Debt cycles, instability and fiscal rules: a Godley–Minsky synthesis

New paper by Yannis Dafermos

Wynne Godley and Hyman Minsky were two macroeconomists who ‘saw the crisis coming’. This paper develops a simple macrodynamic model that synthesises some key perspectives of their analytical frameworks. The model incorporates Godley’s financial balances approach and postulates that private sector’s propensity to spend is driven by a stock-flow norm (the target net private debt-to-income ratio) that changes endogenously via a Minsky mechanism. It also includes two fiscal rules: a Maastricht-type fiscal rule, according to which the fiscal authorities adjust the government expenditures based on a target net government debt ratio; and a Godley–Minsky fiscal rule, which links government expenditures with private indebtedness following a counter-cyclical logic. The analysis shows that (i) the interaction between the propensity to spend and net private indebtedness can generate cycles and instability; (ii) instability is more likely when the propensity to spend responds strongly to deviations from the stock-flow norm and when the expectations that determine the stock-flow norm are highly sensitive to the economic cycle; (iii) the Maastricht-type fiscal rule is destabilising while the Godley–Minsky fiscal rule is stabilising; and (iv) the paradox of debt can apply both to the private sector and the government sector.

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A Minskyan-Fisherian SFC model

A new working paper by Ítalo Pedrosa and Antonio Carlos Macedo e Silva, “A Minskyan-Fisherian SFC model for analyzing the linkages of private financial behavior and public debt” is available here
Abstract: This paper builds a stock-flow consistent (SFC) model to analyze how private financial behavior impacts fiscal variables, by exploring the linkages between the financial and productive sides of the economy with prices given by a Phillips curve. We study three different fiscal expenditure regimes: 1. Automatic stabilizer: government expenditures follow an exogenous long run trend; 2. Countercyclical fiscal expenditure; 3. Fiscal austerity: government reduces expenditures when it faces an increase in its debt to capital ratio. The model has three major implications, ratifying Keynesian intuitions. First, an increase in public debt is an unintended consequence of contractionary financial conditions. Second, in most cases countercyclical fiscal expenditures improve both the economic activity and the trajectory of public debt to GDP. Third, austerity policies postpone and magnify the after-shock adjustment, and may not be compatible with fiscal soundness.