Bill Mitchell — GDP is a flow and is the sum of the all expenditure flows over a given period

I have two days of teaching left in Helsinki and my next stop on Friday is Dublin where I will be discussing unification and exit. Should be a fun topic. Its Wednesday back home already and today I consider a matter that came up in one of my classes that I am taking in macroeconomics at the moment at the University of Helsinki. Students really struggle when first introduced to the idea of a stock and a flow. They can easily be led into defining a flow as a stock. Getting this absolutely right is one of the key building blocks in understanding basic macroeconomics and the links between the expenditure system and financial accumulation. Modern Monetary Theory (MMT) builds heavily on the difference between stocks and flows and is also what we call stock-flow consistent. So all flows that inform stocks are accounted for in a consistent way. So, for example, we know that when households save, which is the residual of disposable income that is not consumed and a flow, this accumulates into a stock of financial wealth. Today, I am seeking to clarify the issue in my class that we did not have sufficient time to deal with in detail last week. And after that, some music to restore sanity....

Bill Mitchell – billy blog
GDP is a flow and is the sum of the all expenditure flows over a given period
Bill Mitchell | Professor in Economics and Director of the Centre of Full Employment and Equity (CofFEE), at University of Newcastle, NSW, Australia

Gennaro Zezza and Francesco Zezza — On the Design of Empirical Stock-Flow-Consistent Models

While the literature on theoretical macroeconomic models adopting the stock-flow-consistent (SFC) approach is flourishing, few contributions cover the methodology for building a SFC empirical model for a whole country. Most contributions simply try to feed national accounting data into a theoretical model inspired by Wynne Godley and Marc Lavoie (2007), albeit with different degrees of complexity.

In this paper we argue instead that the structure of an empirical SFC model should start from a careful analysis of the specificities of a country’s sectoral balance sheets and flow of funds data, given the relevant research question to be addressed. We illustrate our arguments with examples for Greece, Italy, and Ecuador.

We also provide some suggestions on how to consistently use the financial and nonfinancial accounts of institutional sectors, showing the link between SFC accounting structures and national accounting rules.

Levy Economics Institute
On the Design of Empirical Stock-Flow-Consistent Models

Gennaro Zezza and Francesco Zezza

sfc models — New working paper

Modeling economic forces, power relations, and stock-flow consistency:a general constrained dynamics approach

by Oliver Richters and Erhard Gloetzl

Abstract: In monetary Stock-Flow Consistent (SFC) models, accountingidentities reduce the number of behavioral functions to avoid anoverdetermined system of equations. We relax this restriction using adifferential algebraic equation framework of constrained dynamics.Agents exert forces on the variables according to their desire, forinstance to gradually improve their utility. The parameter ‘economicpower’ corresponds to their ability to assert their interest. Inanalogy to Lagrangian mechanics, system constraints generate additionalconstraint forces that lead to unintended dynamics. We exemplify theprocedure using a simple SFC model and reveal its implicit assumptionsabout power relations and agents’ preferences.

Link: https://ideas.repec.org/p/old/dpaper/409.html

sfc models
New working paper

See also

SFC labs at the annual Minsky Summer Seminar

erablogdotcom — Bank income and spending

One of the most common difficulties many people encounter in understanding the mechanics of the financial system lies in their failure to understand the difference between stocks and flows.

erablogdotcom

Bank income and spending

Steve Roth — Why Economists Don’t Know How to Think about Wealth (or Profits)

MMT, SFC, NIPA, FFA, etc. Must-read.

Longish and detailed. Weekend reading.

Angry Bear
Why Economists Don’t Know How to Think about Wealth (or Profits)

Steve Roth

originally published at Evonomics 2016

Brian Romanchuk — SFC Models And Introductory MMT-Style Fiscal Analysis

The usefulness of Stock-Flow Consistent (SFC) models is that they allow us to illustrate concepts in economics without relying solely on verbal descriptions.

In this article, I will discuss my interpretation of some of the ideas floating around in Modern Monetary Theory (MMT). I will note that these are my interpretations of statements made by others, illustrated by an extremely simple model. The key is that even simple models can be used to clarify our thinking.

This article is only a partial response to an article by Gerard MacDonell. He is unhappy about some of the writings of Professor Bill Mitchell, one of the leading MMT economists.

I am not going to argue on Mitchell's behalf, rather I just want to offer some analysis that touches on some of the technical issues Gerard made. He noted that Federal taxation and spending are roughly similar, so how does that square with MMT pronouncements about the independence of taxation and spending? This outcome is not surprising, as it is exactly the sort of thing that is predicted by SFC models -- and MMT mathematical analysis of the economy uses SFC models.

For those if you who are not fully up-to-date on post-Keynesian factionalism, please note that SFC models were meant to be a mathematical lingua franca for post-Keynesian economics. In other words, MMT economists use SFC models, but they are not exclusive to MMT.

Since I want to work with my Python modelling framework here, and it currently cannot support full business cycle analysis (extensions will be added later), I cannot do complete justice to Functional Finance. Therefore, I have to just focus on a couple of more basic ideas about fiscal polict

1. there is little relationship between taxes and spending; and
2. governments cannot control the budget deficit.

I will address these here in turn....

Bond Economics
SFC Models And Introductory MMT-Style Fiscal Analysis
Brian Romanchuk

Andrew Linton — On Loose definitions of Stock Flow Consistency

No DGSE models cannot be called Stock-Flow Consistent.

A correctly specified closed mathematical model will only have a ‘netting’ of flows to zero in one case – equilibrium. In that case you have all stocks no flows – but it cannot handle any out of equilibrium case of its time path – the real world. Because orthodox Neoclassical models are not defined in strict accounting terms – as a balance sheet of assets and liabilities that are unable to model consistency of relations that are defined as assets and liabilities, simple things like assets, debt and money. Crude attempts to overcome this – such as measuring in flows and outflows to a blobby body such as K the stock of capital have irresolvable issues of dimensionality through over over-aggregation.…

Decisions, Decisions, Decisions

On Loose definitions of Stock Flow Consistency

Andrew Linton

Cameron K. Murray — Stock-flow confusion (wonkish)

In his latest article, Noah Smith repeats a claim that has long bothered me: that mainstream economic models are “stock-flow consistent”. Which is to imply that the very popular research agenda in monetary economics using stock-flow consistent (SFC) methods has little new to add to the mainstream. Because. You know. We got that.

I want to respond with two points. First, a theory is a concept. An idea. Theories can therefore be modelled mathematically in many ways. Second, the stocks and flows of the mainstream are different, theoretically, to those of the monetary economists.…

Fresh Economic Thinking
Stock-flow confusion (wonkish)
Cameron K. Murray

Ramanan — Output At Home And Abroad

Accounting identities are tautologies that say nothing about the world other than that the relevant accounts balance. As identities they are not functions, in which inputs determine outputs in terms of a rule. 

However, accounting identities can be used in theoretical interpretation to arrive at causal explanation, but this requires examining relevant behaviors. For example, one entity's expenditure is a flow that increases another entity's income, which will have a cumulative influence on a stock.

Stock-flow analysis observes stock-flow consistency. Accounting identities are boundary conditions of stock-flow consistency.

It’s fairly common for economists to confuse accounting identities and behavioural relationships.

Question: What is the best way to find it?

Answer: The behaviour of output (at home and abroad) is not discussed in their analysis.

It’s not always the case that it’s true but a good way to find – check whether the economist is talking of the effect of changes in stocks or flows on output.

It’s also of course important to discern what someone is literally saying and what that person is trying to say. Economists aren’t the best communicators.…

The Case for Concerted Action
Output At Home And Abroad
V. Ramanan

Ramanan — Stock-Flow Inconsistent? [Reply to Jason Smith]

Ramanan replies to Jason Smith.

The Case for Concerted Action
Stock-Flow Inconsistent?
V. Ramanan

David Ruccio — It’s the math again

On the normative use of mathematics in economics as a rhetorical device for persuasion based on the logical fallacy of appeal to authority not supported by context.

Mathematics never says anything about the state of the world because it is about abstract relationships, but it can be used to appear to do so when accompanied with handwaving. But only testing can determine whether abstract relationships are actually the case.

Consistency does not implies correspondence. That's why we do science. But the math must be consistent. And in economics, this implies stock-flow consistency, which econometric models do not always observe.

Real-World Economics Review Blog
It’s the math again

David Ruccio | Professor of Economics, University of Notre Dame

INET — Matheus Grasselli: How Advanced Mathematics Can Support New Economic Thinking (video)

This episode features Matheus Grasselli, Deputy Director of the Fields Institute for Research in Mathematical Sciences and Institute for New Economic Thinking grantee, discussing how the use of advanced mathematics in economics enables innovative new thinking and could help transform what's possible in the field. Below is an intrduction from Grasselli on how the role of math in economics is changing and what could be next in this exciting area of study.

INET
Matheus Grasselli: How Advanced Mathematics Can Support New Economic Thinking (video)
Interview with Marshall Auerback

The 2007-08 financial crisis was a wake-up call to mathematicians working in the area of quantitative finance, which was by then a mature subject, having grown in size and influence since the pioneering work of Black, Scholes, and Merton in the 1970s. Because the financial instruments that relied on sophisticated mathematics – collateralized debt obligations (CDOs) and other structured products – were at the very center of the crisis, many of us started to look for general models that likewise would put finance at the core of economic activity. It came as somewhat of a surprise that mainstream macroeconomic models, for example those routinely adopted by central banks around the world, had no fundamental role for banks, or financial markets for that matter, other than that of passive intermediaries.

The exceptions were the models used by heterodox economists following earlier work by, among others, Hyman Minsky and Wyne Godley. A general framework to formulate these models is what is called the stock-flow consistent approach, in which the economy as a whole is divided into sectors (households, banks, firms, governments, etc.) and every financial transaction between sectors generates a flow of funds, which in turn alters the stocks of balance sheet items (deposits, equities, etc.) Keeping track of these stock-flow relationships over time leads to systems of equations describing the evolution of the economy as a whole.

My research with the Institute for New Economic Thinking consists of analyzing the systems of equations obtained in this way using the tools of modern dynamical systems theory, including bifurcations, global estimates, and topological properties. As is often the case in judicious applications of mathematics, this kind of study can reveal phenomena that are extremely hard to identify simply by “thinking through the model.” I strongly believe that when motivated by historical experience, grounded by empirical data, and guided by institutional knowledge, mathematics can be much more than a mere language of formalization. It can act as a powerful tool for discovery.

Grasselli is collaborating with Steve Keen.

Dmytri Kleiner — Against the Quantity Theory of Money

Joan Robinson frequently recounts that the great Michal Kalecki once exclaimed to her “I have found out what economics is; it is the science of confusing stocks with flows!” The trouble with the flat earth economists, is that they confuse the dynamic flows of production and consumption that make up an economy with static piles of stuff. Robinson further reasoned that “it is this confusion that has kept the Quantity Theory of Money alive until today.”

P2P Foundation Blog
Dmytri Kleiner: Against the Quantity Theory of Money

JW Mason — Aggregate Demand and Modern Macroeconomics

This is where so many smart people I know end up. You have to use mainstream models -- you can't move the profession or help shape policy (or get a good job) otherwise. But on many questions, using those models means, at best, contorting your argument into a forced and unnatural framework, with arbitrary-seeming assumptions doing a lot of the work; at worst it means wading head-deep into an intellectual swamp. So you do some mix of what my friend suggests here: find a version of the modern framework that is loose enough to cram your ideas into without too much buckling; or give up on telling a coherent story about the world and become a pure empiricist. (Or give up on economics.) But either way, your insights about the world have to come from somewhere else. And that's the problem, because insight isn't cheap. The line I hear so often -- let's master mainstream methods so we can better promote our ideas -- assumes you've already got all your ideas, so the only work left is publicity.

If we want to take questions of aggregate demand and everything that goes with it -- booms, crises, slumps -- seriously, then we need a theoretical framework in which those questions arise naturally.

The Slack Wire
Aggregate Demand and Modern Macroeconomics
JW Mason

[*] Keynes' original term was "effective demand." The two are interchangeable today. But it's interesting to read the original passages in the GT. While they are confusingly written, there's no question that Keynes' meant "effective" in the sense of "being in effect." That is, of many possible levels of demand possible in an economy, which do we actually see? This is different from the way the term is usually understood, as "having effect," that is, backed with money. Demand backed with money is, of course, simply demand.

Andrew Lainton schools Noah Smith on math and SFC

Without a proper modelling of state DGSE is simply mathematically flawed, and to dismiss mathematically correct approaches as ‘physics envy’ displays a basic error of understanding what is necessary to correctly model ANY dynamic system using the fundamental principles of applied mathematics.  Noah needs to get some Maths Envy.

If we correctly model state then we need correct modelling of all factor incomes and investments in future income streams that will yield factor incomes.  Only then will the model be both microeconomically and macroeconomically consistent.  But you have to do both together, at the same time, and only then will you be able to avoid the lucas critique.  The approach that macroeconomics must be microfounded is the wrong way to approach this, it makes the most basic error in all of the social sciences, trying to collapse structure into agency.

Decisions, Decisions, Decisions
@Noahopinion @Profstevekeen The Problem is ‘Maths Envy’ Not ‘Physics Envy’ in Supplanting DGSE
Andrew Lainton | Consultant (UK)

Philip Pilkington: Purging Economics of Religion – A Rebuttal to Robert Nelson’s Defence of The Great Chain of Being

On several occasions I've referred to Robert Nelson's Economics as Religion: From Samuelson to Chicago and Beyond. Philip Pilkington provides an excellent review and critique, explaining neoclassical general and partial equilibrium v. Wynne Godley's stock-flow equilibrium.

Central to the Old Keynesian and Post Keynesian v. Neoclassical and New Keynesian controversy, as well as calling out economic moralizing for what it is.

Naked Capitalism
Philip Pilkington: Purging Economics of Religion – A Rebuttal to Robert Nelson’s Defence of The Great Chain of Beingg

The only way I can think to improve on this post is to add a quotation from Randy Wray about High Priest Paul Samuelson:

The reaction to our post on the nine myths also reminded me of an interview Nobel winner Paul Samuelson gave to Mark Blaug (in his film on Keynes, “John Maynard Keynes: Life/Ideas/Legacy 1995″). There Samuelson said:

“I think there is an element of truth in the view that the superstition that the budget must be balanced at all times [is necessary]. Once it is debunked [that] takes away one of the bulwarks that every society must have against expenditure out of control. There must be discipline in the allocation of resources or you will have anarchistic chaos and inefficiency. And one of the functions of old fashioned religion was to scare people by sometimes what might be regarded as myths into behaving in a way that the long-run civilized life requires. We have taken away a belief in the intrinsic necessity of balancing the budget if not in every year, [then] in every short period of time. If Prime Minister Gladstone came back to life he would say “uh, oh what you have done” and James Buchanan argues in those terms. I have to say that I see merit in that view.”

In other words, the need to balance the budget over some time period determined by the movements of celestial objects, or over the course of a business cycle is a myth, an old-fashioned religion. But that superstition is seen as necessary because if everyone realizes that government is not actually constrained by the necessity of balanced budgets, then it might spend “out of control”, taking too large a percent of the nation’s resources. Samuelson sees merit in that view.

It is difficult not to agree with him. But what if the religious belief in budget balance makes it impossible to spend on the necessary scale to achieve the public purpose? In the same film James Buchanan argues that the budget ought to be balanced except in wartime—and while he does not explicitly endorse Samuelson’s argument that this is nothing but a useful myth, he does imply that there is no financial/economic/solvency reason for balancing the budget. Rather, it is to keep government in check, to ensure it does not grow and absorb too many of the nation’s resources. Ironically, Buchanan’s willingness to deficit-spend in wartime seems to imply that the US ought to almost always run deficits since we are almost always at war with someone. Hence, he seems to advocate nearly permanent budget deficits—no doubt unintentionally. Many might question that position on the argument that if it is OK to run deficits to destroy one’s enemy then it surely makes sense to run deficits to build a strong nation. Indeed, older readers of this blog will remember that our nation got interstate hiways on the argument that this is good for national defense, and that many of us got through college on “national defense student loans”. [emphasis added]

Dirk Ehnts on the austerity fallacy

Historical evidence says that austerity doesn’t work, and to my knowledge there is no theory that supports it either. You can, of course, use neo-classical theory, but that is about flows, not stocks. You simply cannot jump to the conclusion that if you stop a flow (government expenditure) the stock (government debt) will change in the very same direction by the very same amount. For a single household, that may work: I save €100 a month more in order to repay my debt of €1,000, and after 10 months it is all over. However, if all households do it at the same time, then the increase in savings will cause a significant contraction in demand. Hence, firms will not be able to sell and not hire or fire workers. That will make the demand problem worse, since now these newly unemployed consume even less. The government income (taxes) will sink and expenditures will rise (unemployment insurance). There is no one-to-one relationship between the flow and the change in the stock!

The neo-classical theory is a strict flow theory and cannot deal with levels debt. In neo-classical theory, households (entrepreneurs) can only borrow from other households, so that aggregate household debt is zero and non-relevant. However, that is not what reality looks like. Households as an aggregate are indebted, and very much so. Also, some households might face bankruptcy problems. Using neo-classical theory in a situation where debt levels play a major role will lead to wrong policy prescriptions, like austerity. It is the same with some policy prescriptions of Keynesian theory in a situation of full employment, where debt levels might not be binding and a liquidity trap is nowhere in sight. When ideology rules, economies break.

Read it at Econoblog101
Boomtje Boomtje, Bustje BustjeDirk Ehnts | research assistant at the chair for international economic relations at University of Oldenburg, Germany