C. Bruun/C. Heyn-Johnsen: Contributions Towards a Framework for Understanding Financial Crises

Contributions Towardsa Framework forUnderstandingFinancial Crisis

Carsten Heyn-Johnsenand Charlotte Bruun

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The LogicalImpossibility ofMonetary Profits

Marx

Keynes

stock-flow consistentmodels

A Heuristical Solution?

An agent-based modelfounded on thesuggested framework

Contributions Towards a Framework forUnderstanding Financial Crisis

Presentation at MAFIN09, Reykjavik

Carsten Heyn-Johnsen and Charlotte Bruun

Department of Economics, Politics and Public AdministrationAalborg University, Denmark

September 3-5th, 2009



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Keynes




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I The Logical Impossibility of Monetary ProfitsI MarxI KeynesI stock-flow consistent modelling

I A Heuristical Solution?

I An Agent-based model founded on the suggested framework



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Keynes




Macroaccounting of Monetary Production

Without Connectivity of real and financial spheres, financial crisis

only have casino impact!

M - C - M

M - C monetary financing of real production ofcommodities, primo.

C - M monetary realisation of the real product, ultimo.



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Marx

The produced surplus value in commodity form has to be realisedin money.

M - C - C’ - M’

I ”The class of capitalists can not extract from the circulation,what has not previously been thrown in.”) (K. Marx: DasKapital, vol.2, 2.sec., chapt. 17)

I In fact, as paradoxical as it looks immediately , the class ofcapitalists themselves throws into circulation the money, thatserves the realisation of the surplus-value embedded in thecommodities.(ibid.)

I t - turnover of ∆M → surplus value = t ∗∆M

I BUT no simultaneous realization of the surplus. A logicaltimetrick!



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Marx’ Conclusion

But regarding the whole class of capitalists the sentence, that theythemselves have to throw the money for realising theirsurplusvalue (respectively also for circulation their capital,constant and variable) appears not only not paradoxical, it is thenecessary condition for the whole mechanism: because here thereare only two classes: the working class, that only dispose of theirlabourpower; the capitalist class, who hold the social means ofproduction as well as the money in their possession ofmonopoly.)ibid., chapt 20.



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Keynes

Y = E + Q = C + I = D

Df = E + Q financing joint. The financing of productionincludes the profit to be realised at the realisationjoint

Dr = C + I realisation joint.Precluding real quasi-rents to berealised as a monetary profit, as they are alreadyfinanced or monetised; and therefore figure as aliability entry in the financial sphere, even beforethey are to be realised.

Dr > Df ???



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Keynes




Keynes and User Costs

”Prime cost proper, viz. those which can be avoided by notundertaking output in the short period, divide into prime-factorcosts, viz. those involved in employing concurrently ultimatefactors of production, labour, short loans etc. and user costs orsupplementary factor costs, viz. those involved in using machinery,- generally, the products of prime-factors employed in the past.They are prime costs because they can be avoided by not usingthe machinery, but they are not prime-factor costs because they donot involve the concurrent employment of ultimate factors ofproduction (but aren’t necessarily paid out to anyone as income).(Harrod in C.W. xiii, p.539, my underlignings but the brackets areHarrods.)”

I Harrod is envisaging income created in the production sphere,with no counterpoise in the financial or monetary sphere!



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Choice of Units, Effective Demand and Income

units ”In dealing with the theory of employment Ipropose, therefore, to make use of only twofundamental units of quantity, namely, quantities ofmoney-values and quantities of employment.”(G.T.p.41)

effective demand The pivotal concept ’effective demand’designates the entrepreneurs decision to produce intoto, it is expressed as an number of wage-units,that is a number of units of money. At the financialjoint this measures the monetary financing ofproduction. It is the financial disbursement, Df, ofthe circuit. As such it is an empirical fact, and it istherefore what it happens to be.



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Definition of income Inconclusive:

I ”During any period of time the entrepreneurswill have sold finished output for a certain sumwhich we will designate as A. And they willend up with a capital equipment, which termincludes both stocks of unfinished goods orworking capital and stocks of finished goods,both together having a value G.”(Transcription of the first paragraph in G.T. p.52)

I ”We must...deduct...a certain sum, torepresent that part of its value which has been(in some sense) contributed by the equipmentinherited from the previous period...Theproblem of defining income is solved as soon aswe have found a satisfactory method forcalculating this deduction.”(G.T. p.52)



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”The difficulty in arriving at a definition of income is due to thefact that the amount of the sales proceeds of any article is a grossfigure...some deduction has to be made from the gross saleproceeds in order to arrive at a measure of what can be regardedas income...it is not immediately obvious what this deductionshould be.(p.399)...there is a constant leakage going on in thecirculation of income (quite apart from saving) unlessentrepreneurs are making it good by new investment equal to whatthey have deducted from the gross price to cover user cost...Foruser cost is financial provision made by the entrepreneur...If theentrepreneur’s actual financial deduction from gross price which heregards in no sense and in no circumstances available as income,could be laid down by an infallible formula, then I should defineincome as what remains after this deduction. But there is nosuch formula.(p.417, my emphasis )



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The monetising and accounting of profits

A Actual realised sales of finished products - empirical.

F Factor payments (at macrolevel only labour) -empirical.

I Investment as a real phenomenon - imaginary!

S Savings out of money-income - empirical.

Q Profits - the maximand! - imaginary!

1. Q = A-F+I

2. Q+F-A = I

3. F-A = S

4. Q+S = I

5. Q = I-S



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Balance Sheet

House- Firms Bank Totalholds

Deposits +Dh +Df −D 0Loans −Lh −Lf +L 0Capital +K +KEquities +pE −pE 0Net worth Vh Vf ≈ 0 +K

Table: Balance sheet - simplified Godley,Dos Santos or Zezza



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Current Transaction Flow Matrix

Positive is source, negative is use of funds. Capital gains notincluded since they are not transactions.

House- Firms Bank Totalholds current capital

Consumption −C +C 0Investment +∆K −∆K 0Wages +W −W 0interest D +idDh +idDf −idD 0interest L −ilLh −ilLf +ilL 0dividends +F -F 0∑

SAVh Fu −∆K ≈ 0 0

Table: Current transaction flow matrix



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Flow of Funds

From flows to ∆Stock. Sectoral budget constraints. Capital gainsmay be added.

House- Firms BankTotal

holdsSavings SAVh Fu ≈ 0 SAV∆Deposits −∆Dh −∆Df +∆D 0∆Loans +∆Lh +∆Lf −∆L 0∆Equities −p∆Eh +p∆Ef 0∆Capital −∆K −∆K∑

0 0 0 0

∆VSAVh+ Fu− SAV = ∆K∆pEt−1 ∆pEt−1

Table: Flow of Funds



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In a simplified World;

I SAVh = W - C

I Fu = ∆K + C - W = “retained profits”

I SAV = SAVh + Fu = W - C + ∆K + C - W = ∆K

I “firms do retain a part (Fu) of their profits (or Marshallian“quasi-rents”)

(Dos Santos (2004))

I The problem is that such profits have already been spend onpurchasing capital goods!

I Firms only gain a real profit, not a monetary profit.

I Note similarity with Keynes’ Q + S = I



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A Simple Example - current transactions

House- Firms Totalholds current capital

Consumption -80C +80C 0Investment +20∆K −20∆K 0Wages +100W -100W 0∑

SAVh=20 Fu=0 −∆K =20 0What if firms purchase capital for 40 rather than 20?

House- Firms Totalholds current capital

Consumption -80C +80C 0Investment +40∆K −40∆K 0Wages +100W -100W 0∑

SAVh=20 Fu=20 −∆K =40 0



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I Can the retained profits of 20 be seen as a monetary profit forthe aggregate of firms - and can it be spend on purchasingcapital goods or labor in future periods?

I The answer must be NO!

I The retained profits just means that households do not “own”all capital.



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A simple example - flow of funds

With capital purchase of 20:House- Firms

Totalholds

Savings +20SAVh 0Fu 20SAV∆Equities −20∆E +20∆E 0∆Capital −20∆K −20∆K∑

0 0 0∆V 0 0 SAV = ∆K = 20

With capital purchase of 40:House- Firms

Totalholds

Savings +20SAVh +20Fu 40SAV∆Equities −20∆E +40− 20∆E 0∆Capital −40∆K −40∆K∑

0 0 0∆V 0 0 SAV = ∆K = 40



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SFC and monetary profits

I Society’s change in net worth = savings = ∆Capital

I ∆Capital is a real profit to society. Not a monetary profit.Without a theory of value we cannot know its value - in realor monetary terms.

I Fu - retained profits can only be a positive monetary volumeif another sector has negative savings.

I In the aggregate firms can at best get back the money thespent on wages.

I Fu cannot finance future investments. It has already beenused for financing investments.

I cause or effect? Is retained earnings determined by the firm,or by the saving or consumption decision of households?



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Where to search for a solution to the realisationproblem?

“...these difficulties are rightly regarded as “conundrums”. Theyare “purely theoretical” in the sense that they never perplex, orindeed enter in any way into, business decisions and have norelevance to the causal sequence of economic events”

(Keynes(1936))That they cannot obtain a monetary profit does not stop firmsfrom producing. Either Marx and Keynes were wrong aboutM-C-M’, or firms are somehow convinced that they earn amonetary profit!



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A Heuristical Definition of Monetary Wealth

I

Assets- Liabilities= Wealth

I Works for monetary assets, but if we insists on a theoreticalmeasure of real assets we end up in another logicalimpossibility (Capital controversy).

I valuation of real capital - that’s what stock markets are for!!!

I

Monetary assets + equity evaluated at stock market prices- (Monetary Liabilities + equity evaluated at issuing price)= Monetary Wealth

I profit = ∆monetary wealth of firms

I almost stock-flow consistent - a flow deduced from stocksrather than all changes in stocks determined from flows!



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Praxis of the corporate sector

There are, however, some distinctions between conventions thatshould be adopted when dealing with national accounts, one theone hand, and corporate sector accounts on the other.Emphasising the importance of constructing income and balancesheet accounts on a sectoral consistent basis leads us to the usualnational accounting convention of treating equities as a liability ofthe corporate sector. [...] On the other hand, it is usual ininterpreting corporate sector accounts not to treat equities asliabilities.The concept of wealth which is likely to be of economic interestexcludes (some part of) equity as a liability of the corporate sector.

(Patterson (1990))



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almost Stock-Flow Consistency


Deposits +Dh +Df −D 0Loans −Lh −Lf +L 0Capital +K +KEquities held +pEh +pEf pE

issued −E s −E s

Net worth Vh Vf ≈ 0 (p − 1)E + K

Table: Heuristical Balance sheet



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Flows generate stocks

House- Firms Bank Totalholds current capital

Consumption −C +C 0Investment +∆K −∆K 0Wages +W −W 0interest D +idDh +idDf −idD 0interest L −ilLh −ilLf +ilLg 0dividends +Fh +Ff − F 0∑

SAVh SAVf −∆K ≈ 0 0

Table: Current transaction flow matrix



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Flows generate stocks

House- Firms BankTotal

holdsSavings SAVh SAVf ≈ 0 SAV∆Deposits −∆Dh −∆Df +∆D 0∆Loans +∆Lh +∆Lf −∆L 0∆Equities −p∆Eh −p∆Ef −p∆E

New issues +p∆E +p∆E∆Capital −∆K −∆K∑

0 0 0 SAV = ∆K




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Introducing revaluations


Savings SAVh SAVf SAVb SAV∆Depos. −∆Dh −∆Df +∆D 0∆Loans +∆Lh +∆Lf −∆L 0∆Equity −p∆Eh −p∆Ef −p∆E s

new issues +p∆E s +p∆E s

∆Capital −∆K −∆K∑0 0 0 SAV = ∆K

revaluationsEquity ∆pEht−1 ∆pEft−1 ∆pEt−1

new issues p∆E s −∆E s p∆E s −∆E s

∆V

∆Vh = ∆Vf = ∆Vb ≈ 0 ∆K+SAVh+ SAVf+ ∆Ep++∆pEht−1 ∆pEft−1+ ∆pEt−1

p∆E s −∆E s −∆E s




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The monetary profit

I When equity prices go up, society feels richer, and this mayaffect the behaviour of firms as well as households.

I The monetary wealth of households increase, and with awealth-effect in consumption, consumption increases.

I The monetary profit of firms, defined as change in monetarywealth, increases, and this may make firms, as well as banks,more optimistic.

I When equity prices go down, we see the opposite effect.



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An agent-based model founded on the suggestedframework

I Agent-based macroeconomics - monetary production theory!

I Accounting identitites emerge since every flow has a senderas well as a recipient.

I All agents within a sector (household, producer of investmentgoods, producer of consumption goods) start out identical

I All agents trade on equity market

I Behaviour on equity market is stabilizing rather than herdfollowing, i.e. they try to sell expensive and buy cheap!

I A Tobin’s q effect in investment decision.

I Herding behaviour as well as wealth effects in consumption!



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Results from an agent-based model founded onthe suggested framework

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Consumption

Investment Consumption

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Stock Prices

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Stock - New Issues

Equity price New Issues

C. Bruun/C. Heyn-Johnsen: Contributions Towards a Framework for Understanding Financial Crises

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