THE IMPORTANCE OF THE RETENTION RATIO IN A KALECKIAN MODEL WITH DEBT ACCUMULATION

By using a Kaleckian model with debt accumulation, Hein (2007; Metroeconomica, 56 (2), pp. 310–39) found that the long‐run equilibrium value of the debt–capital ratio is positive and stable only if interest rates are extremely high and if the short‐run equilibrium exhibits the ‘debt‐led’ growth regime. However, this conclusion crucially depends on the assumption that the retention ratio of firms is equal to unity. By relaxing this assumption, we show that there exists a positive and stable long‐run equilibrium even under the ‘debt‐burdened’ regime without any constraint on the nominal interest rate.     

MATURITY,STAGNATION AND CONSUMER DEBT: A STEINDLIAN APPROACH

This paper extends a Steindlian model of growth and income distribution to incorporate borrowing by consumers. It shows that borrowing by consumers can improve growth prospects in the short run by increasing consumer demand. However, in the longer run the effects of increasing consumer borrowing are ambiguous because, by increasing consumer debt, it redistributes income towards the rich who have a higher propensity to save, thereby possibly depressing aggregate demand and growth despite the borrowing‐induced expansion. The problem may be exacerbated by financial considerations involving the increase of the interest rate due to greater borrowing, but these considerations are not necessary for it. The problem is more likely to occur when autonomous investment demand is weak, i.e. when borrowing‐induced consumption increases are most required to counter tendencies towards stagnation.     

INCOME DISTRIBUTION,CREDIT RATIONING AND HOUSEHOLDS' DEBT

In this paper, we present a model of an economy with household debt, and discuss the conditions under which financial fragility arises. Financial instability is driven by distributive effects. In addition to the income transfers associated with interest payments, the accumulation of debt feeds back with the distribution of income between labour and capital. The model also gives a central role to banks and credit rationing. Contrary to the existing literature, credit supply does not depend on the characteristics of borrowers, but on those of banks. There is a feedback channel between the health of the financial system and the quantity of credit in the economy. We show that there is a diversity of channels through which financial fragility may arise. We identify three channels: a debt–deflation effect à la Fisher, a credit‐financed consumption boom and an exhilarating debt effect.     

RISK‐AVERSION,OPTIMAL LEVERAGE AND THE INVESTMENT–UNCERTAINTY RELATION

We develop a partial equilibrium dynamic model in which firms are risk‐averse. We analyse the determinants of the investment–uncertainty relationship by means of numerical techniques. When firms can borrow ‘outside’ resources at the riskless rate, an increase in price volatility depresses investment for realistic parameter values. In our model, portfolio considerations play an important role. When the marginal revenue of capital becomes more uncertain, the risk‐averse firm's owners reduce their ‘short position’ in the risk‐free asset, thus diminishing the firm's debt level. The contraction in leverage reduces the expected returns on investment because the expected marginal revenue product is higher than the user cost of capital. In turn, the reduction in expected yields tends to depress investment.     

PUBLIC DEBT AS PRIVATE WEALTH: SOME EQUILIBRIUM CONSIDERATIONS

Government bonds are interest‐bearing assets. Increasing public debt increases wealth, income and consumption demand. The smaller government expenditure is, the larger consumption demand must be in equilibrium, and the larger must be public debt. Conversely, lower public debt implies higher government spending and taxation. Public debt plays, thus, an important role in establishing equilibrium. It distributes output between consumers and government. In case of insufficient demand, a larger public debt entails higher private consumption and less public spending. If upper bounds on public debt are introduced (as in the Maastricht treaty), such constraints place lower bounds on taxation and public spending and may rule out macroeconomic equilibrium. As an aside, a minor flaw in Domar's (American Economic Review, 34 (4), pp. 798–827) classical analysis is corrected.     

Bond Rate,Loan Rate and Tobin's q in a Temporary Equilibrium Model of the Financial Sector

The paper sets up a portfolio model of the financial sector with markets for equity, government bonds, money and debt. The comparative statics of the temporary equilibrium are studied analytically and numerically. Subsequent simulations explore the reactions of financial markets in response to stylized oscillations of some of the exogenous variables. These include economic activity, income distribution, inflation, investors' sentiment, and banks' perceived bankruptcy risk of firms. Special emphasis is put on the resulting cyclical pattern of Tobin's q and the interest spread between loan rate and bond rate.     

The Role for Long‐run Target Values of the Exchange Rate in the Bank of Japan's Policy Reaction Function

This paper analyses whether the Bank of Japan (BoJ) had fundamental concepts in mind when carrying out interventions in the foreign exchange market. We start by considering different long‐run fundamental target values based on a monetary exchange rate model and compare them with more ad hoc targets. Based on these findings, we explain the intervention probability for the BoJ after 1991 based on an ordered probit model by accounting for subperiods and asymmetric effects. It turns out that estimated fundamentally based values for the exchange rate provide additional information for the decision to intervene, in particular after 1995. However, short‐run ad hoc targets seem to be very important, in particular from 1991 until 1995, while medium‐run ad hoc targets gain importance at the end of the 1990s. Overall, we find a ‘leaning against the wind’ strategy in the event of overvaluation relies on ad hoc targets while intervention in cases of undervaluation seems to be guided more strongly by deviations from fundamental values.     

Asymmetric information and credit quality: Evidence from synthetic fixed‐rate financing

In this article the usage of synthetic fixed‐rate financing (SFRF) with interest rate swaps (i.e., borrowing short‐term and using swaps to hedge interest rate risk, instead of selecting conventional fixed‐rate financing) by Fortune 500 and S&P 500 nonfinancial firms is examined over the period 1991 through 1995. Credit ratings, debt issuance, and debt maturities of these firms are monitored through 1999. Strong evidence is found supporting the asymmetric information theory of swap usage as described by S. Titman (1992), even after controlling for industry, credit quality, size effects, and the simultaneity of the capital structure and the interest rate swap usage decision. Consistent with theoretical predictions, SFRF firms are more likely to undergo credit quality upgrades. When limiting the sample to firms where asymmetric information costs are potentially the greatest, the results are even stronger. These findings are important because they document that swaps serve a highly valuable service for firms subject to information asymmetries. © 2006 Wiley Periodicals, Inc. Jrl Fut Mark 26:595–626, 2006     

Optimal Utilization of Capital and a Financial Sector in a Classical Gravitation Process

In a production price framework, a two‐sectoral gravitation process with cross‐over adjustments of prices and quantities is advanced. To overcome an inconsistency in the treatment of fixed capital in disequilibrium, the socio‐technological input coefficients are assumed to vary with the sectoral output–capital ratio, such that for each relative price there exists an optimal degree of capital utilization which maximizes the sectoral rate of profit. Production prices prevail if these maximizing rates of profit are equalized. In addition, a financial sector determining the rate of interest is incorporated into the model. The mathematical analysis establishes a broad scope for local stability of the long‐run equilibrium position once a condition applies that ensures stability of the output adjustments in the short period.     

Modeling the conditional mean and variance of the short rate using diffusion,GARCH, and moving average models

This article introduces a two‐factor‐discrete‐time‐stochastic‐volatility model that allows for departures from linearity in the conditional mean and incorporates serially correlated unexpected news, asymmetry, and level effects into the definition of conditional volatility of the short rate. The new class of econometric specifications nests many popular existing symmetric and asymmetric GARCH as well as diffusion models of the short‐term interest rate. This study attempts to determine the correct specification of conditional mean and variance of the short rate by developing a more general econometric framework that allows for nonlinear effects in the drift of the short rate, and that defines the conditional volatility as a nonlinear function of unexpected information shocks and interest rate levels. The existing and alternative models are compared in terms of their ability to capture the stochastic behavior of the short‐term riskless rate. The empirical results indicate that the relative performance of the two‐factor models in predicting the future level and variance of interest‐rate changes is superior to the nested models. © 2000 John Wiley & Sons, Inc. Jrl Fut Mark 20:717–751, 2000     

Real and Financial Sector Interaction Under Liberalization in an Open Developing Economy

A short‐run model incorporates instantaneous portfolio equilibrium with macroeconomic flows to clarify the structure of real–financial sector interactions. If equity and foreign exchange markets are introduced in structuralist theories of asset markets in developing countries, the key result that a fall in money supply raises the rate of inflation now holds only under special conditions on partial derivatives. But there is a tendency for interest rates to rise and for fluctuations in asset prices. Fuller integration of asset markets moderates these fluctuations. Outcomes are stable in spite of the generalized complementarity distinguishing equity markets from loan markets. Expectations play a major role. Implications for policy are to link domestic interest rates to foreign, remove artificial barriers to market integration, and stimulate demand as well as supply.     

ARE FISCAL SUSTAINABILITY AND STABLE BALANCED GROWTH EQUILIBRIUM SIMULTANEOUSLY ATTAINABLE?

This paper presents an examination of the sustainability of national debt and economic growth, and the growth effects of government debt and income taxation. Results show sustainability of national debt and economic growth under the primary surplus rule. Fiscal policy and balanced growth are compatibly sustainable if and only if the government sets a long‐run target debt/GDP (gross domestic product) ratio within a reasonable range. Results also show that a rise in the long‐run debt/GDP ratio reduces the balanced growth rate. Based on these two results, the long‐run debt/GDP ratio is greater than zero if the government aims to maximize the balanced growth rate.     

On dynamics in a Keynesian model of monetary and fiscal stabilization policy mix with twin debt accumulation

In this paper, a six‐dimensional model of flexible prices with the monetary and fiscal policy mix, describing the development of the firms’ private debt, the output, the expected rate of inflation, the rate of interest, government expenditure, and government bonds are analyzed. The stress put on the “twin debt accumulation” means that in our model both private debt accumulation and the public debt (government bond) accumulation are explicitly introduced. Questions concerning the existence of limit cycles around its normal equilibrium point are investigated. The bifurcation equation is found. The formulae for the calculation of its coefficients are gained. Numerical example illustrating the results attained is presented by means of numerical simulations.     

ASSET PRICE BUBBLES,LIQUIDITY PREFERENCE AND THE BUSINESS CYCLE

In his Treatise on Money, Keynes relied on two different themes to argue that the interest rate need not rise with rising levels of expenditure. One of these was the elasticity of the money supply, and the other was the interaction between financial and industrial circulation. A decrease (increase) in what Keynes called the bear position was similar in its impact to that of a policy‐induced increase (decrease) in the money supply. In the General Theory, this second line of argument lost much of its force as it became reformulated under the rubric of Keynes liquidity preference theory of interest. Assuming that the expected return on capital adjusts to the interest rate in short‐period equilibrium, Keynes ignored the effect of bull or bear sentiment in equity markets as a second‐order complication that can be ignored in analyzing the equilibrium level of investment and output. The objective of this paper is to go back to this old theme from the Treatise and underscore its importance for Keynesian theory of the business cycle.     

An empirical comparison of continuous time models of the short term interest rate

This article tests the performance of a wide variety of well-known continuous time models—with particular emphasis on the Black, Derman, and Toy (1990; henceforth BDT) term structure model—in capturing the stochastic behavior of the short term interest rate volatility. Many popular interest rate models are nested within a more flexible time-varying BDT framework that allows us to compare the models and find the proper specification of the dynamics of short rates. The empirical results indicate that the equilibrium models that do not allow the drift and diffusion parameters to vary over time and parameterize the volatility only as a function of interest rate levels overemphasize the sensitivity of volatility to the level of interest rate and fail to model adequately the serial correlation in conditional variances. On the other hand, the GARCH-based arbitrage-free models with time-dependent parameters in the drift and diffusion functions define the volatility only as a function of unexpected information shocks and fail to capture adequately the relationship between interest rate levels and volatility. This study shows that the most successful models in capturing the dynamics of short term interest rates are those that introduce time-dependent parameters to the short rate process and define the conditional volatility as a function of both the interest rate levels and the last period's unexpected news. © 1999 John Wiley & Sons, Inc. Jrl Fut Mark 19: 777–797, 1999     

How does capital control spur economic growth?

This paper provides a conceptual and empirical framework for evaluating the effect of capital controls on long‐term economic growth. In a small open economy which relies on successful investment projects to provide capital goods, taking out short‐term loans has two contradictory impacts: (i) it reduces the interest costs of financing investment projects; and (ii) it also leads to larger asset losses in the scenario of short‐term debt run. In this work, we hypothesise that private financing decisions made by domestic investors are distorted towards excessive risk‐taking, leading to ineffective capital formation. Thus, capital control policies, particularly regulations on short‐term loans, can be socially beneficial as they alter the debt composition, promote capital formation and achieve a higher output level. Using a panel data set covering 77 countries from 1995 to 2009, we employ a system generalised method of moments (GMM) estimator to sequentially test three hypotheses and find strong empirical evidence that supports our theory.     

Credit Card Indebtedness and Psychological Well‐Being Over Time: Empirical Evidence from a Household Survey

While a number of studies have investigated the relationship between debt and psychological well‐being, none so far has explored if and how this relationship evolves over time. We seek to fill this gap in the literature by empirically analyzing the impact of household credit card debt on debt stress. Using cross‐sectional data collected by The Ohio State University's Consumer Finance Monthly survey between August 2008 and December 2010, we construct a debt stress index and categorize households into three groups based on the length of credit card indebtedness. Our empirical results provide statistical evidence of time‐varying impacts of credit card debt on stress levels. Specifically, we find that debt stress for short‐run debtors is more than twice that of long‐run debtors. The results are robust across a range of econometric specifications.     

Monetary Policy,Taylor’s Rule and Instability

We analyse the dynamic behaviour of an economy where the central bank (CB) sets interest rates according to a Taylor‐type policy rule. A simple model for a closed and instability‐prone economy is constructed and subjected to formal dynamical analysis and numerical simulation. It is shown that a requirement for local stability is that the two response coefficients in the policy rule be positive. Similarly, it is shown that raising the response coefficient of the output gap increases the likeliness of the economy being stable, whereas raising the response coefficient of the inflation gap has an uncertain and probably negligible effect on local stability. Self‐sustained oscillations may arise for certain parameter values. Policy mistakes in the estimation of the long‐run equilibrium real interest rate or potential real GDP may prevent the CB from achieving its inflation target. A suggestion for enhancing the stabilization capacity of Taylor‐type policy rules in the context of the model presented is made.     

The rise of dollar credit in emerging market economies and US monetary policy

This paper examines the hypothesis that the boom in dollar credit in emerging market economies (EMEs) is associated with an excessively low interest rate in the US. For this purpose, we use a multivariate correlated unobserved component model that allows for correlation between shocks to dollar credit, cross‐border interest rate gaps—measured as the difference between emerging market interest rate and the US interest rate, and dollar index both in the short run and in the long run. In addition, it also provides us a quantitative estimate of the permanent and transitory movements in dollar credit in EMEs, interest rate gaps and dollar index. The results from this model do suggest that a temporary increase in interest rate gaps and decline in the dollar index are associated with a temporary increase in the dollar credit in EMEs with a very high degree of correlation. The estimate of the cyclical component of the dollar credit in EMEs from our model captures the recent boom and bust in this market and compares favourably to alternative trend–cycle decomposition methods.     

ON THE IMPORTANCE OF THE RETENTION RATIO IN A KALECKIAN DISTRIBUTION AND GROWTH MODEL WITH DEBT ACCUMULATION—A COMMENT ON SASAKI AND FUJITA (2012)

In a paper published in Metroeconomica, Sasaki and Fujita (2012) argue that an earlier paper of mine (Hein, 2007 ; Metroeconomica, 57, pp. 310–39), which introduces interest payments and corporate debt into a post‐Kaleckian distribution and growth model, leads to empirically implausible and unusual results from a Keynesian/Kaleckian perspective. The major reason for the presumed shortcomings is found in the overly restrictive assumption of a retention ratio equal to unity. However, in the alternative model presented by Sasaki and Fujita either perfect capital gains have to be assumed or firms have to be allowed to issue equity in the accumulation process. The latter variant yields results which are again close to Hein ( 2007 ).