Download Reconciling the Cambridge and Wall Street

Towards a postKeynesian consensus in
macroeconomics:
Reconciling the
Cambridge
and Wall Street views
Marc Lavoie
University of Ottawa
Problem statement
• The current financial crisis, which started to unfold in August
2007, is a reminder that macroeconomics cannot ignore
financial relations, otherwise financial crises cannot be
explained.
• It was not always clear how Cambridge economists did integrate
financial relations in their real models.
American PK vs Cambridge PK
• American PK: Money, debt, liquidity, interest
rates, cash flows
– Fundamentalist PK
– Financial Keynesianism
– Wall Street Keynesianism
• Cambridge PK: Real economy, actual and
normal profit rates, pricing, rates of utilization
– Robinsonians/Kaleckians
– Kaldorians
– Sraffians
Purpose of paper
• Recall frustrations of American PK strand with regards to the
apparent absence of monetary factors
• Go over standard Robinsonian/Kaleckian real growth models
• Recall early efforts to remedy to the problem in 1950s and
1960s
• Discuss efforts in the mid 1980s and early 1990s
• Discuss stock-flow consistent models as means to reconciliation
and provide some sort of consensus method
Cambridge macroeconomics
without money
• Davidson (1968, 1972) notes that in Kaldor’s famous
neo-Pasinetti theorem, where the propensity to save
out of wages has no impact on the rate of profit, as in
the Pasinetti 1962 model, there is no money.
• All saving is done in the form of stock-market shares.
• The theorem does not hold up when money as a
second asset is introduced.
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Cambridge macroeconomics
without money II
• Jan Kregel (1985, p. 133):
– “Money plays no more than a perfunctory role in the
Cambridge theories of growth, capital and distribution
developed after Keynes”.
• Cambridge macroeconomics without money is like Hamlet
without the Prince.
• Kregel (1986) calls for the introduction of Bulls and Bears into
heterodox Keynesian analysis, and for a generalization of
liquidity preference theory.
• The partial failure of the Trieste PK Summer school (1980s) to
integrate the Wall Street and the Cambridge views is an
exemplar of the growing frustration of members of both strands .
CAMBRIDGE-KALECKIAN
MODELS WITHOUT MONEY
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Effective demand and growth
• 1. The Old Cambridge growth models
– Robinson and Kaldor models
– Keynes’s paradox of thrift applied to the long run
• 2. The New Kaleckian growth models
– Paradox of costs
– Variants of the model
Stability in the Robinsonian model
gs
g
H
gi
gh*
g0
gs = sp.r
gi =  + .re
gb*
B
rb *
ra
r0
rh*
r
The paradox of thrift in the Robinsonian model:
A lower propensity to save leads to faster growth
g
gs
gs(sc2)
H’
g2 *
H
gi
g1*
gs = sp.r
=  + .re
r1 *
r2 *
r
The Kaleckian growth model
gs
g
gi

gs = sp.r
gi =  + (u-us )
r = f.u/v (PC)
f =profit share
u
g0*
 - .us
r
PC
ED
rs
ED obtained by
equating both g’s
r0 *
u0*
us
u
g
The Kaleckian paradox of costs: effect of a
reduction in
gs
gi
costing margins
g1*
gs =sp.r
gi =  + .(u-us )
g0*
u
r
PC
ED
r1 *
r = f.u/v
p = (1+)(w/pr)
w/p = pr/(1+)
f = / (1+)
r0 *
rmic
u0* u1
u1*
u
Limits to the paradox of costs
• The investment equation may be positively related to the profit
share f or to the target rate of return rs
(Bhaduri and Marglin 1990; Kurz 1990)
• In an open economy, rising real wages achieved by rising
wages may be detrimental to competiveness.
Limits to the paradoxes of
costs and of thrift
• There must be some mechanism that will bring back
the actual rate of utilization towards the normal rate
of utilization (Skott, Shaikh, Committeri)
• Here is one mechanism, based on inflation:
• What if higher rates of growth and/or higher rates of
capacity utilization are conducive to faster growth
rates?
• What if the central bank reacts to higher inflation
rates by raising real interest rates?
• What if real interest rates reduce investment?
• This is the Marxist story (Duménil and Lévy)
g
The Marxist story: return to the standard rate
gs
of capacity utilization
gi
g1*
g0
g2*
gs =sp.r
gi =  + .(u-us )
 = (u-us)
d/dt = - 
u
PC
r
ED
r1 *
r = f.u/v
p = (1+)(w/pr)
w/p = pr/(1+)
f = / (1+)
r2 = rs
us
u1*
u
Questioning the necessity of any
adjustment of u towards un
• Provisional equilibrium; everything moves anyway
(Chick and Caserta 1997)
• Other stock-flow norms in growth models are not
realized, even when agents try to achieve them –
wealth/income targets (Godley)
• There is a large range of acceptable “desired” or
“normal” rates of capacity utilization (Hicks, Dutt
1990).
• A firm may operate each running plant at optimal
capacity (cost-minimizing), while being unable to to
run all plants (idle capacity) (Caserta 1990).
An acceptable range of rates of capacity
utilization around the normal rate
• ‘The stock adjustment principle, with its
particular desired level of stocks, is itself a
simplification. It would be more realistic to
suppose that there is a range or interval,
within which the level of stock is
“comfortable”, so that no special measures
seem called for to change it. Only if the
actual level goes outside that range will there
be a reaction.’ (Hicks 1974, p. 19)
Even Sraffians accept that firms
usually have idle capacity
• ‘It is virtually impossible for the investment-saving
mechanism … to result in an optimal degree of
capacity utilization…. It is, rather, expected, that the
economy will generally exhibit smaller or larger
margins of unutilized capacity over and above the
difference between full and optimal capacity’. (Kurz
1994)
• ‘One must keep in mind that although each
entrepreneur might know the optimal degree of
capacity utilization, this is not enough to insure that
each of them will be able to realize this optimal rate’.
(Kurz 1993)
Still, we do not wish to sweep
the problem under the carpet
• There are mechanisms that can bring together the actual
and the normal rates of capacity utilization, by making the
normal rate endogenous to the values taken by the actual
rate (Lavoie 1992, 1996, 2003; Cassetti 2006,
Commendatore 2006).
• So normal rates adjust to the actual rates.
• With some specifications, these path-dependent models
safeguard both the paradoxes of thrift and of costs.
• A critique of these has been: why would firms modify the
normal rate of utilization just because it has not been
achieved recently (Skott 2008)?
BRINGING IN MONETARY
FACTORS IN CAMBRIDGE
MODELS
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A few efforts by Cambridge authors to
insert monetary factors
• Pasinetti (1974) distinguishes between the interest rate and the rate
of return of capitalists.
• Kaldor’s (1966) neo-Pasinetti model inserts stock market shares, as
does Moore (1975), with growth depending on the q-ratio, but they
both money deposits, as already pointed out.
• Several chapters on money and credit in Robinson’s (1956) The
Accumulation of Capital.
– the loaned amounts depend on the interest covering ratio, that is,
the ratio of (profit) income to due interest payments.
– the borrowing power of entrepreneurs will depend on “the
strictness of the banks’ standards of creditworthiness” and the
state of mind of individual investors, as well as “the subjective
attitude of potential lenders” .
• Joseph Steindl (1952) pays attention to the debt ratio of firms, and
the possible contradiction in the evolution of the target and the
actual debt ratios, but his book falls into oblivion.
The Sraffian contribution
• Garegnani (1979), Pivetti (1985) and Panico (1988) argue that
the trend rate of interest and the normal profit rate are linked
one on one.
– Wray (1988) and Robinson (1979) unconvinced, despite
Robinson (1952) having a similar mechanism
• There is a link with target return pricing and normal-cost pricing,
where the interest rate determines the target rate of return that
will help to set the markup.
• Raising interest rates to slow down the economy can have
inflationary consequences.
• This approach has been extended within a Kaleckian model by
Dutt (1992), Lavoie (1993), Hein (2006, 2008), and more
recently by Setterfield and Tadeu Lima (ROPE 2010).
– Investment function takes interest payments into account
– Saving function also does
– But no stock market
Minsky-Cambridge models
• The Taylor and O’Connell (1985) model
• The Semmler and Franke (1991) model
– Both have portfolio choice (deposits, equities)
– Both have an investment function that depends on
confidence
– Both have a differential equation determining
confidence (spread profit-interest rates, leverage
ratio) and producing cycles.
Minsky-Cambridge models II
• The Delli Gatti and Gallegati (1990s) models.
– Investment is a function of q ratio and a multiple of
retained earnings, this multiple changing procyclically (Minsky 2-price diagram).
• The Jarsulic 1988, early 1990s models
• Charles (2006, 2008)
– Ad hoc non-linearities, effect of debt ratios, chaos,
bifurcations
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Minsky-Cambridge models III
• Palley (1991, 1994) models
– Introduce loans to consumers.
– An extension of Minky’s FIH to the consumer
sector.
– initially, the higher debt taken on by borrowers
leads to higher economic activity; but then, as
more interest payments must be made, this slows
down economic activity.
• Skott’s models (1981, 1988, 1989)
– An earlier forgotten effort at synthesis, which is
stock-flow consistent
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Drawbacks of previous
models: Sometimes ….
• Models are not fully stock-flow consistent
• Models do not incorporate growth
• Money is exogenous, or set by the
government deficit
• The leverage ratio is not considered explicity
• There is no stock market, or,
• The stock market value of equities is
determined by fundamentals, and not by the
market supply and demand
Stock-flow consistent models
• The main claim of the present paper is that
stock-flow consistent models (SFC models),
inspired in particular by the work of Wynne
Godley, are the likely locus of some form of
post-Keynesian consensus in
macroeconomics, as it allows to entertain
both monetary and real issues within a single
model.
SFC models and Minsky
•
It is interesting to note that the possible links
between flow-of-funds analysis and balance sheet
accounts on the one hand, and the Minskyan view of
Wall Street economics on the other hand, were
already underlined by Alan Roe (1973).
• Roe argued that that individuals and institutions
generally follow stock-flow norms, but that during
expansion they may agree to let standards
deteriorate. He was also concerned with sudden
shifts in portfolio holdings.
• Roe explicitly refers to the work of Minsky on financial
fragility, showing that a stock-flow consistent
framework is certainly an ideal method to analyze the
merits and the possible consequences of Minsky’s
financial fragility hypothesis.
Minsky and SFC models
• “The structure of an economic model that is
relevant for a capitalist economy needs to
include the interrelated balance sheets and
income statements of the units of the economy”
(Minsky 1996, p. 77).
• Thus starting out with an appropriate balance
sheet matrix insures that economists “analyze
how financial commitments affect the economy”
(Minsky 1986, p. 221), by taking into account all
the interrelated cash flows of the various
sectors.
• Still, different behavioural equations will lead to
different results.
A complete balance sheet
The simple Lavoie and Godley
(2001-02) balance sheet
Split households, add loans to
consumers
Add government and the central
bank
Focus instead on the porfolio of
banks
Add housing and mortgages (Zezza 2008)
Rich
Households
Other
Households
Productive
capital
Firms
+ ph.hrh
Bills
+ Brh
Cash
+ HPMrh
Central
Bank
+ Drh
+ Kh
+ Bf
+ HPMoh
+ Doh
− Lf
Loans
− Moh
Mortgages
Equities
+ pf.efrh
Net worth
− NWh
∑
+ Kf
+ ph.hoh
Advances
∑
Govt
+ pk.kf
Homes
Deposits
Banks
+ Bb
−B
+ Bcb
0
+ HPMb
− HPM
0
−A
+A
0
−D
0
+L
0
+M
- pf.ef
0
− NWh
− NWf
0
− NWg
0
−K
0
0
0
0
0
0
How about mortgage-backed financial
assets?
Simulating current changes in financial flows
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Effect on the stock of personal loans of a one-time increase
in the flow of gross household loans to personal income
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Effect of a one-time increase in the flow of gross household
loans to personal income
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Effect of a one-time decrease in the flow of gross household
loans to personal income ratio, with a decrease in the
propensity to consume out of personal income
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Effect of a one-time decrease in the flow of gross household
loans to personal income ratio, with a decrease in the
propensity to consume out of personal income
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Conclusion
• This tour should dispel the notion that Cambridge
economics was impervious to the challenge posed by
the earlier fundamentalist Post Keynesians, who were
very much concerned with a monetary production
economy.
• The SFC approach, despite its complexities, is far
superior to the New consensus approach (new
neoclassical synthesis), which however extended,
cannot take into account the financial commitments of
banks and other agents of the economy – a constraint
that has turned up to be so important for our banking and
financial system during the recent financial crisis.