UK System Dynamics Society Chapter: Student Colloquium 2016,London, - PowerPoint PPT Presentation

UK System Dynamics Society Chapter: Student Colloquium 2016,London, Friday 15 th April 2016 Neil Smith, Plymouth University Business School A ‘small - world’ Stock -Flow Consistent (SFC) economics flight simulator in system dynamics with questions of methodology, pedagogy and impact

A ‘small - world’ Stock -Flow Consistent (SFC) economics flight simulator in system dynamics with questions of methodology, pedagogy and impact • Abstract, ‘small - world’ economic system dynamics model • Godley & Lavoie’s (2007) simplest model of a Stock-Flow Consistent monetary economy • Both system dynamics and SFC modelling introduced and simulated in simplest circular-flow model. • A management flight simulator is offered to allow classroom demonstration and manipulation. • Textbook economic theory:  axiomatic-deduction  abstraction from complexity  telling stories with parsimonious small-world models • Stock-Flow Consistent (SFC) economic modelling:  Rigorously accounted, ‘stylized’ monetary economies  Mesoeconomic structure limits degrees of freedom • System dynamics offers economics:  intuition  more empirical induction  less abstraction, more complexity – dynamics and disequilibrium  expanded choice of technique/method and real-world application ‽ …however, does not dictate necessary expansion of model boundaries ‽ simple abstract models remain essential tools of education and persuasion

Principal Literature Godley, W. & Lavoie, M. (2007) Monetary Economics: An Integrated Approach to Credit, Money, Income, Production and Wealth. Basingstoke: Palgrave Macmillan. Andresen, T. (ND) 'A block diagram approach to macroeconomic dynamics, and why IS/LM is fatally flawed'. Trondheim, Norway: The Norwegian University of Science and Technology. Keen , S. (2015) 'Minsky: Extending System Dynamics to easily handle financial flows', UK Chapter of the System Dynamics Society . London School of Economics 26th-27th March 2015. Campiglio, E. (2012) 'Modelling the Great Transition', UK Chapter of the System Dynamics Society . South Bank University, London 9 th - 10th February 2012. Jackson, T. & Victor, P. (2015) Towards a stock-flow consistent ecological macroeconomics: An overview of the FALSTAFF framework with some illustrative results. United Nations Environment Programme. Yamaguchi, K. (2014) Money and Macroeconomic Dynamics: Accounting System Dynamics Approach . Japan Futures Research Center. Radzicki, M. J. (2011) 'System Dynamics and Its Contribution to Economics and Economic Modelling'. in Meyers, R.A. (ed.) Complex Systems in Finance and Econometrics. New York: Springer, pp 727-738. Saeed, K. (2008) Limits to Growth Concepts in Classical Economics. Worcester, MA: Worcester Polytechnic Institute. Saeed, K. (2014) 'Jay Forrester's operational approach to economics'. System Dynamics Review , 30 (4). pp 233-261. Wheat, I. D. (2007a) The Feedback Method: A System Dynamics Approach to Teaching Macroeconomics . University of Bergen. Wheat, I. D. (2007b) 'The feedback method of teaching macroeconomics: is it effective?'. System Dynamics Review , 23 (4). pp 391-413. Harvey, J. T. (2013) 'Keynes's trade cycle: a system dynamics model'. Journal of Post Keynesian Economics , 36 (1). pp 105-130.

Traditional textbook approach in macroeconomics In particular critiqued by Wheat (2007a, 2007b)

Origins of ‘Circular Flow’ in macroeconomics John Law (1705) Richard Cantillon c. 1755 (see Murphy 1993) Landlord Paper money for Paper money commodities for rent Manufacturing Farmers Workers Paper money for food Murphy, A. E. (1993) 'John Law and Richard Cantillon on the circular flow of income'. The European Journal of the History of Economic Thought , 1 (1). pp 47-62. Cantillon, R. (1755 [2010]) An Essay on Economic Theory . Ludwig von Mises Institute. An English translation of Richard Cantillon’s Essai sur la Nature du Commerce en Général .

Samuelson’s ‘canonical’ circular flow diagram (1948) Wages, interest, etc Productive services PUBLIC BUSINESS Goods and services Consumption purchases “…what appear to be two tanks … linked by pipes Cf. the Phillips’ Machine (1949) through which water (income) could flow” Backhouse, R. E. & Giraud, Y. (2010) 'Circular flow diagrams'. in Blaug, M. and Lloyd, P. (eds.) Famous Figures and Diagrams in Economics. Cheltenham, UK: Edward Elgar .

“I have found out what economics is; it is the science of confusing stocks with flows.” Michal Kalecki c 1936, quoted in Godley & Lavoie (2007) Godley, W. & Lavoie, M. (2007) Monetary Economics: An Integrated Approach to Credit, Money, Income, Production and Wealth. Basingstoke: Palgrave Macmillan.

Godley & Lavoie’s simplest model: ‘Model SIM ’ matrices and equations Balance sheet of Model SIM Σ Households Production Government +H 0 -H 0 Money Stock Accounting (transactions) matrix for Model SIM Σ Households Production Government 3.1 C s = C d -C +C 0 Consumption 3.2 G s = G d +G -G 0 Govt. expenditures 3.3 T s = T d [Y] [Output] 3.4 N s = N d +WB -WB 0 Factor income (wages) -T +T 0 Taxes 3.5 YD = W · N s − T s Change in stock of - ∆H +∆H 0 3.6 T d = θ ·W · N s θ < 1 money 3.7 C d = α 1 · YD + α 2 · H h−1 0 < α 2 < α 1 < 1 0 0 0 0 Σ 3.8 ∆H s = H s − H s−1 = Gd − Td 3.9 ∆H h = H h − H h−1 = YD − Cd Behavioural (transactions) matrix for Model SIM 3.10 Y = C s + G s Σ Households Production Government 3.11a Y = W · N d -C d +C s 0 Consumption +G s -G d 0 3.11 N d = Y / W Govt. expenditures [Y] [Output] 3.12 ∆H h = ∆H s +W.N s -W.N d 0 Factor income (wages) -T s +T d 0 Taxes Change in stock of - ∆ H h +∆H s 0 money Σ 0 0 0 0

Stocks of ‘High - powered money’ ( i.e. household wealth / government debt) Source: AnyLogic NB – in this model:  • The government will always have negative financial wealth (i.e. debt) • the only money is government ‘high - powered’ money; the government sector prints and destroys its own IOUs so no external monetary source or sink in the model. • (By assumption) producers do not accumulate wealth Godley, W. & Lavoie, M. (2007) Monetary Economics: An Integrated Approach to Credit, Money, Income, Production and Wealth. Basingstoke: Palgrave Macmillan.

Flows of money. ? 

Information flows/links. + + + + ?  + + + + Taxation function Consumption function Government budget constraint Household budget constraint

The circular flow of money sector + + + +

Government sets a level of annual spending, G d (20 in the model), and chooses a tax rate, θ (20% in the model) . Taxation function Consumption function Government budget constraint Household budget constraint Consumers choose to consume a portion ( α 1 ) of their disposable income and portion ( α 2 ) of their wealth ( this implies a target wealth-to-disposable income ratio ( α 3 ) , given by the equation α 3 = (1 − α 1 )/α 2 ).

Model boundaries and observations Endogenous Exogenous Excluded GDP / Output (Y) Fiscal stance (tax & spending) Banks (inc. Central) Budget deficit / surplus Consumption propensities Corporate Profits Government ‘debt’ Implied target wealth-to-income ratio Lending & borrowing Consumer wealth Prices/inflation Debt-to-GDP ratio Overseas sector Wealth-to-income ratio Tangible assets or goods Model demonstrates (see Godley & Lavoie, p. 68 ff) • Steady-state GDP is function of ‘fiscal stance’ (specifically G/ θ ) • Steady-state (‘equilibrium’?) may take several years to attain • Steady-state = balanced budget and no consumer saving/dissaving flows • Government debt-to-GDP ratio is driven primarily by consumer desire to accumulate financial wealth • If consumers wish to attain a higher wealth/income ratio, govt. debt/GDP ratios will rise. • Government attempts to lower debt-to-GDP ratio ( ceteris paribus ) by: i. Increased taxation: will eventually work, but reduce steady-state GDP; ii. Spending cuts: will fail *, but lead to a ‘permanent’ drop in GDP. * Cutting spending reduces government debt, but GDP falls faster than debt is reduced – assuming consumers base decision on levels of disposable income.

www.runthemodel.com G = 20 in period 1 (instigates circular flow) Household Taxes Household Saving/dissaving Wealth ‘Austerity’ spending cut in period 31 Government Government Wealth Tax increase in period 51 Surplus/deficit Household GDP Wealth/YD ratio Disposable Income Govt Debt/GDP Ratio Household Consumption Wealth/income ratio

Consumer wealth decreases over time as government debt is reduced. In period 73 consumers increase propensity to consume out of income (implicitly reducing target wealth/YD ratio)… … spike in GDP is eliminated over time as stock-flow norm reasserts itself.

Thank you for listening. Questions or comments? neil.smith@plymouth.ac.uk