The sector financial balances model of aggregate demand.

The perfect Econ 101 model?

Oliver PicekPhD student, New School for Social ResearchPresentation at the 12th International Post-Keynesian Conference at the

University of Missouri Kansas CitySeptember 27, 2014

Paper outline

• The SFB of AD was proposed as a good replacement of the IS-LM model for a first model economics students should learn

• Review some of the criticism of the idea of using sector financial balances for aggregate demand considerations

• Formulate the model in terms of equations• Assessment and suggested use for a “sector financial

balances model of aggregate demand”• Wrong name!

Idea of a SFB model of AD

• Traces back to three balances approach of Wynne Godley

• Godley (1999) uses a “fiscal ratio” (G/t) and the “government deficit”, a sector financial balance, as a measure of a contribution to aggregate demand, also in Godley and Lavoie (2007, Ch. 3 & 4)

• taken up by Zezza (2009), Taylor (2004), Shaikh (2011), Fulwiller (2009,2011)

Criticism - Meaning of financial balance and growth contributions

• Lavoie (Interview), Dos Santos and Macedo e Silva (2010), Fiebiger (2013) Teixeira (2014)

• Main point: GDP consists of C,I,G,E-M

According to national accounts: Growth contributions to GDP only from these, but not SFB such as T-G or S-I.

• SFBs as growth contributions work only for alternative definition of AD such as aggregate supply (GDP+M, AD=PS+G+E) in Taylor (2004) or excess demand in Shaikh (2011) leaves national accounts definitions

The SFB model of AD in the blogosphere: Krugman’s cross (2009)

SFB model of AD: blogosphere

• Fulwiller (2009,2011) and co-authors pick it up and build a graphical model.

• Debate about the model without actually writing down the equations. Fulwiller refers to a graphical representation of the SFC approach and more complex models initially, and argues at some point that interest can be in there.

• But the model is simply the IS-LM model without the LM part. No short run shock and then long-run adjustment through interest rate demand effects of government bonds as in Godley & Lavoie 2007.

Statements

• ..the government’s deficit is currently too small to accommodate the non-government’s desired surplus alongside full employment (Cooper 2014)

• ..the SFB model shows that aggregate demand is set by the government’s deficit relative to net savings [the financial balance] desires of the non-government sectors (Fulwiller 2009)

• directs attention to financial balances, but it is underlying parameters in the model that determine financial balancese.g. Haavelmo Theorem leaving desired government financial balance unchanged (Teixeira 2014).

Conclusions for a SFB model of AD• IS model: Joint determination of both GDP and financial

balances by the same underlying parameters (autonomous spending times the multiplier) analyze parameter shifts, similar to SFC model

• The only financial balance on AD effect is in the long run, the reversal from an unsustainable situation wrong name! Rename the model?

• SFC connection? No NFA, no stock-flow norm, and the authors probably did not have a consumption function with wealth effect in mind to explain the crisis and deleveraging:A G&L type “classical” long-run adjustment to a higher level of GDP through government interest payments), because then a lower propensity to consume or fall in NFA would imply a higher long-run stationary income (GL 2007)

Alternative: SFC and credit

• Let’s make a connection to SFC and credit literature:Long-term equilibrium of a model without growth requires:∆ NFA = ∆ FA = ∆L = ∆ K(=I) = 0

• Then the only long run equilibrium possible is when: FBgov=FBp=0• No interest in the model financial balance is the primary

balance• From debt dynamics we know: a certain primary balance

required to stabilize debt!• Too much credit creation (credit impulse could lead us away

from equilibrium, with a shift back when debt levels become too high)

Conclusion for a modified SFB model of AD

• Connects well to dynamic models such as SFC models, Taylor et. al (2012), Mason and Javadev (2014)

• SFB effect on AD only in medium run (reversal of trend), so perhaps a different name, but the framework as such is excellent

• Perfect model for Econ 1011) everyone knows comparative static IS-model2) brings in financial balances naturally3) simplified, but ok crisis explanation for first few weeks of Intro course4) potentially allows for gross stocks analysis, not only net stocks