Debt cycles, instability and fiscal rules: a Godley-Minsky synthesis, Cambridge Journal of Economics, advance access: 27 December 2017

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.

Climate change, financial stability and monetary policy PKSG Working Paper 1712, 2017 (with M. Nikolaidi and G. Galanis)

Using a stock-flow-fund ecological macroeconomic model, we analyse (i) the effects of climate change on financial stability and (ii) the financial and global warming implications of a green QE programme. Emphasis is placed on the impact of climate change damages on the price of financial assets and the financial position of firms and banks. The model is estimated and calibrated using global data and simulations are conducted for the period 2015-2115. Four key results arise. First, by destroying the capital of firms and reducing their profitability, climate change is likely to gradually deteriorate the liquidity of firms, leading to a higher rate of default that could harm both the financial and the non-financial corporate sector. Second, climate change damages can lead to a portfolio reallocation that can cause a gradual decline in the price of corporate bonds. Third, financial instability might adversely affect credit expansion and the investment in green capital, with adverse feedback effects on climate change. Fourth, the implementation of a green QE programme can reduce climate-induced financial instability and restrict global warming. The effectiveness of this programme depends positively on the responsiveness of green investment to changes in bond yields.

A stock-flow-fund ecological macroeconomic model, Ecological Economics, 2017, 131, pp. 191-207 (with M. Nikolaidi and G. Galanis)

This paper develops a stock-flow-fund ecological macroeconomic model that combines the stock-flow consistent approach of Godley and Lavoie with the flow-fund model of Georgescu-Roegen. The model has the following key features. First, monetary and physical stocks and flows are explicitly formalised taking into account the accounting principles and the laws of thermodynamics. Second, Georgescu-Roegen’s distinction between stock-flow and fund-service resources is adopted. Third, output is demand-determined but supply constraints might arise either due to environmental damages or due to the exhaustion of natural resources. Fourth, climate change influences directly the components of aggregate demand. Fifth, finance affects macroeconomic activity and the materialisation of investment plans that determine ecological efficiency. The model is calibrated using global data. Simulations are conducted to investigate the trajectories of key environmental, macroeconomic and financial variables under (i) different assumptions about the sensitivity of economic activity to the leverage ratio of firms and (ii) different types of green finance policies.