Winner of the New Statesman SPERI Prize in Political Economy 2016

Sunday 4 September 2016

More on Stock-Flow Consistent models

This is a follow-up to this post, but which is prompted by this Bank of England paper, which builds a stock-flow consistent model for the UK. If you are not familiar with the term ‘stock-flow consistent’ (SFC) then read on, because in a sense this post is all about why I think the way the authors and others define this class of models is misleading.

SFC models are popular with Post-Keynesians, and the definition you find on Wikipedia is “a family of macroeconomic models based on a rigorous accounting framework, which guarantees a correct and comprehensive integration of all the flows and the stocks of an economy.” Now I suspect any mainstream macroeconomists would immediately respond that any DSGE model is also stock-flow consistent in this sense. This point is made in a post by Noah Smith, and it is completely valid, although otherwise I think his account of the weaknesses of SFC models is wide of the mark.

If you think this is a trivial debate about titles, take this description of the pros and cons of SFC compared to DSGE models taken from the paper:

Take the cons (merits of DSGE compared to SFC) first. Number one is almost definitional: DSGE models have to be microfounded, but SFC models start with aggregate relationships. But that is not a defining feature of SFC models, because there is a long tradition of macro modelling that is not microfounded but starts with aggregates, a tradition that begins well before DSGEs with the simultaneous creation of national accounts data, econometrics and Keynesian economics. This tradition goes by many names: ‘Structural Econometric Models’ (SEMs), ‘Cowles Commission’ (favoured by Ray Fair) or most recently ‘policy models’ (see Blanchard). I’ll just call them aggregate models here.
A key question, therefore, is what marks SFC models out from other aggregate models? The authors obviously think there is something, because of their second ‘con’. The third and fourth ‘cons’ are common to many large SEMs. (I once wrote a paper on how to mitigate the first of these problems.) The fifth ‘con’ just follows from the first.

At first sight the sixth ‘con’ does the same, but I would argue that if there is anything that characterises SFCs among aggregate models it is this. Aggregate models would generally involve an extensive discussion of the theoretical origins of the relationships they used, but if this paper is anything to go by that is less true for SFCs. If you think this last point is unfair, look at the discussion of the consumption function (before equation 4).

This failure to acknowledge the existence of other aggregate models is even more apparent among the ‘pros’. The first and second can be true for any model, including a DSGE model, but the third is critical. It is true, but again it is also true for many aggregate and some DSGE models. As I argue in my previous post, the key point about the archetypal DSGE model is that it does not need to track household wealth, because there is no attempt by consumers (given the theory) to achieve some target value of wealth.

The fourth is true for any model, including DSGE models. The fifth is true for any aggregate model as long as expections variables are explicitly identified. The sixth is also almost bound to be true of any aggregate model, because starting with aggregates and being eclectic (and potentially internally inconsistent) with theory allows you to more closely match the data than DSGEs.

To summarise, if you were to ask how this model compares to other aggregate (non-microfounded) models, the answer would probably be that it takes theory less seriously and it has a rather elaborate financial side.

The New Classical counter revolution had many good and bad consequences, but one of the undesirable consequences was, it seems, to define the equivalent of a year zero in macroeconomics, where nothing that was not in the New Classical tradition created before (or even after) this revolution is deemed to exist. The same should not be true for heterodox economists. If you are going to effectively return to a pre-DSGE tradition, please do not pretend that tradition did not exist.

There is a well known UK professor of econometrics who was very fond of admonishing authors who failed to cite work that they were either extending or just copying. The intention here is not just to do the same. One of the big dangers with any kind of elaborate aggregate model is that you can get bizarre model properties from not thinking enough about the theory, or imposing enough because of the theory. Knowing some of the authors I doubt that has happened in this case. But it would be a mistake for others to believe that the properties of their model show the importance of accounting rather than the theory they have used.        


  1. «where nothing that was not in the New Classical tradition created before (or even after) this revolution is deemed to exist»

    That's a very good and sad observation. It may be a related subject that both "history of economic thought" and "economic history" seem to have been disappearing as chairs and topics of teaching and research as departments of political economy have become departments of Economics and then often departments of business studies. I wonder whether there is a common thread :-).

  2. There's going to be lot of hetecon calling hypocrisy on this one and with some justification. Take for example mainstream papers about how debt build ups often end in crisis.
    Not much citing outside the circle there

  3. " would be a mistake for others to believe that the properties of their model show the importance of accounting rather than the theory they have used."

    True, but please don't downplay the usefulness of SFC models, simply because some people make this mistake.

    The question is whether study of this type of model, which emphasises balances and the relationship between them, can provide us with useful insights and help us focus on what matters. I think you yourself answer this question best when you state in your previous post:

    ".. the fact that leverage was allowed to increase substantially before the crisis was not something that most macroeconomists were even aware of let alone approved of. As I have said before, if I had seen a chart showing bank leverage .. before the crisis I would have been extremely worried."

    1. Absolutely. I'm very pleased that people are working on these models. I just wish they acknowledged previous aggregate modelling and put a little more theory into them.

    2. Simon, I must ask you a question

      " and put a little more theory into them"


      What do you mean here? Causation? Prediction?

  4. "To summarise, if you were to ask how this model compares to other aggregate (non-microfounded) models, the answer would probably be that it takes theory less seriously and it has a rather elaborate financial side."
    This definition depends on how you understand what "theory" is. From the quote it seems that microfoundations is good theory (internal consistency) and aggregate models which are not microfounded but explain better what happens in the real world (external consistency) is bad theory. I think its the other way round.
    Not as Friedman said, that the only thing that matters is the power of prediction. SFC models have theory in it, in fact a lot I would say.

    1. I have no problem at all with a model that says we have theory (a) and theory (b) and we choose (b) because it fits better. I do have problem with a model that has no discussion of any theory - you might as well run a VAR.

    2. I really dont understand why you say that these models have no discussion of any theory. Practically all behaviour equations are derived from a theory (consumption, investment, savings, etc).

    3. But where is the discussion. Why is consumption independent of real interest rates, for example?

  5. Surely there's still a problem with stock-flow consistent modeling in that they are still too aggregated, though less so than DSGE. Do SFC models allow for financial innovation like securitization ? I don't think so, so their vaunted accounting accuracy is chimerical.

  6. "the answer would probably be that it takes theory less seriously"

    Can you elaborate that please? I have read quite a lot about Stock-Flow Consistent models and I wonder why you think they are lesser models / theory? E.g. Godley & Lavoie (2007): Monetary Economics seems to be very theoretical - I cannot see how it "takes theory less seriously"?

  7. An excellent post. I too was struck by the fact that a large macromodelling tradition in the UK seems to have been largely forgotten. Consistent treatment of the flows of funds, allowance for the impact of liquidity shortages on the behaviour of companies and consumers, and the feedback from net asset imbalances on consumption and investment were all key parts of macromodelling at HM Treasury, NIESR, the LBS and elsewhere from the early 1980s onwards (including your own work of course!).


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