Debt Cycles, Instability and Fiscal Rules: A Godley-Minsky Model

37 Pages Posted: 11 Sep 2015

Date Written: September 9, 2015

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

JEL Classification: E10, E20, E32, E62

Suggested Citation

Dafermos, Yannis, Debt Cycles, Instability and Fiscal Rules: A Godley-Minsky Model (September 9, 2015). Available at SSRN: https://ssrn.com/abstract=2658255 or http://dx.doi.org/10.2139/ssrn.2658255

Yannis Dafermos (Contact Author)

SOAS University of London ( email )

Thornhaugh Street
Russell Square
London, WC1H 0XG
United Kingdom

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