Advanced Political Economy

1
Advanced Political Economy

• The Circuitist School

2
It aint just neoclassical economics thats bad

• Political economists in general united in
  opposition to Neoclassical economics
• But
• Divided over nature of alternative and
• Why neoclassical is bad and
• What alternatives there are
• Often problem is not neoclassicism per se, but
  economics in general
• Lacks experimental method as means to reject
  unsound theories
• Self-referentialisolated from real sciences (
  even other social sciences)

3
It aint just neoclassical economics thats bad

• As a result
• Theories experiment would show to be wrong
  persist
• Methods in economics in general often primitive
• Rebels against neoclassicism often slip into
  same mistakes as neoclassicals
• Obsession with equilibrium as the actual state of
  economy
• Inappropriate static methodology
• Ignorance of modern analytic techniquesincluding
  computer simulation, visualisation etc.

4
It aint just neoclassical economics thats bad

• An instance Circuitist School analysis of money
• Brilliant underlying insight but
• Use of inappropriate equilibrium methodology to
  try to develop it
• Stalemate went backwards on crucial issues
• (Relatively!) easy solution to dilemma with more
  appropiate methodology
• Monetary Post Keynesian (MPK) thought mainly
  developed in US/UK
• Companion theory has developed in Europe the
  Circuitist school
• Key focus developing a true monetary theory of
  production

5
A French/Italian connection

• Basic focus is the circuit by which debt-based
  money is created when loan made, and eventually
  destroyed when it is repaid.
• Like MPK approach, Circuitist school emphasises
  that monetary economy is fundamentally different
  to barter economy
• Cant treat monetary economy by just tacking
  money onto commodity model
• Many schools of thought (Classical, Neoclassical,
  Marxian) treat money as commodity
• Keynes argued monetary economy fundamentally
  different to barter economy, but insights poorly
  expressed modelled

6
What is money?

• Circuitists attempt codification of money from
  1st principles
• Argue a commodity cannot be money
• The starting point of the theory of the circuit,
  is that a true monetary economy is inconsistent
  with the presence of a commodity money. A
  commodity money is by definition a kind of money
  that any producer can produce for himself. But an
  economy using as money a commodity coming out of
  a regular process of production, cannot be
  distinguished from a barter economy. A true
  monetary economy must therefore be using a token
  money, which is nowadays a paper currency.
  Graziani (1989 3)

7
Circuitist creation of money

• Ignore creation of fiat (outside) money by
  government and focus on creation of debt-based
  money by banking system
• the money stock is increased or decreased by
  means of debt and credit operations taking place
  between the Central Bank and commercial banks.
  The ideal model of the theory of the circuit
  therefore resembles the so-called Wicksellian
  model of a pure credit economy, with the addition
  of a Central Bank. (3)
• But money seen as essentially different to
  credit
• If in a credit economy at the end of the period
  some agents still owe money a final payment is
  needed, which means that no money has been used.
  (3)

8
Conditions for money

• Must be a token (otherwise a barter model if a
  commodity)
• Must be means of final settlement (3)
• Must not grant rights of seignorage (agents
  cant create it indefinitely at negligible cost
  as formally Governments can with fiat money)
• The only way to satisfy those three conditions
  is to have payments made by means of promises of
  a third agent (3)
• Essential point in Circuitist case (and
  endogenous money in general) transactions are
  all 3 sidedbuyer, seller, banker. Banks are an
  essential aspect of capitalism.

9
Conditions for money

• When an agent makes a payment by means of a
  cheque, he satisfies his partner by the promise
  of the bank to pay the amount due. Once the
  payment is made, no debt and credit relationships
  are left between the two agents. But one of them
  is now a creditor of the bank, while the second
  is a debtor of the same bank. This insures that,
  in spite of making final payments by means of
  paper money, agents are not granted any kind of
  privilege. For this to be true, any monetary
  payment must therefore be a triangular
  transaction, involving at least three agents, the
  payer, the payee, and the bank. Real money is
  therefore credit money. (3)
• Second essential point of this school the
  minimum number of agents in a capitalist economy
  is three

10
Commodity money just n1 barter economy

• Barter economy 2 sided, 2 commodity exchanges
• person A gives person B d units of commodity X
• in return for ? units of commodity Y
• Calling one the money commodity simply semantics

• 1st essential insight
• Money a non-commodity
• A true monetary economy must therefore be using
  a token money, which is nowadays a paper
  currency. (3)

X
A
B
Y
11
Three agents minimum for money economy

• Monetary economy 3 sided, single commodity,
  financial exchanges
• person A gives person B d units of commodity X
• in return for person B having bank Z transfer ?
  currency units from B's account A's account
• Every transaction has 3 partners
• Two for exchange
• One for double-entry book-keeping

Capitalism's eternal triangle
d X
B
A
B -?
A ?
Z
12
Three-cornered exchange the rule
goods
Seller A
Buyer B

• Seller A accepts Bank Cs implicit promise to pay
  as full discharge of buyer Bs obligation to pay
  A for commodity.

13
Conditions for money

• Banks and firms must be considered as two
  distinct kinds of agents. Firms are present in
  the market as sellers or buyers of commodities
  and make recourse to banks in order to perform
  their payments banks on the other hand produce
  means of payment, and act as clearing houses
  among firms. In any model of a monetary economy,
  banks and firms cannot be aggregated into one
  single sector. (4)
• Circuitists develop a strict time-based model of
  sequence of transactions leading to creation and
  destruction(?) of money

14
The money process (Model 1 only one bank)

• Workers either spend wages or buy corporate bonds
• Either activity extinguishes firms debt to banks
• Graziani asserts this destroys money created at
  start of cycle
• As soon as firms repay their debt to the banks,
  the money initially created is destroyed.
  (Graziani 1989 5)
• But rate of purchase by workers a time-dependent
  thing money not spent immediately
• This money (not spent or invested) stays in
  economy in workers bank accounts
• Residue of money means corresponding debt of
  firms to banks (with interest accruing over time)
• Circuit has thus created net money/debt
• New circuit begins

15
The money process

• Model aggregates
• Firms into commercial sector
• Labour into household sector
• Banks into banking sector
• Model sequence
• Banks grant firms right to finance
• Firms hire labour at wage rate determined by
  negotiation (amount of labour hired omitted from
  modelimplicit that hiring reflects firms
  expectations of profit)
• Workers deposit wages in bank accounts
• Workers now creditors of banks, firms debtors to
  banks

16
The money process (Model 2 multiple banks)

• With more than one bank, possibility than money
  paid by one agent (with debt to bank A) may be
  deposited by recipient in bank B
• Thus Bank A has a debt to Bank B
• Each bank needs reserves equivalent to own share
  of credit market
• How does Bank A repay Bank B?
• Third party again needed, otherwise Bank A would
  repay with promise to repay the Central Bank
• Just as single agents use bank deposits, namely
  promises to pay issued by banks, single banks use
  promises to pay issued by the Central Bank. The
  role of the Central Bank is in fact that of
  acting as third party between single banks so far
  as their reciprocal payments are concerned. (9)

17
The money process (Model 3 Central Bank)

• Without a government sector in the model,
• reserves can only be created if the Central Bank
  opens credit positions with single commercial
  banks. The total amount of reserves is therefore
  a debt of commercial banks towards the Central
  Bank, just as the total amount of deposits is a
  debt of firms towards commercial banks. (10)
• With a government sector
• The possibility exists for the Central Bank to
  create money in order to finance the Government
  deficit. Central Bank money thus created is no
  longer a debt of commercial banks, but a debt of
  the Government towards the Central Bank. (10)

18
Putting a foot wrong

• Up to this stage, Circuitists have
• Structured model of money/credit creation process
• Where model depends on rate of change of worker
  spending for creation of money
• Next stage should have been to create dynamic
  model of money creation process
• Move from double-entry book-keeping approach to
  rate of change approach
• Instead, Graziani works out income distribution
  and price relations using simultaneous equations
• But these equations represent steady state or
  equilibrium outcomenot ones involving dynamics
• Kaleckian identities thus to some extent
  incompatible with underlying Circuitist schema.
• Nonetheless

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Income distribution equations

• Definitions
• w Money wage rate
• N Total employment
• c,s worker consumption and savings propensities
• p Labour productivity
• B Total bonds issues by firms
• i rate of interest on bonds
• p market price of output
• X total supply of commodities ( pNp)
• b Fraction of total output bought by firms
• Equating monetary supply and demand yields

Worker demand from wages Bond income
Firms demand for intermediate goods
p (price) on both sides of equation
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Static income distribution equations

• Deriving the price level in equilibrium

21
Static income distribution equations

• Deriving the rate of profit in equilibrium

Substitute
Cancel
22
Static income distribution equations

• Deriving the rate of profit

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Guidance from static equations

• Money prices independent of quantity of money
• Profits are related to the price level
• Real profits are independent of the interest rate
  on bonds
• Profits equal investment if workers consume
  everything.
• Just one problem with all these conclusions
• Based on equilibrium conditions, yet
• Model of money formation required
  disequilibrium otherwise level of money in
  economy falls to zero
• An assumption is therefore required for the
  existence of a money stock, namely that
  wage-earners spend their money incomes gradually
  over time It is a necessary assumption if we do
  not want money to disappear altogether from the
  system. (6)

24
The problem

• Circuitist logic leads inevitably to a need for
  one component of their system (workers
  expenditure) to have a rate of change with
  respect to time rather than an equilibrium value
• But in equilibrium all rates of change are zero
• Equilibrium analysis thus inappropriate for
  circuitist case
• E.g., of course money plays no role in setting
  money prices in equilibriumbecause in
  equilibrium (in their model) there is no money!
• Instead, have to use dynamic methods
• But thats not what happened

25
Inability to model

• Two parts to Grazianis attempt to model circuit
• Verbal trace cycle of path of single dollar
• Initial loan by bank to capitalist
• Payment of wage by capitalist to worker
• Purchase of goods/securities by worker
• Extinguishment(?) of original debt
• Simultaneous equation/equilibrium analysis
• But verbal logic implied need for dynamic model
• An assumption is therefore required for the
  existence of a money stock, namely that
  wage-earners spend their money incomes gradually
  over time (6)

26
The equilibrium cringe

• Despite criticism of equilibrium fetish of
  neoclassical economics, Circuitists/Post-Keynesian
  s still havent definitively broken with statics
• Consider these excerpts from Graziani
• the preceding equality is an equilibrium
  condition in a perfectly competitive market
• if s b, profits are zero, as in a perfectly
  competitive equilibrium
• Equilibrium prevails if firms get back the
  whole of the money they have initially spent and
  that they now owe to the banks.
• Circuit theory defines the money stock as a
  debt of firms towards the banks as soon as money
  balances exceed their equilibrium level, firms
  will reduce their debt, therefore destroying
  money by the same amount.

27
One step forward, two steps back?

• Circuitists provide first sound foundation for a
  monetary theory of production
• A monetary system cannot have a commodity as
  money
• Then develop logic of 3-sided exchange model with
  double-entry book-keeping of transactions
• But then face dilemmas
• If all transactions are balanced, how can any one
  agent make a profit?
• How can capitalists repay debts with interest and
  not lose money?
• These dilemmas didnt exist with Marxs
  non-monetary theory (which many Circuitists
  subscribe to)
• Capitalists make a profit out of the surplus
  generated in production

28
Marx the source of profit

• Wrongly attributed surplus entirely to labour,
  but basic point correct shared by other PE
  schools
• The conversion of money into capital has to be
  explained on the basis of the laws that regulate
  the exchange of commodities, in such a way that
  the starting point is the exchange of
  equivalents. Our friend, Moneybags, who as yet is
  only an embryo capitalist, must buy his
  commodities at their value, must sell them at
  their value, and yet at the end of the process
  must withdraw more value from circulation than he
  threw into it at starting. His development into a
  full-grown capitalist must take place, both
  within the sphere of circulation and without it.
  These are the conditions of the problem. (Marx
  1867, pp. 163)

29
Marx the source of profit

• The change of value that occurs in the case of
  money intended to be converted into capital ...
  must ... take place in the commodity bought by
  the first act, MC, but not in its value, for
  equivalents are exchanged, and the commodity is
  paid for at its full value. We are, therefore,
  forced to the conclusion that the change
  originates in the use-value, as such, of the
  commodity, i.e. its consumption. In order to be
  able to extract value from the consumption of a
  commodity, our friend, Moneybags, must be so
  lucky as to find, within the sphere of
  circulation, in the market, a commodity, whose
  use-value possesses the peculiar property of
  being a source of value. (Marx 1867, pp. 164.
  Emphases added.)

30
Marx the source of profit

• The past labor that is embodied in the labor
  power, and the living labor that it can call into
  action the daily cost of maintaining it, and its
  daily expenditure in work, are two totally
  different things. The former determines the
  exchange-value of the labor power, the latter is
  its use-value. The fact that half a working
  day's labor is necessary to keep the laborer
  alive during 24 hours, does not in any way
  prevent him from working a whole day. Therefore,
  the value of labor power, and the value which
  that labor power creates in the labor process,
  are two entirely different magnitudes and this
  difference of the two values was what the
  capitalist had in view, when he was purchasing
  the labor power... What really influenced him was
  the specific use-value which this commodity
  possesses of being a source not only of value,
  but of more value than it has itself. This is the
  special service that the capitalist expects from
  labor power, and in this transaction he acts in
  accordance with the 'eternal laws' of the
  exchange of commodities. The seller of labor
  power, like the seller of any other commodity,
  realizes its exchange-value, and parts with its
  use-value. (Marx 1867, p. 188.)

31
Incomplete attempts at dynamics

• Marxs insight lost in initial difficulties of
  dealing with double-entry bookkeeping monetary
  vision of Graziani
• Subsequent Circuitist writers compounded problem
• Simplifying assumptions that remove essential
  aspects of the model
• Bellofiore et al. 2000 (footnote 8) For the
  sake of simplicity, we exclude the payment of
  interest to the banks
• Inability to work out whether system allows for
  profit
• Bellofiore et al. 2000 (footnote 9) are firms
  able to obtain money profits? in the basic
  circuit approach, it is impossible for all
  firms to obtain money profits
• Bellofiore et al. stymied by question can
  capitalists borrow money pay it back at a
  profit?
• Effectively answer no

32
Bellofiore et al. Marx Inside the Circuit

• The circuit of the capitalist economy
• (a) banks create money and firms acquire
  labour power
• (b) the production process takes place
• (c) workers spend their income on wage goods
• and firms repay the initial debt contracted to
  the banks.
• Assuming a propensity to consume equal to one,
  firms would always get back the money wage bill
  and repay the banks (interest apart). (407-08)
• Huh? We have to assume MPC1 for firms to get
  back what they have paid out in wages? And this
  wouldnt repay accumulated interest?

33
Bellofiore et al. Marx Inside the Circuit

• Attempt to turn Grazianis verbal vision into
  mathematical model stymied by lack of dynamic
  analysis
• Rather than confronting dynamic process, shied
  away from complex essential aspects
• Cant borrow money without paying interest
• Cant borrow money without repaying it
• Yet capitalists do make profits
• But Circuitists argue that in the basic circuit
  approach, firms in the aggregate can only obtain
  the wage bill they advanced to workers (wN) and,
  as a result, it is impossible for all firms to
  obtain money profits. (410)
• Other Circuitists confront same dilemma the
  paradox of monetary profit how can capitalists
  borrow money, repay it with interest, and still
  make a profit?

34
The source of profit

• Rochon put is well
• The existence of monetary profits at the
  macroeconomic level has always been a conundrum
  for theoreticians of the monetary circuit not
  only are firms unable to create profits, they
  also cannot raise sufficient funds to cover the
  payment of interest. In other words, how can M
  become M? (125).
• Problem arises from failure to distinguish
  between transactions and income once working in
  monetary framework
• Double-entry system records all transactions
• Income is sum of transactions net of costs
• Capitalists make profit if production produces a
  surplus over costs, just as Marx explained in
  non-monetary model

35
A monetary advance but

• Marx answers source of profit, but expresses it
  only in value terms
• No explanation of how value converted into
  money
• Circuitists, inspired by Marx, develop true
  monetary model of capitalism, but lose the source
  of profit!
• What went wrong here? One step forward, two steps
  back?
• Problem caused by
• Inability to follow logical argument through in
  verbal terms
• Equilibrium fetishtrying to analyse dynamic
  process as if it occurs in equilibriumand
• Use of static simultaneous equations to analyse a
  dynamic process
• Paradox easily solved with appropriate
  mathematics Ordinary Differential Equations
  (ODEs)
• Normally not taught to economics students, but
  fundamental part of training of engineers,
  physicists, etc.
• Simple illustration from Grazianis point that
  wage-earners spend their money incomes gradually
  over time

36
Modelling workers expenditure, money

• Basic and realistic assumption/fact that
  wage-earners spend their money incomes gradually
  over time
• E.g., Workers spend a of their wages per unit
  of time
• rate of change of their money account wage per
  week is a
• Rate of change of money wage account is a per
  week
• Mathematically

• This can be solved for M using integration

• C0 is initial stock of money
• Lets try C0100, a1

37
Modelling workers expenditure, money

• Balance in accounts (and thus money) from initial
  deposit of 100 is

• Inverse dynamic needed for accumulating
  additional debt of firm (interest on 100 at r
  per time period, compounded)

38
A modelling dilemma

• Circuitist initial case well thought out, but
• complexities of cycle overwhelm verbal reasoning
• in mathematical modelling, they fall back on
  familiar methods of simultaneous equations
• Simultaneous equations incompatible with their
  basic insights
• Common problem, even in non-neoclassical
  economics economists use wrong tools for the job
  because they dont know the right tools
• Right tool for this sort of analysis is ordinary
  differential equations (ODE)
• Some insights from previous ODE

39
ODE Insights

• Process modelled involves single bank-firm loan
  and its aftermath
• Clearly these are occurring all the time
• In a growing economy, these would be positive
• There is a rate of change function for new debt
  issues
• Firms must aim to make a profit out of this
• Level of borrowing probably a function of
  expected profits
• Whole model must tie back into itself current
  model is incomplete
• Two more related insights from other economists

40
Additional insights for Circuitist approach

• Minsky debt must always be growing in growing
  economy
• If income is to grow, the financial markets,
  where the various plans to save and invest are
  reconciled, must generate an aggregate demand
  that, aside from brief intervals, is ever rising.
  For real aggregate demand to be increasing, ...
  it is necessary that current spending plans,
  summed over all sectors, be greater than current
  received income and that some market technique
  exist by which aggregate spending in excess of
  aggregate anticipated income can be financed. It
  follows that over a period during which economic
  growth takes place, at least some sectors finance
  a part of their spending by emitting debt or
  selling assets. (Minsky 1963 1982)

41
Additional insights for Circuitist approach

• Marx sum of excess demands of producers/consumers
  negative in a capitalist economy
• The capitalist throws less value in the form of
  money into the circulation than he draws out of
  it... Since he functions ... as an industrial
  capitalist, his supply of commodity-value is
  always greater than his demand for it. If his
  supply and demand in this respect covered each
  other it would mean that his capital had not
  produced any surplus-value... His aim is not to
  equalise his supply and demand, but to make the
  inequality between them ... as great as
  possible. (Marx 1885)
• Bank debt needed to balance (as per Minsky)
• Expanding debt a basic feature of growing
  capitalist economy

42
Weaknesses in circuitist approach

• No proper consideration of production
• Clearly workers produce output after hired
• Output must be priced and sold
• Physical surplus must be monetized
• For profitable economy, sale price must exceed
  cost of production
• Circuitist model as laid out by Graziani (and
  also much as developed to date) therefore only
  one step in overall dynamic process
• Basic flowchart of full process

43
Full flowchart of circuitist model

• Spagetti notion?

Workers
Factory
Firm
Other Firms
Bank A
Output
Bank B

• But in fact this complex web can be modelled
  mathematically using ODEs ordinary differential
  equations
• Basic mathematical method for analysing dynamic
  processes
• Expresses system in terms of rates of change as
  function of current states

Central Bank
44
Dynamic analysis

• Basic equation of money balances earlier

Current state of money balance
Rate of change of money balance

• More elaborate systems built up from this simple
  building block
• Can develop entire dynamic Circuitist model and
  solve dilemma of monetary profits

45
A dynamic Circuitist model

• Start from the basics
• Bank lends money to capitalist
• Loan paid into credit account for capitalist KC
• Debt recorded in debit account KD
• How to model discussed soon
• Loan must be repaid
• Interest must be paid by capitalist
• This component simple if debt not repaid, debt
  grows at the debit interest rate times the
  current level of debt

• Capitalist earns (lower) credit rate of interest
  on balance in credit account

46
A dynamic Circuitist model

• How to model repayment of debt?
• Simplest way same as interest payment itself
  only different sign
• Capitalists repay outstanding debt KD at rate R
• Amount R.KD has to come from credit account

Amount R.KD taken from credit account
paid into debit account
What about the Bank?
47
A dynamic Circuitist model

• Payment of RKD really goes to bankentry in KD
  account simply keeps record of how much
  capitalist still owes
• So need account for bank to receive interest
  principal repayments
• Payments out (initial loan interest on KC
  balance)
• Initial loan an initial condition, not rate of
  change (a constant of integration)
• Payments in (RKD)

• Absolutely simplest system is thus

48
A dynamic Circuitist model

• How does it operate?
• Lets simulate it!
• Many tools for dynamic simulation these days
• I use Mathcadsimulate actual equations
  Vissimconvert into flowchart
• Firstly, in Mathcad

• Lets check that out slowly

49
A dynamic Circuitist model

• Components of Mathcad Simulation

Declares constants
Initialconditions
Model

• Might look complicated on first exposure, but
  easily simplest and fastest means to simulate
  dynamic model
• Now the flowchart approach

Solves model
Variablesto graph
Values after one year
50
A dynamic Circuitist model

• Flowchart software developed by systems
  engineers
• Represent dynamic system as flowchart
• Enable numeric simulation of relationships
• Initially used to model Club of Rome scenarios
  about potential depletion of earths resources
• Now commonest tool used by engineers to design
  dynamic systems
• Advantage over equation approaches
• Shows flow of system variables
• Simulated in real time
• Example basic debt dynamics

51
A dynamic Circuitist model

• Debt dynamics

Current level of debt
Integrated
Times interest rate
Gives current level of debt
(Added to initial debt)
Simulated live in Vissim
Returning to Mathcad
52
A dynamic Circuitist model

• Base model indicates dilemma Circuitists felt
• Capitalists end up owing money after 1 year
• 37.36 left in KC account
• 38.67 still owing to Banker (KD account balance)
• Banker well ahead
• 62.64 in banker account
• Also points out error in Grazianis verbal logic
• Money not destroyed when debt repaid (as Graziani
  believed), but accumulates in hands of banker as
  unencumbered asset!
• Sum of KC and B is 100 identical to original
  creation of money To be examined
• Money not identical to debt
• Money not destroyed when debt repaid

53
A dynamic Circuitist model

• Model somewhat sloppy at this point
• Debt repayment factor R unrelated to initial debt
• In reality, debt repayment terms always related
  to initial debt
• Seignorage being able to print money and then
  spend it
• Bank should be able to spend income from spread
  between lending and deposit payments, but not
  principal
• As specified, bank could spend principal
• Have to split B account in BP for principal and
  BY for income
• Repayment stream R goes into BP
• Deposit and interest streams into out of BY

54
A dynamic Circuitist model

• First step relate principal repayment factor R
  to initial debt
• Standard debt contract annuity payment
• Continuous stream of equal payments for defined
  period
• At end, payments stop
• Complicated to model in ODE terms
• Also suits single transaction
• Circuitist model aggregate one notionally
  includes many capitalists, banks, workers
• Better to use aggregate view of debt
• Capitalists intend to pay debt down to target
  fraction of initial debt by a defined time
• Modelling this as an ODE

55
A dynamic Circuitist model

• By time T, outstanding debt KD(T) will be a
  fraction Xlt1 of debt at time t0
• As an equation

• Objective achieved by adding term RKD to debt
  equation, where part reflects payment of interest
  and part repayment of principal

• Solve by rearranging into log equation

• Rearrange dKD and dt

• Integrate both sides

• Result is logarithm

• Take exponentials

56
A dynamic Circuitist model

• Debt equation is

• At time t0, CKD(0)

• Now use this equation to solve for R

given that
so then X is
Take logs
Solve for R
57
A dynamic Circuitist model

• So final debt equation is

Call this RP (repayment principal) Positive
because Xlt1
Call this Ri (repayment interest)

• Ri goes to Bankers income account BY
• RP goes to Bankers principal account BP
• Basic properly specified model now is

58
A dynamic Circuitist model

• Circuitist model without production

These two cancel
Lets simulate this
59
A dynamic Circuitist model

• Result of system

• Can now see that capitalist debt bank principal
  equals amount of initial money created
• Money not destroyed by repaying debt, but changes
  from debt of firms to banks to pure bank asset.

60
A dynamic Circuitist model

• Still no production how to model?
• Simplest approach do it implicitly
• Production undertaken to generate profit
• Production requires workers
• Sum of output sum of income
• All output resolves into flow of income to
  workers and capitalists
• Production takes time
• New concept a time lag
• Remember workers spending formula from earlier
  in lecture?

• Parameter a related to a time lag
• How long it would take worker to exhaust account
  if absolute rate of spending maintained

61
A dynamic Circuitist model

• If we express workers account formula as

• Then t is a measure of how much time it would
  take before M returned to zero linearly
• Actual ODE gives exponential decay
• t is value of tangent to M at t0

• With t2, tangent crosses time axis at 2 (weeks)
• Use same concept for production time lag tKC
  represents flow out of capitalist accounts to
  finance production

62
A dynamic Circuitist model

• Use Marxian relation here (problems with labour
  theory of value dont arise in single commodity
  model)
• Income from factory resolves into either profits
  or wages
• Ratio is s(1-s)
• Same as s/v in Marxian analysis
• So we
• Add outflow from KC account of -1/tKC that
  finances production
• Time lag represents time involved in production
  sale
• s/tKC returns to capitalist account as income
• (1-s)/tKC goes to workers as wages

63
A dynamic Circuitist model

• One new account workers WY
• Consumption flows now occur from workers
  bankers
• Transactions by workers and bankers to buy output
  of factories
• Time lag tB for bankers consumption tW for
  workers

Expenditureonproduction
Profits
WorkersConsumption
BankersConsumption
Wages
WorkersConsumption
BankersConsumption
64
A dynamic Circuitist model

• Incomes are the flows
• Into workers accounts from capitalists (wages)
• Back into capitalist accounts from production
  (profits)
• Of interest to and from bankers income (bank
  income)
• The integrals of these show the sum of income
  generated by the original loan and the production
  it financed

• Lets put some numbers to all this

65
A dynamic Circuitist model

• Initial loan 1 million rd 5 rc 3 T
  (repayment horizon) 1 year X (repayment target)
  1 tW workers consumption time lag 2 weeks
  (1/26 years) tB bankers lag 1 year tKC
  production lag 3 months (1/4 years) ProfitWages
  ratio s(1-s)0.30.7

66
A dynamic Circuitist model

• With those figures
• Initial debt1 million
• Debt after 1 year10,000
• Aggregate Profit578,649
• Aggregate Wages1,350,180
• Aggregate Bank Income4,370
• How come sum of income exceeds initial loan?
• Circulation from bankers workers (
  capitalists!) back to capitalists renews
  financing of production turnover of credit
  finances more than initial loan over 1 year

67
A dynamic Circuitist model

• Dynamics also more complex now interaction of
  1st order systems generates some 2nd order
  effects

• Final extension (before explicit production)
  relending of bank principal with time lag tBP

68
A dynamic Circuitist model

• Outflow from relending of bankers principal into
  Capitalists credit account
• Matching debt recorded in capitalists debt
  account

DebtRecord
Creditpayment
Relending
69
A dynamic Circuitist model

• With relending, model settles down to stable
  flows (dynamic equilibrium)
• Wages 1,109,038 p.a.
• Profits 475,302 p.a.
• Bank income 3,678 p.a.
• Different figures would apply with different time
  lags, etc.
• But basic point applies can have sustained level
  of economic activity with profit repay
  (relatively minor!) debt obligations on 1
  million loan

70
A dynamic Circuitist model

• Many insights from Circuitists dynamic model
• Endogenous credit money analysis makes sense
• Money not destroyed when debt repaid
• Money is capitalists debt to banks (KD) plus
  balance in bankers principal accounts (BP)
• Money endogenously created simply by bank
  advancing loanno necessity for reserve or
  gold backing of loan
• Instituted in practice for security of system
• Circuitist confusion on source of profit due to
  confusing transactions with income
• Mathematical modelling can assist verbal logic in
  non-neoclassical economics if it is dynamic

71
References

• Bellofiore, Riccardo, Davanzati, G. F. and
  Realfonzo, R, (2000), Marx inside the Circuit
  Discipline Device, Wage Bargaining and
  Unemployment in a Sequential Monetary Economy,
  Review of Political Economy, 12, pp. 403-17.
• Fontana, Guiseppe, Realfonzo, R., (eds.),
  (2005), The Monetary Theory of Production,
  Palgrave, New York.
• Marx, Karl, (1954 1867), Capital Vol. I,
  Progress Publishers, Moscow.
• Rochon, Louis-Philippe, (2005), The existence of
  monetary profits within the monetary circuit, in
  Fontana Realfonzo (2005), pp. 125-138.