Stock-Flow Consistent Macroeconomic Modeling: Theory, Practice and Applications

The Great Recession made even clearer the need for a deep reassesment of the economic profession. Mainstream macroeconomic models (both DSGE and CGE types) failed at predicting both the financial crash and the effects of the policies put in place afterwards, in particular with respect to the effects of austerity and the increase of Financial Fragility. Broadly speaking, this was so because of the absence, in most of these models, of relevant aspects of the existing economic systems. In particular, endogenous growth models suffer from major shortcomings: i.e., General Equilibrium framework, unreliable/untestable micro-foundations, not really endogenous growth models, no real endogenous money, no clear treatment of banks and of financial sector (and so on). In a period that has been labelled as "Financialisation" (Stockhammer, 2012), where the role and power of the financial sector has increased exponentially (which has contributed to the huge increase in income and wealth inequality highlighted by the works of Piketty and Saez, 2010), while the rest of the economy is facing "Secular Stagnation" (i.e. declining growth rates since the late 80s for output, productivity, wages), not to treat these issues means missing a big part of the picture. However, there are alternatives. Stock-Flow Consistent (SFC henceforth) macroeconomic models, in turn, do pay a lot of attention to the financial side of the system and on the interdependencies that connect the balance sheets of the various institutional secotrs to their real transactions in a monetary production economy. This, coupled with the fact that there has been a wide recognitnion, from both the press and academics (Chancellor, 2010; Wolf, 2012; Schlefer, 2013; Bezemer, 2010), that Godley and applied models based on the SFC approach have been between the few that correctly predicted both the 2001 and the 2007-08 crisis (Godley, 1999; Godley et al. 2007), caused a renewed interest in the approach in both its theoretical and emprirical aspects, being it the perfect roof to host various heterodox views and to discuss how modern capitalist financialized systems works. The aim of this work is threefold. The first, carried out in Part I, is to provide an overview of the SFC approach to macroeconomic modelling from a theoretical/methodological perspective. In this regard, in Chapter 1 we present a SFC neo-Kaleckian Supermultiplier model that deals with the dynamics of government Deficits and Debt within a five-sector closed-economy with three types of assets. After discussing the structure of the model, the second part of the Chapter provides a methodological discussion of how the current SFC literature deals with these models. In particular, this is done by solving the model using the two different approaches (Marshall-Keynes vs Godley-Lavoie) and comparing the results. We will then present, in Chapter 2, Godely's Financial Balances model and discuss the Fundamental Identity and, more generally, how the SFC literature deals with Open Economy issues. The second, dealt with in Part II , is how to make the step from a theoretical to an empirical model. Chapter 3 and 4 are indeed devoted to show how to build an applied SFC Macroeconomic Model, starting from the appropriate data sources, and how to deal with all the technical and practical issues that emerges when dealing with such models. We will guide the reader through all the steps needed to build a sound accounting structure, in Chapter 3, while Chapter 4 describes how to reconcile Stocks&Flows. Finally, in Part III, we will show some application of the model developed in previous Chapters for forecasting the effects of Monetary and Fiscal economic policies over the medium-run. Contrary to the standard macroeconometric models, our SFC framework will make sure that all relevant real-financial connections would not get lost, to possibly detect increasing financial fragility and better evaluate the system wide effects of different regimes. In Chapter 5, we will report the full model devoleped in the Second Part of the work, "close" the Financial Acoounts for each sector, defining the buffer stocks for each asset class and sector and, finally, detail the estimation of the stochastic equations of the model. We will close this work in Chapter 6, where we will perform some Economic Policy simulation on our model, to ascertain the effect and outcomes of different expansionary fiscal policies, the interest rate transmission mechanism and, more generally, the system-wide effect on growth, distribution and Financial Stability.