A Minimalist's Monetary Economy – Excel Edition (and one way in which capitalism will not end)

I've tried to recreate an embryonic monetary economy in an Excel, inspired by Steve Keen's basic model of endogenous-money economy.

The guy does it with all the bells and whistles, differential equations and system dynamics modelling, so if you're after that sorts of stuff, go and read his paper.

But I thought the whole thing may be simplified in an Excel spreadsheet without lost of the essential. Heck, isn't Excel an economist's best friend these days?

This is a minimalistic approach, even sort of a suprematism of economic modelling, but it nonetheless hints at answers to few questions which seem to puzzle so many people, such as: 
  1. If the firms have to repay loans with interests, where is that extra money supposed to come from on aggregate? 
  2. How are profits possible, if the loans have to be repaid with interests and there is only that much money in the economy? Are further loans the only possible source of money to repay the interests on the existing loans? 
  3. Is a steady state possible? Or the only way to keep the show running is to keep expanding the amount of outstanding loans (the debt) ad libitum? 
So, the model. It is a highly simplified representation of a closed economy: there's only one bank borrowing money (yes, out of thin air), a capitalist who owns a firm producing MacGuffins, and a bunch of workers.

The story goes like this:
  1. at start, the firm borrows the money from the bank, to start the production of MacGuffins; 
  2. each month the firm pays a wage to workers, a profit to the capitalist and an interest on loan to the bank; 
  3. each month the workers, the capitalist and the banker consume MacGuffins, buying it from the firm. 
There are just a handful of parameters in the model:
  • the value of the initial loan 
  • the monthly interest rate on the loan 
  • the monthly aggregate wages paid to workers 
  • the monthly profit paid to the capitalist 
  • workers', capitalist's and banker's consumption rates (the fraction of savings they spend on consumption) 
  • the rate of loan repayment (how much of the loan's principal is repaid each month). 
So this is how our workers, capitalist and banker are faring after 36 months (the values of parameters in yellow):


(Here's the Excel file if you want to play with it yourself.)

So, what does it show?

First off, as you can see, with those parameters a steady state is reached circa after 24 months. The firm's cash flow has never gone negative, even if there is a positive flow of profits, wages and interest payments. 

So, you can after all have a constant flow of monetary profits and wages, while still paying interests on loan to the bank. Indeed, in the steady state, the yearly sum of profits ($120) and wages ($240) is higher than the loan's principal ($100). This is not a surprise if you understand the difference between a stock and a flow. This example neatly illustrates the difference: the loan is a stock (the total amount of money present in the economy), while profits, wages and interest payments are flows the capitalist, the banker and the workers juggle back and forth among themselves month by month.

Of course, profits and wages are just monetary aggregates, and what's important here are their relative values which tell us the thing that really matters: how MacGuffins are distributed between workers and the capitalist. In our case for every 30.42 MacGuffins produced, ten are consumed by the capitalist, twenty by the workers and 0.42 by the banker.

Now, things break apart if the firm starts to repay the principal (you can test this by putting any positive value as a rate of loan repayment). All is good as long as the firm just pays the interests, but as so soon as you set a rate of principal repayment, you are basically withdrawing money from circulation and the system comes to a halt. (I know, I know, all kind of feedbacks and stabilisers kick in in the real economy, but still there is some basic story to it.)

That being said, the sustainability and the possibility of a sustainable steady state of positive profits and wages depend on how the consumption rates, wages and profits are set relative to each other.

Higher consumption rates (and hence less saving), especially from the workers who make the bulk of it, bring in more cash to the firm, and thus higher profits can be paid to the capitalists. A neat explanation of the commandment "thou shalt consume".

Actually that's slightly misleading, the cash brought in to the firm can be used both for higher profits or for higher wages (or for higher interest rate for bankers!). The relation between profits and wages depends, of course, on the class struggle between the capitalists and the working class the marginal productivity of labour and capital (if you live on a planet with competitive markets).

Now, is this too simple a model to tell us something useful about a real monetary economy? I'd say no it isn't.

Imagine what would happen is we had a more realistic situation with more than just one firm each producing a different good (and more than just one bank). Here the firms would compete for workers' money because now the workers could go out and buy all sorts of different MacGuffins from others than their employers. Firms would also compete to get better workers, and workers would compete among themselves to get better jobs. Firms would also compete for loans, trying to convince bankers that their MacGuffin is really special. Some firms would survive, some die. There would also be competition among bankers, as now the flow of interests from a loan (and eventually its repayment) is no longer guaranteed because, as we just said, some firms could go belly up.

 So, the situation would be more intricate, but in the aggregate, you'd still get the general picture we had before: there would be some aggregate outstanding sum of loans (some firms might actually repay their loans, but then others would borrow) which would be our money in circulation, and as long as it's there the system can function, businesses can be ran, workers can produce and earn wages, capitalists can get their profits and banks collect their interests. So the general story is the same: there is no need in principle to increase the money supply in the system by further loans just to repay the existing ones.

Mind you, I'm not saying that in general there are no reasons ever to increase the money supply, there are many good ones (say, when a new entrepreneur convinces a banker she will produce a unique kind of MacGuffin everybody will go crazy for, and they both, the enterpreneur and the banker, believe they can profit from it). All I'm saying is that no extra loans (and thus money) is necessary in the system specifically for the purpose of paying interests on the existing ones.

Just a small final diversion: some may ask: how can the banker create money out of thin air? Well, a way could be that some guys with the monopoly of the legitimate use of physical force allow her to. Another, historically antecedent way, is to have people trust in her service of keeping in the vault some kind of tokens that happen to be a symbolic, mutually shared illusion as a storage of value.

So, is capitalism doomed? Of course it is, but it won't happen because we need to create loans indefinitely just to repay the old ones and still be able to have profits. People who say that may just happen to have another bug in their Excel spreadsheets.

   

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