Tuesday, September 8, 2009

Flow of Funds model central to crisis prediction

The FT this morning has an interesting opinion piece.

Ever since Aug 07 the economic profession is caught up in a self-centered post mortem analysis, how could they miss this crisis so badly?


Central to the contrarians’ thinking is an accounting of financial flows (of credit, interest, profit and wages) and stocks (debt and wealth) in the economy, as well as a sharp distinction between the real economy and the financial sector (including property). In these “flow-of-funds” models, liquidity generated in the financial sector flows to companies, households and the government as they borrow. This may facilitate fixed-capital investment, production and consumption, but also asset-price inflation and debt growth. Liquidity returns to the financial sector as investment or in debt service and fees.



Basically this is a focus on the derivative equations of money. Do not focus on equilibrium but on the flow of money. In the flow of money you see interest, new debt, repayments etc and when you see these it becomes trivially clear that the OECD was on a debt binge or as the article mildly puts it


Growth in the US and UK has been finance-driven since the turn of the millennium.


Ouch. I am slowly reaching the conclusion that, from a theoretical standpoint, money is never in equilibrium but can only be understood in dynamic models, money is always in movement.

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