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A Primer on SFC Models

A Primer on SFC Models. Cláudio H. Dos Santos (IPEA and Levy Economics Institute) Presentation at Unicamp – October 2, 2009. The “ Unexplored Frontier ” of Keynesian Theorizing ? (1-Davidson) .

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A Primer on SFC Models

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  1. A Primer on SFC Models Cláudio H. Dos Santos (IPEA and Levy Economics Institute) Presentation at Unicamp – October 2, 2009

  2. The “UnexploredFrontier” ofKeynesianTheorizing? (1-Davidson) • It will be the objective of the historical model developed below to provide a simple analysis of capital accumulation by blending the stock and flow elements in the demand and supply of (i) real capital, (ii) money, and (iii) securities (. . .) with the more familiar concepts (. . .) of effective demand developed in the General Theory. Within such a framework it is possible to provide more perspective on the interplay among organized security exchanges, corporate financing policy, investment underwriters and the banking system in channeling the financial funds necessary for capital accumulation. Regrettably this is an analysis which is virtually ignored in most ‘analytical’ Post-Keynesian models. (Davidson, 1972, p. 31)

  3. TheUnexploredFrontierofKeynesianTheorizing? (2 - Minsky) • “an ultimate reality in a capitalist economy is the set of interrelated balance sheets among the various units (…) the items in the balance sheets set up cash flows” (Minsky, 1975, p. 118). More precisely, “cash flows are the result of (1) the income-producing system, which includes wages, taxes and nonfinancial corporate gross profits after taxes, (2) the financial structure, which is composed of interest, dividends, rents, and repayments on loans, and (3) the dealing or trading in capital assets and financial instruments” (ibid., p. 118) • In fact, Minsky went as far as stating that his own “alternative interpretation [of Keynes] can be summarized as a theory of the determination of the effective budget constraints [of the various macroeconomic sectors],” and that “the economics of the determination of the budget constraint logically precedes and sets the stage for the economics of the selection of particular items of investment and consumption” (JMK, p. 132)

  4. TheUnexploredFrontierofKeynesianTheorizing? (3 - Tobin) • Hicks’s ‘IS-LM’ version of Keynesian [theory] . . . has a number of defects that have limited its usefulness and subjected it to attack. In this lecture, I wish to describe an alternative framework, which tries to repair some of those defects . . .. The principal features that differentiate the proposed framework from the standard macromodel are these: (i) precison regarding time . . . ; (ii) tracking of stocks . . . ; (iii) several assets and rates of return . . . ; (iv) modeling of financial and monetary policy operations . . . ; (v) (…) adding-up constraints. • (Tobin, 1982, Nobel Lecture)

  5. The “UnexploredFrontier” ofKeynesianTheorizing? (4 - Godley) • In what follows I am going to present a greatly simplified, but within its limitations realistic, model of how a modern monetary economy may work. Looked at one way, it contains nothing new. Keynes, Kaldor and Hicks (I hardly need say) all had very well worked out notions as to how economies - extremely complicated interdependent systems changing through historical time - function. The trouble is that none of these authors chose to formalise their systems, so it is extremely difficult to teach them reliably or rigorously, and there remains a penumbra of ambiguity around too much of what they wrote; for instance, there is still much room for argument about "what Keynes really meant". (Godley, 1996)

  6. “Familiar Concepts of Effective Demand” • P*X = Y = C + I + G + X – M What is the time horizon involved in this (flow) equilibrium? One year? Two years? A decade? In reality, this kind of reasoning is static and short run.

  7. Whataboutthe “less familiar” conceptsofeffectivedemand? • Any particular set of hypotheses one makes about “familiar flows” unavoidably has (saving and therefore) stock consequences. Just rearrange, for example, the equation mentioned before • Y – C – I – T– NISA= G - T + X – M – NISA • (where NISA= net income sent abroad) • Or Private Financial Balance = Current Account Balance – Gov Deficit • Unavoidably, unavoidably, unavoidably!!! If you want to ignore stock implications, do it knowing this.

  8. The famous Godley-Levy Graphs

  9. Obviously, flowscummulate in stocks..... • “De um ponto de vista estritamente contábil, o estoque da dívida externa bruta, em qualquer momento dado o resultado acumulado da parcela dos déficits em transações correntes não financiados pelo ingresso de capital de risco (ou por variações nas reservas internacionais). • DAVIDOFF CRUZ (1984, p. 11)

  10. More “less familiar concepts of effective demand”(1) – Financing Patterns • investment theories that neglect the financing needs of investing firms amount to ‘palpable nonsense’ (Minsky, 1986, p. 188).

  11. More “less familiar concepts of investment demand (2) –More generally, the decisions of wealth-owners • “O elemento crucial (...) [na dinâmica de uma economia periférica em um contexto de finanças globalizadas] é a expectativa dos “agentes” acerca dos efeitos provocados pelas mudanças nas relações entre juros e câmbio quanto à conveniência de se manter riqueza financeira em moeda local ou em divisa estrangeira” (Belluzo, no prefácio ao livro do professor Ricardo Carneiro). • And, ofcourse, thepost-Keynesianreadingofchapter 17 ofthe General Theory (seeKregel, in particular, and Carvalho and Possas)

  12. So what, then,makes a model SFC? • 1 – Identifying who are the “owners of the wealth” , the precise size of this wealth, and what they do with it! • 2 – Identifying how the size and distribution of the stocks of wealth change with time (i.e with short period flows and capital gains). • The previous two points allow one to identify the accumulation regimes which are “sustainable”. Or in other words, to analyze the patrimonial implications (and therefore sustainability) of any given configuration of effective demand

  13. Butthischangestheball game completely! • Because now, the emphasis is not on flows, but on stock-flow and stock-stock ratios. • To make the same point differently: changes in stock-flow and stock-stock ratios are very meaningful! Examples: capital to output ratio; loans to capital ratio; debt to income ratios, and so on... • And hence the meaning of the SFC steady-state. It is a situation in which all flows and stocks are growing at the same rate – so the patrimonial picture is frozen! Hence it has not a normative value, but a purely analytical one.

  14. “MeanigfulStock-flowandFlow-FlowRatios”

  15. The Nature of the SFC steady-state If the economy is moving away from any given steady-state, this means that stock-flow and/or stock-stock ratios are changing continuously – in other words, the balance of economic power (or fragility) is changing. A given configuration of effective demand is deeemed unsustainable if the economy is moving away from the steady-state – which means that some stock-flow or stock-stock ratios are exploding.

  16. TheMeaningofthe Stock Matrix. The Players andwhattheyhave

  17. Butwhoprecisely are the players in our patrimonial games? • SFC models make the relevant players explicit from the outset. This is done with the presentation of the “quintessentially SFC” accounting matrices. • But the choice of players is non-trivial. Who are the relevant players, for example, in the Brazilian patrimonial game? The government, sure. Multinationals, also. Banks, definitely. Brazilian productive capital? Pension Funds? • Following national accountants, most models define the players as households, productive firms, the financial sector, the government, and the rest of the world.

  18. TheMeaningoftheTransactionsMatrix – The players andwhatthey do

  19. Themodeltellsyouimplicationsof players doingwhatthey do.... • Theaccounting is notofcourseanend in itself– it mustbeadded to: 1)Behavioralequationsaboutflows + 2)Behavioralequationsaboutportfoliochoice + 3)Theoreticalequationsaboutassetpricedetermination = Short period (dis)equilibrium • Buteach short periodchangesthe stocks. Sothenext short period is differentfromthepreviousone. Sequencesof short period (dis)equilibria = Accumulation regimes

  20. OK, butsowhat (for policyandreflection)? • SFC models are theoreticallyrelevant for theirownsake. It is interesting to knowhowthingscould work. Our Arrow-Debreu equivalent? • Complex SFC modelscanbewrittenandcalibrated to shed light onspecifichistoricalperiodsandproduceusefulcenarios • But chances are thatthesimulationresultswilldependonspecificparameterchoices (andthere are manyofthemparameters) • Onanappliedcontextweprefer small parcimoniousmodels (New Cambridge ones) thatcanbecomplementedwithextra-modelinformation • Butthe debates are on.....

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