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«Abstract: This paper develops an ecological stock-flow-fund (ESFF) modelling framework that provides an integrated platform for the analysis of the ...»

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An ecological stock-flow-fund modelling

framework

Yannis Dafermos, University of the West of England

Giorgos Galanis, New Economics Foundation

Maria Nikolaidi, University of Greenwich

Abstract: This paper develops an ecological stock-flow-fund (ESFF) modelling

framework that provides an integrated platform for the analysis of the interactions

between the ecosystem, the financial system and the macroeconomy. The ESFF

framework has three distinct features. First, it formulates explicitly the monetary stocks and flows and the physical stocks and flows taking into account the accounting principles and the laws of thermodynamics. Second, it pays particular attention to the distinction between stock-flow resources and fund-service resources and formulates the interaction of funds with monetary and physical stocks and flows. Third, it allows an explicit analysis of the various stock-flow-fund channels through which the stability of the ecosystem, the financial system and the macroeconomy are interconnected. The paper illustrates how the ESFF framework can form the basis for the combined examination of ecological, financial and macroeconomic issues. In so doing, the suggested framework contributes to the development of an ecological macroeconomics in which finance plays a nonneutral role and physical and monetary variables are examined in an interconnected and consistent way.

Key words: Ecosystem, macroeconomy, finance, accounting principles, laws of thermodynamics, ecological stock-flow-fund modelling.

JEL codes: E1, E12, E44, Q57 Preliminary draft: May 2015 Address for correspondence: Yannis Dafermos, University of the West of England, Coldharbour Lane, Bristol, BS16 1QY, UK, e-mail: Yannis.Dafermos@uwe.ac.uk Acknowledgements: We are grateful to Sebastian Berger, Peter Bradley, Jo Michell, Andrew Mearman, Ewa Karwowski, Engelbert Stockhammer and Rafael Wildauer for valuable comments. An earlier version of this paper was presented at the 19th SCEME Seminar in Economic Methodology, Bristol, May 2014 and the 18th Conference of the Research Network Macroeconomics and Macroeconomic Policies, Berlin, October-November 2014. We wish to thank the participants for helpful comments. This research is part of a project conducted by the New Economics Foundation. The financial support from the Network for Social Change is gratefully acknowledged. The usual disclaimers apply.

An ecological stock-flow-fund modelling framework

1. Introduction Ecological macroeconomics is a new interdisciplinary field that examines the macroeconomy as part of the ecosystem, taking explicitly into account the biophysical limits of a finite planet (Harris, 2009; Jackson, 2011; Rezai et al., 2013; Jackson et al., 2014). It largely draws onthe synthesis of ecological and post-Keynesian macroeconomics which has been identified as a fruitful avenue for the combined examination of economic and ecological issues (e.g. Holt and Spash, 2009; Mearman, 2009; Kronenberg, 2010; Spash and Ryan, 2012; Fontana and Sawyer, 2013, 2015).

The rationale for this synthesis can be briefly described as follows: Ecological economics provides a solid framework for the analysis of the economy-ecosystem interactions which is based on the conceptualisation of the economy as an open subsystem of the closed ecosystem as well as on the detailed analysis of the implications of the First and the Second Law of Thermodynamics. Post-Keynesian economics provides a quite rich explanation of the dynamics of modern capitalist economies by putting at the centre of its analysis the importance of aggregate demand, the non-neutral role of money and finance, the impact of fundamental uncertainty on economic decisions and the links between income distribution and economic activity. Ecological economics lacks the solid macroeconomic framework of post-Keynesian economics. Post-Keynesian economics almost totally ignores the ecological constraints of macroeconomic activity. Therefore, by synthesising these two fields, ecological macroeconomics can analyse in an integrated way the interactions between the ecosystem and the macroeconomy and can suggest new policies that are likely to attain a combination of macroeconomic stability and ecological sustainability.

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 large-scale models with Keynesian features that take into account the energy sector and various environmental issues. Jackson (2011), Fontana and Sawyer (2013), Rezai et al.

(2013) and Taylor and Foley (2014) have put forward certain frameworks that combine ecological with Keynesian (or post-Keynesian) insights. Godin (2012), Jackson et al. (2014), Berg et al. (2015), Naqvi (2015) and Fontana and Sawyer (2015) have examined environmental problems within stock-flow consistent or monetary circuit models that include a financial sector.

However, in the literature there is still a lack of an integrated framework that combines physical stocks, flows and funds and monetary stocks and flows in a consistent way. The development of such a consistent framework is important for the joint analysis of ecological issues (such as the depletion of ecosystem services and the degradation of natural resources), financial issues (such as financial fragility and the financing of green investment) and macroeconomic issues (such as growth and unemployment). This paper puts forward an ecological stock-flow consistent (ESFF) modelling framework that provides such an integrated analytical platform. Our modelling framework has three distinct features. First, it formulates explicitly the monetary stocks and flows and the physical stocks and flows taking into account the accounting principles and the laws of thermodynamics; the formulation of monetary stocks and flows draws on the stock-flow consistent literature (Godley and Lavoie, 2007); the formulation of physical stocks and flows draws on the tradition of Georgescu-Roegen (1971) and the literature on physical input-output tables (see e.g. Giljum and Hubacek, 2009). Second, the ESFF framework pays particular attention to the distinction between stock-flow resources and fund-service resources and formulates the interaction of funds with monetary and physical stocks and flows. The importance of funds in the examination of environmental issues has been pinpointed by Georgescu-Roegen (1971). Third, our framework allows an explicit analysis of the various stockflow-fund channels through which the ecosystem, the financial system and the macroeconomy are interconnected.





The purpose of this paper is to describe the main features of this framework by presenting a benchmark ESFF model and by discussing the environmental, financial and macroeconomic issues that can be analysed by using this framework. The paper is organised as follows. Section 2 describes the main features of the ESFF modelling framework. Section 3 presents the matrices and the equations of a benchmark ESFF model. Section 4 outlines the main stock-flow-fund interactions between the ecosystem, the macroeconomy and the financial system. Section 5 concludes.

2. Main features of the ESFF modelling framework

Over the last decade or so, stock-flow consistent (SFC) modelling has become a very popular technique in post-Keynesian macroeconomics. Following the contributions of Godley (1999), Lavoie and Godley (2001-2) and Godley and Lavoie (2007), various post-Keynesian macroeconomists have used SFC models to analyse a plethora of macroeconomic issues.1 SFC models rely on the use of balance sheet and transactions matrices which allow the explicit consideration of the dynamic interactions between flows (e.g. interest, profits, wages) and stocks (e.g. loans, deposits, equities). The integration of accounting into dynamic macro modelling permits the detailed exploration of the links between the real and the financial spheres of the macroeconomy and illuminates the non-neutral role of money and finance.

However, a prominent drawback of the SFC models is the absence of any analysis of the transformation of matter and energy that takes place due to the economic processes. In SFC models it is assumed that the energy and matter that are necessary for production and consumption are available without limit and the degradation of ecosystem services has no feedback effects on the macroeconomy. Therefore, provided that there are no capital or labour constraints, the output of the economy is demand-determined and, hence, if an adequate policy mix is implemented, economic growth is theoretically feasible for an infinite period of time.

This feature comes in stark contrast with the fundamental propositions of ecological economists according to which that the macroeconomy is an open subsystem of the closed ecosystem2 and economic activity unavoidably respects the laws of thermodynamics.3 Ecological economists point out that, in line with the First Law of Thermodynamics, the macroeconomy continuously uses energy and matter inflows from the ecosystem and continuously produces waste which is an outflow to the ecosystem. Moreover, it is argued that by converting low-entropy materials and energy (e.g. fossil fuels and minerals) into high-entropy materials and energy (e.g. material waste and thermal energy), macroeconomic activities tend to increase the entropy in the See, for example, Le Heron and Mouakil (2008), Zezza (2008), van Treeck (2009), Dafermos (2012) and Nikolaidi (2014). See also Caverzasi and Godin (2014) for a recent review of the post-Keynesian stock-flow consistent modelling literature.

2 In thermodynamics, an open system is a system that exchanges both energy and matter with its surrounding environment. A closed system exchanges only energy, not matter. An isolated system exchanges neither energy nor matter.

3 For a presentation of the laws of thermodynamics and their implications for economics see e.g. Amir (1994), Baumgärtner (2002) and Daly and Farley (2011).

ecosystem. This stems from the Second Law of Thermodynamics and suggests that current economic activity reduces the ability of the macroeconomy to reproduce itself in the future.

Physical input-output accounting provides an adequate platform for the consideration of these ecological limits. Drawing on the flow-fund model of Georgescu-Roegen (1971, ch. 9; 1979; 1984) and the traditional Leontief monetary input-output tables, physical input-output accounting is a framework that records in a consistent way the physical flows associated with macroeconomic activities.4 In this framework the formulation of physical flows (uses of natural resources, emissions to nature etc.) relies explicitly on the First and the Second Law of Thermodynamics.

Moreover, the energy-matter relationships between the various processes is depicted using input-output techniques that allow the researcher to analyse the use of resources and the amount of waste that correspond both to final and intermediate output. Importantly, in physical input-output tables all flows are measured in physical units (e.g. tonnes or tonnes of oil equivalent), avoiding thereby the problems that arise when market prices are assigned to natural resources.

The ESFF framework put forward in this paper is a synthesis of the post-Keynesian SFC models and the physical input-output framework. This synthesis allows us to combine the aforementioned advantages of these two approaches and to formulate the financial system and the macroeconomy as part of the ecosystem. Although the ESFF framework incorporates without modifications the transactions and the balance sheet matrices of the SFC framework, two important extensions are made in the physical input-output formulation.

First, based on the flow-fund model of Georgescu-Roegen a distinction is made between the stock-flow resources and the fund-service resources (see also Mayumi, 2001 and Daly and Farley, 2011). The stock-flow resources (energy and matter) are materially transformed into what they produce (including by-products), can theoretically be used at any rate desired and can be stockpiled for future use. The fund-service resources (labour, capital and Ricardian land) are not embodied in the output produced can be used only at specific rates and cannot be stockpiled for future use. The distinction between these two types of resources is significant basically for two reasons. First, it points out that production needs both fund-service and stock-flow resources, and there is no possibility to replace the one with the other. In conventional presentations of the production function this is not the case as capital, labour and natural For a detailed analysis of the features of physical input-output tables see Strassert (2002), Hoekstra and van den Bergh (2006) and Giljum and Hubacek (2009).

resources are described as ‘factors of production’ without a clarification of their different role; it is also argued that perfect substitutability is possible. Second, the distinction between stock-flow and fund-service resources is crucial for our understanding of biophysical limits: it emphasises that while people cannot use the services of fund resources at the rate that they wish, they can do so with the stock-flow resources. This implies that the stock-flow resources can be exhausted in a short period of time if people decide to increase substantially the associated flow rate.

Second, while the physical input-output framework focuses only on the physical flows, the ESFF analysis developed in this paper analyses also the dynamics of physical stocks that are considered to be the most important for economic activities. This is crucial because without the consideration of physical stocks it is not possible to explore issues of ecological sustainability. As explained below, this becomes possible by constructing a physical stock matrix.

Overall, the ESFF modelling framework relies on four matrices: 1) the physical input-outputfund matrix; 2) the physical stock matrix; 3) the transactions flow matrix; 4) the balance sheet matrix. The first matrix is an extension of the physical input-output tables. The second matrix represents selected stocks of matter and energy. The third and the fourth matrix describe the changes in the stocks and flows of the macroeconomic and financial systems, following the traditional formulations in the SFC literature.

3. Matrices and equations



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