School of something FACULTY OF OTHER
LUBS Economics Division
On Some Open Issues in the Theory of Monetary Circuit
Marco Veronese Passarella
A Day in Honour of Augusto Graziani
Amphithéâtre Vedel, Faculté Jean Monnet, Université Paris-Sud
January 20th, 2015
1. Introduction: Graziani and the Italian contribution to the TMC
2. Open issues in the TMC
3. The conception of pricing and the role of demand
Graziani’s equations / Theoretical consequences
4. The need for a stock-flow consistent redefinition of the TMC model
5. Financialisation in the monetary circuit
The standard monetary circuit / A new paradoxical cycle? / Main amendments to the benchmark
model / The storyboard / Nominal balance-sheets / Nominal transactions-flow matrix / Some
equations… / Other equations… / The dynamics of the basic model / Wage cut, derivatives and
debt repayment
6. Remarks
Outline
While there are clear affinities of Graziani with French Circuitistes and (Post) Keynesian
authors, Graziani’s take also shows some distinctive features.
Graziani’s specific contribution can be defined as a rediscovery of the most far-reaching
aspects of the monetary thought of both Karl Marx and a number of dissenting economists of
the early twentieth century (e.g. Wicksell 1898, Keynes 1930).
The keystone of Graziani’s take is the association of Keynes’s concept of ‘initial finance’ with
Marx’s notion of ‘money capital’ (Messori, 1983). Capitalism is a circular sequence of
monetary (social) relations. Firms need money in order to purchase labour power from
workers and to start the production. This initial flow of money is created (ex nihilo) by banks.
Graziani’s macro-monetary take allows him to clarify that:
Looking at capitalists as a social class, capital valorisation can only derive from exchanges
capitalists make outside their own class. The only possible external exchange is the purchase of
labour-power. […] Capitalists’ profit can only arise from the difference between the total labour
employed and the quantity of labour that the worker gets back in the form of real wage.
(Graziani 1983, Italian in the original)
1. Introduction: Graziani and the Italian contribution to the TMC
The chief aim of Graziani’s TMC is to account for the process of money creation and
destruction (both viewed as endogenous phenomena) under a capitalist regime during
‘normal times’ (i.e. ‘without crisis’, Graziani 1984).
The precautionary and the speculative motives (liquidity preference) must be ruled out of the
analysis. The focus is on a specific subcategory of the transaction motive: the finance
motive. Money is regarded as the the initial banking finance enabling firms to start the
process of production in a world marked by social stratification (Graziani 2003).
The benchmark single-period monetary circuit scheme has been questioned by many, as it
would be affected by some theoretical and analytical weaknesses.
The paradox of monetary profit
Market-clearing pricing and no role for effective demand
The pure flow accounting framework and the single-period horizon
No room for recent developments in capitalist economies (financialisation)?
2. Open issues in the TMC
Let us suppose that: 𝑟𝑙 = 𝑟𝑏 = 𝑟𝑚 = 0. The algebraic skeleton of the TMC model can be
written as follows:
(1) 𝑋𝑠 = 𝑁𝑠 ∙ 𝑎 (2) 𝑝 ∙ 𝑋𝑑 = 𝐶 + 𝐼
(3) 𝐶 = 1 − 𝑠 ∙ 𝑤 ∙ 𝑁𝑑 (4) 𝐼 = 𝑏 ∙ 𝑝 ∙ 𝑋𝑠
(5) 𝑝 = (𝑤/𝑎) ∙ (1 + 𝜎) (6) 𝐿𝑑 = 𝑤 ∙ 𝑁𝑠
(7) 𝑁𝑠 = 𝑁𝑑 (8) 𝑋𝑠 = 𝑋𝑑 (9) 𝐿𝑠 = 𝐿𝑑 (10) 𝑀(𝑠) = 𝐿𝑠
In equations above, 𝐶, 𝐼, 𝐿𝑑 , 𝐿𝑠, 𝑀(𝑠), 𝑁𝑠, 𝑝, 𝑋𝑑 , 𝑋𝑠 and 𝜎 are usually regarded as the
endogenous variables, whereas 𝑎, 𝑏, 𝑠, 𝑤 and 𝑁𝑑 are treated as exogenous.
In principle, it would be possible either to derive 𝑝 and hence 𝜎 given 𝑁𝑑 (and hence 𝑋𝑠), or
to derive 𝑋𝑠 and 𝑁𝑑 given 𝜎 (and, say, 𝐼 instead of 𝑏).
3. The conception of pricing and the role of demand
Graziani’s equations
Graziani chose 𝜎 as the endogenous variable: 𝜎 = (𝑏 − 𝑠)/(1 − 𝑏). The scale of
production (𝑁𝑑) is set autonomously by firms, along with the share of investment (𝑏).
The rationale of Graziani’s choice is linked with the chief aim of the TMC: to analyse how
money is created, circulated and destroyed in a capitalist economy during ‘normal times’ (no
uncertainty, no liquidity trap, no credit rationing, no lack of demand).
Controversial corollary: any increase in aggregate demand components leads to an increase
in profit rate and unit price of output, with no effect on employment and real output.
The above conception of pricing is potentially at odd with the vast majority of Post
Keynesian, Kaleckian and other heterodox approaches.
Graziani’s original take looks inconsistent with the recognition of the role of effective demand
in determining (i.e. constraining) real output and employment (Seccareccia 2014).
When a plurality of sectors is taken into account, it is also inconsistent with the long-run
equalisation of the rate of profit across the economy (Lunghini & Bianchi 2004).
3. The conception of pricing and the role of demand
Theoretical consequences
The benchmark TMC model relies on a pure-flow accounting framework. It is usually defined
in static terms, i.e. within a single-period horizon.
That was a useful simplifying assumption, but it should be dropped. The dynamics of the
economic system should be modelled explicitly.
When a multi-period model is adopted, stocks and their relations with flows have to be
accounted for. The TMC model should be revised in the light of the stock-flow consistent
modelling technique (e.g. Godley 2005, Lavoie 2005, Godley & Lavoie 2007, Zezza 2004,
Zezza 2012).
The coherence of the TMC narrative with Godley’s take has been recognised explicitly by
Graziani when defining the nature and the amount of the initial finance (e.g. Graziani 2003,
p. 28; to be compared with Godley and Lavoie 2007, p. 49).
This crossbreeding, inter alia, makes it possible both to amend the TMC price-setting (in
order to take into account the impact of demand on real output) and to extend the monetary
circuit scheme to the analysis of the financialisation.
4. The need for a stock-flow consistent redefinition of the TMC model
The starting point is the benchmark TMC model (Graziani 2003): closed economy with no
government sector.
Production/investment are financed by ‘inside’ money created by banks.
The benchmark TMC scheme is redefined in a SFC fashion (call it Model DER).
Model DER can be considered an amended version of Model BMW created by Zezza 2006
and corresponding to the model used in Godley & Lavoie 2007, Ch. 7.
Main amendments concern:
Households can access credit (Van Treeck 2009)
Workers vs. rentiers (Dos Santos & Zezza 2006, Van Treeck 2009)
Banks vs. other financial intermediaries (Sawyer 2014)
Securitisation and derivatives (Veronese Passarella 2014)
5. Financialisation in the monetary circuit
Main amendments to the benchmark model
5. Financialisation in the monetary circuit
The standard monetary circuit
Banking System
debt discharge: closing (5)
(2)
(3.a)
(1) initial finance: opening
Financial
Market
(3.b)
(4) Households Firms
Commodity
Market
final finance
consumption
wage-bill
household saving
5. Financialisation in the monetary circuit
A new paradoxical cycle?
Workers
Firms
(1)
(3)
(2)
derivatives
(securitisation)
consumer credit
(financial
asset
inflation)
Commodity
Market
(4)
Financial
Market
Clearing Banks
corporate extra-profits
credit-based consumption
Rentiers
OFIs
financial
investment
Rentiers
Bank credit is used by both rentiers and workers to finance additional consumption.
The amount of new loans to rentiers (∆𝐿𝑟) is an increasing function of their wealth (𝑉𝑟), the
latter being used as collateral.
Loans to workers (∆𝐿𝑤) are an increasing function of both workers’ wealth (𝑉𝑤) and the
‘degree of cartolarisation’ of household debt (𝜑).
The banking sector is split into two subsectors: clearing banks vs. other financial
intermediaries (OFIs).
Unlike loans to firms, loans to households are created by banks and then ‘handed’ to OFIs
(e.g. via structured investment vehicles).
The role of OFIs is not to create money, but to transform a portion of household loans into
‘financial derivatives’ (securitisation) (𝑑𝑠).
These are sold to rentiers who seek for high return rates on their financial investment.
5. Financialisation in the monetary circuit
The storyboard
5. Financialisation in the monetary circuit
Nominal balance-sheets
Households
Production firms Banking sector
Σ Workers Rentiers Clearing Banks OFIs
Deposits +Mw +Mr –M +Mo 0
Loans –Lw –Lr –Lf +Lf +Lh (–Lh) (+Lh) 0
Capital +K +K
Securities of firms (+B) (–B) 0
Derivatives +d ∙ pd –d ∙ pd 0
Balance (net worth) +Vw –Vr 0 0 0 –Vh
Σ 0 0 0 0 0 0
Notes: A ‘+’ before a magnitude denotes an asset, whereas ‘–’ denotes a liability.
5. Financialisation in the monetary circuit
Nominal transactions-flow matrix
Workers Rentiers Production firms Clearing Banks OFIs
Σ Current Capital Current Capital Current Capital
Consumption –Cw –Cr +C 0
Investment
(change in capital stock)
+I = +ΔK
–I = –ΔK
0
Wages +WB –WB 0
Depreciation allowances –DA +DA
Interest on loans –rl,–1 ∙ Lw,–1 –rl,–1 ∙ Lr,–1 –rl,–1 ∙ Lf,–1 +rl,–1 ∙ Lf,–1 +rl,–1 ∙ Lh,–1 0
Interest on deposits +rm,–1 ∙ Mw,–1 +rm,–1 ∙ Mr,–1 –rm,–1 ∙ M,–1 +rm,–1 ∙ Mo,–1 0
Return on securities +rb,–1 ∙ B–1 –rb,–1 ∙ B–1 0
Return on derivatives +rd,–1 ∙ pd ∙ d–1 –rd,–1 ∙ pd ∙ d–1 0
Entrepreneurial profits +Ff –Ff 0
Bank profits +Fb –Fb 0
Financial profits +Fo –Fo 0
Change in loans +ΔLw +ΔLr +ΔLf –ΔLf –ΔLh (+ΔLh) (–ΔLh) 0
Change in deposits –ΔMw –ΔMr +ΔM –ΔMo 0
Change in securities (–ΔB) (+ΔB) 0
Change in derivatives –Δd ∙ pd +Δd ∙ pd
Σ 0 0 0 0 0 0 0 0 0
Memo: capital gains –Δpd ∙ d–1 +Δpd ∙ d–1
Notes: A ‘+’ before a magnitude denotes a receipt or a source of funds, whereas ‘–’ denotes a payment or a use of funds.
(20) Share of securitised loans
𝜑 =𝑑𝑠 ∙ 𝑝𝑑
𝑙𝑤,−1+𝑙𝑟,−1
(28) Number of rentiers
𝑁𝑟 = ℎ1 ∙ 𝑁𝑠 + ℎ2 ∙ 𝜀
(29, 30) Nominal consumption of workers and rentiers
𝐶𝑤 = 𝛼0 + 𝛼1 ∙ 𝑌𝐷𝑤𝑒 + ∆𝐿𝑤, 𝐶𝑟 = 𝛽0 + 𝛽1 ∙ 𝑌𝐷𝑟
𝑒 + ∆𝐿𝑟
(36) Loans to workers
∆𝐿𝑤= 𝛼2 ∙ 𝑉𝑤,−1 + 𝛼3 ∙𝐶𝑟
𝑁𝑟−
𝐶𝑤
𝑁𝑠− 𝛼4 ∙ 𝑤 − 𝑤−1 ∙
𝑝
𝑝−1− 𝑟𝑒𝑝1 ∙ 𝐿𝑤,−1
(37) Loans/wealth ratio of workers
𝛼2 = 𝜂1 ∙1−[𝐿𝑤,−1∙ 𝑟𝑒𝑝1+𝑟𝑐 ]
𝑉𝑤 + 𝜂2 ∙ 𝜑
5. Financialisation in the monetary circuit
Some equations…
(38) Premium over risk on loans to workers
𝜋 = 𝜋0 + 𝜋1 ∙𝐿𝑤,−1 ∙ 𝑟𝑒𝑝1
𝑉𝑤,−1
(41) Demand for firms’ securities of workers
𝐵𝑤
𝑉𝑤= 𝜆0 + 𝜆1 ∙ 𝑟𝑏 − 𝜆2 ∙
𝑌𝐷𝑤
𝑉𝑤
(44) Demand for derivatives of rentiers
𝑝𝑑 ∙ 𝑑𝑟
𝑉𝑟= 𝜆3 + 𝜆4 ∙ 𝑟𝑑 − 𝜆5 ∙
𝑌𝐷𝑟
𝑉𝑟
Structure of return rates:
(17) 𝑟𝑚 = 𝑟𝑙 − 𝑎𝑑𝑑 (deposits) (21) 𝑟𝑐 = 𝑟𝑙 + 𝜋 (consumer credit)
(22) 𝑟𝑑 = 𝑟𝑐 (derivatives) (23) 𝑟𝑏 = 𝑟𝑚 (securities)
5. Financialisation in the monetary circuit
Other equations…
5. Financialisation in the monetary circuit
The dynamics of the basic model
104
108
112
116
120
124
2000 2010 2020 2030 2040 2050
Total disposable income
Aggregate consumption
Figure 1: Evolution of C and YD following an increase in autonomous consumption of workers
11.8
12.0
12.2
12.4
12.6
12.8
13.0
13.2
13.4
2000 2010 2020 2030 2040 2050
Gross investment
Capital depreciation
Figure 2: Evolution of Id and DA following an increase in autonomus consumption of workers
101
102
103
104
105
106
107
2000 2010 2020 2030 2040 2050
Total disposable income
Aggregate consumption
Figure 3: Evolution of C and YD following an increase in the propensity to save of workers
0.96
0.98
1.00
1.02
1.04
2000 2010 2020 2030 2040 2050
Figure 4: Evolution of the output to capital ratio following an increase in the propensity to save of workers
5. Financialisation in the monetary circuit
Wage cut, derivatives and debt repayment (I)
£118.4
£118.5
£118.6
£118.7
£118.8
£118.9
£106.6
£106.8
£107.0
£107.2
£107.4
2000 2010 2020 2030 2040 2050
GDP (left axis)
Aggregate consumption (right axis)
Figure 1A: Evolution in GDP and total consumption following a wage cut
93.1%
93.2%
93.3%
93.4%
93.5%
93.6%
93.7%
93.8%
6.2%
6.3%
6.4%
6.5%
6.6%
6.7%
6.8%
6.9%
2000 2010 2020 2030 2040 2050
Disposable income of workers (to total, left axis)
Disposable income of rentiers (to total, right axis)
Figure 1B: Evolution in income distribution following a wage cut
5. Financialisation in the monetary circuit
Wage cut, derivatives and debt repayment (II)
28.4%
28.8%
29.2%
29.6%
30.0%
30.4%
30.8%
31.2%
23.36%
23.40%
23.44%
23.48%
23.52%
23.56%
23.60%
23.64%
2000 2010 2020 2030 2040 2050
Leverage ratio of workers (to total, left axis)
Leverage ratio of rentiers (to total, right axis)
Figure 1C: Evolution in leverage ratios of households following a wage cut
11.5%
11.6%
11.7%
11.8%
11.9%
12.0%
3.8%
3.9%
4.0%
4.1%
4.2%
4.3%
2000 2010 2020 2030 2040 2050
Interest rate on derivatives (left axis)
Interest rate on bank loans (right axis)
Figure 1D: Evolution of interest on derivatives following a wage cut
5. Financialisation in the monetary circuit
Wage cut, derivatives and debt repayment (III)
£11.1
£11.2
£11.3
£11.4
£11.5
£11.6
£11.7
£11.8
£11.9
£12.0
9.3%
9.4%
9.5%
9.6%
9.7%
9.8%
9.9%
10.0%
10.1%
10.2%
2000 2010 2020 2030 2040 2050
Total amount of derivatives (left axis)
Derivatives to GDP ratio (right axis)
Figure 1F: Evolution of derivatives following a wage cut
3.824%
3.828%
3.832%
3.836%
3.840%
3.844%
3.848%
3.852%
3.856%
3.860%
1.29%
1.30%
1.31%
1.32%
1.33%
1.34%
1.35%
1.36%
1.37%
1.38%
2000 2010 2020 2030 2040 2050
Bank profit to GDP (left axis)
OFIs profit to GDP (right axis)
Figure 1E: Evolution of financial profitability following a wage cut
Graziani’s approach allows us to point out that:
The creation of bank money is a both historical and logical necessary condition to start
the production process
While it is usually neglected by mainstream economics, class divide is a fundamental
feature of capitalist society
Workers do not control means of production, i.e. investment and production decisions are
taken autonomously by the ruling class (capitalists or rentiers)
Clearing banks are linked with, but different from, other financial intermediaries: they are
different economic units with different functions in the monetary circuit
While the analysis of financialisation requires an extension / improvement of the basic
TMC scheme, TMC’s pillars still look rather sound
6. Remarks
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