Monetary Policy and Central Banking

Monetary Policy and Central Banking

New Directions in Post-Keynesian Theory

Edited by Louis-Philippe Rochon and Salewa ‘Yinka Olawoye

Divided into two parts, this book presents a detailed, multi-faceted analysis of banking and monetary policy. The first part examines the role of central banks within an endogenous money framework. These chapters address post-Keynesian interest rate policy, monetary mercantilism, financial market organization and developing economies. In the second part of the book, the focus switches to the analysis of the financial crisis that began in 2007. The chapters in this section discuss the role of central banks in times of crisis.

Chapter 6: Financial Crisis, State of Confidence, and Economic Policies in a Post Keynesian Stock-flow Consistent Model

Edwin Le Heron

Subjects: economics and finance, financial economics and regulation, money and banking, post-keynesian economics


Edwin Le Heron* INTRODUCTION 1 While in 2007 it was only a financial crisis and, particularly, a banking crisis, now economic growth and employment are deteriorating sharply. The aim of this chapter is to understand how the financial crisis was transformed into a global real economic crisis and how it passed through banking behavior. We are particularly interested in psychological variables such as the state of confidence, because these variables play a key role in the Post Keynesian tradition through expectations. We develop a model of a “financialized” economy suffering a strong fall in the state of confidence of banks, firms and households. In order to do so, we analyzed two policy mixes. We contrast a rule on public expenditures with a rule on public deficits, and a usual Taylor rule with a truncated Taylor rule. In the first case, the government implements a fiscal policy with automatic stabilizers and the central bank has a dual mandate: inflation and growth. There is a coordination between fiscal and monetary policies. The second policy mix implements an orthodox fiscal policy (balanced budget) and the independent central bank implements inflation targeting. In Section 2, we present the most important equations of a Post Keynesian stock-flow consistent (SFC) model (Dos Santos and Zezza, 2004; Godley and Lavoie, 2007; Le Heron and Mouakil, 2008; Le Heron, 2009) with a private bank sector introducing more realistic features. We introduce the borrower’s and the lender’s risks from the Minskian approach. In Section 3, we simulate a model...

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