Simon Wren-Lewis — Sector Financial Balances as a Diagnostic Check

Simon Wren-Lewis finally addresses sectoral balances and Wynne Godley in response to Martin Wolf, and says that he has been aware of this type of analysis since working at British Treasury in the Seventies.

Martin Wolf has a nice post explaining the financial crisis using sector financial balances. He rightly attributes this way of looking at things to Wynn Godley. It goes way back – I remember using them as a cross-check on forecasts in the UK Treasury in the 1970s, but it was probably Godley’s influence that helped that happen too. They are not a substitute for thinking about macroeconomic behaviour, but they can often be a very useful check on whether your thoughts (or forecasts) make sense.

And then admits that he didn't look at them closely enough.

Looking at sector balances are not a substitute for thinking about behaviour, but they can and should demand that we are able to tell stories about them that make sense. Where I think criticism of the mainstream macroeconomic profession is correct is that there were not enough people telling convincing stories about why the household sector balance was evolving the way it did over the two decades before the recession. (I talk more about this here.) What was I doing? The answer is writing papers looking at the impact of fiscal policy in DSGE models, and not looking at this kind of data at all. In that sense I was definitely part of the problem, although it did kind of come in useful later on.

Read it at mainly macro

Sector Financial Balances as a Diagnostic Check

by Simon Wren-Lewis | Professor, Oxford University

"In that sense I was definitely part of the problem..." Apology acknowledged and accepted.

I am gratified to see that Professor Wren-Lewis admits, like Paul Krugman did recently, that he was looking at the wrong thing, even through he had more appropriate tools at hand. This is definitely progress.

But no mention yet that Wynne Godley successfully predicted the crisis based on his SFC modeling and sector balance macro analysis. He did not have to wait until the collapse to "diagnose" it.

So did others using this approach, like MMT economist Randy Wray who combined Godley's method of analysis with Hyman Minsky's.

Ann Pettifor also predicted an impending debt deflationary episode in 2003 and reiterated the warning in 2006.

Orthodoxy’s monumental blind spot for the nature of credit, and disregard for the impact of high borrowing costs, meant of course that economists were blind-sided by the crisis in 2007. The wealthy LSE e.g. could not do what we at the new economics foundation achieved in 2003 with very little funding and in a harsh and dismissive intellectual climate: the publication of a book that clearly spelled out the inevitability of the global asset bubble bursting.  

Without the help of a single Dynamic Stochastic General Equilibirum (DSGE) model, and ignoring the Rational Expectations Hypothesis, I edited a nef book: “The real world economic outlook” (Palgrave Macmillan, 2003) which predicted “a seismic crisis” – the bursting of the credit bubble “in America, not Argentina”. (Cover of the New Statesman 1st September, 2003.)

What confounded us for the next four years was how long it took for the ‘dagger’ of rising interest rates to puncture the credit bubble.

Three years later, in 2006, desperately worried about the borrowing habits of my fellow citizens, I authored a book with the cheerful title: ‘The coming first world debt crisis’ (Palgrave 2006) which spelled out the causes, nature and extent of the threat facing the global financial system.

It was not rocket science!

Nor was much of it new.

We owed much of our analysis and insight to the genius of JMK, who himself failed to predict the 1929 crisis, and lost a great deal of money on the stock exchange as a result.

Ann Pettifor: speech notes for presentation to the Just Banking Conference, Edinburgh, 20th April, 2012

So I would conclude that both Professors Wren-Lewis and Krugman were looking the wrong way even though they had the necessary before them because the theory they were relying on did not direct them properly. Those following in the footsteps of JMK, Wynne Godley, and Hyman Minsky, and other Post Keynesians, did have the correct guidance.