Towards an ecological macroeconomics
A couple of weeks ago I attended the International conference on Ecological Economics, held in Rio de Janeiro just a few days before the Rio+20 UN Summit, where a few hundreds researchers have been presenting their work together with some high-level keynote speakers (Peter Victor, Mathis Wackernagel, William Rees, the Prime Minister of Bhutan, Ignacy Sachs and others).
One of the most debated topics during sessions and informal discussions seemed to be the one nef has been intensively working on lately, that is Ecological Macroeconomics (otherwise termed Macroeconomics of sustainability). The aim of this line of research is to give sound macroeconomic foundations to ecological/environmental issues, and more in general to include sustainability (including financial sustainability) into the macro picture.
Apart from some pioneering work (such as the proposal to “green” the usual IS-LM textbook framework), macroeconomic theory has been ignoring wider environmental and social implications for many decades. A crucial change took place with the publication in 2008 of Peter Victor’s book “Managing without Growth”, in which the author, using system dynamics methodology, presents a macroeconomic model of the Canadian economy able to investigate the implications of low growth rates. The model can be downloaded here.
Victor’s work has become exceptionally popular among researchers interested in sustainability issues. This, together with other influential publications and the widespread diffusion in the general public of environmental concerns, has led to a promising stream of research committed to the development of a wider macroeconomic theory capable of including energy and the environment and analyzing their effects on the economic system. See, for example, the work by Armon Rezai at the Vienna University, and Simone D’Alessandro at the University of Pisa. Recently, a brand new academic journal has been created entitled “Societal Transitions and Environmental Innovations”, whose aim is to gather the most innovative contributions on the socio-economic transition to an environmentally sustainable economy.
At the same time, an attempt to expand and improve macro theory has also been coming from a different perspective, more focused on banking and finance. As many have argued, modern macroeconomics has proved itself spectacularly unsuited to anticipate and understand the crisis. This is no wonder, considering that the majority of models - including the macroeconometric models of the main central banks - treat money in an unrealistic textbook way and don’t even consider the existence of private banks, which, instead, are the major players in the process of creation and allocation of credit in the economy, as nef’s recent “Where does money come from?” brilliantly explains.
In this field, Steve Keen’s modeling work is one of the most innovative pieces of research. Using system dynamics methodology, Keen was able to qualitatively replicate the “Great Moderation” (the 20 years period of low inflation and low unemployment) and the subsequent “Great Recession”. A crucial role in his analysis is played by the process of accumulation of private debt and the power of banks to independently create new money supply. His model can be downloaded here.
This new wave of macro research has gained much space during the last couple of years, as proven by the fact that both Peter Victor (together with Tim Jackson) and Steve Keen have been awarded conspicuous grants by Soros’ Institute of New Economic Thinking (INET). Here at nef, we have been working along similar lines, in an ambitious project devoted to identifying and studying the macro mechanisms linking the “real” economy to environmental variables (energy and climate change), on one side, and to the financial and banking system on the other.
At the Ecological Economics conference in Rio de Janeiro we presented a first version of the model, very much focused on banks and the mechanisms of money creation. Although we have some work already done on other topics, we felt that the first necessary step was to get the banking part right, both because it’s one of the most relevant variables affecting real economic dynamics and because nef has been extensively working on the topic lately and the modeling research could draw on a vast stock of internal knowledge. Energy and climate change will be the focus of the second stage of research.
We are thus now at the point of having a simple but powerful framework centred on banking, debt, money creation, private investment financing. We paid great attention to the model stock-flow consistency using a double-entry book keeping representation and creating consistency checks. We also worked on building a user-friendly interface that researchers can use to change the model default assumptions and values. You can flip through the presentation below or download it with animations at this link. This will be followed by a working paper on the model in a few weeks time.
Still much work has to be done, but we are confident that the model could be used, with the appropriate modifications, to study a wide variety of economic issues, ranging from the analysis of the macroeconomic effects of Quantitative Easing policies to the study of how to finance the transition to a low-carbon economy. Therefore, stay tuned!