Homework 2 (amendments made on 05/05/08 are in bold)
1. Fill in the blanks
Behavioral Transactions Matrix for SIM
1.1 Why must the Vertical Columns sum to zero?
The zero-sum rule for each column represents the budget constraint for each sector. The budget constraint for each sector describes how the balance between flows of expenditure, factor income and transfers generate counterpart changes in stocks of assets and liabilities, i.e. everything comes from somewhere and everything goes somewhere. The matrix shows how any sector’s financial balance - the difference between inflows and outflows – must be exactly matched by the sum of its transactions in stocks of financial assets.
1. Households: Their factor income can be spent in three ways: consumption, tax and financial assets investment. The accumulation of households’ wealth is determined by their financial balance – the excess of disposable income over expenditure. Amendment (05/05/08) - Thus, the change in the amount of money held must always be equal to the difference between households' receipts and payments.
The zero-sum rule for each column represents the budget constraint for each sector. The budget constraint for each sector describes how the balance between flows of expenditure, factor income and transfers generate counterpart changes in stocks of assets and liabilities, i.e. everything comes from somewhere and everything goes somewhere. The matrix shows how any sector’s financial balance - the difference between inflows and outflows – must be exactly matched by the sum of its transactions in stocks of financial assets.
1. Households: Their factor income can be spent in three ways: consumption, tax and financial assets investment. The accumulation of households’ wealth is determined by their financial balance – the excess of disposable income over expenditure. Amendment (05/05/08) - Thus, the change in the amount of money held must always be equal to the difference between households' receipts and payments.
2. Production: Producers earn income by providing services to households and government equal to its wage bill. Based on assumptions of the model - no goods in the economy provided, no capital equipment needed, no intermediate costs of production, no inventories and only three sectors included, such equilibrium can be established. Amendment (05/05/08) - Thus, as they are assumed to hold no cash, producers' receipts from sales must equal their outlays on wages.
3. Government: Its source of funding from taxes and public debt equals its spending. Government expenditure that is not covered by taxes must be covered by the issue of debt. Cash money is that debt. Amendment (05/05/08) - Thus, the amount of money created must always be equal to the difference between the governments receipts and outlays.
1.2 Why must the Horizontal Rows sum to zero?
The rule enforcing that all rows must sum to zero is such that each row represents the flows of transactions for each asset or for each kind of flow. The matrix shows that every component must have an equivalent component, or a sum of equivalent components, elsewhere. Amendment (05/05/08) - However, it cannot be just assumed in advance that the horizontal entries sum to zero, i.e. that supply equals demand. There must be a mechanism that makes it so. To that end, the so-called Keynesian, or Kaleckian, quantity adjustment mechanism 'allows' production to be the flexible element of the model. In other words, producers produce exactly what is demanded. Hence, there are no inventories and the equality between supply and demand is achieved by an instantaneous quantity adjustment mechanism. Rows 1 & 2 therefore embody the mainstream, or neo-classical, equilibrium between aggregate supply and aggregate demand. The system as a whole is now closed in the sense that every flow and every stock variable is logically integrated to such a degree that the value of one item is implied by the values of all the others taken together. Amendment (05/05/08) - The system is founded on two behavioural assumptions. Firstly, firms sell whatever is demanded. Secondly, there are no inventories.
2 Write out an explanation for each row.
All sources of funds appear with a plus sign (incoming flows of money) and all uses of funds appear with a minus sign.
Row 1, Consumption: The household sector demands consumption services (outflow of funds) that the production sector supplies (inflow of funds). Therefore Cs = Cd.
Row 2, Government: Similarly the government sector demands the services that the production sector supplies. Therefore Gs = Gd.
Row 3, [Output]: This is not a transaction between sectors and hence only appears once. Total production is defined either as the sum of all expenditures on goods and services or as the sum of all payments of factor income. Therefore Y = C + G = WB.
Row 4, Factor Income: The production sector demands a certain volume of employment at a wage rate exogenously determined and this is provided by the household sector. Therefore Ns = Nd.
Row 5, Taxes: The government demands taxes that the household sector pays. Therefore Ts = Td.
Row 6, Change in Money Stock: Because there is only a single financial asset and because there are no tangible assets in this economy, outflows (additions) to cash holdings constitute the saving of households. This asset has a counterpart liability in the issuance of money by the government, i.e. change Hh = change Hs. This states that saving must be equal to investment. In model SIM, there is no investment. This implies that social saving; the saving of the overall economy must be equal to zero. Here the term ‘change Hh’ represents household saving: the term ‘change Hs’ stands for government fiscal deficit, and hence government dissaving. For overall saving to be zero, the two terms must equal each other. Amendment (05/05/08) - However, model SIM contains no equilibrium condition which makes the two equal to each other. To that end, the watertight accounting, combined with the two behavioural assumptions, allows us to logically infer their equality by all the other rows and columns summing to zero (Walrasian principle).
References:
Monetary Economics, Godley & Lavoie, chapters 2 & 3.
1.2 Why must the Horizontal Rows sum to zero?
The rule enforcing that all rows must sum to zero is such that each row represents the flows of transactions for each asset or for each kind of flow. The matrix shows that every component must have an equivalent component, or a sum of equivalent components, elsewhere. Amendment (05/05/08) - However, it cannot be just assumed in advance that the horizontal entries sum to zero, i.e. that supply equals demand. There must be a mechanism that makes it so. To that end, the so-called Keynesian, or Kaleckian, quantity adjustment mechanism 'allows' production to be the flexible element of the model. In other words, producers produce exactly what is demanded. Hence, there are no inventories and the equality between supply and demand is achieved by an instantaneous quantity adjustment mechanism. Rows 1 & 2 therefore embody the mainstream, or neo-classical, equilibrium between aggregate supply and aggregate demand. The system as a whole is now closed in the sense that every flow and every stock variable is logically integrated to such a degree that the value of one item is implied by the values of all the others taken together. Amendment (05/05/08) - The system is founded on two behavioural assumptions. Firstly, firms sell whatever is demanded. Secondly, there are no inventories.
2 Write out an explanation for each row.
All sources of funds appear with a plus sign (incoming flows of money) and all uses of funds appear with a minus sign.
Row 1, Consumption: The household sector demands consumption services (outflow of funds) that the production sector supplies (inflow of funds). Therefore Cs = Cd.
Row 2, Government: Similarly the government sector demands the services that the production sector supplies. Therefore Gs = Gd.
Row 3, [Output]: This is not a transaction between sectors and hence only appears once. Total production is defined either as the sum of all expenditures on goods and services or as the sum of all payments of factor income. Therefore Y = C + G = WB.
Row 4, Factor Income: The production sector demands a certain volume of employment at a wage rate exogenously determined and this is provided by the household sector. Therefore Ns = Nd.
Row 5, Taxes: The government demands taxes that the household sector pays. Therefore Ts = Td.
Row 6, Change in Money Stock: Because there is only a single financial asset and because there are no tangible assets in this economy, outflows (additions) to cash holdings constitute the saving of households. This asset has a counterpart liability in the issuance of money by the government, i.e. change Hh = change Hs. This states that saving must be equal to investment. In model SIM, there is no investment. This implies that social saving; the saving of the overall economy must be equal to zero. Here the term ‘change Hh’ represents household saving: the term ‘change Hs’ stands for government fiscal deficit, and hence government dissaving. For overall saving to be zero, the two terms must equal each other. Amendment (05/05/08) - However, model SIM contains no equilibrium condition which makes the two equal to each other. To that end, the watertight accounting, combined with the two behavioural assumptions, allows us to logically infer their equality by all the other rows and columns summing to zero (Walrasian principle).
References:
Monetary Economics, Godley & Lavoie, chapters 2 & 3.
1 comment:
competent summary.
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