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Debt cycles, instability and fiscal rules: a Godley-Minsky model

Yannis Dafermos ()

Working Papers from Department of Accounting, Economics and Finance, Bristol Business School, University of the West of England, Bristol

Abstract: Wynne Godley and Hyman Minsky were two macroeconomists who ‘saw the crisis coming’. This paper develops a simple macrodynamic model that synthesises some key perspectives of their analytical frameworks. The model incorporates Godley’s financial balances approach and postulates that private sector’s propensity to spend is driven by a stock-flow norm (the target net private debt-to-income ratio) that changes endogenously via a Minsky mechanism. It also includes two fiscal rules: a Maastricht-type fiscal rule, according to which the fiscal authorities adjust the government expenditures based on a target net government debt ratio; and a Godley-Minsky fiscal rule, which links government expenditures with private indebtedness following a counter-cyclical logic. The analysis shows that (i) the interaction between the propensity to spend and net private indebtedness can generate cycles and instability; (ii) instability is more likely when the propensity to spend responds strongly to deviations from the stock-flow norm and when the expectations that determine the stock-flow norm are highly sensitive to the economic cycle; (iii) the Maastricht-type fiscal rule is destabilising while the Godley-Minsky fiscal rule is stabilising; and (iv) the paradox of debt can apply both to the private sector and to the government sector.

Keywords: Godley; Minsky; debt cycles; instability; fiscal rules (search for similar items in EconPapers)
JEL-codes: E10 E20 E32 E62 (search for similar items in EconPapers)
Date: 2015-01-09
New Economics Papers: this item is included in nep-mac
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