A Day in Honour of Augusto Graziani - MARXIANOMICS · A Day in Honour of Augusto Graziani Amphithéâtre Vedel, Faculté Jean Monnet, Université Paris-Sud January 20th, 2015 . 1

School of something FACULTY OF OTHER

LUBS Economics Division

On Some Open Issues in the Theory of Monetary Circuit

Marco Veronese Passarella

A Day in Honour of Augusto Graziani

Amphithéâtre Vedel, Faculté Jean Monnet, Université Paris-Sud

January 20th, 2015

1. Introduction: Graziani and the Italian contribution to the TMC

2. Open issues in the TMC

3. The conception of pricing and the role of demand

Graziani’s equations / Theoretical consequences

4. The need for a stock-flow consistent redefinition of the TMC model

5. Financialisation in the monetary circuit

The standard monetary circuit / A new paradoxical cycle? / Main amendments to the benchmark

model / The storyboard / Nominal balance-sheets / Nominal transactions-flow matrix / Some

equations… / Other equations… / The dynamics of the basic model / Wage cut, derivatives and

debt repayment

6. Remarks

Outline

While there are clear affinities of Graziani with French Circuitistes and (Post) Keynesian

authors, Graziani’s take also shows some distinctive features.

Graziani’s specific contribution can be defined as a rediscovery of the most far-reaching

aspects of the monetary thought of both Karl Marx and a number of dissenting economists of

the early twentieth century (e.g. Wicksell 1898, Keynes 1930).

The keystone of Graziani’s take is the association of Keynes’s concept of ‘initial finance’ with

Marx’s notion of ‘money capital’ (Messori, 1983). Capitalism is a circular sequence of

monetary (social) relations. Firms need money in order to purchase labour power from

workers and to start the production. This initial flow of money is created (ex nihilo) by banks.

Graziani’s macro-monetary take allows him to clarify that:

Looking at capitalists as a social class, capital valorisation can only derive from exchanges

capitalists make outside their own class. The only possible external exchange is the purchase of

labour-power. […] Capitalists’ profit can only arise from the difference between the total labour

employed and the quantity of labour that the worker gets back in the form of real wage.

(Graziani 1983, Italian in the original)

1. Introduction: Graziani and the Italian contribution to the TMC

The chief aim of Graziani’s TMC is to account for the process of money creation and

destruction (both viewed as endogenous phenomena) under a capitalist regime during

‘normal times’ (i.e. ‘without crisis’, Graziani 1984).

The precautionary and the speculative motives (liquidity preference) must be ruled out of the

analysis. The focus is on a specific subcategory of the transaction motive: the finance

motive. Money is regarded as the the initial banking finance enabling firms to start the

process of production in a world marked by social stratification (Graziani 2003).

The benchmark single-period monetary circuit scheme has been questioned by many, as it

would be affected by some theoretical and analytical weaknesses.

The paradox of monetary profit

Market-clearing pricing and no role for effective demand

The pure flow accounting framework and the single-period horizon

No room for recent developments in capitalist economies (financialisation)?

2. Open issues in the TMC

Let us suppose that: 𝑟𝑙 = 𝑟𝑏 = 𝑟𝑚 = 0. The algebraic skeleton of the TMC model can be

written as follows:

(1) 𝑋𝑠 = 𝑁𝑠 ∙ 𝑎 (2) 𝑝 ∙ 𝑋𝑑 = 𝐶 + 𝐼

(3) 𝐶 = 1 − 𝑠 ∙ 𝑤 ∙ 𝑁𝑑 (4) 𝐼 = 𝑏 ∙ 𝑝 ∙ 𝑋𝑠

(5) 𝑝 = (𝑤/𝑎) ∙ (1 + 𝜎) (6) 𝐿𝑑 = 𝑤 ∙ 𝑁𝑠

(7) 𝑁𝑠 = 𝑁𝑑 (8) 𝑋𝑠 = 𝑋𝑑 (9) 𝐿𝑠 = 𝐿𝑑 (10) 𝑀(𝑠) = 𝐿𝑠

In equations above, 𝐶, 𝐼, 𝐿𝑑 , 𝐿𝑠, 𝑀(𝑠), 𝑁𝑠, 𝑝, 𝑋𝑑 , 𝑋𝑠 and 𝜎 are usually regarded as the

endogenous variables, whereas 𝑎, 𝑏, 𝑠, 𝑤 and 𝑁𝑑 are treated as exogenous.

In principle, it would be possible either to derive 𝑝 and hence 𝜎 given 𝑁𝑑 (and hence 𝑋𝑠), or

to derive 𝑋𝑠 and 𝑁𝑑 given 𝜎 (and, say, 𝐼 instead of 𝑏).


Graziani’s equations

Graziani chose 𝜎 as the endogenous variable: 𝜎 = (𝑏 − 𝑠)/(1 − 𝑏). The scale of

production (𝑁𝑑) is set autonomously by firms, along with the share of investment (𝑏).

The rationale of Graziani’s choice is linked with the chief aim of the TMC: to analyse how

money is created, circulated and destroyed in a capitalist economy during ‘normal times’ (no

uncertainty, no liquidity trap, no credit rationing, no lack of demand).

Controversial corollary: any increase in aggregate demand components leads to an increase

in profit rate and unit price of output, with no effect on employment and real output.

The above conception of pricing is potentially at odd with the vast majority of Post

Keynesian, Kaleckian and other heterodox approaches.

Graziani’s original take looks inconsistent with the recognition of the role of effective demand

in determining (i.e. constraining) real output and employment (Seccareccia 2014).

When a plurality of sectors is taken into account, it is also inconsistent with the long-run

equalisation of the rate of profit across the economy (Lunghini & Bianchi 2004).


Theoretical consequences

The benchmark TMC model relies on a pure-flow accounting framework. It is usually defined

in static terms, i.e. within a single-period horizon.

That was a useful simplifying assumption, but it should be dropped. The dynamics of the

economic system should be modelled explicitly.

When a multi-period model is adopted, stocks and their relations with flows have to be

accounted for. The TMC model should be revised in the light of the stock-flow consistent

modelling technique (e.g. Godley 2005, Lavoie 2005, Godley & Lavoie 2007, Zezza 2004,

Zezza 2012).

The coherence of the TMC narrative with Godley’s take has been recognised explicitly by

Graziani when defining the nature and the amount of the initial finance (e.g. Graziani 2003,

p. 28; to be compared with Godley and Lavoie 2007, p. 49).

This crossbreeding, inter alia, makes it possible both to amend the TMC price-setting (in

order to take into account the impact of demand on real output) and to extend the monetary

circuit scheme to the analysis of the financialisation.

4. The need for a stock-flow consistent redefinition of the TMC model

The starting point is the benchmark TMC model (Graziani 2003): closed economy with no

government sector.

Production/investment are financed by ‘inside’ money created by banks.

The benchmark TMC scheme is redefined in a SFC fashion (call it Model DER).

Model DER can be considered an amended version of Model BMW created by Zezza 2006

and corresponding to the model used in Godley & Lavoie 2007, Ch. 7.

Main amendments concern:

Households can access credit (Van Treeck 2009)

Workers vs. rentiers (Dos Santos & Zezza 2006, Van Treeck 2009)

Banks vs. other financial intermediaries (Sawyer 2014)

Securitisation and derivatives (Veronese Passarella 2014)


Main amendments to the benchmark model


The standard monetary circuit

Banking System

debt discharge: closing (5)

(2)

(3.a)

(1) initial finance: opening

Financial

Market

(3.b)

(4) Households Firms

Commodity

Market

final finance

consumption

wage-bill

household saving


A new paradoxical cycle?

Workers

Firms

(1)

(3)

(2)

derivatives

(securitisation)

consumer credit

(financial

asset

inflation)

Commodity

Market

(4)

Financial

Market

Clearing Banks

corporate extra-profits

credit-based consumption

Rentiers

OFIs

financial

investment

Rentiers

Bank credit is used by both rentiers and workers to finance additional consumption.

The amount of new loans to rentiers (∆𝐿𝑟) is an increasing function of their wealth (𝑉𝑟), the

latter being used as collateral.

Loans to workers (∆𝐿𝑤) are an increasing function of both workers’ wealth (𝑉𝑤) and the

‘degree of cartolarisation’ of household debt (𝜑).

The banking sector is split into two subsectors: clearing banks vs. other financial

intermediaries (OFIs).

Unlike loans to firms, loans to households are created by banks and then ‘handed’ to OFIs

(e.g. via structured investment vehicles).

The role of OFIs is not to create money, but to transform a portion of household loans into

‘financial derivatives’ (securitisation) (𝑑𝑠).

These are sold to rentiers who seek for high return rates on their financial investment.


The storyboard


Nominal balance-sheets

Households

Production firms Banking sector

Σ Workers Rentiers Clearing Banks OFIs

Deposits +Mw +Mr –M +Mo 0

Loans –Lw –Lr –Lf +Lf +Lh (–Lh) (+Lh) 0

Capital +K +K

Securities of firms (+B) (–B) 0

Derivatives +d ∙ pd –d ∙ pd 0

Balance (net worth) +Vw –Vr 0 0 0 –Vh

Σ 0 0 0 0 0 0

Notes: A ‘+’ before a magnitude denotes an asset, whereas ‘–’ denotes a liability.


Nominal transactions-flow matrix

Workers Rentiers Production firms Clearing Banks OFIs

Σ Current Capital Current Capital Current Capital

Consumption –Cw –Cr +C 0

Investment

(change in capital stock)

+I = +ΔK

–I = –ΔK

0

Wages +WB –WB 0

Depreciation allowances –DA +DA

Interest on loans –rl,–1 ∙ Lw,–1 –rl,–1 ∙ Lr,–1 –rl,–1 ∙ Lf,–1 +rl,–1 ∙ Lf,–1 +rl,–1 ∙ Lh,–1 0

Interest on deposits +rm,–1 ∙ Mw,–1 +rm,–1 ∙ Mr,–1 –rm,–1 ∙ M,–1 +rm,–1 ∙ Mo,–1 0

Return on securities +rb,–1 ∙ B–1 –rb,–1 ∙ B–1 0

Return on derivatives +rd,–1 ∙ pd ∙ d–1 –rd,–1 ∙ pd ∙ d–1 0

Entrepreneurial profits +Ff –Ff 0

Bank profits +Fb –Fb 0

Financial profits +Fo –Fo 0

Change in loans +ΔLw +ΔLr +ΔLf –ΔLf –ΔLh (+ΔLh) (–ΔLh) 0

Change in deposits –ΔMw –ΔMr +ΔM –ΔMo 0

Change in securities (–ΔB) (+ΔB) 0

Change in derivatives –Δd ∙ pd +Δd ∙ pd

Σ 0 0 0 0 0 0 0 0 0

Memo: capital gains –Δpd ∙ d–1 +Δpd ∙ d–1

Notes: A ‘+’ before a magnitude denotes a receipt or a source of funds, whereas ‘–’ denotes a payment or a use of funds.

(20) Share of securitised loans

𝜑 =𝑑𝑠 ∙ 𝑝𝑑

𝑙𝑤,−1+𝑙𝑟,−1

(28) Number of rentiers

𝑁𝑟 = ℎ1 ∙ 𝑁𝑠 + ℎ2 ∙ 𝜀

(29, 30) Nominal consumption of workers and rentiers

𝐶𝑤 = 𝛼0 + 𝛼1 ∙ 𝑌𝐷𝑤𝑒 + ∆𝐿𝑤, 𝐶𝑟 = 𝛽0 + 𝛽1 ∙ 𝑌𝐷𝑟

𝑒 + ∆𝐿𝑟

(36) Loans to workers

∆𝐿𝑤= 𝛼2 ∙ 𝑉𝑤,−1 + 𝛼3 ∙𝐶𝑟

𝑁𝑟−

𝐶𝑤

𝑁𝑠− 𝛼4 ∙ 𝑤 − 𝑤−1 ∙

𝑝

𝑝−1− 𝑟𝑒𝑝1 ∙ 𝐿𝑤,−1

(37) Loans/wealth ratio of workers

𝛼2 = 𝜂1 ∙1−[𝐿𝑤,−1∙ 𝑟𝑒𝑝1+𝑟𝑐 ]

𝑉𝑤 + 𝜂2 ∙ 𝜑


Some equations…

(38) Premium over risk on loans to workers

𝜋 = 𝜋0 + 𝜋1 ∙𝐿𝑤,−1 ∙ 𝑟𝑒𝑝1

𝑉𝑤,−1

(41) Demand for firms’ securities of workers

𝐵𝑤

𝑉𝑤= 𝜆0 + 𝜆1 ∙ 𝑟𝑏 − 𝜆2 ∙

𝑌𝐷𝑤

𝑉𝑤

(44) Demand for derivatives of rentiers

𝑝𝑑 ∙ 𝑑𝑟

𝑉𝑟= 𝜆3 + 𝜆4 ∙ 𝑟𝑑 − 𝜆5 ∙

𝑌𝐷𝑟

𝑉𝑟

Structure of return rates:

(17) 𝑟𝑚 = 𝑟𝑙 − 𝑎𝑑𝑑 (deposits) (21) 𝑟𝑐 = 𝑟𝑙 + 𝜋 (consumer credit)

(22) 𝑟𝑑 = 𝑟𝑐 (derivatives) (23) 𝑟𝑏 = 𝑟𝑚 (securities)


Other equations…


The dynamics of the basic model

104

108

112

116

120

124

2000 2010 2020 2030 2040 2050

Total disposable income

Aggregate consumption

Figure 1: Evolution of C and YD following an increase in autonomous consumption of workers

11.8

12.0

12.2

12.4

12.6

12.8

13.0

13.2

13.4

2000 2010 2020 2030 2040 2050

Gross investment

Capital depreciation

Figure 2: Evolution of Id and DA following an increase in autonomus consumption of workers

101

102

103

104

105

106

107

2000 2010 2020 2030 2040 2050

Total disposable income

Aggregate consumption

Figure 3: Evolution of C and YD following an increase in the propensity to save of workers

0.96

0.98

1.00

1.02

1.04

2000 2010 2020 2030 2040 2050

Figure 4: Evolution of the output to capital ratio following an increase in the propensity to save of workers


Wage cut, derivatives and debt repayment (I)

£118.4

£118.5

£118.6

£118.7

£118.8

£118.9

£106.6

£106.8

£107.0

£107.2

£107.4

2000 2010 2020 2030 2040 2050

GDP (left axis)

Aggregate consumption (right axis)

Figure 1A: Evolution in GDP and total consumption following a wage cut

93.1%

93.2%

93.3%

93.4%

93.5%

93.6%

93.7%

93.8%

6.2%

6.3%

6.4%

6.5%

6.6%

6.7%

6.8%

6.9%

2000 2010 2020 2030 2040 2050

Disposable income of workers (to total, left axis)

Disposable income of rentiers (to total, right axis)

Figure 1B: Evolution in income distribution following a wage cut


Wage cut, derivatives and debt repayment (II)

28.4%

28.8%

29.2%

29.6%

30.0%

30.4%

30.8%

31.2%

23.36%

23.40%

23.44%

23.48%

23.52%

23.56%

23.60%

23.64%

2000 2010 2020 2030 2040 2050

Leverage ratio of workers (to total, left axis)

Leverage ratio of rentiers (to total, right axis)

Figure 1C: Evolution in leverage ratios of households following a wage cut

11.5%

11.6%

11.7%

11.8%

11.9%

12.0%

3.8%

3.9%

4.0%

4.1%

4.2%

4.3%

2000 2010 2020 2030 2040 2050

Interest rate on derivatives (left axis)

Interest rate on bank loans (right axis)

Figure 1D: Evolution of interest on derivatives following a wage cut


Wage cut, derivatives and debt repayment (III)

£11.1

£11.2

£11.3

£11.4

£11.5

£11.6

£11.7

£11.8

£11.9

£12.0

9.3%

9.4%

9.5%

9.6%

9.7%

9.8%

9.9%

10.0%

10.1%

10.2%

2000 2010 2020 2030 2040 2050

Total amount of derivatives (left axis)

Derivatives to GDP ratio (right axis)

Figure 1F: Evolution of derivatives following a wage cut

3.824%

3.828%

3.832%

3.836%

3.840%

3.844%

3.848%

3.852%

3.856%

3.860%

1.29%

1.30%

1.31%

1.32%

1.33%

1.34%

1.35%

1.36%

1.37%

1.38%

2000 2010 2020 2030 2040 2050

Bank profit to GDP (left axis)

OFIs profit to GDP (right axis)

Figure 1E: Evolution of financial profitability following a wage cut

Graziani’s approach allows us to point out that:

The creation of bank money is a both historical and logical necessary condition to start

the production process

While it is usually neglected by mainstream economics, class divide is a fundamental

feature of capitalist society

Workers do not control means of production, i.e. investment and production decisions are

taken autonomously by the ruling class (capitalists or rentiers)

Clearing banks are linked with, but different from, other financial intermediaries: they are

different economic units with different functions in the monetary circuit

While the analysis of financialisation requires an extension / improvement of the basic

TMC scheme, TMC’s pillars still look rather sound

6. Remarks

School of something FACULTY OF OTHER

LUBS Economics Division

Thank You

[email protected]

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A Day in Honour of Augusto Graziani - MARXIANOMICS · A Day in Honour of Augusto Graziani Amphithéâtre Vedel, Faculté Jean Monnet, Université Paris-Sud January 20th, 2015 . 1