Using Stock-Flow Norms To Explicate Secular Stagnation (Part 1)

Stock-Flow norms are a critical element of stock-flow consistent (SFC) modelling. Using this concept, nosotros tin run across why economical growth has move slower inwards recent economical cycles, inwards item the latest one. Unfortunately, this analysis indicates that the electrical current dull growth - oftentimes referred to equally secular stagnation - is structural, as well as non easily remedied. The ground is that at that spot is considerable demand for savings, as well as the solely way of generating those savings is via authorities deficits, which solely appear if nominal gross domestic product growth is slow. Finally, the fact that the ascent of authorities debt outstanding was the number of policies that were aimed at increasing growth rates has the number that at that spot is lilliputian take away a opportunity of "fixing the debt", equally those other policies would cause got to reversed.

Due to the length of this essay, I cause got split upward it into ii parts. (Link to Part 2.)

The analysis herein is inwards a long tradition of "under-consumption" theories, which pre-date Keynesian economics. However, it is residue sail focussed, which is a mutual characteristic of Post-Keynesian analysis, as well as Modern Monetary Theory (MMT) inwards particular. For example, Warren Mosler (blog link) stresses diverse "demand leakages" inwards modern economies, which was my initial trigger to showtime thinking to a greater extent than carefully most this topic.

Theoretical Background

The theory behind this article is explained inwards ii recent posts - my primer explaining what stock-flow norms are, as well as my explanation of how the demand for authorities bonds creates supply. As a brief summary, stock-flow norms are the human relationship betwixt the desired stock of savings for an entity relative to its income flow. An entity (such equally a identify or business) that wants to increment the ratio of its internet financial assets relative to income volition ask to increment its savings out of income.

Within a modern welfare nation economy, an increased wishing for holdings of financial assets that cannot live matched to increased individual sector borrowings volition depress nominal gross domestic product growth. This lowers taxes paid, as well as increases social transfers. In other words, the financial deficit has to rise, creating the authorities liabilities (bonds, bills, as well as base of operations money) that human activity equally provide to satisfy the increased demand for financial assets. And the nature of accounting identities is that such an adjustment must happen; at that spot is no way of an economical model to non hit this behaviour, unless of course of teaching it ignores accounting identities.

Under-consumption theories of this form cause got a long history, as well as are typically considered disreputable equally they telephone yell upward into the enquiry the thought that capitalist economies e'er hit optimal outcomes. Quaint analysis using the S=I identity applied to barter alongside a few people on a desert isle is oftentimes used to "prove" that under-consumption is non possible. Although that analysis mightiness live useful if yous are on a desert island, I volition explicate inwards Part 2 why increased financial property holdings cause got really lilliputian to do with investment inwards modern economies. (Realistically, if yous are on a desert isle with a minor number of people, yous would probable cause got to adopt a tribal scheme if yous intend on surviving. Real ground tribes do non barter internally, rather they cause got a spider web of complex non-monetary liabilities that regulate activity.)

Other mainstream explanations of secular stagnation oftentimes revolve roughly the storey that the natural charge per unit of measurement of involvement somehow falling. These are justified with complex mathematical models, which makes them facial expression respectable. However, the natural charge per unit of measurement of involvement is non straight observed*, rather it is inferred from other variables. The estimated value volition live depressed if economical growth is lower, "all else equal".  In other words, secular stagnation is "explained" yesteryear slower economical growth, which is non a peculiarly useful insight. Conversely, the stock-flow norm explanation I outline hither leaves its footprint inwards economical data, as well as nosotros too cause got a skilful thought of why that saving conduct is changing. (Changing that conduct is difficult, unfortunately.)

Empirical Analysis In The United States

I cause got chosen to illustrate my analysis using Flow of Funds information for the United States. These information are compiled yesteryear the Federal Reserve quarterly, as well as are known equally the Z.1 Release.

The USA is the centre of the ground roughly "secular stagnation", as well as the province of affairs is relatively straightforward there, at to the lowest degree when compared to the other developed countries. Euro expanse nations are locked into the fetters of a virtual Gold Standard, as well as and so financial flows human activity inwards a different fashion. Nihon has been inwards a secular stagnation for a long time, as well as I promise to seat out analysis of those information eventually. The other "Anglo" nations - the United Kingdom, Canada, Commonwealth of Australia as well as New Zealand - cause got similar tendencies to the United States, but they cause got other special factors that distinguish them (the U.K. has an oversized global financial centre inwards London that distorts the national picture, Commonwealth of Australia has an oversized resources sector that greatly influences upper-case missive of the alphabet flows, as well as Canada's housing bubble has non withal popped). Nonetheless, they too exhibit symptoms of "the American Disease".

The ascent inwards the U.S. Federal debt-to-GDP ratio since the terminate of the financial crisis is good known, although financial hysteria has largely died downwardly equally a final result of political trends as well as the decrease inwards the deficit (chart above). What was largely ignored (outside of the economical schools of thought that emphasise residue sail analysis) is that the vogue inwards the provide of Treasury debt is next the vogue inwards the demand. The U.S. Treasury is non the solely origin of provide of financial assets, but it has been forced to create total inwards for the other sources. I volition hash out the provide province of affairs inwards the minute business office of this essay.

The repose of this business office of the article discusses the trends inwards the demand for financial assets.

The External Sector

Although I unremarkably focus on domestic considerations when looking at developed economies, the external sector is the 800-pound gorilla of the Treasury market. The United States' perpetual electrical current concern human relationship deficits create a corresponding ask for foreigners to accumulate financial assets inside the United States. The nautical chart to a higher identify shows the "Rest of the World" holdings of U.S. financial assets equally good equally Treasury securities equally a percent of U.S. GDP. External holdings cause got risen to roughly 47% of the Treasury marketplace (as of the minute quarter of 2014).

H5N1 meaning part of the Treasury holdings are the belongings of unusual governments equally business office of their unusual reserves. The Flow of Fund information does non segregate yesteryear type of holder; ane could facial expression at the New York Fed custody holdings information to larn a handgrip on what percent of unusual holdings are "official" (foreign authorities or supranational) holdings of Treasurys. (Foreign governments for some ground or some other do non completely trust the financial sector, as well as oftentimes concur reserve assets straight at the primal bank.) However, it appears that some governments cause got decided to displace assets to entities domiciled exterior the United States, as well as and so the custody holdings may live capturing less of the truthful official holdings.

However, I do non retrieve nosotros tin easily distinguish betwixt the "foreign individual sector" as well as "foreign authorities reserves", as well as so I do non pursue making that breakdown here. There are large "sovereign wealth funds" that oftentimes human activity equally a semi-official agency of recycling electrical current concern human relationship surpluses (for example, for the OPEC nations). Additionally, the Japanese individual sector has been recycling Japan's previously hefty electrical current concern human relationship surpluses inwards a fashion that was quite convenient for Japan's economical bureaucracy.

Since I am showing the stock of holdings, upper-case missive of the alphabet gains inwards the equity marketplace cause got too helped force upward the ratio of assets to GDP. Given that the duration of holdings of reserve assets tends to live fairly short, upper-case missive of the alphabet gains cannot completely explicate the ascent inwards Treasury holdings. In whatever event, at that spot has been no vogue for foreigners to harvest upper-case missive of the alphabet gains.

The implications of these flows are straightforward as well as good known. Since exports add together to gross domestic product as well as imports subtract from GDP, running an increasing merchandise deficit slows nominal gross domestic product growth, as well as therefore nominal domestic income growth. The fact that unusual official holders cause got extremely minor holdings of individual sector financial assets additionally makes it harder to recirculate these flows into the individual sector. Weaker domestic growth depresses the revenue enhancement base, as well as increases the Federal authorities deficit.

(As an aside: Modern Monetary Theory emphasises that exports are a cost to an economy, as well as imports are a benefit. Therefore, at that spot is no item worry most the countries with free-floating currencies running persistent electrical current concern human relationship deficits. However, financial policy needs to live to a greater extent than accommodative to compensate for this drag on aggregate demand.)

This "demand for Treasurys" (or U.S. financial assets) is partially number of decisions yesteryear unusual nations (mainly inwards Asia) to suppress their currencies versus the U.S. dollar, as well as to boundary imports. The other major origin of unusual demand results from the United States' massive stone oil imports, as well as the wishing of stone oil producers to recirculate their electrical current concern human relationship surpluses into financial assets. Changing the U.S. revenue enhancement code tin do lilliputian to halt this, other than yesteryear triggering a recession that stops imports inwards their tracks. However, recessions volition heighten the deficit on concern human relationship of domestic factors, as well as so this would non assist the overall financial position.

From the standpoint of stock-flow norms, what is amazing most the unusual sector is how badly calibrated their normative rules are. Normally inside a SFC model, ane assumes that increased financial assets volition Pb to increased spending out of those assets, leading eventually to dis-saving. Instead, some unusual governments continued to pile upward reserve assets without whatever apparent wishing to increment consumption. But it appears that the unsustainability of these policies lastly registered, as well as the stair of growth of reserve assets is slowing.

Retirement Needs

Demographics has driven the desired stock of assets inwards retirement accounts ever-higher. The nautical chart to a higher identify shows the degree of assets inwards pension plans of all types - individual defined contribution as well as defined do goodness (including 401(k)-style plans), State as well as Local authorities pensions, as well as Federal pensions. I exclude claims on the sponsoring entity - unfunded pension benefits - equally good assets held at Life Insurance companies (which are shown below). Since assets are weighted towards equities, the repeated ascent as well as autumn of stock prices is evident.

The ascent of unusual official investors inwards Treasury securities has pushed individual sector bond managers out of that market, as well as so I present the holdings of all credit marketplace instruments (which are weighted towards corporate bonds). Since I volition facial expression at the corporate sector provide inwards the adjacent part, nosotros ask to facial expression at aggregate demand for credit marketplace instruments. (Note that the credit marketplace instruments do non include the sizeable holdings of non-marketable Treasury securities.)

Life Insurance companies, through their involvement with annuities as well as other savings products, are some other of import intermediary for retirement savings. The nautical chart to a higher identify shows their financial holdings.

In both cases above, the amount of credit marketplace instruments has been fairly stable equally a percent of GDP. But since gross domestic product is growing, that implies a steady acquisition of assets. The nautical chart below shows the 4-quarter average of credit marketplace acquisition yesteryear these entities. It represents an average origin of demand of most 1.5% of GDP. However, it should live noted that this demand is genuinely less than it was during the to a greater extent than inflationary 1980s.

Household Sector

Household financial assets equally a percent of gross domestic product cause got been increasing, although this largely reflects the deport upon of rising equity values. (In the pinnacle panel of the nautical chart above, I excluded the value of pension benefits, equally those were inwards embedded inwards the charts of the previous section.) It is hard to run across the vogue inwards bond holdings, equally those holdings are increasingly intermediated yesteryear financial institutions similar mutual funds.

However, if yous facial expression at personal saving (the middle panel of the nautical chart above; I present the Flow of Funds Definition of personal savings, which differs from the NIPA definition), the displace inwards savings is the opposite of what an underconsumption theory would suggest. Savings rates were higher inwards the high inflation (and growth) menses ahead of 1990. However, higher growth rates meant that the asset/GDP ratios were lower than they are at present, despite these higher savings rates.

In terms of internet provide as well as demand as well as funds, the motion painting is to a greater extent than neutral over time. The internet lending of the identify sector has been relatively stable over time, other than during the housing bubble menses (bottom panel).

This savings flow motion painting is non what ane would facial expression based on the rising inequality since the 1950s. Normally, rich households relieve to a greater extent than of their income than poorer households. However, savings rates are lower. This is presumably explained yesteryear changes of conduct over fourth dimension - people at the same income cohort are saving less. However, the vogue to accumulate large fortunes alongside the ultra-rich may explicate the continued ascent inwards the ratio of financial assets to GDP.

Other Sectors

• State & Local Governments. State as well as Local governments are large holders of Treasury securities. I believe that this is the final result of defeasance - the purchase of Treasurys that are held inwards trust to "cancel out" a State or Local authorities bond (a "muni" bond). This practise is unusual, equally the USA is the solely jurisdiction that I am aware of where sub-sovereigns tin borrow at a lower charge per unit of measurement than the sovereign (as a final result of revenue enhancement laws). This represents a reduction of internet bonds outstanding, but it does non hateful that these governments are "investors". (Since I worked for a Canadian property managing director that constitute muni bonds non-economical, I paid lilliputian attending to the workings of that market. As a result, I am working from memory.)
• The Monetary Authority (Fed). Historically, the Fed would live a steady buyer of Treasurys inwards guild to allow it to grow the monetary base. But subsequently the crisis, the Fed went on a rampage buying Treasurys, reducing Treasurys available to others as well as supplying banks with Federal authorities liabilities inwards the shape of reserves. This recent activity makes no sense, as well as and so I am going to ignore it.
• Banks.  Banks used to live of import holders of Treasury debt, but that practise was injure downwardly yesteryear the 1970s. Correspondingly, nosotros cause got been treated to periodic banking crises that lay depression the economy. At present, banks largely human activity equally a residual holder of authorities bonds - they volition mechanically purchase bonds if other investors dorsum away from the marketplace (as seen inwards Japan). But until the crisis hit, unusual purchases as well as other investors pushed banks away from holding them. This trading activity keeps bond yields pinned unopen to the path of the expected path of the overnight charge per unit of measurement inside the banking system.
• Nonfinancial Businesses. No modern corporate Treasurer is going to straight concur Treasury securities other than for legal reasons or equally the final result of some short-term transaction. If anything, they may concur Treasury Bills inside coin marketplace funds. As a result, this sector is non genuinely a major origin of demand for Treasury securities.

Coming Up...

The wishing to accumulate assets yesteryear the external sector as well as the households sector, inwards item for retirement needs, is evident inwards the Flow of Funds data. In Part 2, I volition embrace the provide of financial assets (demand for funds), which explains why rising demand for financial assets (supply of funds) is negative for growth. I volition too explicate why I retrieve "secular stagnation" is non going away (although it may fade until the adjacent recession hits), equally I thought it equally unlikely that these structural factors volition live reversed. Continued hither (link).

Footnote:

* Using the terminology of command theory, it is non technically right to refer to the natural charge per unit of measurement of involvement (or similar theoretical quantities, similar the output gap) equally "unobservable" (even though I likely cause got done as well as so myself inwards other articles). They cannot live straight observed, but they tin live inferred inside a model on the ground of measured variables, using something similar a Kalman Filter. As an example, a inwardness temperature inwards a nuclear reactor may non live straight measured, but it could live inferred yesteryear temperature measurements taken elsewhere. An unobservable variable would live ane whose value cannot live deduced on the ground of measurements. Such a province of affairs is considered to live really undesirable inside technology scientific discipline systems, as well as and so "observability" (all of import nation variables are observable) is oftentimes a key requirement. Returning to economics, this concept assumes that the model is a skilful approximation of reality, which is a debatable supposition for models that role the natural charge per unit of measurement of interest.

(c) Brian Romanchuk 2014