## Posts tagged “sectoral balances”

A simple model of boom and bust
How private sector spending behaviours drive the economy and government budget

In the last two posts we developed simple models of how government money circulates in the economy. In this post, we'll experiment with some of the behaviours encoded in these models in order to elucidate some of the ways in which the government and private sector interact with one another.

In the first model we assumed that the private sector saved a constant fraction of their income. This resulted in a stable aggregate income level and ever-increasing saved wealth. It also meant that the government - which is the monetary authority - had to constantly add money into the economy to counteract this "leakage" of money into savings. As such, the government had a permanent budget deficit and the size of the government "debt" was ever increasing through time, mirroring the private savings.

In the second model we added the ability of the private sector to spend out of their saved wealth. This resulted in larger aggregate incomes and a stabilised level of saved wealth, interpreted to represent the private sector's wealth target. By implication, the government ended up with a balanced budget position and a stable level of debt.

Here, we're going to retain the final form of the model and simply adjust some of the input parameters - specifically, the propensity to spend out of income ($$\alpha_Y$$). First we'll decrease the propensity to spend out of income and then we'll increase it again. This effectively represents a variation in the spending and saving behaviours of the population. We could also adjust the propensity to spend out of savings ($$\alpha_H$$) but we'll stick to just varying $$\alpha_Y$$ for the sake of simplicity.

A model economy with government money and private wealth target
A self-limiting private sector and a stabilizing economy

This post will describe another complete - but simple - model economy. It follows directly from the previous model and introduces one fairly simple innovation. In the last model the private sector spent a certain proportion of it's disposable income, saving the rest. In this model the private sector spend out of both income and saved wealth. The introduction of spending out of wealth in the only difference. This model is the starting point for the stock-flow consistent models described in Monetary Economics by Wynne Godley & Marc Lavoie (model "SIM").