Tuesday, December 11, 2012

Lars Syll — Wynne Godley and the Fiscal Cliff

Looking at balance sheets from a macroeconomic perspective, it is of course important not to look at the different sectors in isolation. Assets and liabilities of households, banks and government have to be analyzed as interdependent parts in a cumulative process where one sector’s surplus is counterbalanced by another sector’s deficit.
To Wynne Godley – and those of us who have absorbed at least a rudiment of MMT – this was self-evident. A sectoral balance approach is a necessary ingredient in understanding financial crises – and that’s also one of the reasons why the Fiscal Cliffers are so wrong.
Lars P. Syll's Blog
Wynne Godley and the Fiscal Cliff
Lars P. Syll | Professor, Malmo University


Matt Franko said...

Good stuff from Lars here....

"To Wynne Godley – and those of us who have absorbed at least a rudiment of MMT – this was self-evident. "

For it to be "self-evident", one has to possess a high level of what some cognitive folks call "mathematical maturity"... not all of we humans have this...


Some of us have a lot of this, some of us have enough of this, some of us not enough of this, and some of us NONE of this...


geerussell said...

This led me to do a bit of reading on Godley and I have a question that hopefully someone can weigh in on with an MMT perspective.

Here, Galbraith sets forth what I have often seen on this blog and generally in MMT circles which I took to be a consensus position that as long as r is less than g, debt:GDP will level off. And if r is greater than g debt:GDP grows unsustainably.

Is the Federal Debt Unsustainable?

Then I read the following and it appears that Godley and Lavoie are saying no, in their SFC model debt:GDP will level off, even if r>g for basically any arbitrary rate.

Fiscal Policy in a Stock-Flow Consistent (SFC) Model

One of the first concerns often raised by critics of MMT is what happens if interest rates go up. The stock answer has been that the Fed has the ability to hold r<g. Is that answer incomplete, should it be "...and even if they don't it doesn't matter" in terms of fiscal sustainability?

Or am I mis-reading the implications (or the merit? substance?) of the Godley/Lavoie paper?

Ramanan said...
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Ramanan said...

Well Galbraith is wrong because r can be greater than g and one can yet have public debt/gdp not rising forever with wide range of parameters. But for Galbraith it blows up.

The most important factor is the rise in ouput which stabilizes the ratio.

In an open economy however one has to be very careful. Very careful!

Ramanan said...
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Ramanan said...

Should have added ...

the increase in output (say due to a permanent rise in government expenditure) also brings in more taxes (even if tax rates are not changed) also contributes to the stabilizing the debt/gdp ratio

PeterP said...
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PeterP said...
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PeterP said...


And so did the second one, I used "smaller than" signs.

My post:

r smaller than g is a sufficient condition, the debt/GDP will never blow up even if your fiscal policy is "stupid" and doesn't support growth.

Lavoie/Godley have a much smarter model: they look at *optimal* fiscal policy that supports full employment full time. You don't have to add much debt after you have reached full employment. So even if r is larger than g the debt/GDP is stable.

Galbraith simply makes fewer assumptions and tells a simpler story. In his model you can imagine *any* fiscal policy, even a very stupid one. Both models are consistent with one another, they just depict different worlds.

Tom Hickey said...

I believe that the definitive MMT paper on this is Scott Fullwiler, "Interest Rates and Fiscal Sustainability."

geerussell said...


As far as I can tell, Scott Fullwiler's paper makes basically the same argument as Galbraith with regard to r less than g as a condition for sustainability.


Your comment seems to offer a logical reconciliation between the two positions. r less than g is sustainable for any fiscal policy, even poor or incoherent fiscal policy. r greater than g is sustainable with a particular case of well-designed fiscal policy offered by Godley & Lavoie.


What do you think of Peter's response?

Ramanan said...


If you carefully think about it, the issue is not straightforward.

The usual derivation is an old argument - goes back to Evsey Domar from I think the 1940s or 50s.

The analysis is half right. For it tells you that the "primary balance" should come into surplus if r were to be greater than g.

Most mainstream economists look at this and argue that the budget needs to aim at achieving a primary surplus to bring the primary balance into surplus.

Of course, one could also argue that if r is less than g, a primary surplus is not needed. This argument is not very clean because it implicitly implies there is less room for the primary balance.

But all this is deflationary. G&L show that a budget need not aim at targeting a primary surplus but the mechanism which leads to the sustainability happens via higher output (which suppresses the debt/gdp ratio) and also because higher economic activity leads to higher taxes thereby leading to primary surpluses in the long run.

(More like the Keynesian quote that look after employment, the budget will look after itself).

A simple summation of a series tells us nothing about what is happening. This is because in the derivation, the budget deficit is held constant which is not the best assumption. It kind of assumes implicitly that the deficit can be exogenously fixed.

In the case of an open economy, the analysis is much complicated.

The most proper analysis is an article/chapter-appendix by Wynne Godley in this book http://www.amazon.co.uk/Unemployment-Europe-Jonathan-Michie/dp/012494065X on which the G&L paper mentioned in your comment is based.