Why SFC models are based on Better Theory – a Response to Simon Wren Lewis

What makes Stock Flow Consistent models distinctive?

Simon Wren Lewis enters the fray following the publication of a paper jointly by Stephen Kinsella and Bank of England Collaborators.

Simon Wren Lewis damns with faint praise.

SFC models are popular with Post-Keynesians, and the definition you find on Wikipedia is “a family of macroeconomic models based on a rigorous accounting framework, which guarantees a correct and comprehensive integration of all the flows and the stocks of an economy.” Now I suspect any mainstream macroeconomists would immediately respond that any DSGE model is also stock-flow consistent in this sense. This point is made in a post by Noah Smith, and it is completely valid,…it would be a mistake for others to believe that the properties of their model show the importance of accounting rather than the theory they have used.      (my emphasis).

First off impressive as it is the BOE model has flaws.  Its treatment of investment and savings is insufficiently Kaldorian/Kaleckian to my taste, hence its unsurprising estimate of the fiscal multiplier as 1 – missing the fundamental Keynesian insight that savings are driven by investment.  Also its treatment of banking (and central bank ) equity is too Godleyian, so it still retains vestiges of the treatment of the financial sector as barter.

Unsurprisingly though Simon Wren Lewis misses that and feigns a ‘so what’response as if they are no different that pre DGSE aggregate models.  They are not.

Simon seems to treat accounting and theory as if they are counterposed.  The fundamental insight of SFC models is that modelling must be based on accounting theory.  Fundamentally the identity Assets=capital+liabilities.  With this one relationship you can derive all other economic identities Bourbaki style, such as equity, profits, debt and money.  Done properly you can avoid elementary errors which have led to such confusions as neoclassical capital and growth theory, the neglect of the financial sector and unsound concepts of state money where central banks have assets but no liabilities.

Simon is right that DGSE neglects through theory  intertemporal wealth balances, and doesn’t even have an accounting framework for measuring them.  This is why Noah Smith, Nick Rowe and others are wrong to state DGSE models as SFC.  If you allow this is an error the fundamental theoretical break with SFC models is they enable all economic actors to target some level of balances.  For example a householder saving for a deposit on a loan, or targetting investment returns for retirement, or a business forgetting  rate of return (as of course businesses maximise returns not profits).

In my own work I have used Ole Peters concept of rational leverage to replace the Euler equation approach which dogs DGSE and develop a concept of demand for money deriving from technological change which drives the financial sector.

The so called ‘heterodox’school has done a poor job of selling how and why SFC is theoretically superior.  It needs to get fundamental and undertake a project of defining all foundation economic concepts from accounting identities – right back to the roots of value theory, and tackling each and every component of orthodox theory.

 

 

6 thoughts on “Why SFC models are based on Better Theory – a Response to Simon Wren Lewis

  1. ” Also its treatment of banking (and central bank ) equity is too Godleyian, so it still retains vestiges of the treatment of the financial sector as barter.”

    Haha. From where did you ever get this conclusion?

    ” Its treatment of investment and savings is insufficiently Kaldorian/Kaleckian to my taste,”

    Does that mean you’re claiming Kaldorian/Kaleckian is insufficient or that it is not KK enough?

  2. Andrew: I see this as a genuine attempt to clarify/explain. And it’s getting somewhere. But I’m still not quite getting it.

    When you say ” If you allow this is an error the fundamental theoretical breach of SFC models is they enable all economic actors to target some level of balances.” can I replace the word “breach” in that sentence with “advance”, or “difference” or some other word? Because “breach” isn’t working for me. Maybe that sentence needs a re-write (for me).

    And maybe “Stock-Flow Consistent” isn’t very useful as a name, and it’s only a name anyway, and we are reading too much into it?

    All I know is that Marc Lavoie is a really smart and determined guy, so there *may* be *something* to it.

  3. The problem with both DSGE and SFC models is they only splash around on the surface of accountancy examining debits and credits instead of looking into the empirical data of its more relevant subset cost accounting. Doing the latter one discovers how inherently dis-equilibrated and riven with unethically dominating institutions and enslaving ideas modern capital intensive economies actually are. And if they keep examining the present time economic and monetary realities therein they might even re-discover modernity’s biggest and most subtle menace….the habituation to abstraction at the expense of actual self awareness.

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