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Behavioural Finance. Lecture 10 Part 2 Extending Endogenous Money. Variable wages. Basic Phillips curve introduced here Advanced Phillips curve includes all 3 influences Phillips noted: Level of unemployment (highly nonlinear) Rate of change of unemployment
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Behavioural Finance Lecture 10 Part 2 Extending Endogenous Money
Variable wages • Basic Phillips curve introduced here • Advanced Phillips curve includes all 3 influences Phillips noted: • Level of unemployment (highly nonlinear) • Rate of change of unemployment • Rate of change of retail prices “operating through cost of living adjustments in wage rates… when retail prices are forced up by a very rapid rise in import prices … or … agricultural products.” [Economica 1958 p. 283-4] • Done in final model in last lecture • Function fitted to employment rate rather than unemployment • A generalised exponential function
Variable wages • Exponential function is y(x) = ex (where e = 2.718) • Generalised version which • can place an exponential curve anywhere on the x-y axis • & control the slope: Slope at that point (x,y) pair curve goes through Minimum value • Don’t worry about the details • Fitted to Phillips’s UK data the values for this are:
Variable wages • Employment—money wage change function is: • Other elements of reality introduced now: • Rising population • Rising labour productivity • Still a very basic model, but first truly monetary “circular flow” model ever
Variable wages Looks complicated, but if you understood the table of financial flows, you understand this • Model in detail: • Financial system as before • Prices a lagged adjustment to markup on cost of production • Employment = Flow of money wages divided by money wage Prices Employment • Output = Employment times productivity Output Exponential growth in productivity and population • Change in money wage a nonlinear reaction to employment rate Employment Rate Money Wage
Basic Circular Flow Model • Model still “skeletal” • Basic entities in economy • Financial accounts • Firms • Workers • Relationships between them • Interest & Debt payments • Wages and consumption • But only one “muscle” • Worker response to level of employment • Much more needed for adequate model…
Basic Circular Flow Model • Firm response to rate of profit • Speculation rather than investment • Variations in consumption due to economic conditions, etc. • But interesting results even from skeleton: • Non-neutrality of money • Higher money creation—lower unemployment • Persistent inflation possible • Deflation if rate of money creation drops • Can also ask the model “policy questions” (shown later)…
Basic Circular Flow Model • Some sample outputs…
Policy (1) Should lenders be controlled? • What happens to bank income if • Rate of new money creation speeds up • Rate of relending existing reserves accelerates • Rate of repayment of existing loans drops? • Changing lending parameters by factor of 2 triples bank income • Banks have inherent bias to providing as much debt as possible… • As endogenous money theorists assert
Policy (2) Can a credit crunch cause a recession? • 3 key financial parameters altered by factor of 2: • Crunch causes temporary rise in unemployment AND sustained higher level • Inflation turns to deflation and then lower sustained rate of inflation…
Policy (3) Best way to fight a credit crunch? • Standard “multiplier model” policy: • Obama explaining his economic policy, April 2009: • “there are a lot of Americans who understandably think that government money would be better spent going directly to families and businesses instead of banks – ‘where’s our bailout?,’ they ask”. • “the truth is that a dollar of capital in a bank can actually result in eight or ten dollars of loans to families and businesses, a multiplier effect that can ultimately lead to a faster pace of economic growth.” (page 3 of speech) • Simulation: $100 billion injection 1 year after crunch: • (a) Boost banks’ reserves; OR • (b) Boost firms’ (debtors’) deposits
Policy (3) Best way to fight a credit crunch? • New flows table:
Policy (3) Best way to fight a credit crunch? • Stimulus inflow of $100 billion for one year after crunch • Modelled as a “pulse” • Takes value of $100 (billion) for a year after crunch till two years after • No consideration yet of how government money created…
Policy (3) Best way to fight a credit crunch? • Stimulus inflow of $100 billion for one year after crunch • Outcome opposite of “money multiplier” prediction • Better to give stimulus to debtors than banks • Reason: higher rate of turnover • Funds injected into BR flow out slowly • Funds injected into FD flow out quickly • Higher rate of turnover—greater impact from stimulus
Policy (3) Best way to fight a credit crunch? • Showing same model as flowchart: • A “circular flow” • But in fact like two “coupled electric fields” • Don’t mix, but… • Rotation of money in financial system • Causes opposite rotation of goods in production system
Conclusion • Circuit model still skeletal • But already reaches different economic policy results to standard models • Model has been extended to • multiple commodities • fixed capital • Financial Instability Hypothesis • and government policy • Next week • The Financial Instability Hypothesis