E22 PK Money_ Credit and Finance

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E22 PK  Money_ Credit and Finance Powered By Docstoc
					Money, Credit and Finance

        Marc Lavoie
     University of Ottawa
• 1. The main claims of the post-Keynesian views
  on money, credit and finance
• 2. PK monetary theory in historical perspective.
• 3. The horizontalist and structuralist
• 4. New developments in monetary policy
• 5. Open-economy monetary economics.
• 6. The integration of PK monetary economics
  into PK macroeconomics
    Part I

The main claims
    Post-Keynesian monetary sub-schools

                 Horizontalists      Circuit theory
Structuralists   Accommodationists

  Chartalists                          Emissions          Free
                    Paris and
 UKCM school                             theory       University of
                                          Dijon       Berlin School
Neoclassical monetary sub-schools

                 monetary schools

                           New Paradigm
Monetarists   IS/LM                       New Consensus
                             Ms                   Ms


    Horizontalists        Monetarists    Structuralists
    (New Consensus)       IS/LM          (New Paradigm)

                      A simplified overview
                      of endogenous money
Endogenous money supply: A PK claim now
       accepted by many schools
• Post-Keynesians
• Neo-Austrians
• New Keynesians
  – (New consensus authors), Woodford, Taylor,
    Roemer, Meyer
  – (New Paradigm Keynesians, focus on credit) Stiglitz,
    Greenwald, Bernanke
• Real business cycle theorists
  – Barro, McCallum
• Goodhart
     Main features in monetary economics
Features               PK school             Neoclassical

Money                  Has counterpart       Falls from an
                       entries               helicopter
Money is seen          As a flow and as a    A stock
Money is tied to       Production            Exchange

The supply of money    Endogenous            Exogenous
Main concern with      Debts, credits        Assets, money

Causality              Reversed: credits     Reserves allow
                       make deposits         deposits
Credit rationing due to Lack of confidence   Asymetric information
     Main features, interest rates
Features               PK School                  Neoclassical

Interest rates         Are distribution           Arise from market
                       variables                  laws
Liquidity preference   Determines the             Determines the
                       differential relative to   interest rate
                       base rate
Base rates             Are set by the central     Are influenced by
                       bank                       market forces
The natural rate       Takes multiple values      Is unique, based on
                       or does not exist          thrift and productivity
  Main features, macro implications
Features                 PK School               Neoclassical

A restrictive monetary   Has negative effects    Has negative effects
policy                   in short and long run   only in the short run
Schumpeter‟s             Monetary analysis     Real analysis
distinction              (monetized production (money neutrality,
                         economy)              inessential veil)
Macro causality          Investment              Saving determines
                         determines saving       investment
Inflation                The growth in money     Price inflation is
                         stock aggregates is     caused by an excess
                         caused by the growth    supply of money
                         in output and prices
   Two kinds of financial systems,
     according to Hicks 1974
• The overdraft financial     • The auto or asset-based
  system                        financial system
• Firms are in debt towards   • Firms finance investment
  commercial banks              with retained earnings
• Commercial banks are in     • Commercial banks have
  debt towards the central      large amounts of T-bills in
  bank                          assets
 Overdraft vs Asset-based systems
• Overdraft systems                • Asset-based systems
• 90% or more of the world         • Only in some anglo-saxon
  financial systems (including       countries
  the pre-euro Bundesbank)         • Described by mainstream
• Ignored by textbooks               textbooks
• No control on HPM, except        • Based on open-market
  through credit control             operations; is said to be
• Clarifies how the monetary         efficient in controlling the
  system functions                   money stock
• In a sense, all systems are of   • Puts a veil on the operating
  the overdraft type: no central     procedures of monetary
  bank controls directly the         systems
  supply of money
   Simplified neoclassical view
           Central bank balance sheet

Assets                  Liabilities

Foreign reserves        Banknotes

Domestic T-bills        Reserves of commercial
           Simplified PK view
           Central bank balance sheet

Assets                  Liabilities

Foreign reserves        Banknotes

Domestic T-bills        Reserves of commercial
Loans to domestic       Government deposits
                        (Central bank bills)
        Part II

  PK monetary theory
in historical perspective
        Cambridge proverbs
• « Highbrow opinion is like a hunted hare; if
  you stand in the same place or nearly in
  the same place it can be relied upon to
  come round to you in circle. » (D.H.
  Robertson 1956)
• « Economic ideas move in circles: stand in
  one place long enough, and you will see
  discarded ideas come round again. »
  (A.B. Cramp 1970)
     1844 Currency school vs
         Banking school
• Ricardo and            • Tooke and the
  Currency school          Banking School
• Only coins and Bank    • The definition of
  of England notes are     money is more
• The stock of money
  determines aggregate   • Aggregate demand
  demand                   determines the stock
• Aggregate demand         of money
  determines prices      • If controls are needed
                           to influence prices,
                           control credit
Most of modern monetary controversies can
be brought back to the Currency school and
         Banking school debates
• Definitions of money
• Stability of the velocity of money
• Stability of the deposit multiplier
• Money versus credit
• The operational target: the supply of high
  powered money or interest rates?
• Endogenous or exogenous money (reversed
• Inflation through excess money growth or
  excess wage growth
     An additional complexity
• An author can be found in two different
  camps at a time. This is often the case of
  creative authors.
  – Wicksell (who pretends to support the
    Quantity Theory, while throwing it back into
  – Keynes (who pretends to attack the Quantity
    Theory, while barely modifying it)
• Hence it is difficult or even impossible to
  classify some authors
      Keynes, a proto Monetarist?
• « We are all Keynesians now, says Friedman, at the
  height of the IS/LM frenzy.
• This can be better understood by reading Kaldor (1982),
  according to whom Keynes‟s 1936 monetary theory is
  « a modification of the quantity theory of money, not its
• Keynes 1930 (The Treatise on Money), despite some of
  its innovations and some indications about money
  endogeneity, is still very much in the Quantity tradition:
   – He objects to those who believe that interest rate ought to
     be the main operational target of central banks;
   – He approves of the money multiplier (Phillips 1920);
   – He supports the use of quantitative instruments for the
     conduct of monetary policy: open market operations and
     changes in reserve coefficients, which, at that time, were
     only advocated by Americans and the Fed.
    Two different viewpoints, already well
              identified in 1959
• « There are two opposing viewpoints concerning
  the relationship between the supply of and the
  demand for money. On the one hand – for the
  quantity theorists and Keynes – the quantity theory
  of money is believed to be fixed independently by
  the banking system…. The opposing view – held
  by the Banking school and Wicksell – is that the
  banks set not a quantity but a price. The banking
  system fixes a rate (or a set of rates) for the
  money market and then lends however much
  borrowers ask for, provided that they can offer
  satisfactory collaterals». Jacques Le Bourva
  1959 (1992).
             Back to the future?
• « The quantity theory of money is dying. The most banal
  criticisms lodged against it, and long since accepted as
  truths by all, concern the instability of the velocity of
  circulation of money …. The principal criticism of the
  theory, however, rests on the determination of the
  money supply. It is essential to the validity of the quantity
  theory that the quantity of money be a variable that is
  independent of national income and the current
  economic situation. This implies tha the bankers fix the
  amount of the money supply by some sovereign act
  dictated from the heights of their own secret Olympus.
  This is precisely the premise of the quantity theory that is
  no longer accepted in France today, and so the Banking
  school and Wicksell prevail. » Le Bourva 1962 (1992)
      Quantity theory of money (Academics) vs
 the Radcliffe Commission 1959 (Central bankers and
                  Kaldor and Kahn)
• Quantity theory         • Radcliffe Commission
• Control of the money    • The central bank controls
  supply, in particular     interest rates, but very
  reserves, by central      indirectly only money
  banks                     aggregates
• The velocity of money   • The velocity of money is
  and the money             unstable (many substitutes):
  multiplier are quasi      « general liquidity » concept
  constants               • Monetary policy only has a
• Causality runs from       moderate effect on inflation,
  money to prices           which depends on many
                            other factors
                          • Credit controls?
         The 1960s and 1970s
• The quantity theory and Monetarism gradually take
• The Radcliffe view is strongly criticized by Old
  Keynesians, who consider it dépassé:
• « There still do exist in England men whose minds were
  fromed in 1939, and who haven‟t changed a thought
  since that time, and who … say money doesn‟t matter.
  They have embalmed their views in the Radcliffe
  Committee, one of the most sterile operations of all
  time» Samuelson 1969
• With the oil shocks of the 1970s and the productivity
  slowdown, inflation rises.
• Monetarism and monetary targets flourish.
    The scourge of monetarism induces
        a post-Keynesian reaction
• Until 1970, even 1980, the PK monetary theory is
  unclear. Its best exposition can be found in Joan
  Robinson‟s 1956 book, The Accumulation of Capital, but
  it is towards the end of the book, after a complex
  exposition of growth theory and value theory, so that
  hardly anybody pays attention to her monetary theory.
• Before 1970, the main criticisms against the quantity
  theory are based on the instability of the velocity of
  money or that of the money multiplier (Kaldor 1958,
  Minsky 1957). Only Robinson and Kahn have a proper
  understanding of the crucial issue
• Starting in 1970, the more essential issue of reversed
  causality is brought to the forefront by a number of
 Reverse causality: three groups of authors

• Researchers at the Fed (Holmes 1969, Lombra, Torto,
  Kaufman, Feige+McGee)
• Post-Keynesians
   – Cramp 1970, Kaldor 1970 and 1980, Robinson 1970
   – Davidson and Weintraub 1973, Moore 1979)
• Iconoclasts: Le Bourva 1959 and 1962, F.A. Lutz 1971

   – The supply of money is not independent; it is determined
     by demand.
   – Credits make deposits; deposits make reserves.
   – Short-term interest rates are the exogenous variable.
   – The money/price causality is reversed.
   – We are back to the Banking School and current PKE!
            Part III

The Structuralist vs Horizontalist
       PK controversies
 “A storm in a tea cup” (Moore 2001) ?
• The first exponents of money endogeneity were mainly
  “horizontalists”: Robinson, Kahn, Le Bourva, Kaldor, Moore, and the
  French “circuitists”.
• The main “structuralist” critics were Le Héron, Dow, Wray, Howells,
  Pollin, and Palley, many of which got their inspiration from Minsky.
• As Fontana (2003) puts it, “structuralists took over where the
  accommodationists had stopped”.They brought some clarifications
  and provided new details. For instance, they insisted that spreads
  between interest rates could quickly vary, due to assessed default
  risks or changes in liquidity confidence. Sometimes, however, they
  constructed a “horizontal strawman” in an effort to highlight the
  originality of their contributions.
• To a large extent, the controversy has petered out, for reasons that
  will soon be given (although Rochon has rekinkled some excitement
  by editing a forthcoming book on the topic!).
        The horizontalist claims
• 1. The supply curve of money (or high powered money)
  can best be represented as a flat curve, at a given
  interest rate. The short-term interest rate can be viewed
  as exogenous, under the control of the central bank,
  within a reasonable range.
• 2. There can never be an excess supply of money.
• 3. The supply curve curve of credit can best be
  represented as flat curves, at a given interest rate (or set
  of interest rates).
• 4. Central banks cannot exert quantity constraints on the
  reserves of banks.
          The structuralist points
• 1a. What about the reaction function of the central bank? [Chick
  1977, Rousseas 1986, Palley 1991, Musella and Panico 1995]
• 1b. Long-term and other market-determined rates “cause” the
  overnight rate [Pollin 1991]
• 2. If loans create deposits, how do we know that households wish to
  hold these deposits? [Howells 1995]
• 3a. What about credit rationing (shape of credit supply curve)?
  [Dow2 1989]
• 3b. What about borrower‟s risk? [Minsky 1975, Dow and Earl 1982]
• 3c. and lender‟s risk (liquidity preference of banks)? [Dow2, Wray
  1989, Chick and Dow]
• 4a. Surely the central bank does not always “accommodate” and
  hence exerts quantity constraints on bank reserves. [Pollin 1991]
• 4b. What about changes in the velocity of money and liability
  management, which are the main sources of money endogeneity
  [Pollin 1991, Palley 1994]
    The horizontalist answers I
• 1. On the horizontal supply of HPM:
  – New operating procedures, based on a target
    overnight rate, show clearly that central banks control
    the overnight rate and can set it at will; recent events
    also show that the central bank reaction function has
    a large discretionary component. Thus, we can still
    see the target overnight rate as an exogenous
    variable, under the full control of the central bank.
  – Of course, if, in general, higher economic activity is
    accompanied by higher inflation rates, then, through
    the central bank reaction function, higher interest
    rates are likely to accompany higher economic
    activity, and thus the supply of money or HPM will
    appear to be upward-sloping through time.
       Horizontalist answers II
• 2. On the impossibility of excess money:
  – The main argument is the “reflux principle”.
  – The stock-flow consistent models of Godley have
    shown that, despite the presence of an apparently
    independent money demand function and the
    presence of a supply of money function based on the
    supply of loans, flow-of-funds accounting is such that
    deposits must equate loans despite no such
    condition being inserted into the model.
  – In more sophisticated models, changes in liquidity
    preference by households will induce changes in
    relative rates; but this was never denied by
        Horizontalist answers III
• 3. On the horizontal supply of credit:
   – It has been shown by Wolfson (1996) that there is no
     incompatibility between credit rationing and horizontalism.
   – It is now clearly established that higher economic activity does
     not necessarily entail higher debt ratio for firms (contradicting the
     essence of Minsky‟s financial fragility hypothesis). This is now
     recognized by Wray, a student of Minsky.
   – But of course, as firms move from one risk class to another, they
     will trigger higher interest rates.
   – The remaining issue is lender‟s risk: recent events have shown
     that banks have no clue what their lender‟s risk is, and so it
     cannot be ascertained that banks will raise interest rates if their
     balance sheet expands.
Credit rationing when there is a reduction in bank confidence
(Credit-worthy demand: demand with appropriate collateral:
Cf. De Soto, and Heinsohn and Steiger)

     Interest rate

                   Credit-        demand
                   demand     
                                     A N
             i1                      

     Horizontalist answers IV
• 4. On quantity restraints on bank reserves:
  – There is no incompatibility between
    horizontalism and bank innovations or liability
  – New central bank operating procedures
    clearly show what was hidden before: central
    banks passively try to provide the reserves
    being demanded by the banking system.
• The original horizontalist depiction, that of Kaldor and
  Moore, is the most appropriate. Structuralists have
  helped to fill in some details. As Wray (2006) concludes:
• “There cannot be any automatic and necessary impact of
  spending on interest rates because loans and deposits
  can and normally do increase as spending rises. The
  overnight rate will change only if and when the central
  bank decides to allow it to do so. Short-term loan and
  deposit retail rates can be taken as a somewhat variable
  mark-up and mark-down from the overnight rate.
           Part IV

New developments in monetary
policy implementation by central
        New operationg procedures and
• Central banks have new operating procedures, although
  they are not that much different from what they used to
  be. They bring central banks closer to the « overdraft
  economy», and further away from the «asset-based
  econonomy» as defined by Hicks.
• The procedures of some central banks are more
  transparent (than they were and than those of other
  central banks), so the horizontalist story is more obvious:
  Canada, Australia, Sweden
• The procedures of other central banks are less
  transparent; but when interpreted in light of
  horizontalism, we can see that their operational logic is
  identical to that of the more transparent central banks
  (like the Fed).
The new operating procedures put in place in Canada
and other such countries are fully compatible with the
                PK monetary theory
• Central banks set a target overnight rate, and a band
  around it
• Commercial banks can borrow as much as they can at
  the discount rate
• There are no compulsory reserves and no free reserves
  (zero net settlement balances)
• The target rate is (nearly) achieved every day
• Central banks only pursue defensive operations, trying to
  achieve zero net balances.
• When there are tensions, as during the recent subprime
  financial crisis, they try their best to supply the extra
  amount of balances demanded by direct clearers (mainly
      The Bank of Canada channel

              Overnight rate

 Bank rate = TR+25pts

      Target rate TR

  Rate on positive
balances = TR-25pts

                         - (overdraft) 0 + (surplus)    balances
  Two different justifications for the
  current interest rate procedures ?

• Post-Keynesians           • New Consensus
• Based on a                • Based on the 1970
  microeconomic               Poole article
  justification             • A macroeconomic
• Tied to the inner           justification
  functioning of the        • If the IS curve is the
  clearing and settlement     most unstable, use
  system                      monetary targeting
• Linked to the day-by-     • If the LM curve is
  day, hour-per-hour,         unstable (money
  operations of central       demand is unstable),
  banks                       use interest rate targets
                         Poole 1970
  rate                                                                       LM
                           LM                 IS

                                     IT                                       IT


              A     MT    IT        Output         A = IT     MT

                                             Demand for money is unstable:
  Investment is unstable:
                                             Use interest rate targeting
  Use monetary targeting MT
                                             No variability in output
  Less variability in output
The microeconomic justification for
      interest rate targeting
• Central bank interventions are essentially « defensive ».
  Their purpose is to compensate the flows of payments
  between the central bank and the banking sector.
• These flows arise from: a) collected taxes and
  government expenditures; b) interventions on foreign
  exchange markets; c) purchases or sales of government
  securities, or repurchase of securities arrriving at
  maturity; d) provision of banknotes to private banks by
  the central bank.
• Without these defensive interventions, bank reserves or
  clearing balances would fluctuate enormously from day
  to day, or even within an hour. The overnight rate would
  fluctuate wildly.
      Authors who support the
     microeconomic explanation

• Several central bank economists
  – Bindseil 2004 ECB, Clinton 1991 BofC,
    Lombra 1974 and Whitesell 2003 Fed
• Some post-Keynesian authors
  – Eichner 1985, Mosler 1997-98, Wray 1998
   and neo-chartalists in general
• Institutionalists
  – Fullwiler 2003 et 2006
       Bank of Sweden: overdraft system

• « Lending to the banking system currently comprises a
  significant part of the Riksbank‟s assets….
• Stage 1 involves a forecast of … how much liquidity
  needs to be supplied or absorbed for the banks to be
  able to avoid using the deposit and lending facilities
  during the coming week …. Stage 3 involves executing
  open market operations to parry the daily fluctuations in
  the banking system‟s current payments so the banking
  system will not need to utilise the facilities »
   – Mitlind and Vesterlund, Bank of Sweden Economic Review, 2001
The Fed never tried to constaint reserves !

• “The primary objective of the Desk‟s open
  market operations has never been to
  „increase/decrease reserves to provide for
  expansion/contraction of the money supply‟
  but rather to maintain the integrity of the
  payments system through provision of
  sufficient quantities of Fed balances such
  that the targeted funds rate is achieved”.
  Fullwiler (2003)
  This was understood a long time ago by
           some PK economists
• “The Fed‟s purchases or sales of government
  securities are intended primarily to offset the
  flows into or out of the domestic monetary-
  financial system” (Eichner, 1987, p. 849).
• “Fed actions with regards to quantities of
  reserves are necessarily defensive. The only
  discretion the Fed has is in interest rate
  determination” Wray (1998, p. 115).
   There is no relationship between open
   market operations and bank reserves

• “No matter what additional variables were
  included in the estimated equation, or how the
  equation was specified (e.g., first differences,
  growth rates, etc.), it proved impossible to obtain
  an R2 greater than zero when regressing the
  change in the commercial banking system‟s
  nonborrowed reserves against the change in the
  Federal Reserve System‟s holdings of
  government securities ....”(Eichner, 1985, pp.
  100, 111).
      Cf Poole in 1982, JMCB
• «The old procedures [before 1979-1982] are
  best characterized as an adjustable federal
  funds rate peg system ….The new system
  [1979-1982] is qualitatively similar to the old
  ….The vast bulk of speculation about Fed
  intentions by money market participants
  concerns Fed attitudes toward interest rates….
  The issue is always one of when and how hard
  the Fed will push rates ….»
   Why is the federal funds rate sometimes
       different from the target rate ?
• In Canada, the Bank is able to know with perfect
  certainty the demand for settlement (clearing) balances.
• In the States, the Fed forecasts the net demand. Without
  reserve averaging, the federal funds rate would fluctuate
  widely between zero and the discount rate, as the set
  daily supply would be different from the given demand
  (two vertical curves).
• With reserve averaging, banks can speculate on future
  values of the federal funds rate, and get extra reserves
  when the rate turns out to be low. The daily supply is still
  fixed, but the demand is interest elastic.
  Problems with no tunnel and a not so credible
target: central bank needs to be very precise in its
daily forecast of reserves demand (Whitesell 2003)

                S   S’
 Lending rate

   Fed rate
Expected Fed
funds rate
                                Demand for reserves
Deposit rate
And it is the same for the ECB !
•    „The logic of the ECB’s liquidity management ...
    can be summarised very roughly as follows: The
    ECB attempts to provide liquidity through its
    open market operations in a way that, after
    taking into account the effects of autonomous
    liquidity factors, counter-parties can fulfil their
    reserve requirements as an average over the
    reserve maintenance period. If the ECB provides
    more (less) liquidity than this benchmark,
    counterparties will use on aggregate the deposit
    (marginal lending) facility‟ Bindseil and Seitz
  The case of the ECB: reserve averaging
           with a tunnel/corridor

                S’   S

 Lending rate

Target rate

                            Demand for reserves
 Deposit rate

      The Cambridgian hare!
• « Today‟s views and practice on monetary
  policy implementation and in particular on
  the choice of the operational target have
  returned to what economists considered
  adequate 100 years ago, namely to target
  short-term interest rates » Ulrich Bindseil
  2004, ECB, formerly from the
      Part V

Open-economy monetary
         Exogenous interest rates in open
• Wray 2006 argues that interest rates are clearly exogenous in
  flexible exchange regimes and endogenous in fixed exchange
  regimes, because the central bank must protect its reserves; but
  what about China!)
• My position and that of Godley (The PK horizontalist position ?) is
  that interest rates are exogenous both in flexible and in fixed
  exchange rate regimes.
• By contrast sophisticated neoclassical authors argue that interest
  rates are exogenous in neither flexible nor fixed exchange rate
• Or, within the Mundell-Fleming model, IS/LM neoclassical authors
  argue that monetary policy is effective in a flexible exchange rate
  regime, but powerless in a fixed exchange rate regime, because the
  supply of money is then endogenous, as it varies in line with the
  balance of payments.
 A critique of the Mundell-Fleming model in
           fixed exchange regime
• In the Mundell-Fleming model, the supply of money is
  endogenous, but still supply-led; demand must adjust to
• In PKE, the supply of money is endogenous, but it is
  demand-led, as in a close economy. Any increase in
  foreign reserves will be compensated by a decrease in
  another asset of the central bank, or will be
  compensated by an increase in some liability of the
  central bank.
• This is the compensation thesis, or the thesis of
  endogenous sterilization (Godley and Lavoie 2005-06).
           Simplified PK view
           Central bank balance sheet

Assets                  Liabilities

Foreign reserves        Banknotes

Domestic T-bills        Reserves of commercial
Loans to domestic       Government deposits
                        (Central bank bills)
 A critique of the sophisticated neoclassical
    model in flexible exchange regimes
• The neoclassical argument is that changes in expected
  future spot exchange rates determine the forward rate
  relative to the spot rate.
• This differential, through the covered interest parity
  condition, which is known to hold at all times, determines
  the domestic interest rate relative to world rates.
• The answer to this claim is, once again, reverse
  causality (Smithin 1994, Lavoie 2000). It is the
  differential between domestic and world interest rates
  that determines, nearly as an identity, the differential
  between the forward and the spot exchange rates. The
  forward rate has nothing to do with the expected spot
  rate. Forward rates in no way predict future spot rates
  (Moosa 2004).
          Part V

The integration of PK monetary
      economics into PK
 The integration of PK monetary economics
          into PK macroeconomics

• (a) in PK models competing with New
  Consensus models, Rochon and
  Setterfield 2007, Hein and Stockhammer
  (see lecture on Friday)
• (b) in PK growth and distribution models;
• (c) through the stock-flow consistent
  approach (SFC) tied to flow-of-funds
 The integration of PK monetary economics
  into PK models of growth and distribution
• Very early on, it was pointed out that neo-Keynesian
  models of growth were neglecting monetary factors
  (Kregel 1985, “Hamlet without the Prince”).
• For instance, Davidson (1972) pointed out that the
  famous neo-Pasinetti model of Kaldor (1966), which, in a
  very astute way, introduced stock market equities in a
  neo-Keynesian model, was omitting money balances.
• The same drawback hurt early Kaleckian growth models.
• The situation started to change only in the early 1990s,
  when the impact of interest rates was considered
  explicity, and when debt ratios also got introduced, along
  with cash-flow issues or interest payments relative to
         The case of the Kaleckian model
• The canonical Kaleckian growth model is made up of three
  equations: an investment function, a saving function, and a pricing
• Obviously the interest rate can be introduced into the investment
• Should it be the real interest rate (higher opportunity costs) or the
  nominal interest rate (lower cash flow, lower retained earnings)?
• But if so, an increase in the interest rate also has an impact on the
  saving function (reducing the overall saving rate).
• And the interest rate may also have an impact on the normal profit
  rate (the Banking School argument, picked up by Sraffians), thus
  having an impact on the markup.
• And all these will have an impact on the debt ratio, and hence may
  have a feedback effect on the investment function.
• Things quickly get more complicated. Despite assuming short-run
  stability, there may not be long-run stability (the debt ratio may
  explode in the long run).
• What if we introduce inflation and unemployment. More
  complications! [See Hein‟s book 2008]
       The Stock-flow consistent approach
• The Holy Grail of PKE has always been the full integration of
  monetary and real macroeconomic analysis, i.e., provide a true
  “Monetary” analysis in the Schumpeter sense.
• Until recently, this seemed like a rather impossible task.
• Godley (1996, 1999) has now done it, under the name of SFC.
  [Other authors, around W. Semmler, also achieve something nearly
• Portfolio and liquidity preference issues, along with banking and
  financial stocks of assets and liabilities, are now tied with flows of
  production, income, and expenditures. Deflated and monetary
  variables can also be carefully distinguished.
• The method is presented in Godley and Lavoie (2007).
• In my view, the method is particularly appropriate to model the
  interaction between (Minsky) financial crises and real crises.
• The lecture this evening will give a simple example of SFC.