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

UK System Dynamics Society Chapter: Student Colloquium 2016,London, Friday 15th 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

• 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

• 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.

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 9th- 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.

Principal Literature

Traditional textbook approach in macroeconomics

In particular critiqued by Wheat (2007a, 2007b)

Origins of ‘Circular Flow’ in macroeconomics

Richard Cantillon c.1755

Paper money for food

Landlord

Manufacturing Workers

Farmers John Law (1705)

(see Murphy 1993)

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. 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.

Paper money for commodities Paper money for rent

Samuelson’s ‘canonical’ circular flow diagram (1948)

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.

BUSINESS PUBLIC Productive services Goods and services Wages, interest, etc Consumption purchases

“…what appear to be two tanks … linked by pipes through which water (income) could flow”

• Cf. the Phillips’ Machine (1949)

“I have found out what economics is; it is the science of confusing stocks with flows.”

Michal Kalecki c1936, 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.

Balance sheet of Model SIM Households Production Government Σ Money Stock +H

• H

Accounting (transactions) matrix for Model SIM Households Production Government Σ Consumption

• C

+C

• Govt. expenditures

+G

• G

[Output] [Y] Factor income (wages) +WB

• WB

Taxes

• T

+T Change in stock of money

• ∆H

+∆H Σ Behavioural (transactions) matrix for Model SIM Households Production Government Σ Consumption

• Cd

+Cs

• Govt. expenditures

+Gs

• Gd

[Output] [Y] Factor income (wages) +W.Ns

• W.Nd

Taxes

• Ts

+Td Change in stock of money

• ∆Hh

+∆Hs Σ

3.1 Cs = Cd 3.2 Gs = Gd 3.3 Ts = Td 3.4 Ns = Nd 3.5 YD = W · Ns − Ts 3.6 Td = θ ·W · Ns θ < 1 3.7 Cd = α1 · YD + α2 · Hh−1 0 < α2 < α1 < 1 3.8 ∆Hs = Hs − Hs−1 = Gd − Td 3.9 ∆Hh = Hh − Hh−1 = YD − Cd 3.10 Y = Cs + Gs 3.11a Y = W · Nd 3.11 Nd = Y / W 3.12 ∆Hh = ∆Hs

Godley & Lavoie’s simplest model: ‘Model SIM’ matrices and equations

Godley, W. & Lavoie, M. (2007) Monetary Economics: An Integrated Approach to Credit, Money, Income, Production and Wealth. Basingstoke: Palgrave Macmillan.

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



Flows of money.



?

Information flows/links.

Taxation function Consumption function Government budget constraint Household budget constraint



+ + + +

?

+ + + +

+ + + +

The circular flow of money sector

Taxation function Consumption function Government budget constraint Household budget constraint

Government sets a level of annual spending, Gd (20 in the model), and chooses a tax rate, θ (20% in the model). Consumers choose to consume a portion (α1) of their disposable income and portion (α2) of their wealth (this implies a target wealth-to-disposable income ratio (α3), given by the

equation α3 = (1 − α1)/α2).

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.

G = 20 in period 1 (instigates circular flow) ‘Austerity’ spending cut in period 31 Tax increase in period 51

Household Wealth Government Wealth Household Saving/dissaving Government Surplus/deficit GDP Consumption Disposable Income Taxes Govt Debt/GDP Ratio Household Wealth/income ratio Household Wealth/YD ratio

www.runthemodel.com

In period 73 consumers increase propensity to consume out of income (implicitly reducing target wealth/YD ratio)… Consumer wealth decreases over time as government debt is reduced. … 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