In the previous post I cover the fundamentals of Keyness theory, without deeping dive in the goal of monetary policy in the steady state economy.
This post aims to deep dive into the implications of monetary policy on growth and the conditions for a steady state economy.
Davidson: Revenue Expectations and Monetary contrains
Davidson transforms Keyne's theory into a long run theory. As finance plays a major role in the business cycle, it needs to be a part of a growth theory too. Firms are key decising the amount of investments in a given macroeconomic context. Due to the time lag between decision and production, the investors should make predictions of the evolution of prices, costs and demand. Investments increase capacity for multiple periods, while demand can fluctuate very rapidly, creating excesses or shortages. In order for the desired investment to happen, sufficient monetary capital should be available at affordable costs. The money supply is not given, as is rather a result of bank lending decisions depending on the costs of financing and expected returns.
Steady state conditions
It is required that on average invetments are only of the same size of capital depreciated. The push for investments can be moderated by changing preferences, the cost of capital and the cost of money.
Monetary Keynessianism
The following theory explains that in the long run macroeconomic variables such as unemployment depend on the monetary policy. The adjustment between high savings, low consumption and unemployment is not perfect. As money supply is defined endogenously, high demand of money via savings puts prices up and real wages down, and therefore unemployment should go down as well. That prediction will only happen if the holder of money have incentives to increase money flow via investments, and this will depend on the net interest rates, or in order words the rewards for money accumulation. The interest rate place a crucial role given incentives to hold or invest the money.
Private banks issue money they get from central banks at interest, and they charge customers this interst plus a premium to protect from risk and stablish certain profitability.
To reach an equilibrium, the demand of capital follows effective demand, which changes according to the costs of financing. Supply of capital will be balanced depending on the target cost of financing, set by the central bank. So it is up to the central bank to define endogenously an equilibrium in the capital markets.
This capital market equilibrium affects the levels of income and employment, which respond to the effective demand and the state of technology, being possible unemployment in the long run (with sufficiently low labor coefficient or income per worker ).
The definition of capital costs and technology will affect the long term equilibrium and the steady state of macroeconomic variables. While central banks can affect equilibrium state supply and demand of capital, goverments can affect effective demand and the state of technology. While the demand for labor depends on effective demand and the technology, the ultimate amount of inequality depends on the extend of social spending and deficit, the latter putting public expending back to creditors and the first redistributing wealth.
It is important then to achieve high levels of employment and low levels of inequality to ensure a stable effective demand with low deficit to dedicate no resources to debt payments.
Steady State Conditions
In order to reach a steady state, net capital good creation have to be zero, or equal to depreciation. One way to achieve this is to reduce the supply of capital goods via taxation. On the demand side, it is important that gains from capital goods are consume and not further saved, to avoid accumulation. Long term demand levels have to be achieved via working hour reduction, taxation or in sacred economic terms, the gift economy or money destruction (usages of money that does not multiply money, such as environmental preservation or social investments with negative returns).
Binswanger: Growth Imperative and Impetus
The author claims than an increasing money supply is required for economic growth. Not only that, it explains why some growth is required to avoid an spiral of decay.
In his theory, profit maximizing firms interact to expand profits as long as there is sufficient effective demand. For him, positive profits equals the creation of new money that is earned and not spent. Additional money is required to expand production and profits. This is only possible with loans given with interest, which are usually normally as investments as this is more profitable than savings. Expansion provides greater returns to shareholders than dividends that could be saved. Investments proceed as long as they are profitable. Without growth, the firm returns do not catch up and investors would move away to other firms that do grow.
Formal theory
There is a central equation in his theory:
This equation explaint the growth of equity capital as a function of:
- the ratio of bank earnings and expenditures on wages and dividens b
- there interest rate i
- the proportion between borrow and equity capital
- the profit rate of equity capital rho (p)
The following equation explains the profit mandate as b <1(some earning must stay), i>0 (banks only give credit with positive interest) and the denominator is positive as the capital invested is larger than the profits and interest payments combined.
Steady state conditions
Note that the mandate for growth assumes always positive interest rates (recently negative interest rates have been observed and sacred economists advocated for that as a policy to stop growth).
If we keep his assumptions on the direction of the sign of the variables, which are hard to discussed with the exeption of interest rates as they satisfy basic accounting pples, there is need for dramatic institutional and policy changes for the steady state economy.
As with other theoriesm net zero investments are required and all profits must be given given as dividends and not reinvested. In general, all profits from good and banking sectors have to be given as dividends. Further expansion can be stop in the absent of debt, with debt growth will need to happen though. It is not clear why the author claim the mandate of growth in the absence of debt, as companies could stay profitable and pay salaries in the steady state economy.
The most reasonable explanation could be using game theory, if competitors could increase market share and expand reinvesting, not doing so is a loosing strategy. Shareholders will tend to invest in those companies expanding as rewards from expansions are greater than dividend payments.
The author claims that the mandate for growth is the result of a shareholder value maximization business management. Other businesses organizations such as private enterprise or cooperatives do not have this mandate for growth.
Godley and Lavoie: Stock-Flow Consistent Models
The following model describe accurately the stocks (inventories, money deposits, bonds, bills, loans...) and the flows of the economy (consumption, goverment spending, wages, taxes...) and its actors (housholds, firms, goverments, central and private banks...). The realism come at the price of lack of derivability of the conditions and computer simulation are required.
The level of consumption and goverment expenditures determine actual sales. These define the change in inventories and influence the expected sales for the next period, Subsequently, aggregate supply of the next period is determined, which in turn influences income and wealth of the next period, leading to a specific level of actual sales... There are various additional factors affecting the exact development of the economy, as the interest rates affect the equilibrium levels in a join interaction between central bank, privat banks, expected demand...
In the steady state, all stocks and flows will become constant. The level of production will depend ultimately of goverment expenditures, public debt ad tax rates. The rate of economic growth also depends on goverment expenditure and the rate of productivity growth.
Steady State conditions
To reach the steady state in his model, productivity growth should stay constant, as goverment spending and capital stocks. In case there is productivity growth, the input augmented factor (resources,labor, capital) have to be reduced accordingly to keep output constant. As firms can be profitable without growth, there is no mandate for growth. The liability levels or debt should also stay constant. Capital accumulation will stop if retained earnings stop too. How the economy will transition to stagnate investments, goverment spending and productivity is not clear.
Results of the section and discussion
It is a common thread among monetary and fundamental theories that economic expansion is based on the expectation to cover more demand and make profits. If consumption and goverment spending stays constant, then investments will also stop.
Further expansion does not go against profitability if most of the theories, but the steady state requires that all profits are given in form of dividends and not reinvested. Avoiding the growth in debt is key to ensure profitability and stability remains in the absence of economic growth.
Shareholder value driven orgs are pressure to provide profits via expansion as this creates more money that the reimborsing of dividends. It is therefore key to reduce the capacity of reinvestment to create more money and make dividends more attractive, changing how business are organized or via tax schemas.
All in all, those theories show again that either via public policies( changes in the interest rates, taxes on capital, redirection of technology from labor augmenting to resource augmenting, constant goverment expenses) or a change in the business organization, there are conditions to achieve a stable steady state economy, with the amount of inequality to be decided as a function of the amount of the surplus given to wages and profits. We have not dealt with enviromental and resource contraints, nor have we analyze decaying money policies in detail. We will cover keynessian environmental theories in the next post.
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