Circuit theory extended: The role of speculation in crises
Economics - The Open-Access, Open-Assessment E-Journal, 2012, vol. 6, pages =1-27
This paper asks why modern finance theory and the efficient market hypothesis have failed to explain long-term carry trades; persistent asset bubbles or zero lower bounds; and financial crises. It extends Godley and Lavoie (Monetary Economics: An Integrated Approach to Credit, Money, Income, Production and Wealth, 2007) and the Theory of the Monetary Circuit to give a mathematical representation of Minsky's Financial Instability Hypothesis. In the extended circuit, the central bank rate is not neutral and the path is non-ergodic. The extended circuit has survival constraints that include a living wage, a zero interest rate and an upper interest rate. Inflation is everywhere. The possibility of stable carry trades emerges. In high interest rate, hedge economies, powerful banks invest surplus loan interest. With speculation, banks lobby to enter investment markets and the system is precariously liquid/illiquid. In a Ponzi economy, where loans never get repaid, solvency is a balance between increasing reserves, reducing interest rates and rebuilding banks' balance sheets during systemic crises. Simulating bank bailouts, household bailouts and a Keynesian boost suggests that bank bailouts are the least effective intervention, exerting downward pressure on wages and household spending: austerity.
Keywords: circuit theory; macroeconomic simulation; carry trade; austerity; banking regulation; interest rate policy (search for similar items in EconPapers)
JEL-codes: E10 E27 E43 E58 E60 (search for similar items in EconPapers)
References: View references in EconPapers View complete reference list from CitEc
Citations Track citations by RSS feed
Downloads: (external link)
Working Paper: Circuit theory extended: The role of speculation in crises (2012)
This item may be available elsewhere in EconPapers: Search for items with the same title.
Export reference: BibTeX
RIS (EndNote, ProCite, RefMan)
Persistent link: http://EconPapers.repec.org/RePEc:zbw:ifweej:201234
Access Statistics for this article
Economics - The Open-Access, Open-Assessment E-Journal is currently edited by Dennis J. Snower
More articles in Economics - The Open-Access, Open-Assessment E-Journal from Kiel Institute for the World Economy
Contact information at EDIRC.
Series data maintained by ZBW - German National Library of Economics ().