Stock Flow Consistent Modeling session at 12th International Conference

1. The sector financial balances model
of aggregate demand.
The perfect Econ 101 model?
Oliver Picek
PhD student, New School for Social Research
Presentation at the 12th International Post-Keynesian Conference at the
University of Missouri Kansas City
September 27, 2014

2. 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!

3. 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)

4. 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

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

6. 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.

13. 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 balances
e.g. Haavelmo Theorem leaving desired government
financial balance unchanged (Teixeira 2014).

16. 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)

17. Alternative: SFC and credit
• Let’s make a connection to SFC and credit literature:
Long-term equilibrium of a model without growth requires:
Δ NFA = Δ FA = ΔL = Δ 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)

19. 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 101
1) everyone knows comparative static IS-model
2) brings in financial balances naturally
3) simplified, but ok crisis explanation for first few
weeks of Intro course
4) potentially allows for gross stocks analysis, not only
net stocks