Financialisation Issues in a Post-Keynesian Stock-Flow Consistent Model Marc Lavoie University of Ottawa (based on work with Wynne Godley)

Paper is…  Based on Chapter 11 of a book written with Wynne Godley  Monetary Economics: An Integrated Approach to Credit, Money, Income, Production and Wealth  Macmillan/Palgrave 2007

The model …  Can be found as an E-views file on the web site: gennaro.zezza.it/software/models

Outline of the presentation  SFC features  Main features of the model  Experiments (simulations): changing some parameter values linked to financialisation issues: charts

SFC ?  All sectors face budget constraints  Financial interdependence between sectors  Stock variables arise from flows and capital appreciation: historical time  There exist stock-flow norms (which may change through time)  People react and adjust to disequilibria

SFC of some form in PKE and other heterodox economics  Davidson, Minsky  Eichner 1985  Peter Skott 1989  Institutionalists: Copeland 1947

The buffer principle: All sectors need a buffer that provide an adjustment factor  Firms: inventories and bank loans  Households: holdings of money deposits  Government: bills issued  Central bank: residual purchaser of bills or advances made to private banks  Banks: bills held or advances obtained from central bank

Objective  To simulate a complicated model that entertains several realistic features  All blocks (sectors) are well developed  Growth model  Where demand is constrained in the long run by the growth rate of the supply side (labour productivity)  Here we look at issues tied to financialisation

Firms  Follow normal cost pricing procedures, based on historical costs  Mark-up depends on planned entrepreneurial profits, which depend on investment expenditures  Firms borrow mainly to fund inventories  Firms issue shares to finance investment not funded through retained earnings  The rate of accumulation depends on capacity utilization and the real interest rate The main drawback is that firms do not hold financial assets

Inflation: a kind of conflictual inflation  Workers are targeting a real wage, based on productivity growth and employment rates.  Firms are looking for a profit margin that will finance a given proportion of their investments.  The inflation rate is proportional to the discrepancy between the actual and the target real wage.  The Phillips curve is flat within a certain employment range.

Households  Consumption on the basis of past real wealth current disposable income net of interest payments on loans, plus net additions to outstanding loans  Gross new loans is a fraction of personal income  Standard portfolio equations with adding-up conditions

Government and the central bank  Pure government expenditures (excluding debt servicing) grow at a rate equal to the growth rate of labour productivity. This is the main exogenous variable.  Cash, bank reserves, bills and bonds are all supplied on demand (monetization is fully demand-led)

More realistic PK bank  Banks have own funds (net worth)  Banks have retained earnings  Banks make loans to firms and to consumers  Banks face a BIS-imposed capital adequacy ratio (CAR) – the Cooke ratio (own funds to loans ratio)  Banks have a target liquidity ratio: bills to deposits ratio (both target ratios must be achieved in the medium run

The determination of interest rates  The (nominal) Treasury bill rate is set exogenously by the central bank.  The bond rate is also set exogenously (or it can be made endogenous, if its supply is set in relative terms)  The deposit rate relative to the bill rate is endogenous, set by banks, based on a bank reaction function that depends on the liquidity preference of banks  The lending rate is marked up over the deposit rate, to insure bank profits and fulfil BIS rules

Experiments  Increase the proportion of gross investment financed by retained earnings (i.e. diminish equity issues)  Increase the proportion of profits distributed as dividends  Increase the desire to hold equities  Increase the ratio of gross new loans to personal income  Increase the default rate on loans