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1 Introduction
I have found out what economics is; it is the science of confusing stocks with flows.
A verbal statement by Michal Kalecki, circa 1936, as cited by Joan Robinson, in ‘Shedding darkness’, Cambridge Journal of Economics, 6(3), September 1982, 295–6.
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13.2 A summary
The sketch of what an alternative monetary theory ought to look like, as has been presented in this book, had been put forward by Godley (1992: 199200). We reproduce below its ten main elements, without further comment, in the belief that they provide a fair summary of the content of the book and of our intentions when writing it. 1. Institutions, in particular industrial corporations and banks, have a distinct existence and motivation; 2. The production process must be seen as taking time, and hence requires credit and is tied to the monetary system;
500 Monetary Economics
3. A realistic model must start with a comprehensive system of national accounts, flowsoffundsandbalancesheets,whicharecoherentlyrelated; 4. Hypotheticalequilibriumconditionsshouldbeconceivedintermsofreal stock-flow ratios; 5. The entire system of accounts needs to be inflation accounted; 6. Both closed and open economies should be modelled, so as to highlight different features; 7. Firms operate under conditions of imperfect competition and nondecreasing returns; 8. Pricing decisions are inter-related with growth and adequate finance; 9. Government budgetary policy plays a key role; 10. Inflationmaybegeneratedoutofastruggleforsharesoftherealnational income.
4 In reality, central banks set the target overnight rate (or target one-day repo rate), with the overnight rate closely tracking this target rate, leaving the bill rate adjust to the overnight rate. But the introduction of the overnight rate in a model such as ours would require at least two sets of banks, so that one set could borrow from the other.
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Kalecki, M. (1944) ‘Professor Pigou on “The classical stationary state”: A comment’, Economic Journal, 54 (213) (April), pp. 131–2.
Kalecki, M. (1971) Selected Essays on the Dynamics of the Capitalist Economy (Cambridge: Cambridge University Press).
Minsky, H.P. (1975) John Maynard Keynes (New York: Columbia University Press).
Minsky, H.P. (1986) Stabilizing an Unstable Economy (New Haven: Yale University Press).
Minsky, H.P. (1996) ‘The essential characteristics of Post Keynesian economics’, in G. Deleplace and E.J. Nell (eds), Money in Motion: The Circulation and Post-Keynesian Approaches (London: Macmillan), pp. 532–45.
Zezza (2007) Is There a Way Out of the Woods? The Levy Economics Institute Strategic Analysis, November 2007. At http://www.levy.org/
Accordingly, in equilibrium models, solving the optimization problems is what determines the model outcome. In accounting models, its completeness drives the outcome, as the ‘watertight accounting of the model implies that there will always be one equation which is logically implied by the others’ (Godley 1999:395) – with important practical implications. For instance, in accounting models including a private sector (firms and households), a government sector and a foreign sector, sectoral balances must sum to zero. Specifically, Godley and Lavoie (2007b:xxxvi) note the ‘strategic importance’ of the ‘accounting identity which says that, measured in current prices, the government’s budget deficit less the current account deficit is equal, by definition, to private saving minus investment’. This identity allowed Godley and Wray (2000) to conclude that ‘Goldilocks was doomed’: with a government surplus and current account deficit, economic growth had to be predicated on private debt growth – an inference impossible to make from an equilibrium model. Accounting models can identify a growth path as unsustainable given the existing bedrock accounting relations in our economic system, leading to a sure prediction of its reversal (even though the triggering event, and its timing, will be less clear). No such certainty is built into
Whilst these are surely helpful recommendations - including financial and capital variables in official macroeconomic assessment would be a major step forward -, the authors seem oblivious of the fact that this presaging is precisely what the Godley model employed at the Levy Institute had been doing from before 2000, actually using the disaggregation of assets and institutions they recommend. What is also missing is any discussion of the size of the US debt and its systemic implications as a constraint on further US growth, which is central in the flow-of-fund models discussed in the present paper, and which underpinned Godley and Wray’s (2000) prediction that ‘Goldilocks is doomed’. From the latter perspective, analysing the flow of funds for crisis potential without reviewing debt build-up as in Palumbo and Parker (2009), is akin to avoiding a discussion
Wynne Godley is a Distinguished Scholar at the Levy Economics Institute of Bard College, New York and a Visiting Research Associate with the Cambridge Endowment for Research in Finance (2002-2005). From 2000 he has consistently argued that a US housing market slowdown was unavoidable in the medium term, and that its implication would be recession in the US. Godley warned that ‘Goldilocks is doomed’, as he put it in a 2000 article with Wray. ‘Goldilocks’ was the simile after the children’s tale, employed in the years after the dotcom crash for the US economy, which was said to be neither too ‘cold’ (low unemployment) nor too ‘hot’ (low inflation). Godley and Wray (2000) argued that this stability was unsustainable, as it was driven by households’ debt growth, in turn fuelled by capital gains in the real estate sector. Based on an accounting framework of the US economy developed by Godley (on which more below), they predicted that that as soon as debt growth slowed down – as it inevitably would within years -, growth would falter. When house prices had started to fall, Godley and Zezza (2006) published Debt and Lending: A Cri de Coeur. They demonstrated again the US economy’s dependence on debt growth and argued that only the small slowdown in the rate at which US household debt levels were rising, resulting form the house price decline, would immediately lead to a “sustained growth recession … somewhere before 2010” (Godley and Zezza, 2006:3). In January 2007, the US Congressional Budget Office (CBO) produced its annual report, which, as Godley and others noted in an April 2007 analysis, had predictions on GDP and inflation “indicating a Goldilocks world in the medium term” which they deemed ”wildly implausible” (p.1) as it required continued growth in household indebtedness while real estate collateral values were I na steep and continued fall. In contrast to CBO projections of GDP growth averaging 2.85 percent between 2007 and 2010, Godley in April 2007 predicted output growth “slowing down almost to zero sometime between now and 2008 and then recovering toward 3 percent or thereabouts in 2009–10”; but warned that “unemployment [will] start to rise significantly and does not come down again.” (Godley et al 2007: 3). Again, in November 2007 Godley and others forecast “a significant drop in borrowing and private expenditure in the coming quarters, with severe consequences for growth and unemployment”. These forecasts describe the actual developments from spring 2007 until the time of this writing in spring 2009. If anything, they were sanguine: US growth not only ‘slowed to zero’ but actually turned negative in 2008, and the recovery ‘toward 3 percent or thereabouts in 2009–10’ is now widely forecast, but yet to start.
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