Inside Money in a Kaldor-Kalecki-Steindl Fiscal-policy Model: The Unit of Account, Inflation,

Leverage, and Financial Fragility

Greg HannsgenLevy Economics Institute of Bard College, Annandale-on-Hudson, NY

www.levyinstitute.orgPrepared for International Post Keynesian Conference, Kansas City,

September 2014

Some broad influences from existing literatures, Slide 1

• The Keynes/Kalecki growth-and-distribution literature that continued with Harrod, Kaldor, Pasinetti, Robinson, Stiendl, and others

• Neo-Ricardian themes of longer-run monetary influences on distribution, e.g., Panico (1997)

• Post Keynesian themes of endogenous credit and money, determination of markup by cash flow needs, importance of income distribution, futility of nominal “adjustment” in recession, dual/segmented labor markets, irreversible time, and a role for expectations in an uncertain world

• Functional finance and chartalism (MMT)• The literature dubbed the “formal Minskyan literature” by Dos Santos

and others, including Ferri (1990), Ferri and Minsky (1991), Nishi (2012), Ryoo (2013), Skott (1994), Taylor (1985), etc.

• And more…

Some broad influences from existing literatures, continued

• Stock-flow macro modeling, as in Godley and Lavoie (2012) and the Levy Institute macro team

• The Cambridge-Keynesian fiscal policy targets literature (e.g., Godley and Lavoie (2007) and Greenwood-Nimmo (2014))

• Models from finance of probabilities of financial “events”• Works such as Charpe et al. (2011), Chiarella, Flaschel, and Semmler

(2001), Commendatoré, Panico, and Pinto (2009), Gallegati and Gardini (1991), Goodwin (1990), and Keen (1995, 2000, 2013, 2014), and numerous others that treat the economy as a dynamical system, looking at bifurcations, cycles, hysteresis, and the like.

• Realism from Kaleckian political economy about the political space for fiscal stimulus (Rugitsky 2013, Moudud and Martinez-Hernandez 2014); Emphasis also on misguided macro policy.

Broad goals of this paper and related studies by this author

• to look at the effects of fiscal policy on endogenous fluctuations in macro variables, including phenomena collectively known as the business cycle

• Specifically, to use analytical methods (theorems), computed vector fields, and simulated solution pathways in both static and interactive form (Wolfram CDFs).

Features of model on which this one builds (Hannsgen 2014a, Hannsgen 2014b)

A Kalecki-Stiendl investment functionClassical/Kaleckian savings propensitiesKeynesian instability in the goods marketWage-led aggregate demandKaldorian (1940) nonlinear continuous-time dynamicsGovernment deficitsGovernment production of a public service from labor inputsA fixed tax rate on all incomeLeontief technology for goods production using labor and the capital stockChartalist state money A time-varying Kaleckian markup for goods with a nonlinearity in the speed of adjustmentA fixed, policy-determined real interest rate on government securitiesA government spending rule with dual resource-utilization targetsOne or more additional options for a fiscal stabilizing ruleEndogenous labor-force growth

3D Policy conclusions from old model (Hannsgen 2014b)

• manifolds that act as “walls” in state space that prevent crossing into low-markup region via continuous flow—but a big nudge in the interest-rate would work if distance not too far

• For high p, birth of a corridor of stability where there is a tendency to move toward target values, instead of following unbounded pathways

• Balanced-budget targets do not yield stability due to fiscal drag• Still, if targets for p and u are still low, then unemployment will

be high in long run• Caveat: Results may be dependent on calibrated values of

parameters and on avoiding “structural breaks” that change the dynamics

Some shortcomings in previous model

• Lack of role for banks and stock markets, which are of course sometimes endogenous sources of instability

• No role for net worth in consumption—important perhaps in medium and long runs

• open to orthodox charge that inflation will somehow arise in the model as a “price” of deficit spending

• Have not worked Minskyan model of financial crises into simulations or analytical results

• Reported simulations need to include more outcome variables, such as wage share, profit rate, growth rate, etc.

• No technological change—endogenous or otherwise

Elements added to model in earlier paper

• A Minskyan Poisson model of financial crashes• An unconventional nonlinear wage Phillips curve• Endogenous equity prices and issuance• Bank deposits• Margin finance for equity positions• Bank loans to workers• A wage contour that fixes relative wages in the government and private

sectors• Endogenous productivity growth via Kaldor-Verdoorn effects• Cash-flow ratio effects in the investment function• The addition of energy inputs to the production function for goods• Greenhouse gas accumulations via a physical identity• Time-varying credit constraints in the form of stock-flow norms• A time-varying markup for bank loans

Types of policy implications looked for with this new model

• Medium-term Minskyan asset-debt effects of fiscal policy• These might include qualitative changes in the dynamics

(switches between unstable and stable regimes), as the capital stock or government debt accumulate over time.

• Implied pathways for inflation/deflation• Possible additional roles of nudges to policy parameters• Minskyan shocks leading to permanent effects, and a

more realistic sense of potential for fiscal stabilization

“Supply side” of model

• Leontief production function with labor, capital goods, and energy

• Rate of expansion of labor force a decreasing function of unemployment rate

• Growth of labor productivity an increasing function of capital-stock growth rate (Kaldor/Verdoorn)

• Stock of capital goods depreciates at constant rate• Equation from physics determines greenhouse gas

accumulation at time t

Demand-side behavioral assumptions

• Investment a function of capacity utilization, after-tax profit rate, and liquidity ratio (Kalecki/Steindl and many others)

• Kaldorian (1940) nonlinearity in investment function• Workers borrow and spend what they can• K-sector households consume a fraction of their

disposable incomes and a fraction of appreciation in their equity holdings

• Expected number of financial crises per year depends on financial fragility and capacity utilization (more on model of financial crashes later)

Factors affecting broad inflation

• Nominal wage subject to one of two rules:(1) Private sector wage a function of capacity utilization

or (2) public-sector (P-sector) wage grows at rate chosen by P-sectorRatio of public sector wage and private sector wage constantEnergy costs assumed constant but could be shocked• Rate of change of goods markup a declining function of (1)

net operating revenues and/or (2) capacity utilization. Latter relationship has long flat segment near “normal” capacity utilization rate

Income flows

• P-sector and K-sector workers receive wages• K-sector households receive dividends from

financial and nonfinancial firms and interest on bank deposits

• Banks collect interest on loans to workers, the P-sector, and wealthy households

• P-sector workers, K-sector workers, and wealthy households pay taxes on all income

Model’s assumptions about government money, taxation, and spending

• Monetary base (reserves + currency) endogenous• Mix of monetary base and currency determined by

asset demand functions• Government deficits imply issuance of state money

and bills • Interest rate on bills is policy-determined• Interest rate rule specifies a fixed “real” rate• Government production determined by policy rule • Constant tax rate on all household income

Model’s assumptions about bank credit

• Bank loans are given for equity positions, unsold inventories, and consumer purchases

• Bank loan rates are subject to a time-varying markup• Bank loan markup varies with financial fragility level • Bank credit is rationed. Amount of margin and

consumer loans determined by prudence and inflation-adjusted interest rate.

• Bank rate markups jump when a crisis occurs.

Stock-price model

• No Tobinesque stable asset demand and supply curves

• Almost always, price-earnings ratio determined by growth rate and leverage used by investors

• Rare financial shocks from conditional Poisson model cause sudden drop in stock price index, as mentioned before. Rate at which these occur is a function of capacity utilization and financial fragility.

Financial shock model• Rate of occurrence of financial shocks (number per year) is a

decreasing function of (1) financial fragility and (2) capacity utilization

• Financial fragility (1) increases with liquidity ratios in W-sector and K-sector households, (2) is a decreasing function of capacity utilization, and (3) is a decreasing function of the safe-asset ratio (bills plus money over capital)

• Consumer credit limit and margin limit a decreasing function of “Prudence.” Also, loan rate effects.

• Prudence declines with (1) capacity utilization; (2) time since last crisis (“the instability of stability”); and increases with (3) spending on financial supervision/regulation.

• Shocks cause jumps in bank-loan markups and stock prices

“Previous study” or “Hannsgen 2014”

“Fiscal policy, chartal money, mark-upDynamics and unemployment insurance in a model of growth and distribution.” July issue Metroeconomica

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Levy Institute Macro Team Strategic Analysis Series

Series reports the results of simulationsconducted using the LevyInstitute’s 3-sector stock-flowmodel for the United States.

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