Modelling the Great Transition Emanuele Campiglio Giovanni Bernardo International Conference on Ecological Economics Rio de Janeiro 19/06/2012
Introduction• nef: – Wellbeing and measurement of progress – Reform of finance and banking; – Environmental limits (fisheries); – Social policy (work time); – Inequality; – “Good” jobs.• Macroeconomic model of the UK economy: How to manage the UK economy within environmental limits whilst delivering increasing wellbeing and avoiding instability?• Complex framework at first (Working paper – October 2011 – session 49, n.311)..• .. then: focus on banking and finance.
Focus on money and banking• Economic theory needed! Very poor performance of mainstream modelling: – No money – No banks – No debt• Or, if present, banks seen just ad intermediaries:
But: banks create money • Every loan creates a deposit • “By far the largest role in creating broad money is played by the banking sector.. When banks make loans they create additional deposits for those that have borrowed.” (Bank of England, 2007)Berry et al. (2007) Interpreting movements in Broad Money, Bank of England Quarterly Bulletin 2007 Q3Source: Bank of England, Interactive Database, data series LPQAUYM (M4), LPQVQKT (notes and coins), YWMB43D (Central bank reserves).
And most importantly,they allocate money in the economy
The model• Simpler framework centred on banking, money creation mechanisms and private investment financing.• Great attention to consistency (double-entry book keeping).• A consistent framework, to be modified and potentially used for a variety of research questions: – Green economy financing; – Quantitative easing; – Fiscal and monetary policies; – Debt dynamics; – Crisis/housing bubble; – General macroeconomic dynamics.
The structure of the model Aggregate macroeconomic framework Production Demand Employment Sectoral accounts Non CentralBanks Gilt sellers Households financial Government Bank firms
The macro framework Wage share (α) Consumption + Government expenditures (C+G)Productivity (A) C (1 t )W ; G tW Output (Y) Wages (W) Capital (K) Aggregate Demand (AD) Profits (Π) Labour (L) Investments (I) Y AK1 L Profit share (1-α) Net change in debt (ΔD) I D Y D AD Income + net change in debt = aggregate demand
The macro framework (t+1) Time t Time t+1Consumption +Govt expenditures (Ct+Gt) Productivity (A t+1) Wages (Wt+1) Desired Output Labor Ldt Labor (Lt+1) (Yt+1)AggregateDemand (ADt) 1 ADt Ld AK 1 t Investments (It) Capital (Kt+1) Profits (Πt+1)
Sectoral accounts Balance sheetAssets LiabilitiesAsset 1 LiabilityAsset 2 Net worth Total assets = Total liabilities Total change in assets = Total change in liabilities
Private banks balance sheet Balance sheet Assets Liabilities Reserves Deposits Loans Net worth Total assets = Total liabilities
Firms balance sheet Balance sheet Assets Liabilities Deposits LoansCapital stock Net worth Total assets = Total liabilities
Central Bank balance sheet Balance sheet Assets Liabilities Gilts Reserves Total assets = Total liabilities
The mechanics of credit creation Private Banks Central Bank 1. The bank lends 100 to the firm +100 +100 2. The bank seeks new +10 +10 (Loans) (Deposits) (Gilts) (Reserves) reserves at the central+10 +10 bank (suppose r=10%)(Reserves) (Deposits) 3. The central bank buys the same amount of gilts from the Gilt sellers Non financial firms secondary market.. 4. .. creating new +10 +100 +100 deposits (Deposits) (Deposits) (Loans) -10 (Gilts)
Private banks balance sheet Balance sheet Assets Liabilities Reserves Deposits +10 +100 +10 Loans Net worth +100 Total assets = Total liabilities
Desired Investments : I d N ; where N DR Z Demand for loans : Ld I d N ( 1) N Credit creation : CC Ld ( 1) N
Conclusions• Much work still to do: – Allow for households and government to accumulate debt; – Make (some of) the crucial parameters endogenous: • Propensity to invest (η) function of growth rate, profit rate, interest rate..; • Banks confidence (β) function of growth rate, profit rate..; • How do central bank interest rate affect the rest of interest rates (on deposits, loans etc.)?• Future research directions: – How does allocation of new purchasing power affect the macroeconomy? • Financing the green economy; • Productive vs speculative investments; • How does QE change the picture? – What are the alternatives? • Credit controls • Public money • Full fractional reserve banking