Solution Properties of Stock-Flow ConsistentDSGE Models
B.G. Romanchuk
∗
January 28, 2014
Abstract
This paper presents the solution to a stock-flow consistent DynamicStochastic General Equilibrium (DSGE) model. The model has been sim-plified by removing fiscal policy, although a central bank is still present.Stock-Flow consistency in enforced by examining dividends paid by thebusiness sector to the representative household. The solution to the sys-tem of equations is trivial in real terms, as the output is always at thenotional full employment level. Variables involving monetary variablesare somewhat arbitrary, as the household sector has the ability to pur-chase goods from either wage or dividend income. This implies that pricestickiness cannot affect the real variables, nor does the time preference pa-rameter enter into the solution.
This version of the paper is a draftand the literature survey component is largely missing.
1 Introduction
This paper currently consists mainly of a mathematical proof, with some com-mentary. The literature survey is incomplete. The author welcomes comments,which may be made at
.This paper presents the solution to a optimisation problem that is similar tothat presented in Chapter 2 of the text [1]. However, some changes have beenmade to the notation, and modifications have been made to take into accountthe effect of dividends for the business sector.The model mainly focusses the behaviour of two sectors of a closed economy,the Household Sector and a Business Sector, but the Central Bank is present aswell. The available financial assets have been simplified to just consist of money,upon which interest is paid (or charged, in the case of negative balances) by thecentral bank. Fiscal policy has been removed for simplicity.There have been other papers that have noted problems with the stock-flowconsistency of mainstream models. For example, the paper [2] examines the
∗
Publisher of
bondeconomics.com. The author would liketo thank Professor Marc Lavoie for suggested references.
1
problems associated with the assumption that profits are disbursed. Since themodel discussed here has the financial instrument of the equity of firms payingdividends, the problems noted in that paper are avoided.This paper does not included stochastic factors for ease of notation. The de-terministic analysis herein could be interpreted as the central solution (solutionbased on expectations) of a fuller stochastic framework.
2 Notation
We are interested in finding the solutions of a path-planning problem for asystem of equations over time. Without loss of generality, denote the initialtime from which point we are doing the path planning from as
t
= 0.We assume that there is a single composite good produced in the economy,which is what is produced and consumed.We define the following time series (components of the state
x
(
t
)) as,
Y
(
t
) production (units of the single good),
C
(
t
) consumption by the Household Sector (units of the single good),
M
h
(
t
) money held by the Household Sector,
M
b
(
t
) money held by the Business Sector,
M
c
(
t
) money held by the Central Bank,
r
(
t
) interest rate on money balances (set by the Central Bank),
N
(
t
) number of hours spent working by the Household Sector,
W
(
t
) wages paid per hour worked,
P
(
t
) price per unit of the single good,
D
(
t
) dividends paid by the Business Sector to the Household Sector.The following identities characterise the monetary stocks and flows.Money is assumed to be a liability of the Central Bank:
M
c
=
−
(
M
b
+
M
h
)
.
(1)The Household Budget Constraint is:
M
h
(
t
) = (1 +
r
(
t
−
1))
M
h
(
t
−
1) +
W
(
t
)
N
(
t
) +
D
(
t
)
−
C
(
t
)
P
(
t
)
,
∀
t >
0
.
(2)The Business Budget Constraint is:
M
b
(
t
) = (1 +
r
(
t
−
1))
M
b
(
t
−
1)
−
W
(
t
)
N
(
t
)
−
D
(
t
) +
C
(
t
)
P
(
t
)
,
∀
t >
0
.
(3)The above imply that
M
c
(
t
) =
r
(
t
)
M
c
(
t
−
1),
∀
t >
0.The nominal interest rate is assumed to be positive, i.e.,
r
(
t
)
>
0
.
(4)Other DSGE models, such as those in [1], have the equivalent to a govern-ment treasury bill and non-interest bearing money instead of the interest-bearing2
cash used here. If money does not appear in the utility function, the optimal so-lution is to hold treasury bills instead of money in those other models. This endsup being equivalent to the framework herein, with just a change of conventionfor interest rates.This framework implicitly allows for borrowing by the Household and Busi-ness Sectors by allowing them to have negative cash balances. One could imag-ine that there is a ”Financial Sector” which is consolidated with the rest of theBusiness Sector as a means of allowing negative cash balances to occur.Other constraints, such as the “No Ponzi” condition [1, equation 3, p. 16]may be added, but are not binding. However, see the discussion within Section5 regarding to the “No Ponzi” condition.Turning now to the dynamics of the real economy, we add the followingconstraints.We assume that the goods market clears,
Y
(
t
) =
C
(
t
)
,
(5)in other words, there are no inventories of goods that accumulate from periodto period.Production of goods is determined by the following production function:
Y
(
t
) =
ξ
(
t,N
(
t
)) =
A
(
t
)
N
1
−
α
(
t
)
,
(6)where
α
∈
(0
,
1). One property that is useful to note is that
ξ
(
t,
0) = 0
.
(7)
Remark 1
The form of the production function may be relaxed, although it can-not be a completely general function since a solution to the optimisation problem may not exist. For example,
ξ
(
t,N
(
t
)) =
e
N
(
t
)
could lead to an ”optimal” choice of
N
(
t
)
being arbitrarily large
Finally, although we unrealistically do not put an upper bound on
N
(
t
) (thenumber of hours worked), we have a physical constraint that
N
(
t
)
≥
0
.
(8)
3 Optimisation Definition
Denote as
x
(
t
) the ensemble of all state variables to be determined. This includesall the variables listed in the previous section, except for Productivity (
A
(
t
))which is determined outside the model. The time variable
t
is an element of
Z
+
(i.e., this is a discrete time model).Let the set
F
be the set of all
feasible
state trajectory solutions
x
such that
x
is valid (i.e., all constraints in equations (1)-(8) are satisfied)
The point-in-time utility function
U
(
C
(
t
)
,N
(
t
)) is a function that has thefollowing properties.3