Winner of the New Statesman SPERI Prize in Political Economy 2016

Sunday 11 September 2016

Stock-Flow Consistent models: response to Jo Michell

Jo has a thoughtful and constructive response to my post discussing a recent Bank of England paper that presents a new Stock-Flow Consistent (SFC) model. One of the reasons it is constructive is because it is not tribal: too many followers of heterodox schools seem to just want to rubbish mainstream macro and suggest their particular school represents the new dawn. So I thought I might make a few points on Jo’s post that might be helpful.

  1. A model that includes a lot of institutional detail is not a virtue in itself: indeed if at the end of the day these institutions do not matter too much it is an unnecessary and distracting feature. A useful way to think about modelling approaches is in terms of the validity of simplifications or short-cuts. It is for this reason that my method of theoretical deconstruction outlined and demonstrated here for large models is so important. By trying to relate large model properties to simpler models, you find out where additional detail is important or unnecessary. And of course, the answer to that problem may be context specific.

  2. I hope I never said SFC modes were “accounting, not economics”, because that statement makes no sense. Any behavioural model contains some kind of theory. What I think I said was that these models often seemed ‘light on theory’, which means that they talk a great deal about the accounting and rather little about theory.

    For example, to say that consumers have a desired wealth to income ratio is light on theory. Why do they have such a ratio? Is it because of a precautionary motive? If it is, that will mean that this desired ratio will be influenced by the behaviour of banks. The liquidity structure of wealth will be important, so they may react differently to housing wealth and financial assets. Now the theory behind the equations in the Bank’s paper may be informed by a rich theoretical tradition, but it is normal to at least reference that tradition when outlining the equations of the model.

  3. It is true that stock-flow accounting is important in modelling, in the sense that doing it stops you making silly errors. But it is not dissimilar to identities or market clearing conditions in this respect. You would never call a class of models ‘National Income Identity models’. [1] If the point is to emphasise that stocks matter to behavioural decisions about flows, then that is making a theoretical point. As Jo says, DSGE models are stock-flow consistent, but in the basic model consumers have no desired wealth ratio: it is the latter that matters. So when Jo says this absence should ring alarm bells, he is making a theoretical statement.

    I think Jo is right that the SFC name is unfortunate, but you can make a similar case for the name DSGE. It only matters when some people believe that stock-flow consistency is some kind of heterodox invention. Equally the label DSGE becomes a problem when economists start thinking that macroeconomists cannot do partial equilibrium any more, a point that Blanchard makes in his discussion of DSGE models.

  4. When Jo tries to connect the unimportance of stocks in DSGE to the return to full employment I think he is painting with too broad a brush. Let’s take a simple example. In the baseline small open economy model of mainstream macro, a temporary shock that leads to a current account deficit will permanently reduce welfare because net assets permanently fall. The trade balance has to improve, and consumption is therefore lower. A permanent depreciation worsens the terms of trade. In that case what happens to stocks has a permanent effect. Indeed, if you alter the model by replacing the consumption function with one based on Blanchard/Yaari consumers, there would be a feedback from wealth to consumption which would mean this shock would no longer have a permanent effect.

  5. In using the quote of mine about ‘not their field’ from a previous post he is rather unfair. As I go on to say, mainstream macro was at fault in neglecting finance. Pretty well every mainstream macroeconomist will say the same. The point I wanted to make was that it is not true that they all did this because they were sure it didn’t matter, the sector would regulate itself etc etc. What I have argued in this paper is that macroeconomists might well have not neglected the financial sector if they had allowed more traditional aggregate (i.e. non-microfounded) models to continue to be a legitimate area of academic research. Some might want to argue that this neglect of the financial sector reflected that mainstream macroeconomists were inherently neoliberal and believed financial markets looked after themselves. Perhaps some were, but plenty of others were not.

  6. I also think it is a bit unfair to suggest that I was criticising the model in the Bank’s paper. As it represents an alternative to DSGE models it should be welcomed. (Especially so for the Bank. Many public institutions, like the Fed, have maintained their aggregate models alongside DSGE models: the Bank of England has not.) What I was criticising was (a) the emphasis in the paper on the accounting at the expense of theoretical discussion (b) that the paper ignored the non-DSGE non-Post Keynesian modelling tradition.
[1] It may well be that the models I quoted, like the 1970s Treasury model, were SFC because of the influence of Godley, but they would have thought that this was just good modelling, and not a defining aspect of what they were doing. 


  1. "Now the theory behind the equations in the Bank’s paper may be informed by a rich theoretical tradition, but it is normal to at least reference that tradition when outlining the equations of the model."

    I think what might worries many observers of this discussion is the pedestal on which economic theory seems to be put upon. It looks somewhat theological. Rational expectations might be rich theoretically, but so what? If that theory does not conform to historical experience is it worth anything at all? Is this what we want informing policy decisions that affect millions of people? People would be more comfortable if you could say that it conforms to historical experience and you have had some solid historical evidence (including non-quantitative primary documentation) that supports it. It would not matter so much if models were not the central part of economic analysis - that they were just a technical appendix to investigate a particular aspect of a more comprehensive and multifaceted form of analysis where algebra is useful. But this is not economics in 2016 - essentially economics has become models, and if discussion is basically model, we have to have realism in it. Ideally, however, what we would like to see is not reference to theory, but authoritative case studies - informed by rich historical analysis.


    1. (Almost) Exactly what I thought. IMO it is a bit weird theological discussion.

      But does it make sense to say one is "rich theoretically" and the other one is "light on theory"?

      Both models have their specified behavioral equations, one is based on rationality and the other uses more descriptive equations. But these are just modelling choices. One could write down a SFC model incorporating rationality. But that model wouldn't be a) as descriptive and b) would be harder or impossible to solve.

      So a SFC model typically makes less restrictive assumptions but then uses, by necessity, simpler behavioral equations. DSGE on the other hand abstracts other critical features away, eg no financial sector or simplified/aggregated production function etc - which makes it being less conform to historical experience. Maybe this is heavy on theory and light in practical applications?

    2. Spot on. Being theoretically informed is a virtue. So are lots of other things. And we need to make the best methodological trade-offs.

  2. Simon, I find this debate to be surreal—something out of Cervantes’ Don Quixote.

    It seems quite clear to me that the last time we faced the kind of situation we face today was in the 1930s, the only difference being the growth in social insurance programs since then and the fact that policy makers (for the most part) had the good sense in 2008-09 not to follow the disastrous policies followed in 1929-1933. Keynes explained the nature of this problem in excruciating detail throughout the GT in terms of what Robertson dubbed “the long-period of saving.” He did this not by specifying a sophisticated mathematical model, but in terms of a Marshallian analysis based on logic, reason, and observation with regard to how a free-enterprise system works. What’s more, his arguments are based on sound economic principles on which I believe virtually all economists agree. Based on these principles and arguments Keynes’ ultimate conclusion was that this problem cannot be solved in the long run through the kinds of monetary and fiscal policies envisioned in the models discussed above.

    Unfortunately, the nature of Keynes’ argument got lost in the Liquidity-Preference/Loanable-Funds debate that followed publication of the GT as the Keynesians argued from their Walrasian models that it didn’t matter how the rate of interest was determined and the anti-Keynesians argued that Keynes was wrong. I have tried to explain the basic issues and confusions in this debate and how it relates to the problem we face today here: .

    The conclusion I draw from applying Keynes’ methodology and looking at US data is that the primary cause of the Great Depression in the US was the increase the concentration of income leading up to 1929 and an insufficient fall in the concentration of income during the 1930s. And, yet, I see virtually no one who sees the concentration of income as being a primary cause of the situation we face today. As far as I can tell everyone seems to see this as something that can be ignored so long as we implement the right monetary and fiscal policies. This seems to be the case even among those who believe the concentration of income is important. I don’t think so, and I would welcome and deeply appreciate any comments on my paper that you or anyone else might have either through this blog or by email. (I would note that while this paper is 35 pages long, only 20 pages are text. The rest is references and rather long quotations from Robertson and Keynes that document or expand on what is said in the text and can be ignored by those who do not have time for this sort of thing.)

    Finally, I would note that I do not view this as a trivially matter. Contrary to what most economics seem to believe, the world economy did not ‘recover’ the last time we faced this problem. What happened was WW II as governments in the belligerent countries took over their economies. ( and ) Today we see the powers that be in the developed economies attempting to roll back the kinds of social insurance programs that have saved us so far from the kinds of deprivations experienced during the 1930s, and we also see the beginnings of same kind of political chaos that lead up to that war. It seems quite clear to me that in this nuclear age it does not bode well for the future if economists cannot come up with a rational solution to the fundamental problem we face today that goes far beyond the kinds of descriptive models discussed above.


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