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Edwin Le Heron (2012) Financial crisis, state of confidence and economic policies in a post-keynesian stock-flow consistent model”, in Louis-Philippe Rochon, Salewa Yinka Olawoie (eds.), Monetary Policy and Central Banking: New Directions in Post-Keynesian Theory, Edward Elgar

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Abstract: While in 2007 it was only a financial crisis and particularly, a banking crisis, now economic growth and employment are deteriorating sharply. The aim of this chapter is to understand how the financial crisis was transformed in a global real economic crisis and how it passed through the banking behaviour. We are particularly interested in psychological variables such as the state of confidence, because these variables play a key role in the Post-Keynesian tradition through expectations. We develop a model of a `financiarized’ economy suffering a strong fall in the state of confidence of banks, firms and households. In order to do so, we analysed two policy mix. We contrast a rule on public expenditures with a rule on public deficits and a usual Taylor rule with a truncated Taylor rule. In the first case, the government implements a fiscal policy with automatic stabilizers and the central bank has a dual mandate: inflation and growth. There is a co-ordination between fiscal and monetary policies. The second policy mix implements an orthodox fiscal policy (balanced budget) and the independent central bank implements inflation targeting. In the first part, we present the most important equations of a Post-Keynesian stock-flow consistent (SFC) model (Godley-Lavoie, 2007, Dos Santos-Zezza, 2004, Le Heron-Mouakil, 2008, Le Heron, 2009) with a private banks sector introducing more realistic features. We introduce the borrower’s and the lender’s risks from the Minskian approach. In the second part, we simulate the model to study the effects of a financial crisis on the banking behaviour within our two policy mix. The aim is to deal with the consequences of a fall in the state of confidence of banks, firms and households. We make a comparison for the two assumptions on the policy mix and we analyze the channel of transmission on the economic activity.

Keywords: financial crisis, lender risk, Real-financial Interaction, state of confidence

November 13, 2010 | Comments Closed