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Debt, Financial Fragility and Economic Growth: A Post-Keynesian Macromodel

The paper develops a post-keynesian macromodel of capacity utilization and growth in which the supply of credit money is endogenous and firms’ debt position and thus the financial fragility of the economy à la Minsky – is explicitly modeled. Both the influence of interest rate and indebtedness on capacity utilization and the rates of profit and growth, on the one hand, and the effect of the parameters of the saving and investment functions on financial fragility, on the other hand, are carefully analyzed.

Following the post-keynesian monetary approach, the supply of credit-money at any point in time is endogenous, demand-driven at an exogenously given nominal interest rate. The underlying presumption is that at any given point in time banks are price makers and quantity takers in their markets for loans, and price takers and quantity makers in the markets where they raise funding. Saving, in turn, is generated by and concurrently with investment. The choice variable is therefore investment rather than saving, with investment being financed by credit-money generated by entrepreneurial borrowing from the banking system and not by prior saving.

More broadly, and in line with the financial instability hypothesis developed by Minsky (1975, 1982), the capital development of the economy is conceived of as being accompanied by exchanges of present money for future money. While the present money pays for resources that are used in the production of investment output, the future money is the amount of profits that will accrue to firms as their capital assets are used in production.

As a result of the process through which investment by producing units is financed, the liabilities on their balance sheet determine a series of prior payment commitments, while their assets generate a series of conjectured cash inflows. With investment being financed by credit-money generated by entrepreneurial borrowing from the banking system, the flow of money to firms is a response to expectations of future profits, while the flow of money from firms is financed by profits that are actually realized.

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Debt, Financial Fragility and Economic Growth: A Post-Keynesian Macromodel