A Nonlinear Model of the Business Cycle With Money and Finance (*)

Abstract

In this paper we analyze the working of a capitalist system with sophisticated financial institutions, where the Modigliani-Miller theorem does not apply, so that the financial part of the economy affects the working of the real side. This model, in which the real and the financial sectors are connected throught a simple portfolio approach, and where the ratio between cash flow and debt commitment affects the pace of investment, explains the emergence of instability and, more generally, the cyclical behavior of the economy as an internally generated phenomenon of a capitalist system. As far as the dynamic behavior of the model is concerned, we can envisage the following process: when investment activity is low, the system evolves toward a stationary state; as soon as the accumulation rate starts growing, the model shows the existence of limited cycles and, when the elasticity of investment to internal finance increases further, a chaotic dynamic appears. Finally, we expect a situation of financial crisis to emerge when the elasticity of investment to internal financing constraint goes beyond a certain level, i.e. when the realized flow of profits is not sufficiently high to validate the debt commitments. The working of the model is referred to an economics with no technical change, while its dynamic properties will be investigated by the use of numerical simulation.

A Theory of Minsky Super-cycles and Financial Crises

“…These include (to list a few) Foley (1987), Semmler and Franke (1991), Gallegati and Gardini (1991), Skott 6 (1994), and Delli Gatti et al (1994. All of these models emphasize the emergence of gradually more fragile corporate balance sheets that are marked by either reduced liquidity or higher debt-equity ratios.…”

Inside Money in a Kaldor-Kalecki-Steindl Fiscal Policy Model: The Unit of Account, Inflation, Leverage, and Financial Fragility

“…In the Minsky Model in Keen (2013Keen ( , 2014, private debt hurts growth for the sole reason that high debt burdens add to firms' costs, reducing the profit rate, which determines net investment. Another continuous, deterministic approach to modeling the financial fragility hypothesis is to simply augment the investment function with a financial conditions variable, a tack that is taken in Asada (2006), Charles (2008), Datta (2012), Fazzari et al (2001Fazzari et al ( , 2008, Fisher and López (2014), Gallegati and Gardini (1991), Palley (2010), Patriarca and Sardoni (2011), Ryoo (2013), Schoder (2014) and many others. Kapeller and Schütz (2014) features constraints on consumer loans that change over time with financial conditions.…”

The Simple Analytics of Debt-driven Business Cycles

“…|Figure 2 here| Most Keynesian models emphasize balance sheet congestion effects (see for instance Gallegati and Gardini, 1991;Franke and Semmler, 1991;Skott, 1994) whereby debt imposes a finance constraint on firms, which in turn impacts investment spending and AD. This class of Keynesian models overlaps with new Keynesian models that also use the balance sheet congestion mechanism.…”

“…Thus, nonlinearity of the profit function generates a non-linear investment function, which drives the cycle. 10 Despite this, Gallegati and Gardini's (1991) core insight regarding the significance of firm level finance constraints can still be incorporated to create a debt driven business cycle by re-specifying cash flows to include the effect of borrowing and debt re-payment.…”

“…Debt-service congestion mechanism transfer mechanism Keynesian closure, y = AD New Keynesian closure, y* = AD Minsky, 1982Gallegati & Gardini, 1991Semmler & Franke, 1991Skott, 1994Palley, 1994, 1997Bernanke et al, 1999Kiyotaki and Moore, 1997 Figure 1. Taxonomy of debt-driven business cycle models (y = output, y * = potential output, AD = aggregate demand).…”