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

Dafermos, Yannis

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.

• Working Paper Type: Working Paper
• Publication Date: Sep 9, 2015
• Deposit Date: Sep 9, 2015
• Publicly Available Date: Jun 17, 2016
• Peer Reviewed: Not Peer Reviewed
• Keywords: Godley, Minsky, debt cycles, instability, fiscal rules
• Public URL: https://uwe-repository.worktribe.com/output/805904
• Publisher URL: http://www1.uwe.ac.uk/bl/research/bristoleconomicanalysis/economicsworkingpapers.aspx
• Contract Date: Jun 17, 2016