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A model of the economy for the ecologically minded

Neoclassical (mainstream) environmental economics mostly works within a standard and very confining framework. For example: (1) it is not truly Keynesian in the sense understood by Keynes himself; (2) It mostly denies that there are resources for which there are no substitutes (for example, fresh water, which has a unique biological role); (3) it overly discounts costs expected in the future, even when they could be as profound as the end of an earth inhabitable by humans; and (4) it unrealistically assumes that human beings act in their economic roles so as to maximize “utility,” which is an unobservable quantity to boot. A complete list of the limitations would be long indeed.

This brings us again to the work of Dafermos, Nikolaidi, and Galanis, who again further the effort to incorporate what this blog would call a real Keynesian model with more-deeply ecological concepts. The type of model proposed by the trio is a stock-flow-fund model. This term–as readers may recall from this previous post–is meant to describe a hybrid of (1) stock-flow modeling as innovated by British forecasting “wise man” Wynne Godley (along with the more conventional and boring neoclassical Keynesian James Tobin) and (2) the flow-fund approach proposed by prophetic and brilliant mainstreamer Nicholas Georgescu-Roegin, who sought to integrate the second law of thermodynamics (entropy increases) into economic thinking. (None of these pioneering economists are alive today.) My earlier post contained an attempt at explaining these two paradigms and how the authors sought to combine them.

Both aspects are important to include in a model today, as the world simultaneously grapples with deflationary conditions including high unemployment in most of the developed world at the same time that policymakers seek to deal with existential threats for entire countries that exist as a result of ongoing climate change.

At the end of this paragraph is an abstract of this new iteration on the novel approach proposed by the same authors in the earlier paper, which appeared in working-paper form about a year ago. Interested readers can download the entire paper at this link at the site maintained by the Post Keynesian Study Group. As the abstract makes clear, several related research efforts are underway around the world. I had the pleasure of meeting Dafermos and Nikolaidi at a conference in Berlin last year. And now, the abstract:

A Stock-Flow-Fund Ecological Macroeconomic Model

Recent research has contributed to the development of the building blocks of ecological macroeconomics. Victor and Rosenbluth (2007), Victor (2012) and Barker et al. (2012) have presented simulation econometric models with Keynesian features that incorporate various environmental issues. Jackson (2009), Fontana and Sawyer (2013), Rezai et al. (2013) and Taylor et al. (2016) have put forward theoretical frameworks that combine ecological with Keynesian (or post-Keynesian) insights. Berg et al. (2015), Jackson and Victor (2015), Naqvi (2015) and Fontana and Sawyer (2016) have examined environmental aspects within stock-flow consistent or monetary circuit models that include a financial sector.

However, there is still a lack of an integrated ecological macroeconomic model that combines physical variables with monetary variables in a consistent way. This paper develops such a model by combining the stock-flow consistent (SFC) approach of Godley and Lavoie (2007) with the flow-fund model of Georgescu-Roegen (1971, ch. 9; 1979; 1984). Our stock-flow-fund model has the following key features. First, monetary and physical stocks and flows are explicitly formalised taking into account the accounting principles and the laws of thermodynamics. Second, Georgescu-Roegen’s distinction between stock-flow

resources and fund-service resources is adopted. Third, output is demand-determined but supply constraints might arise either due to environmental damages or due to the exhaustion of natural resources. Fourth, climate change influences directly the components of aggregate demand. Fifth, finance affects macroeconomic activity and the materialisation of investment plans that determine ecological efficiency. The model is calibrated using global data. Simulations are conducted to illustrate the channels through which the ecosystem, the financial system and the macroeconomy interact. Particular attention is paid to the non-neutral role of finance in the ecosystem-macroeconomy interactions.

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