A stock-flow-consistent model of macroeconomic and financial instability

While the 2007-2008 global financial crisis (GFC) began as a localised financial disturbance due to the collapse of the US real estate boom, it quickly transformed into a global economic downturn due to the inter-connectivity of the international financial system. The aim of this study has been to analyse the underlying causes of the 2007–2008 GFC through a stock-flow-consistent macroeconomic modelling approach (SFC). Economists following the Post-Keynesian tradition believe that the slackening aggregate demand in both the US and in many other nations has been caused by policies of continual fiscal withdrawal, aggravated by the decades-long decline of wage share in the GDP, which in combination has led the non-government sector into cumulative deficits and rising indebtedness. The key contribution of this study has been an investigation into the impact of this coupling of real wage repression and declining government, complemented by an analysis of financial behaviour on the part of private sector agents (e.g. credit rationing, asset price appreciation), which was seen to have undermined financial and macroeconomic stability in the US (and elsewhere). To this end, a tractable, and parsimonious stock-flow-consistent macroeconomic model (SFC) with four-sectors (household, production firm, commercial bank and consolidated government) was constructed. Three independent sets of simulations, focusing, respectively, on: (i) government-expenditure and wage-share shocks; (ii) wage-share, interest-rate and-house-price shocks, and, (iii) marginal propensity to consume (MPC), interest-rate, and-house-price shocks were analysed by examining the aftershock paths of most of the key growth variables, both the short run and long run. The first and second set of simulations had similar consequences for the economy. However, due to the presence of capital gains from house price appreciation, in the second set, the increasing net wealth of the households boosted autonomous consumption. The third set featured growth of consumption induced by income. In summary, policies aimed at promoting a consistent and rapid appreciation of asset prices, as pursued by many nations, were shown to be associated with burgeoning private debt, ultimately, with recessionary consequences. Hopefully, this thesis will contribute to a better understanding the downside for policies of this kind, which characterise the current era of New Capitalism—one marked, in particular, by consumption-related expenditure that has become more autonomous in relation to disposable income. The findings can also be applied to the evaluation of more sustainable policy alternatives—including those associated with a currency-sovereign government exploiting its freedom to engage in fiscal policy directed at the maintenance of overall macroeconomic and financial stability.