1. Behavioural Finance Lecture 12 Part 2
The Global Financial Crisis
Empirical Data & Modelling
2. Modelling financial instability Financial Instability Hypothesis only theory that makes sense of this data
Model in previous lecture
Had only implicit money
Omitted Ponzi Finance
Omitted role of deflation
This lecture
Model with Ponzi finance
Combining Minsky and the Circuit
Full monetary model of capitalism
3. Modelling financial instability Firstly: last weeks Goodwin model in equations
Causal chain: capital determines output
4. Modelling financial instability System has 4 differential equations:
5. Modelling financial instability 4 differential equations & 7 algebraic relations
6. Modelling financial instability Cyclical growth
7. Modelling financial instability Firms borrow when desired investment exceeds profits:
8. Modelling financial instability Now add in Ponzi Finance
Borrowing $ to speculate on rising asset prices
Adds to debt without adding to productive capital
Modelled as a function of rate of economic growth
Higher rate of growth, higher level of speculation
9. Modelling financial instability Now a six-dimensional model:
10. Modelling financial instability Dynamics
Borrow money to finance investment during a boom
Repay some of it during a slump
Debt/ Income ratio rises in series of booms/busts
Eventually one boom where debt accumulation passes point of no return
11. Modelling financial instability Driving force is debt to GDP ratio
12. Are We It Yet? Can summarise models equations in 4 stylised facts
Employment rises if growth exceeds productivity + population increase
Wages share grows if wage rises exceed productivity
Bank lend money to finance investment & speculation
Speculation rises when growth rises
Same model in flowchart form (with different parameters)
13. Are We It Yet? Minsky: Ponzi finance extension to Keen 1995
14. Are We It Yet? Weakness of previous model
Implicit money onlydeflationary process ignored
No explicit treatment of aggregate demand
Overcome by blending Minsky with the Circuit
Lay out basic macro operations in accounts table
See Roving Cavaliers of Credit for basic approach
Also Circuit Theory & Post Keynesian Economics
Generate financial flows dynamics
Couple with Goodwin cycle model
15. Are We It Yet? The financial flows table:
16. Modelling Minsky: Wage dynamics Phillips curve much maligned in economics
But used by almost all schools of thought
Also misunderstood: three factors, not just one:
1. Level of unemployment (highly nonlinear relationship)
2. Rate of change of unemployment
3. Rate of change of retail prices operating through cost of living adjustments in wage rates. (Phillips 1958 p. 283-4)
All 3 factors included in this model:
17. Are We It Yet? Graphing employment-wage change function only:
18. Are We It Yet? Investment, debt repayment and money relending functions:
19. Are We It Yet? Overall model: 14 equations (11 ODEs, 3 algebraic)
5 equations for financial sector
1 for prices
1 for wages
7 for physical economy
20. Are We It Yet? Same system in QED:
21. Are We It Yet? Integrating Minsky & the Circuit
Debt-deflationary dynamics in strictly monetary Minsky-Circuit model
The Great Moderation, then The Great Crash
22. Are We It Yet? Stability is destabilizing...
23. Are We It Yet? Income inequality
Not worker vs capitalist but worker vs banker
24. Are We It Yet? Can government policy save us?
Simple model with fiat injection implies can succeed against credit crunch alone:
25. Are We It Yet? My expectation: best outcome of government policy alone will be Japanese Stalemate
Government monetary injections neutralise private sector deleveraging
Outcome Turning Japanese:
Long-term stagnation and borderline deflation
Need debt abolition & real financial reform
Cancel debts that should never have been issued
Cauterise financial sector in the process
Reform assets to minimise chance of future bubbles
Shares on secondary market expire in 50 years
Property leverage limited to 10 times annual rental
