
function of value of independent variable
dy
• Differential equations “rate of change of
 f y 
dependent variable a function of its own value” dx
Modelling Financial Instability
• Maths gets quite complicated (overview only here!); but
– Dividing by dependent variable puts equation in
“percentage change” form:
dx
 f  x  • Rate of change
dt
1 dx
 g  x  • Percentage rate of change
x dt
• % 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 relation
between debt and income is to take an economy with a
cyclical past that is now doing well…” (Minsky 1982: 65)
Modelling Financial Instability
“accelerator”
K
Y 
v
Y
L
a
productivity
• First stage: Goodwin’s model (of Marx’s
cyclical growth theory)
• Causal chain
– Capital (K) determines Output (Y)
– Output determines employment (L)
– Employment determines wages (w)
– Wages (wL) determine profit (P)
– Profit determines investment (I)
– Investment I determines capital K
– chain is closed
dw
L
 w f  
dt
N 


K 
I  k 
dK


 k   Y    K
dt
K 
Investment Depreciation
function
Phillips
curve
 Y w  L
Modelling Financial Instability
• Goodwin’s model reduces to two “% rate of change”
expressions:
1 d
 dt
 gGDP     • “% rate of change of employment rate
equals % rate of economic growth
minus % rate of population growth and
technical change”
• “Employment will rise if the rate of economic growth
exceeds the sum of population growth & technical change”
• “% rate of change of wages share of
 P    
GDP equals % increase in wages
 dt
(Phillips curve) minus % rate of
technical change”
• “Workers share of output will rise if the increase in wages
exceeds the rate of technical change”
1 d
Modelling Financial Instability
• Click on graph to run it dynamically…
• Adding debt relatively easy:
Modelling Financial Instability
• Debt finances investment
• Debt will grow if desired investment exceeds retained
earnings
• Interest is paid on outstanding debt:
dD
 I   where   Y W  r  D
dt
• Adds 3rd “% rate of change” expression:
I  Y W• “The debt to output ratio will
d  r  gGDP  
grow if the rate of interest
d dt
D
1 d
exceeds the rate of growth and
investment exceeds EBIT”
Modelling Financial Instability
0.85
Goodwin with Debt: Stable
0.84
Wages Share
0.95
0.9
0.85
0.8
0.83
0.82
0.81
0.8
0.75
0
10
20
30
40
50
Years
Wages Share Equilibrium
Wages Share 1% deviation
Employment Equilibrium
Employment 1% deviation
0.79
0.955
3.7
3.75
0
10
20
30
0.965
0.97
Debt Stabilises
3.65
3.8
0.96
Employment
Equilibrium Pair
Cycle 1% deviation
Goodwin with Debt: Stable
3.6
Ratio to GDP
• But which can
suffer debtinduced
breakdown if
far from
equilibrium…
Goodwin with Debt: Stable
1
Per cent
• Generates
system which
can be stable
if starts near
equilibrium:
40
50
Years
Debt to Output Equilibrium
Debt to Output 1% deviation
1  1  d1
0.975
0.98
Modelling Financial Instability
• Cyclical
pattern of
debt to output
very similar to
data on US and
Australian
economies:
Goodwin with Debt: Unstable
1.6
1.4
Wages Share
1.2
Per cent
Goodwin with Debt: Unstable
1.6
1.4
1
0.8
1.2
1
0.8
0.6
0.6
0.4
0
50
100
150
200
250
300
Years
Wages Share Equilibrium
Wages Share Non-equilibrium
Employment Equilibrium
Employment Non-equilibrium
0.4
0.6
2
0
2
0
50
100
150
200
250
0.8
0.9
Debt Explodes
4
4
0.7
Employment
Equilibrium Pair
Cycle Non-equilibrium
Goodwin with Debt: Unstable
6
Ratio to GDP
• Exactly the
same model;
• Different
initial
conditions:
300
Years
Debt to Output Equilibrium
Debt to Output 1% deviation
2  2  d2
1
1.1
Modelling Financial Instability
• Click on graph to run it dynamically…
• Model replicates Minsky’s verbal description of “free
market” (no government) capitalist economy
• What about mixed economy?
Modelling Financial Instability
• Add in government sector with spending a
function of unemployment rate:
1 dG
G dt
 g  
• “% rate of change of government spending
is a function of the rate of employment”
• Results in 4th rate of change expression:
1 dg
g dt
 g     gGDP • “The government spending to output
ratio will grow if the rate of growth of
government spending exceeds the rate
of economic growth”
Modelling Financial Instability
• Results in model which is cyclical but not unstable:
1.05
Limit Cycle
1.1
1.00
1.0
.95
.9
.90
.8
.85
.7
.80
.6
.725
.85
.975
1.1
.6
0
Wage Share
Employment rate
2.0
1.5
1.0
.5
100
200
300
0
0
400
100
Time (Years)
Debt/Output
4
.80
200
300
400
Time (Years)
Government spending to output
.55
2
.30
0
-2
0
.05
100
200
Time (Years)
300
400
-.20
0
100
200
Time (years)
300
400
Modelling Financial Instability
• How does model compare to reality?
– Real world a mixture of “free market” & “mixed
economy” models
• Model government “holds the line” on unemployment
– Real-world ones progressively reduced commitment
to 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
Modelling Financial Instability
• Minsky prognosis for world/Australian economies
– Debt levels now at historic highs
– Inflation now close to zero (except for oil, China
impact 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
•
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,
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, Volume
6: 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, Cambridge
University 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
–
•
•
G. & Nell, E.J. (1996a).
Growth, Cambridge University Press, Cambridge, 54-58. Reprinted in Goodwin, R.M., 1982, Essays
in Dynamic Economics, MacMillan, London.