Financial Assets, Debt and Liquidity Crises The macroeconomic development of most major industrial economies is characterised by boom-bust cycles Normally such boom-bust cycles are driven by specific sectors of the economy In the financial meltdown of the years 2007–9 it was the credit sector and the real-estate sector that were the main driving forces This book takes on the challenge of interpreting and modelling this meltdown In doing so it revives the traditional Keynesian approach to the financial–real economy interaction and the business cycle, extending it in several important ways In particular, it adopts the Keynesian view of a hierarchy of markets and introduces a detailed financial sector into the traditional Keynesian framework The approach of the book goes beyond the currently dominant paradigm based on the representative agent, market clearing and rational economic agents Instead it proposes an economy populated with heterogeneous, rationally bounded agents attempting to cope with disequilibria in various markets m atthieu c har p e works as an economist for the International Institute for Labour Studies at the International Labour Organization in Geneva ca r l c hiar ella is Emeritus Professor and Professor of Quantitative Finance in the School of Finance and Economics at the University of Technology, Sydney p eter f las c hel is Emeritus Professor in the Faculty of Economics at Bielefeld University w i lli s emmler is Professor of Economics at The New School for Social Research, New York Financial Assets, Debt and Liquidity Crises: A Keynesian Approach Matthieu Charpe Carl Chiarella Peter Flaschel Willi Semmler cambridge university press Cambridge, New York, Melbourne, Madrid, Cape Town, Singapore, São Paulo, Delhi, Tokyo, Mexico City Cambridge University Press The Edinburgh Building, Cambridge CB2 8RU, UK Published in the United States of America by Cambridge University Press, New York www.cambridge.org Information on this title: www.cambridge.org/9781107004931 © Cambridge University Press 2011 This publication is in copyright Subject to statutory exception and to the provisions of relevant collective licensing agreements, no reproduction of any part may take place without the written permission of Cambridge University Press First published 2011 Printed in the United Kingdom at the University Press, Cambridge A catalogue record for this publication is available from the British Library Library of Congress Cataloging in Publication data Financial assets, debt, and liquidity crises : a Keynesian approach / Matthieu Charpe [et al.] p cm Includes bibliographical references and index ISBN 978-1-107-00493-1 Macroeconomics Business cycles Financial crises Keynesian economics I Charpe, Matthieu HB172.5.F516 2011 330.9 0511–dc22 2011011256 ISBN 978-1-107-00493-1 Hardback Cambridge University Press has no responsibility for the persistence or accuracy of URLs for external or third-party Internet websites referred to in this publication, and does not guarantee that any content on such websites is, or will remain, accurate or appropriate Contents List of figures List of tables Notation Preface page x xiv xvi xxi Financial crises and the macroeconomy 1.1 Open economies, foreign debt and currency crises 1.2 Household borrowing, debt default and banking crises 1.3 Overleveraging, debt and debt deflation 1.4 Plan of the book 10 Part I 13 The non-linear dynamics of credit and debt default Currency crisis, credit crunches and large output loss 2.1 The emergence of currency crises 2.2 Some stylised facts 2.3 The Krugman model: an MFT representation 2.4 Sectoral budget equations and national accounts 2.5 Flexible exchange rates: output and exchange rate dynamics 2.6 Fixed exchange rates and the emergence of currency crises 2.7 International capital flows: adding capital account dynamics 2.8 Conclusions 15 15 16 17 23 29 36 42 48 Mortgage loans, debt default and the emergence of banking crises 3.1 Mortgage and banking crises 3.2 A Keynes–Goodwin model with mortgage loans and debt default 3.3 Excessive overconsumption and an attracting steady state 3.4 Weakly excessive overconsumption and a repelling steady state 3.5 Credit rationing, reduced consumption and the emergence of mortgage crises 50 50 52 55 62 65 v vi Contents 3.6 3.7 3.8 3.9 Monetary policy in a mortgage crisis Adding commercial banking Conclusions and outlook Appendix: some simulation studies of the baseline model 67 71 77 78 116 117 119 124 125 127 128 132 Part II Theoretical foundations for structural macroeconometric model building Debt deflation and the descent into economic depression 4.1 The debt deflation debate 4.2 3D debt accumulation 4.3 4D debt deflation 4.4 Keynes–Metzler–Goodwin real business fluctuations: the point of departure 4.4.1 The basic framework 4.4.2 The 3D Rose type wage-price dynamics 4.4.3 The 2D Metzlerian quantity dynamics and capital stock growth 4.4.4 Putting things together: the KMG growth dynamics 4.5 Feedback-motivated stability analysis 4.6 Debt deflation in the KMG framework 4.6.1 Integrating debt financing of firms 4.6.2 Enterprise debt dynamics in the KMG framework 4.6.3 Analysis of the model 4.7 Conclusions and outlook 133 Keynesian macroeconometric model building: a point of departure 5.1 Introduction 5.2 The real and the financial part of the economy 5.2.1 The structure of the real part 5.2.2 The structure of the financial part 5.3 The structure of the economy from the viewpoint of national accounting 5.3.1 The four sectors of the economy 5.3.2 Gross domestic product, savings, investment and further aggregates 5.4 The model 5.4.1 Preliminaries 5.4.2 Households 5.4.3 Firms 5.4.4 The government 5.4.5 Quantity and price adjustment processes 85 85 88 100 111 112 113 135 135 139 139 140 142 142 148 151 152 155 161 164 168 Contents vii 5.4.6 The dynamics of asset market prices and expectations 5.4.7 External accounts and foreign country data The next steps 171 176 178 Intensive form and steady state calculations 6.1 Introduction 6.2 The real and the financial structure on the intensive form level 6.2.1 The real part of the economy 6.2.2 The financial part of the economy 6.3 The implied 34D dynamics 6.3.1 The laws of motion 6.3.2 Static relationships 6.4 Steady state analysis 6.5 The 18D core dynamics of the model 6.5.1 The laws of motion 6.5.2 Static relationships 6.6 Outlook: feedback structures and stability issues 180 180 181 181 182 183 184 190 192 197 198 200 201 Partial feedback structures and stability issues 7.1 Introduction 7.2 National accounting (in intensive form) 7.2.1 Firms 7.2.2 Asset holders 7.2.3 Workers 7.2.4 Fiscal and monetary authorities 7.2.5 International relationships 7.3 The core 18D dynamical system: a recapitulation 7.4 A Goodwin wage income/insider-outsider labour market dynamics 7.5 Adding the Rose real wage feedback chain 7.6 The Metzlerian expected sales/inventory dynamics 7.7 The dynamics of housing supply 7.8 The Keynes effect 7.9 The Mundell–Tobin effect 7.10 The Blanchard bond and stock market dynamics 7.11 The dynamics of the government budget constraint 7.12 Import taxation 7.13 The Dornbusch exchange rate dynamics mechanism 7.14 Conclusions 206 206 207 207 209 209 209 210 211 Part III Debt crises: firms, banks and the housing markets 251 Debt deflation: from low to high order macrosystems 8.1 Introduction 253 253 5.5 216 219 224 228 230 232 234 240 242 243 248 viii Contents 8.2 Reformulating the structure of the economy 8.2.1 Changes in the financial sector of the economy 8.2.2 Changes from the viewpoint of national accounting The augmented 18+2D system: investment, debt and price level dynamics Intensive form representation of the 20D dynamics Debt effects and debt deflation 8.5.1 3D debt accumulation 8.5.2 4D debt deflation Numerical simulations: from low to high order dynamics 8.6.1 The 3D dynamics 8.6.2 The 4D dynamics 8.6.3 The 20D dynamics Summary and outlook 260 261 261 Bankruptcy of firms, debt default and the performance of banks 9.1 Debt targeting, debt default and bankruptcy 9.2 Tabular representations of stocks and flows 9.3 Commercial banks and pro-cyclical credit supply 9.3.1 Firms 9.3.2 Commercial banks: credit rationing and money creation 9.3.3 Asset holders: Blanchard asset market dynamics 9.3.4 Public sector 9.3.5 Workers 9.4 Reduced form equations and steady state 9.5 Debt default without and with bankruptcy 9.5.1 Debt default without bankruptcy 9.5.1.1 The case of a wage-led aggregate demand 9.5.1.2 The case of a profit-led aggregate demand 9.5.2 Debt default with bankruptcy 9.5.2.1 The case of a wage-led aggregate demand 9.5.2.2 The case of a profit-led aggregate demand 9.6 Simulations: baseline scenarios 9.6.1 Debt default and bankruptcy 9.6.2 Banks’ budget constraint 9.6.3 Pro-cyclical profits and credit supply 9.6.4 Debt default and credit crunch 9.6.5 Bank bailouts and loss socialisation 9.7 Simulations: extended studies 9.7.1 Wage-led aggregate demand 9.7.2 Profit-led aggregate demand 9.7.3 Debt deflation 307 309 311 313 313 317 320 321 323 325 327 328 330 332 333 335 336 338 338 339 340 341 342 343 343 346 347 8.3 8.4 8.5 8.6 8.7 266 273 282 283 287 294 294 296 300 304 Contents 9.8 9.7.4 Interest rate policy rules 9.7.5 Fiscal policy Conclusions ix 349 351 352 10 Japan’s institutional configuration and its financial crisis 10.1 A stable profit-led real sector 10.2 Pro-cyclical financial markets 10.3 Less than optimal fiscal and monetary policies 10.4 Debt default without bankruptcy 10.5 Bad debt and banking crises 10.6 Delayed and weak government response 10.6.1 The early response: buy-in of failing banks 10.6.2 The ineluctable buy-out of failing banks 10.7 Conclusions 10.8 Appendix: data sources 354 356 360 362 365 367 368 370 372 378 379 11 Housing investment cycles, workers’ debt and debt default 11.1 Introduction 11.2 Debt relationships in the household sector 11.2.1 Worker households 11.2.2 Pure asset holder households 11.2.3 Wage, price and interest rate adjustment processes 11.3 Intensive form derivation of a simplified 9D dynamics 11.4 2D, 3D and 5D subcases of integrated 6D real subdynamics 11.5 Numerical investigation of housing cycles and debt deflation 11.6 Debt default and bankruptcy in the private housing market 11.7 Conclusions 380 380 382 382 385 388 389 397 410 414 419 References Index 420 427 418 Housing investment cycles, workers’ debt and debt default 0.14 1.1 0.12 1.0 re rh ph, kh, λw r e, rh, i 0.10 0.08 0.06 i λw 0.7 10 15 20 25 Time 30 35 40 45 0.5 50 1.04 0.92 10 15 20 25 Time 30 35 40 45 50 0.93 1.00 0.96 u 0.92 uh 0.88 0.90 0.89 0.84 0.80 ch 0.91 e ch e, uh, u ph 0.8 0.6 0.04 0.02 kh 0.9 0.88 10 15 20 25 Time 30 35 40 45 0.87 50 ph 0.84 0.86 0.88 0.90 0.92 0.94 0.96 0.98 ph Figure 11.9 Increasing instability due to additional investment in the supply of housing services due to increases in the housing default rate of workers 0.18 0.14 ph, kh, λw r e, rh, i 0.10 0.06 Rates of Return 0.02 –0.02 –0.06 20 40 60 80 Time 100 120 140 180 1.2 1.1 0.9 ch e, uh, u 1.0 0.8 Utilisation Rates 0.7 0.6 20 40 60 80 Time 100 120 140 180 4.0 3.6 3.2 2.8 2.4 2.0 1.6 1.2 0.8 0.4 0.0 λw kh ph 0.98 0.96 ch 0.94 0.92 0.90 0.88 0.86 0.84 0.82 0.5 20 40 60 80 Time 100 120 140 180 ph 0.6 0.7 0.8 0.9 1.0 1.1 1.2 1.3 ph Figure 11.10 Economic breakdown through default dependent price deflation In the second case the combination of = and α2 = 0.35 is sufficient to generate the explosive trajectories (again starting from the simulation shown in Figure 11.6) shown in Figure 11.9 Finally, choosing both of the positive parameter values, α1 = 0.25, α2 = 0.25, again produces a breakdown of the economy as shown in Figure 11.10 We refer the reader back to Part I of the book for a discussion of the current subprime crisis in the US and, spreading out from there, to parts of the world economy This current debt and liquidity crisis is however much more multi-faceted than what could be included into the type of structural macroeconometric model which we extensively 11.7 Conclusions 419 discussed in Part II of the book In contrast to Chapters and we did not model commercial banks as intermediaries between pure asset holders and worker households (and thus also not the process of disintermediation) Furthermore, booms and busts in housing prices were here still coupled in a one-to-one fashion with what was happening on the other goods markets of the economy Nevertheless inflationary and deflationary busts could be shown to be characteristic for the trajectories generated by the 9D subdynamics of this chapter, which however deserves much more investigation than could be done in this final chapter 11.7 Conclusions In this chapter we have reconsidered a general disequilibrium model, with an applied orientation and exhibiting a detailed modelling of the private housing sector, which we have developed in Part II, starting from the Murphy model for the Australian economy discussed in Powell and Murphy (1997) This modelling approach is complete with respect to budget equations and stock-flow interactions and can be reduced to a somewhat simplified 18D core model, the dynamics of which were intensively studied in Part II In the present chapter we have modified this type of model towards the explicit consideration of debtor and creditor households, thus extending the dynamics of the core model by one dimension to 19D by the addition of the dynamics of the debt to capital ratio of the indebted worker households The subdynamics of these 19D dynamics were investigated theoretically and illustrated numerically The basic findings were that there is convergence to the balanced growth path of the model for sluggish disequilibrium adjustment processes, that persistent investment cycles in the housing sector can be generated for certain higher adjustment speeds by way of Hopf bifurcations in particular, and that processes of debt deflation may trigger monotonic 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Federal Reserve Bank of New York Economic Policy Review (May), 259–65 Wilson, D (2000) Japan’s slow-down: monetary versus real explanations Oxford Review of Economic Policy 16(2), 18–32 Index asset holders in commercial banking sector, 72 debt default and banking crisis, 54 money demand of, 76 asset price deflation mechanism., 85 asset price inflation, 9, 253 during economic expansions, 85 balance of payments, of domestic economy, 43 continuous time model, 42 demand for domestic bonds, 43 equilibrium position, 42 flow of demand function, 44 market of foreign bonds, 44 bankruptcies, 307 and debt default, model, 309–311 reduced form equations and steady state dynamics, 325–327 simulation studies, 338–343 Blanchard mechanism for dynamic adjustments, 234–239 boom-bust cycles, 1, asset price, 8, 86 real estate, boom period, budget constraints Murphy model of Australian economy, 141 business cycle–wage led dynamics, 343–347 capital market liberalisation benefits, 3–4 government guarantees, role of, negative externalities, rapid, 3–4 central bank activities, 75–77 credit financing, 73–74 Goodwinian cycle growth dynamics, 75 money demand of, 76 role in the working of economy, 73 Cobb-Douglas utility functions, 155, 158 collateralised debt obligations (CDOs), 5, 5, collateralised default obligations (CDO), 86 collateralised loan obligations (CLOs), commercial bank, Keynesian regime of asset holders, 72 central bank activities, 73–77 dynamics of credit financing, 73–74 volume of loans supplied to workers, 72 workers, 71 commercial bank, stock-flow principle of asset market dynamics, 321 credit rationing and money creation, 317–319 firms, 313–317 public sector, 321–323 workers households, 323–325 credit crunch, in banking sector, credit default swaps (CDS), 86 credit financed economy, 73 currency crisis, evolution of, 15–16 imperfect capital market theory, 15 likely occurrence of, 16 macroeconomic fundamentals, 15 speculative forces, role of, 15 18D core dynamics asset market dynamics, 199 feedback policy rules, 192 growth dynamics, 198 quantity dynamics, 191 steady state dynamics, 212–216 wage/price dynamics, 191 4D debt deflation channels for destabilising price flexibility, 105–106 conditions for convergence, 107–110 convergent dynamics, 106–107 Fisher debt mechanism, 101, 108, 109 of full employment labor intensity, 101 Goodwin type, 101 Jacobian of, 104–105 Keynes-effect, 102 Keynes–Metzler–Goodwin (KMG) dynamics, 100, 102 Metzlerian feedback mechanism, 101, 102 Mundell-effects, 102 policy application and debt capital ratio, 108 reduced to 3D dynamics, 102 427 428 Index 4D debt deflation (cont.) Rose real wage effects, 101, 104–105, 109 steady state dynamics, 103–110 4D dynamics Jacobian determinant, 93 Routh-Hurwitz conditions, 93 debt accumulation, 86 3D dynamics, 283–287 Keynes-effects, 98 Metzler-effects, 98 Mundell-effects, 98 occurrence of explosive, 99 Rose effects, 97 debt default, 307 with bankruptcy, 333–338 effects of fiscal policy, 351 impact of interest rate policy rules, 350 profit-led aggregate demand, 347–348 simulation studies, 338–343 wage-led AD, 347–348 without bankruptcy, 327–333 debt deflation, 8–9 asset price dynamics, 272 budget equation of firms, 270 3D dynamics, 294–295 4D dynamics, 287–294, 296–299 debate, 85–88 and debt effects, 282–294 destabilising potential of, 254 20D model, 273–282, 300–304 18+2D system, 266–272 due to changes in financial part of economy, 261 firms (investment behaviour), 269–270 Fisher debt effect, 86, 255, 257–258 and global strategies, 254 government expenditure and taxation rules, 271 Keen model, 269–272 Keynes or Pigou effects, 256 KMG growth model, 124–128 macroeconomic models, 86–87 Minsky’s financial instability hypothesis, 86 modern macroeconomic theory of, 254–255 national accounting perspective, 260–266 nominal (gross) wages dynamics, 271 numerical stimulations, 294–304 Rose effects, 256, 257 debt financing and budget constraint dynamics, 93 convergent dynamics, 92 34 dimensional dynamical system, 189 in flexible interest rate, 93–94 Goodwin-type growth model, 90, 92 Murphy model, 167 negative contribution of, 94–95 positive contribution, 91–94 pure rate of profit, boundary conditions of, 92 shocks of debt to capital ratio, 96–98 steady state dynamics, 91 threshold values for wage share, 95–100 destabilising/stabilising effect inflationary expectations, Mundell, 121 inventory adjustment, Metzlerian, 121 Keynes, 120 Metzler, 120 Mundell, 120 Rose, 120–122 34 dimensional dynamical system asset prices and expectations, 185 budget constraint of asset holders, 189 consumption decisions, 192 18D core dynamics, 197–201 debt financing, 189 distribution of domestic long-term debt, 189 dynamics of aggregate and individual asset holdings, 188–189 financial part of economy, 182–183 foreign assets, 190 government budget equation, 189 growth dynamics, 187 growth rates of capital stocks, 191 growth rates of open economy, 190 individual assets, dynamics of, 189 laws of motion, 184–190 long-term bonds, dynamics of, 186 monetary and fiscal policy rules, 187–188 NAIRU rate of employment, 193 output and demand on the market for goods, 190 price dynamics, 194 quantity dynamics, 184 rate policy rule of the central bank, impact of, 190 rates of return, dynamics, 191 real part of economy, 181–182 real savings of workers, 189 representation of financial flows, 183 static relationships, 190–192 steady state, 192–197 Tobin’s q, 186 wage payments, 190–191 wage/price dynamics, 185 6D Keynesian dynamics, 123–124 2D Metzlerian quantity dynamics and capital stock growth, 116–117 domestic economy, laws of motion in, 47 Dornbusch exchange rate dynamics, 119, 243–248 Dynamic Stochastic General Equilibrium (DSGE) model, economic system, 311–313 economy, sectors of accumulation account, 143 accumulation account of asset owners, 144 accumulation account of firms, 143 accumulation account of fiscal and monetary authorities, 146 accumulation account of workers, 145 accumulation of real assets, 147 balance of payments, 148 corporate profit taxation, 147 domestic production, 142 external accounts, 148 financial account of asset owners, 144 financial account of firms, 143 Index financial account of fiscal and monetary authorities, 146 financial account of workers, 145 financial wealth taxation, 147 income account of asset owners, 144 income account of firms, 143 income account of fiscal and monetary authorities, 146 income account of workers, 145 income of asset holders, 144 production account of asset owners, 144 production account of firms, 143 production account of fiscal and monetary authorities, 146 production account of workers, 145 real property taxation, 147 sources of government income, 146 taxation, 142, 143, 147 worker households accounts, 146 employment and real wage dynamics, 55 feedback-guided β-stability analysis, 122, 123–124 feedback mechanism Blanchard mechanism for dynamic adjustments, 234–239 Dornbusch exchange rate dynamics mechanism, 243–247 dynamics of government debt, 240–242 dynamics of the housing sector, 228–230 Goodwin wage income/insider-outsider labor market dynamics, 216–219 impact of import taxation rule, 242 Keynes-effect, 230–232 Metzlerian expected sales/inventory dynamics, 224–227 Mundell–Tobin mechanism of inflation, 232–234 Rose real wage feedback chain, 219–224 feedback-motivated stability analysis Jacobian determinant, 123–124 Keynes effect, 120 KMG dynamics, 122–124 laws of motion, 123 Metzler effect, 120 Mundell effect, 120 Rose effect, 120–122 Routh–Hurwitz stability conditions, 123 β-stability methodology, 123–124 financial crises, Asian, 3, 4, 17 Mexican, 3, 9, 253 roles of currency in, Russian, stylised facts, 17 subprime, 5, US 2007/2008, financial innovations, 5, 51 financial market melt down, 2007 See subprime crisis Fisher debt effect, 10, 86 between firms and financial intermediaries, 87 fixed exchange rate regime, 19 429 crisis in terms of, 38–41 demand for foreign bonds during currency crisis, 40, 45 devaluation of currency, 39–40 devaluation of exchange rate, 41 features, 36 foreign bond reserves, 38 goods-market equilibrium curve, 37 investment crisis, 40 law of motion for capital flight parameter, 40–41 normal equilibrium, 38 vulnerable institutional configurations, 46 flexible exchange rate regime, 19 adjustment process to equilibrium, 33–36 asset market equilibrium, dynamics of, 30–35 debt financing, 93–94 depreciation of currency, 31 equilibrium, 30–30 excess demand function for foreign bonds, 33 functional dependence of asset demand curve, 31 impact of contractionary monetary policy, 32–33 implications of a steep AA-curve, 30–31 international capital flows in, 45 problems with flow demand functions, 46–47 reallocations in dollar-denominated bonds, 32 revision of long-run reference value, 36 risk of investing in domestic bonds, 31 semi-stable or stable limit cycles, 34 stable equilibria, 35–36 trade cycle analysis, 33 foreign bond holding, dynamics of asset reallocation constraints, 25 balance sheet of firms, 26 behaviour of central bank, 25 budget constraints of household sector, 24–25 budget equation of firms, 24 exchange rates, 26 financial crisis, 26 goods market equilibrium condition, 25 Goodwinian cycle growth dynamics, 51 credit financing of commercial banks, 75 cross-dual adjustment mechanisms, 94 3D dynamics, 97–98 debt-financed investment, 90, 92 debt to capital ratio, 56 goods market equilibrium, 56 Jacobian determinant of, 74 law of motion for labor-capital ratio, 56 Great Depression of 1930s, 8, 85 Greenspan, Alan, 254 Greenspan low interest rate policy, 7, Harrod-neutral technical change, 90, 118, 137, 162 Hopf-bifurcation theorem, 105, 123, 130, 217 household debt, macroeconomic effect of, 51–52 and bankruptcy, 56–56 6D dynamics, 397–410 9D dynamics, 389–397 debt default and the bankruptcy, 414–419 disequilibrium effects, 51–52 430 Index household debt, macroeconomic effect of (cont.) Goodwinian cycle framework, 51 investment cycles and debt deflation, 410–414 Keynesian macrodynamic theory, 51 pure asset holders, behavioural equations of, 385–388 wage, price and interest rate dynamics, 388–389 worker households, behavioural equations of, 382–385 Housing Loan Administration Corporation (HLAC), 375 imperfect capital markets, theory of, 2, 3, and currency crisis, 15 implicit function theorem, 30, 47, 76 information economics, interest rate peg, 33 international capital flows, 44–45 IS-curve, 22 Jacobian determinant for credit rationing, 66 4D debt deflation, 104–105 of 4D dynamics, 93 of debt financing, 92 Dornbusch exchange rate dynamics mechanism, 246–247 for excessive consumption, 59–61 feedback-motivated stability analysis, 123–124 Goodwin growth cycle dynamics, 74 Goodwin wage income/insider-outsider labor market dynamics, 217 of government debt, 240 KMG growth model, of debt deflation, 131 rate of profit, 76 for weak excessive consumption, 62, 63 Japanese crisis, 355 debt default without bankruptcy, 365–366 destabilising effect on banks, 367 elements influencing the behaviour of private sector and their interaction for stability, 356 failure of government intervention, 368–373 financial assistance and capital injections, 373–375 government interventions, 362–365 “lender of last resort” (LLR) activities, 372 pro-cyclical financial market dynamics, 361 Japanese economy, performance of, 11 Kaldorian saving habits, 118 Murphy model of Australian economy, 141 Keen’s 3D model of debt accumulation process, 10–11 aggregate demand, 88 balanced growth path of, 91 negative contribution of debt financing, 94–95 Phillips curve mechanism, 89–91 positive contribution of debt financing, 91–94 supply side growth cycle dynamics, 88 threshold values for monotonic divergence, 95–100 Keynes-Goodwin model of debt default asset holder, 54 firms, 55 real wage dynamic, 55 worker household, 53–54 Keynesian effective demand problems, 76 Keynesian tradition, of financial markets, Keynes-Metzler-Goodwin (KMG) dynamics, of debt, 88, 100 Keynes-Metzler-Goodwin (KMG) model, of business fluctuations and growth, 111 basic framework, 112–113 cross-over wage-price spiral mechanism, 112 distinguish between workers and asset holders, 113 2D Metzlerian quantity dynamics and capital stock growth, 116–117 3D Rose type wage-price dynamics, 113–116 equations for rate of employment and rate of capacity utilisation, 118 error correction mechanisms, 112 expected rate of profit, 117 growth dynamics, 117–119 independent laws of motion, 116 inflationary expectations, 114 Kaldorian saving habits, 118 laws of motion, 119 new Keynesian approach to business cycle theory, 115 Phillips curve mechanism, 112, 114–115 structural form of the wage-price dynamics, 114 use of continuous time, 111 Keynes-Metzler model of monetary growth, 140 KMG growth model, of debt deflation analysis, 128–132 budget equations of government, 126 cyclical loss of stability, 130–132 7D system of interdependent laws of motion, 124–125 employment capital ratio, 128 enterprise debt dynamics, 127–128 Fisher debt deflation effects, 132 inflationary expectations, 127 integration of debt financing, 125–126 Jacobian determinant, 131 Metzlerian quantity adjustment process, 128 monetary policy and rate of interest, 126 money supply rule, 127 price level dynamics, 129 Rose wage effect, 131 Routh-Hurwitz condition for local asymptotic stability, 130–131 soft budget constraint, 126 steady state dynamics, 129–130 Taylor policy rule for the banking sector, 124, 128, 129 ten laws of motion, 127 liquidity crises, 11 loan rate adjustment dynamics and mortgage crisis, 67–69 Long Term Credit Bank (LTCB), 376 macroeconomic boom periods, macroeconomic developments, in US, Index Metzlerian expected sales/inventory dynamics, 224–227 Metzlerian inventory adjustment, 121 Metzlerian output-inventory adjustment mechanism, 88 Metzlerian quantity adjustment process, 120 Minsky’s financial instability hypothesis, 86 modern macroeconomic theory, mortgage backed securities (MBS), 7, 86 mortgage loans and banking crisis asset holder debt default, 54 firm, debt default by, 54–55 Keynes-Goodwin model of debt default, 52–55 loan rate adjustment dynamics, 67–69 real wage dynamic, 55 reasons for increase in mortgage credit, 50 role of monetary policy, 67–71 and securitisation, 50–51 steady state dynamics See steady state dynamics, of equilibrium worker household debt default, 53–54 Mundell-Fleming-Tobin exchange rate model, Krugman type, 15 aggregate demand, 20 consumption and investment behaviour, 18 demand for domestic bonds, 19–18 domestic bond holdings, 21 dynamic multiplier process, 21–22 expected rate of depreciation or appreciation, 19 foreign bond holdings, 21 goods and asset market equilibria, 22 goods market adjustment process, 21–22 implications of the government deficit, 21 investment behaviour, 20–21 private household consumption and saving, 18–19, 20 variables, 18 Mundell inflationary expectations effect, 121 Mundell-Tobin mechanism of inflation, 232–234 Murphy model of Australian economy, 135 accounts of sector of firms, 142–146 actual investment of firms, 163 actual labor supply, 158 adjustment of bond prices, 174–175 aggregate nominal wealth of asset holders and workers, 154 asset accumulation, 171 asset markets of economy, 175 balance of payments, 176–178 behavioural equations of worker households, 155–161 budget constraints, 141 budget equation of firms, 163 Cagan money demand function, 140 central bank money, 154 consumption behaviour of firms, 161 consumption plans of worker households, 157, 158 debt financing of the government, 167 definitions (rates of return, nominal wealth, wages and prices), 153 34 dimensional nonlinear dynamical model, 66 431 disposable income of asset holders, 159 dynamic of the exchange rate, 173 dynamics of asset market prices and expectations, 171–176 dynamics of quantities and prices, 168–171 equation of government module, 164–168 extrinsic nonlinearities, 136 financial assets, 154 financial flows, 141 financial part of economy, structure of, 140–142 ‘foreign’ economy, 176–177 government expenditures, 165 gross domestic product, 149 gross rate of capital stock accumulation of firms, 162 gross wages, 155 growth of stocks, 140 inflationary expectations, 170 input/output coefficients, 152 interest income of worker households, 156 interest rate policy of the central bank, 166 intrinsic (natural) nonlinearities, 136 inventory adjustment process, 169 Kaldorian saving habits, 141 law of motion for consumer prices, 170 law of motion for the price of long-term domestic bonds, 172 life cycle approach of, 177 liquidity preference, 155 Mundell effects, 136 net domestic product, 149–151 net wealth, 154 nominal savings of four sectors, 150–151 paper money, 154 perspective of macrotheory in, 135 Phillips curve mechanism, 136, 169 preliminary notations, 152–155 price inflation, 170 profitability, 154 pure asset holders, consumption behaviour, 158–159, 160 rate of employment, 171 rate of gross investment of asset holders, 160 rate of inflation of rental price in housing, 160 rate of profit for firms, 164 rate of return, 173 rates of profits, 153–154 rates of return, 176 real part of economy, structure of, 139–140 savings of asset holders, 159 savings plans of worker households, 157 sluggish price dynamics, 137 structural form of, 136, 137 supply of housing services, 159 Taylor policy rule, 142, 165 theoretical reformulation, 135, 151 types of workers, 157 unemployment benefits, 155 wage price dynamics, 169 NAIRU rates of capacity utilisation, 103, 137 432 Index national accounting perspective debt deflation, 260–266 national accounts, perspectives accumulation account of asset owners, 210 accumulation account of firms, 208 accumulation account of the fiscal authority, 211 accumulation account of workers, 210 asset holders, 209 assumptions, 27–27 balance of payments, 28–29 external account, 211 financial account of asset owners, 210 financial account of firms, 208 financial account of workers, 210 firms, 206–209 fiscal and monetary authorities, 209 income, change of wealth and flow of funds accounts of the central bank, 27 income account of asset owners, 210 income account of firms, 208 income account of fiscal and monetary authorities, 211 income account of workers, 210 interest received, 27 international relationships, 210 notations, 27 production account of asset owners, 210 production account of firms, 208 production account of fiscal and monetary authorities, 211 production account of workers, 210 production/income accounts, 28 taxes, 27 workers, 209 Nippon Credit Bank, 376 Okun’s law, 115 Olech’s theorem on global asymptotic stability, 35 open economies, 2–5 over-indebtedness, 87 overleveraging, Phillips curve mechanism, 55, 56, 89, 100, 112 Murphy model of Australian economy, 136 productivity growth, 90 portfolio approach, to banking crisis, incorrect expectation dynamics, impacts, real estate assets, securitisation, process of, self-justifying mechanism, 8, 15 steady state dynamics, of equilibrium Cambridge equation, 58 of credit financing, 73–75 18D core dynamics, 198–200 4D debt deflation, 103–110 debt financing, 91 for a degree of wage flexibility, 61 34 dimensional dynamical system, 192–197 Dornbusch exchange rate dynamics mechanism, 244 for excessive consumption, 78 full credit rationing and repelling steady state, 66–67 instability for small values of loan rate, 63–65 Jacobian determinant for credit rationing, 66 Jacobian determinant for excessive consumption, 59–61 Jacobian determinant for weak excessive consumption, 62 Keynesian IS-curve, 58 NAIRU rate of employment, 198 for a ’normal’ range of parameter values, 61–62 process of debt deflation, 66 reference balanced growth, 61 Routh-Hurwitz condition for local asymptotic stability, 61 for small values of i and flexible wage adjustment, 69–71 static relationships, 200–201 target rate of profit, 57 transition from crisis to “pre-crisis” level, 82 weakly excessive consumption case, 62–65, 78–82, 84 subprime crisis, 5–8, 51 asset pricing theories, evolution of, and Greenspan low interest rate policy, 6–7 portfolio approach argument, Taylor interest rate policy rule, 124, 129 uncovered interest rate parity (UIP), 173 US the financial market crisis of 2007/2008, 6, 86 Real Business Cycle (RBC) theory, Resolution and Collection Bank (RCB), 375 Rose real wage feedback chain, 219–224 Routh-Hurwitz condition for local asymptotic stability, 61–63, 92 4D dynamics, 93, 104 feedback-motivated stability analysis, 123 Goodwin wage income/insider-outsider labor market dynamics, 217 KMG growth model, of debt deflation, 130–131 Walras’ Law of Stocks, 19, 23, 44 weak excessive consumption case case of weak wage adjustment, 78 goods market equilibrium expression, 62 Jacobian determinant, 62, 63 and monetary policy, 84 sector of worker households, 63 for small values of loan rate, 63–65 worker households consumption demand of, 76 and credit rationing of commercial banking, 71 worker’s real debt and debt default, 53 Say’s Law, 71, 74, 90, 93, 99, 100, 126 Zero-root hysteresis, 94 ... xix Total taxes per value unit of capital Desired and actual rate of growth of the capital stock K Desired and actual rate of growth of the housing capital stock Kh Actual debt to capital ratios... interest rate, a stock market crash and a banking crisis and large output loss Yet, financial and exchange rate volatility not always lead to an interest rate increase and a stock market crash It... perfect capital markets has been used in order to justify rapid and radical market liberalisation, in particular product and capital market liberalisation Whereas some parts of the academic profession