Open Macroeconomies as
A Closed Economic System
—SD Macroeconomic Modeling Completed —
Kaoru Yamaguchi san *
Doshisha Business School
Doshisha University
Kyoto 602-8580, Japan
E-mai
: kaoyamag@mail.dosh
Abstract
This paper completes the series of macroeconomic modeling that tries
to model macroeconomic dynamics on the basis of the principle of ac-
counting system dynamics developed by the author. Money supply and
creation processes of deposits were modeled in the first paper, while the
second paper built dynamic determination processes of GDP, interest rate
and price level. In the third paper, these two separate models were inte-
grated to present a complete macroeconomic dynamic model consisting of
real and monetary sectors. The fourth paper presented a model of a dy-
namic determination of foreign exchange rate in an open macroeconomy
in which goods and services are freely traded and financial capital flows
efficiently for higher returns. This fifth and final paper in the series tries
to expand the integrated model in the third paper to the open macroe-
conomies according to the framework developed in the forth paper. It
provides a complete generic model of open macroeconomies as a closed
em, consisting of two economies, a foreign economy as an image of
domestic economy. As a demonstration of its analytical capability, a
of credit crunch is examined to show how domestic macroeconomic behav-
iors influence foreign macroeconomy through trade and financial capital
flows.
1 Open Macroeconomic System Overview
ries of ma
on the bi
This is the fifth and final paper of a
to model macroeconomic dynamic
‘oeconomic modeling that tries
s of the principle of accounting
“This paper is submitted to the 26th International Conference of the System Dynamics
Society, Athens, Greece, July 23-27, 2008. It is partly supported by the grant awarded by the
Japan Society for the Promotion of Science.
stem dynamics developed by the author in [3]. In the first paper [4], money
supply and creation processes of deposits were modeled. In the second paper
[5], dynamic determination processes of GDP, interest rate and price level were
modeled. For this analysis four sectors of macroeconomy were introduced such
as producers, consumers, banks and government. The third paper [6] integrated
real and monetary sectors that had been analyzed separately in the previous
two papers; in other words, by adding central bank, five sectors of the macroe-
conomy were fully integrated together with a labor market. The fourth paper
[7] built a model of a dynamic determination of foreign exchange rate in open
macroeconomies in which goods and services are freely traded and financial
capital flows efficiently for higher returns. For this purpose a new method was
needed contrary to a standard method of dealing with a foreign sector as ad-
junct to macroeconomy; that is, an introduction of another macroeconomy as a
foreign sector as illustrated in Figure 1.
Figure 1: Open Macroeconomic System Overview
In this paper, the integrated macroeconomy in the third paper is opened
to foreign economy through trade and financial capital flows according to the
framework developed in the fourth paper. In other words, a complete mirror
economy is created as a foreign economy except for banking sectors such as com-
mercial and central banks. Specifically, it is assumed that all foreign exchange
transactions are done through domestic banks to meet the demand for foreign
exchange services by consumers and producers. To make our model a little bit
more realistic, Japanese yen is used as a unit of domestic currency from now on,
and dollar is used as a key currency of international trade issued by a foreign
country, say, the United States.
2 The Integrated Model Revisited
Before expanding the integrated economy in the third paper to an open economy,
we have revisited the previous integrated model and found that some revisions
to it are required as stated below.
Wage Rate Adjustment
In the integrated model, a dynamic mechanism of wage rate determination was
1
labor market as follows:
not considered. Nominal wage rate is now assumed to be determined in the
dw sods
a7 EB) (1)
demand for desired labor, while L* indicates supply of labor
forces. Labor demand and net employment is in return determined by a real
wage rate such that R = w/P. Whenever labor market becomes tight and
w®, as a function
where L* denotes
uncmployment rate approaches to zero, an expected wage rate
of wage rate w and inflation rate, will increase, causing desired demand for
labor to decrease. It decreases as the unemployment rate increases, causing the
desired demand for labor to increase. These changes are reflected in Figure 18
below.
Price Adjustment by Cost-push Force
ssumed to be adjusted by the demand-pull
y between desired aggregate demand and full
In the integrated model, price is
forces generated by a discrepar
capacity output such that
dP
— = WY? — yuu). 2
i ( ‘fult) (2)
With the introduction of wage determination in equation (1), it now becomes
pos ss. Theses forces
are represented by a change in the nominal wage rate such that
ible to add cost-push forces to the price adjustment proc
dlog(w)
ef ll 3
dt (8)
The price adjustment process is now influenced by demand-pull and cost-
push forces as well such that
dP
dt
These changes are reflected in Figure 18 below.
W1(Y? — Ypun) + Vo(wy) (4)
Investment Order Placement and Delay
To reflect the fact that investment process takes time, a capital stock under
construction is newly added to the capital accumulation process. That is, new
investment is accumulated to the capital stock under construction, out of which
capital stock (property, plant & equipment) is accumulated after a completion
revision is illustrated in Figure 17.
of capital under construction. Th
Credit Loans by the Central Bank
In the integrated model, banks are assumed to make loans to producers as much
as desired. This unlimited loans by banks caused their vault cash to be negative,
and eventually could have forced them to go bankrupt unless they could raise
additional fund. This serious flaw of the model was utterly overlooked in our
previous analysis.
It turned out that banks are persistently in a state of shortage of cash as
well as producers. This point is neglected in many textbooks. In the case
of producers, they could borrow cnough fund from banks. From whom, then,
should the banks borrow in case of cash shortage? In a close
money or currency has to be created within the system. Only the central bank is
endowed with a power to create currency within the system, and make loans to
as a last resort of
the commercial bank
of the whole economic sys
printing) currency is known 2
5S by the Cena Baik at thie reques
, currency has to be incessantly
of desired borrowing byt banka! Inthe
cated and put into circulation in order to
stain an economic growth under mostly equilibrium states. Roughly speaking,
a growth rate of credit creation has to be in average equal to or slightly greater
than the economic growth rate as suggested by the right hand diagram of Figure
2.
Lending (Central Bank) Growth Rate of Credit
400 =
ss Time (Year)
Time (Yeu) Crow Rate of Cred: Equa
Cea Bek Hai Gra Rat Equine
Figure 2: Lending by the Central Bank and its Growth Rate
In this way, the central bank begins to exert an enormous power over the
economy through credit control. What happens if the central bank fails to
supply enough currency intentionally or unintentionally? An influential role
of the central bank which caused economic bubbles and the following burst
in Japan during 90’s is completely analyzed by Warner in [1]. Our revised
model might give an analytical foundation to support his new
findings in the role of the central bank.
macroeconomi:
Four Types of Interest Rates
With the introduction of credit loan by the central bank, another type of interest
rate needs to be applied to the transaction, which is called discount rate. The
central bank is given a power to § as a part of its monetary policies
whichever ‘making loané to commétcial banks, Tt is det to be 0.8%, or 0.008 in
our model.
Now the economy has four different types of interest rates; discount rate,
real rate of interest, nominal rate of interest, and prime rate. How are they
related one another? It is assumed that the initial value of the real rate of
interest (which is set to be 0.02 in our model) is increased by the amount of
discount rate such that
Initial value = initial interest rate + discount rate (5)
Nominal rate of interest and prime rate are assumed to be determined in our
previous models as
Interest rate (nominal) = real interest rate + inflation rate (6)
and
Prime rate = interest rate (nominal) + prime rate premium, (7)
where prime rate premium is set to be 0.03 in our model to attain positive profits
to the banks. Accordingly, discount rate affect all of the other three types of
interest rate, giving a legitimacy of monetary policies to the central bank.
3 Behaviors of the Revisited Model
Mostly Equilibria
An equilibrium state has been defined as a full capacity aggregate demand equi-
librium if the following three output and demand levels are met:
Full Capacity GDP = Desired Output = Aggregate Demand (8)
If the economy is not in the equilibrium state, then, actual GDP is determined
by
GDP = MIN (Full Capacity GDP, Desired Output ) (9)
In other words, if desired output is greater than full capacity GDP, then actual
GDP is constrained by the production capacity, meanwhile in the opposite case,
GDP is determined by the amount of desired output which producers wish to
produce, leaving the capacity idle.
Even though full capacity GDP is attained, full employment may not be
realized unless
Potential GDP = Full Capacity GDP (10)
Does the equilibrium state, then, exist in the sense of full capacity GDP and
full employment? By trial and error, mostly equilibrium states are acquired in
the revisited model whenever price is flexibly adjusted by setting its coeffic
to be 0.5, as illustrated in Figure 3.
GDP, Aggregate Demand and Growth Rate
1,500 YenReal/Year
0.2 1/Year
1,125 YenReal/Year |~
-3.72529e-009 1/Year
750 YenReal/Year
-0.2 1/Year
375 YenReal/Year
0.4 Year a=
0 YenReal/Year [—[ | | | | | | ———
-0.6 1/Year
0 10 20 30 40 50
Time (Year)
Potential GDP : Equilibrium a venRealVear
"GDP (real)" : Equilibrium ————— YenReal/Year
"Aggregate Demand (real)" : Equilibrium ——————— YenReal/Year
"Consumption (real)" : Equilibrium —___———— YenReal/Year
"Investment (real)" : Equilibrium Yen RealYear
Growth Rate : Equilibrium VYear
Figure 3: Mostly Equilibrium State
In what follows, these equilibrium states are used as a benchmarking state
of the comparison, and illustrated by red lines in Figures.
Fixprice Disequilibria
We are now in a position to make some analytical simulations for the revisited
model before opening it to the foreign economy. First, let us show that without
price flexibility ce is fixed;
period. Figure 4 illustrates how fixprice causes disequilibria everywhere. The
economy seems to stagger; that is, GDP stops growing and economic growth
rate becomes closer to zero.
GP (real) Growth Rate
Figure 4: Fixprice and Mostly Equilibrium States
Business Cycles by Inventory Coverage
In the third paper business cycles are shown to be triggered by inventory cov-
crage and price fluctuation. Let us first examine if similar busines
when producers decide to keep some amount of inventory. Specifically, suppose
the normal inventory coverage is now set to be 0.25 or 3 months instead of
no inventory coverage. The economy, then, begins to be troubled with a short
period of business cycle as Figure 5 portrays.
GDP (real) Growth Rate
Figure 5: Business Cycles by Inventory Coverage
Business Cycles by Price Fluctuation
cles surface when price begins to fluctuate more
ised in equation (4), let us assume
-push changes in nominal wage rate.
ot to be 0.5 from 0. Again, the
cle as depicted in Figure 6.
is rev
adjustment prov
s time price is affected by the co:
Specifically, cost-push(wage) coefficient is
economy is thrown into business
Economic Recession by Credit Crunch
With the introduction of credit loans to banks, the central bank seems to have
acquired an almighty power to control credit. This power has been overlooked
GP (real) Growth Rate
Figure 6: Business Cycles by Cost-push Price Fluctuation
as it is not well explained in standard textbooks. This
in our previous analysi
hidden exerting power has been known in Japan as “window guidanc
To demonstrate how influential the power is, let us suppose that the central
bank reduces the amount of credit loans by 30%; that is, window guidance value
is reduced to 0.7 from 1. In other words, banks can borrow only 70% of the
desired amount of borrowing from the central bank.
GP (real) Growth Rate
Figure 7: Economic Recession by Credit Crunch
ion in the
rates the economy is now deeply triggered into re
sense that the GDP under credit crunch is always below the equilibrium GDP.
It is unexpected to see that the economic recession is provoked by the credit
crunch rather than the business cycles as shown above. Economic recessi
caused by the credit crunch can be said to be worse than the re
by other business cycles.
As discussed above, growing economy needs new currencies to be incessa
put into circulation. If the central bank, instead of the government, is
cally endowed with this important role, savvy control of credits by the central
bank becomes crucial for the stability and growth of macroeconomy as demon-
strated here by our revisited model.
Figure 7 illus
4 Open Macroeconomies (Transactions)
We are now in a position to open our integrated macroeconomy to foreign trade
and direct and financial investment abroad. According to our method in the
fourth paper, this is nothing but a process of creating another macroeconomy as
an image economy of domestic macrocconomy. All variables of the foreign econ-
omy, then, are renamed with a suffix of .f; for instance, GDP.f, consumption.f,
etc.
To avoid analytical complication, we have picked up the existing currency
units of yen and dollar, among which dollar is assumed to plays a role of key
We have further assumed that a domestic economy has yen currency,
currenc
and a foreign economy has dollar currency.
Nominal foreign exchange rate FE (merely called foreign exchange rate here)
is now the amount of yen in exchange for one unit of foreign currency; that is,
dollar as assumed above, and has a unit of Yen/Dollar. At this stage of building
a generic open macroeconomies, initial foreign exchange rate is set to be one;
that is, one yen is exchanged for one dollar. Foreign exchange rate thus defined
does not absolutely reflect that of the current exchange rate in a real world
economy.
Real foreign exchange rate (RFE) is the amount of real goods worth per unit
of the equivalent foreign real goods such that
RFE
(4)
_ FE*Py
~ pet
which has a unit of YenReal/DollarReal.
ibe main transactions of the open macroeconomics
s, government, banks and the central bank.
Producers
Main transactions of producer
lustrated in Figure 19 in which stocks of gray color are newly added for open
economies.
are summarized as follows. They are also il-
© Out of the GDP revenues producers pay excise tax, deduct the amount of
depreciation, and pay wages to workers (consumers) and interests to the
banks. The remaining revenues become profits before tax.
They pay corporate tax to the government out of the profits before tax.
¢ The remaining profits after tax are paid to the owners (that is, consumers)
as dividends, including dividends abroad. However, a small portion of
profits is
allowed to be held as retained earnings.
« Produ
new investment, therefore, they have to borrow money from banks and
pay interest to the banks.
To make
are thus constantly in a state of cash flow defic
o
Producers imports goods and services according to their economic activ-
umed to be 10% of GDP in our model,
sumed to be affected by their demand
ities, the amount of which is
though actual imports are also as
curves.
as
Similarly, their exports are determined by the economic activities of a
foreign economy, the amount of which is also assumed to be 10% of foreign
GDP.
Produces are also allowed to make direct investment abroad as a portion
of their investment, 10% is assumed in our model. Investment income
from these investment abroad are paid by foreign producers as dividends
directly to consumers as owners of assets abroad. Meanwhile, producers
are required to pay foreign investment income (returns) as dividends to
foreign investors (consumers) according to their foreign financial liabilities
Foreign producers are assumed to behave in a similar fashion as a mirror
image of domestic produce
Consumers
Main transactions of consumers are summarized as follows. They are also il-
lustrated in Figure 20 in which stocks of gray color are newly added for open
economies.
Sources of consumers’ income are their labor supply, financial ass
hold such as bank deposits, shares (including direct assets abroad), and
deposits abroad. Hence, consumers receive wages and dividends from
producers, interest from banks and government, and direct and financial
investment income from abroad.
ets they
Financial assets of consumers consist of bank deposits and government
against which they receive financial income of interests from
banks and government.
securiti
In addition to the income such as wages, interests, and dividends, con-
sumers receive cash whenever previous securities are partly redeemed an-
nually by the government.
Out of these cash income as a whole, consumers pay income taxe
the remaining income becomes their disposal income.
, and
Out of their disposable income, they spend on consumption. The remain-
ing amount is cither spent to purchase government securities or saved.
Consumers are now allowed to make financial investment abroad out of
their financial assets consisting of stocks, bonds and cash. For simplicity,
al investment are assumed to be made out of de-
however, their finan
posits. Hence, returns from financial investment are uniformly evaluated
in terms of deposit returns.
10
ment income. Similar
Consumers now receive direct and financial inv
investment income are paid to foreign investors
The difference between receipt and payment of those investment income
is called income balance. When this amount is added to the GDP rev-
enues, GNP (Gross National Product) is calculated. If capital depreciation
is further deducted, the remaining amount is called NNP (Net National
Product).
by producers and banks
¢ NNP thus obtained is completely paid out to consumers, consisting of
workers and shareholders, as wages to workers and dividends to share-
holders, including foreign sharcholde
uumed to behave in a similar fashion as a mirror
image of domestic consume
¢ Foreign consumers are as
Government
Transactions of the government are illustrated in Figure 21, some of which are
summarized as follows.
e Government receives, as tax revenues, income taxes from consumers and
s from producers.
corporate taxes
s and payments
Government spending consists of government expenditure
for its partial debt redemption and inter
sts against its
to the consume:
securiti
Government expenditures are assumed to be endogenously determined
by ci or tax revenue-dependent
expenditures.
her the growth-dependent expenditur
, government has to borrow cash from
If spending exceeds tax revenue:
consumers and banks by newly is
suing government securities.
sumed to behave in a similar fashion as a mirror
image of domestic government.
Foreign government is
Banks
Main transactions of banks are summarized as follows. They are also illustrated
in Figure 22 in which stocks of gray color are newly added for open economies.
¢ Banks receive deposits from consumers and consumers abroad as foreign
i s, against which they pay interest:
They are obliged to deposit a portion of the deposits as the required
reserves with the central bank.
Out of the remaining deposits, loans are made to producers and banks
receive interests for which a prime rate is applied.
ll
If loanable fund is not enough, banks can borrow from the central bank
for which discount rate is applied.
Their retained carnings thus become interest receipts from producers less
interest payment to consumers and to the central bank. Positive carnings
will be distributed among bank workers
as consumers.
Banks buy and sell foreign exchange at the request of producers, con-
sumers and the central bank.
Their foreign exchange are held as bank reserves and evaluated in terms
of book value. In other words, foreign exchange reserves are not deposited
with foreign banks. Thus net gains realized by the changes in foreign
exchange rate become part of their retained carnings (or los
Foreign currency (dollars in our model) is assumed to play a role of key
currency or vehicle currency. Accordingly foreign banks need not set up
foreign exchange account. This is a point where a mirror image of open
macroeconomic symmetry breaks down.
Central Bank
Main transactions of the central bank are summarized as follows. They are also
illustrated in Figure 23 in which stocks of gray color are newly added for open
economic;
The central bank
ues currencies against the gold deposited by the public.
It can also issue currency by accepting government securities through open
market operation, specifically by purchasing government securities from
the public (consumers) and banks. Moreover, it can issue currency by
making credit loans to commercial banks. (These activities are sometimes
called money out of nothing.)
It can similarly withdraw currencies by selling government securities to the
public (consumers) and banks, and through debt redemption by banks.
Banks are required by law to reserve a certain amount of deposits with
the central bank. By controlling this required reserve ratio, the central
bank can control the monetary base direc!
The central bank can additional
through monetary poli
rate.
control the amount of money supply
such as open market operations and discount
Another powerful but hidden control method is through its direct influence
over the amount of credit loans to banks (known as window guidance in
Japan.)
12
The central bank is allowed to intervene foreign exchange market; that is,
it can buy and sell foreign exchange to keep a foreign exchange ratio stable
(though this intervention is actually exerted by the Ministry of Finance in
Japan, it is regarded as a part of policy by the central bank in our model).
Foreign exchange reserves held by the central bank is usually reinvested
with foreign deposits and foreign government securities, which are, how-
ever, not assumed here as inessential.
Missing Loops Fixed
In the fourth paper five loops below are pointed out as missing.
e Imports and exports are a:
tivities of GDPs, which are in turn affected by the size of trade balance.
Yet, they are missing.
sumed to be determined by the economic ac-
Foreign exchange intervention by the central bank (and the government)
such as the purchase or sale of foreign exchange surely changes the amount
of currency outstanding and money supply, which in turn must affect an
interest rate and a price level. Yet, they are being fixed.
A change in interest rat
the level of GDP. Yet, investment is not playing such a role.
s affects investment, which in turn determines
¢ A change in price level must also affect consumption spending and hence
real GDP. Yet, these loops are missing.
¢ Official intervention must influence speculations and estimations on for-
cign exchange and investment returns among international financial in-
vestors. Yet, these fluctuations are only given by outside random normal
distribution.
Our open macroeconomies have successfully augmented these missing feed-
back loops except the last loop of speculation. Figure 8 illustrates newly fixed
feedback loops.
5 Behaviors of Open Macroeconomies
Mostly Equilibria under Trade and Capital Flows
The construction of open macroeconomics is now completed. There are three
channels to open a domes onomy to a foreign economy. Trade channel is
opened by allowing producers to import a portion of its GDP for domestic pro-
duction and distribution. Capital flows have two channels. First, produc
allowed to make direct investment abroad as a portion of their domes
ment. Secondly, consumers are allowed to make deposits abroad out of their
domestic deposits as a financial portfolio investment. (For simplicity, portfolios
et
ors are
c inv
13
—Z Money Supply —
7
very 2
Interest
( ae
\ Ny ‘Net bate A)
he = a eats os
—! ee
cop - Me r ak /
GDP (Yf), ~ a
Sa Expected
; mei
aoe
=
“Random Normal__
“m Distribution
—— Investment <<—
Figure 8: Fixed Missing Loops in the Foreign Exchange Dynamics Model
, shares and set
among deposi urities are not considered here.) These capital
flows by di al investment are determined by the interest arbitrage
as analyzed in the fourth paper.
Let us now open all three channels by
cient, direct investment ratio, and finan
10%, respectively. Under the international activities of such trade and capital
flows, Figure 9 demonstrates that our open macroeconomies can attain mostly
equilibrium states
Mostly equilibrium states thus obtained, however, do not imply balanc
of trade and capital flows. In fact, a small amount of trade imbalance i
observed as illustrated in Figure 10. Moreover, alternating interes
generate small amounts of capital inflows and outflows as illustrated in Figure
11 due to the different interest rates prevailing over two economies, and random
normal distribution that is exerted on the expected foreign exchange rate.
and finan
iting the values of import coeffi-
al investment: ratio to be the
ame
Credit Crunch under Trade and Capital Flows
Our generic model of open macroeconomi
s for the economic analys ’
sited macroeconomic behaviors, two typ
m are triggered out of the mostly equilibrium
a continuation of our discussions, to examine how these domestic
on affect foreign macroeconomies through trade and
could be applied in many different
In the above section of the
s cycles and economic
ates. It would be in-
capital flows.
4
GDP, Aggregate Demand and Growth Rate
1,500 YenReal/Year
0.2 1/Year
1,125 YenReal/Year
-3.72529e-009 1/Year
750 YenReal/Year
0.2 1/Year
375 YenReal/Year
-0.4 1/Year
0 YenReal/Year
-0.6 = 1/Year
0 10
Potential
20 30
Time (Year)
Equilibrium Trade)
50
YenReal'Year
‘YenReal'Year
‘GDP (real): Equilibrium Trade)
*Agaregate Demand (real): Equlbrium( Trade)
"Consumption (eal): Equilibrium Trade)
"investment (Feal)": Equilibrium Trade)
YenRealiYear
YenRealYear
YenReal Year
Year
Growth Rate: Equilibtum(Trade)
Figure 9: Mostly Equilibria und
Trade Balance
er Trade and Capital Flows
Balance of Payments
Figure 10: Trade Balance and Balance of Payments
Interest Arbitrage
Finacial Investment
0.005
001
Figure 11: Interest Arbitrage
15
and Financial Investment
Due to a limited space of the paper, our anal s confined only to the
ion triggered by the credit crunch. For this purpose, let us now
the amount of credit loans by 40%, instead
sion
economic reces
assume that the central bank reduce:
of 30% in the above case. As already demonstrated above, an economic re
is similarly generated again in the domestic economy as illustrated in Figure 12.
(Compare this with Figure 7 above.)
GDP (real) Growth Rate
YerReaYesr
SGD (eal Codie Crunc Trade) Grow Rate: Credit Crunch Trade)
“GDP quite)” = Grew ate: Equlteianeadey
Figure 12: Credit Crunch under Trade and Capital Flow
Does this domestic recession affect the foreign economy? Figure 13 illustrates
the foreign country’s GDP and its growth rate. It clearly displays that economic
recession is being exported to the foreign economy through trade and capital
flows. This means vice versa that our domestic economy cannot be also free
from the influence of foreign economic behaviors. In this
aid to be mutually interdependent and constitute indeed a
ons
open macroe-
conomies can be s
closed economic system as a whole.
GDP (real). Growth Rate.f
Wa 0
Figure 13: Credit Crunch Affecting Foreign Macroeconomy
6 Where to Go from Here?
Robust Foundation of the Model
Our macroeconomic model building is based on the following two well-established
scientific methods;
16
Double-entry accounting system: foundation of so
Theory of differential equations: foundation of natural
ence
Accounting system has been said to be the most rigorous methodology in
social science, and widely used since the ancient days to keep orderly records
of chaotic market transactions. Differential equations have been, since Newton,
widely applied to describe dynamic movements in natural science, and have been
the most fundamental tool for dynami ystem dynami
a computer-based tool for the mumericz ysis of differential equations.
These two well-established scientific are consolidated as the method
of accounting system dynamics [3], and have been applied in our model building
of macroeconomic system. Hence, our model could be said to have been built
on the robust foundation, and in this sense may provide a gencric framework
for further analysis in macroeconomic theory. Where should we go from here
then? At least three roads seem to lie ahead of us.
ina sense
Road 1: Unified Macroeconomic Systems View
By its nature as a generic model, our model could be refined to clarify the fun-
damental causes of disputes among different schools of economic thoughts; for
instance, in the line of unification among Neoclassical, Keynesian and Marxian
ools in [2]. It is our belief that their differences are those of the assumptions
made in the model, not the framework of the model itself. If this i
among economists. Accordingly, depending on the economic is
tion the model could be fine-tuned for sharing various economic views.
Following are some of these fine-tuning directions for further analysis of the
economic issues if they are the focus of macroeconomic controver:
1. Portfolio de
securities are not yet incorporated.
sions for financial assets and wealth among cash, shares and
2. Housing investment and real estate transactions by consumers are not
treated.
3. Consumption is a function of basic consumption Co, income Y and Price
P, but interest i and wealth effect We are still not considered such that
C=C(O,Y,P,i, We) (12)
4. An interdependent relation between money supply and inflation is weak,
and only the following causal route is covered; Money(?) —> Investment(1
) —+ Desired Output(}) — Price(t).
Moreover, inflation in financial assets and real estate is not treated.
. Proportionate movement of price and wages is weak.
on
6. Comparative advantage theory of international trade is not handled.
17
Road 2: Japanese and US Macroeconomic Modeling
The series of macroeconomic modeling was originally intended to construct a
macrocconomic model for strategic applications among business exec-
and policy makers. And we still believe it’s the road we should take
next step. Specifically, we'd like to analyze the world largest and second largest
in terms of GDP simultancously; that is, Japanese macroeconomy
a domestic economy and US macroceonomy as a foreign economy along the
framework of our open macroeconomic:
For this purpose, then, actual macroeconomic data have to be incorporated
into the model. It would be very interesting to see, out of many possible behav-
iors the model can produce like chaos out of a simple deterministic equation,
which possibility is to be chosen historically by the real economy.
a
economies
Road 3: Systems of National Account
Our modeling method turns out to be along the United Nations System of
National Accounts 1993, known as ‘the SNA93’, though in a more wholistic
way. Accordingly, it could be extended closer to the complete SNA93 in a
systemic way.
7 Conclusion
This is
ns. One new addition to the
model is the entral bank, And it is newly shown
that credit crunch triggers ion in addition to the previously an-
alyzed business cycles caused by inventory coverage and price fluctuation.
ed model is, then, extended to the open macroeconomies on the
basis of the balance of payment in the fourth paper. Its main feature is that two
similar macrocconomies are needed to analyze international trade and capital
flows through direct and financial investment.
With a completion of building the open macroeconomies, many po’
are made available for the analysis of economic issues. Due to the limited spa
our analy confined only to the issue of credit crunch. Then, it is shown
that an economic recession triggered by the domestic credit crunch als
imilar recession in a foreign economy through the transactions of trade and
In this nomies are indeed demonstrated to
be a closed system in which economic behaviors are reciprocally interrelated.
The idea of modeling macroeconomic system came up while I was visiting
the Univ. of California at Berkeley as a visiting scholar for 8 months after
the presentation of the paper on the principle of accounting system dynami
at the SD conf. in New York, July, 2003. Since then almost five years have
passed for completing the series of SD macroeconomic modeling in this
paper. Though the model is still far from being complete and genetic by its
The rev
is
causes
as
pital flows mse, open macroec:
c
current,
18
nature, it’s time, I believe, to make it open to the public for further fine-tunings
and revisions by the SD peers and macroeconomists as well as those who are
interested in our approach.
MacroDynamics Model Illustrated!
Macroeconomic Dynamics M odel
< MacroDynamics 1.0 >
- Accounting System Dynamics Approach -
(c) All Rights Reserved.
Porf. K aoru Y amaguchi, Ph.D.
Doshisha B usiness School
Doshisha University
K yoto, Japan
kaoyamag@ mnil.doshisha.ac.jp
This model provides a generic system on which
various schools of economic thoughts can be built.
Your comments and suggestions are most welcome.
[is [iz
(©) Prof. Kaoru Yamaguehi
Doshisha Business Schoo!
Japan
Figure 14: Title Page of the MacroDynamics Model
1{n this illustrated section of the model, only domestic macroeconomy is presented. ‘The
model called MacroDynamics version 1.0 is now available for educational use through the
contact with the author. It runs on the Vensim Model Reader (freeware) which can be
downloaded from http://www.vensim.com
20
te
LD ee
Figure 15: Model Overview
oops ifr:
Figure 16: Population and Labor Force
22
(msS10-panseoi0g
byes
sewissory arya,
oven NL ~~ | \ 2m,
maimed
matte yy
rea | bo
con ses
3
Figure 17: GDP Determination
2
ood
an a oud PMN]
— a
Pperauagy Aou0 yy 10
AIAMISHO 189.091]
HEIOHPOD
Px (80 jy) ysnds0.
{ -
(1) 90d 4
fou
> 0 Kuso A,
Figure 18: Interest Rate, Price and Wage Rate
24
Figure 19: Transactions of Producers
25
ana a0
sto ra)
poay sey
(aan ey
(aun)
sues
seuoxo
(ans
re)
sms
(09)
my aay
ary mse
sap,
Figure 20: Transactions of Consumers
26
smupuoie 1
sme
we
Figure 21: Transactions of Government
27
Figure 22: Transactions of Banks
28
wee yam)
anu
patra
na pao)
sou
pags
Lore lange
er he ‘fan
——
aun ssyjmq
— yoieyy ual
worendg osmpng
— pyenwndo
ae
auors
™ oN
x ssmjamg
(osyamg sea) yy sudo, oma S| rayreyy usd =
Kors pyr IEdO souunaes
/ :
ug pean % one y Pound Ape
ary Ses
ougna ey ual
axogg KRPW WY \
sap HT)
Aupoyy Aunbos amy
SOUND PID —q_—__——
saepng sop Ay
amo. kl
SimpxqBiaioy—_p ayes
By
anany Stes
saimpeg W104
au Lisa
soba. wou 7
— a
-~_——?
oatpmg
aAmpacaidon 4
aya an
seo plon
1907
Spx ew 3
Figure 23: Transactions of Central Bank
29
> aimpxg iiniog <——
2g peu s90xq—
{ eying
psdemqry 4 < ap 4 ea
—_ say ary Fumppxg tow 4 210 y SHUEY
masta [ESHA ony stm up ju By)
beat wWhiaio 4 oy
pe 4 a \
Jrmony sess ; \
Fw ume y pasta | oe \
my parad waa . wep |
lz wy Say) << —— FS | Simpy ang
ray 7 PANT ’ |
2 moiy srexbog \ poate }
—
woumpy pasade mnie
I
\ sour
ape
Se
‘sj usw g—
i Sup ION ‘ = cs
RApy
Sav ~ (a) auoayy nousovy
(an erowe pre roach
saimpxg
or f = a
ont]
aun newaspy
army
fuai0os ca(a (sued
Pa sod
——— (auoduy
8104) sual
~~
Figure 24: Foreign Exchange Market
30
aun 0
Sino a
) wor’ —
Soni. |
(odi99 4 6) 19 oxukeg-) eC
Figure 25: Balance of Payment
31
Ty
anil
i’
aH wT BORA
a PRT AAEM
TREO Pe PROV NID
2
Figure 26: Simulation Panel of GDP
EH oc
32
a —— |
. TH :
‘bara Jo POUR
Sou Spe
EEHGIY SSH Dey SURYA wise ‘Ry NGI pu puBUIBG aIRDBY “ad
Figure 27: Simulation Panel of Trade and Investment Abroad
33
References
[1] Richard A. Werner. new paradigm in macroeconomics: solving the riddle
of japanese macroeconomic performance. Palgrave Macmillan, New York,
2005.
[2] Kaoru Yamaguchi. Beyond Walras, Keynes and Marx ~ Synthesis in Eco-
nomic Theory Toward a New Social Design. Peter Lang Publishing, Inc.,
New York, 1988.
[3] Kaoru Yamaguchi. Principle of accounting system dynamics — modeling
corporate financial statements — In Proceedings of the 21st International
Conference of the System Dynamics Society, New York, 2003. System Dy-
namics Society.
: Sd macroeco-
[4] Kaoru Yamaguchi. Money supply and creation of deposi
[5] Kaoru Yamaguchi. Aggregate demand equilibria and price flexibility : Sd
macroeconomic modeling (2). In Proceedings of the 23nd International Con-
ference of the System Dynamics Society, Boston, USA, 2005. The System
Dynamics Society.
[6] Kaoru Yamaguchi. Integration of real and monetary sectors with labor mar-
ket: Sd macroeconomic modeling (3). In Proceedings of the 24th Interna-
tional Conference of the System Dynamics Society, Nijmegen, The Nether-
lands, 2006. The System Dynamics Society.
[7] Kaoru Yamaguchi. Balance of payments and foreign exchange dynamics:
Sd macroeconomic modeling (4). In Proceedings of the 25th International
Conference of the System Dynamics Society, Boston, USA, 2007. The System
Dynamics Society.
34
