Wednesday, December 25, 2013

Speaking of models...

Via Bill C at Twenty-Cent Paradigms:
The Reserve Bank of New Zealand has a neat animation of Bill Phillips' famous hydraulic computer, which illustrates the stocks and flows of national income with tubes, tanks and gurgling noises.

Go there.

Scroll down and click   TURN IT ON >

Give it a moment. An image of The Moniac will appear.

Click   TURN IT ON !

You can hover over parts of the machine and descriptions will pop up.

Find options buttons in the upper-right corner.

Merry Christmas.


jim said...

Hi Art,

That flow simulation is pretty neat.

But it shows some obvious flaws in the logic. Suppose the spigot to consumption was closed down. Then more would flow into savings and from there to investment. The problem is nobody will invest without the expectation of consumption. That means since the tank representing "investment fund" is large enough to hold the entire quantity of fluid in the system then that tank would fill up (inflow always larger than outflow) and all other flows would gradually drop to zero. That's called supply side economics.

Also there is no representation of flow from credit expansion which obviously would increase the expenditure flow as well as the total volume of fluid. I guess the model assumes only savings can be lent which is not the way the real world works.

Also I like the false claim that high interests get people to save. The data shows interests are high when saving is low and visa versa.

Merry Christmas,

The Arthurian said...

Merry Christmas, Jim.

Interesting analysis. I noticed the fixed-volume-of-water problem, but not the others.

"The data shows interests are high when saving is low and visa versa."

Are you saying that *low* interest rates encourage saving and high rates don't? There must be other factors involved...

jim said...

The implication of the blurb under consumption is that interest rates is what determines the division of flow of disposable income between saving and consumption. However, the fact is, that periods when people are saving the most (like now and the 1930's) are periods of lowest interest rates, so obviously interest rates is not what determines the choices made by individuals between consumption spending and saving.

If we look at this model in terms of a credit based money economy where all transactions are intermediated by the financial sector then the holding tanks represent the points were these transactions occur:

The only 2 places in the model where the in-flow and out-flow are not equal by the strictest definition of the accounting are the investment fund and foreign balances. Credit is what makes up the difference between savings and investment. Credit is why you can have high investing with low saving and low investing when there is high saving rate.

However, the other reservoirs are also transaction points where the financial sector can use credit to modify the outflow from the inflow even though the accounting identity model doesn't allow for that . For instance, You can use your visa card and choose to pay for your consumption a week before you get paid (or not). It would be interesting to see a model that showed all of that. The conventional economic modeling treats credit as if it does not exist even though that has probably become the most important element in modeling how money flows in the economy.

The Arthurian said...

Superb, Jim.

As usual, your remarks drove me to take a look at the numbers. A comparison of interest rates to the Personal Saving Rate indicates that they trend in the same direction except during disturbances like now and the 1930's.

But I agree: It's not interest rates that determine the rate of saving. I think there are other factors involved. I think it's an oversimplification to attribute it all to interest rates.

On the graph, though they have similar trends, it looks to me like the saving rate peaked before interest rates -- with the 1974 recession, rather than in 1981. I'd put more weight on median income or consumer well-being, rather than interest rates, as the driver of the saving rate.

Consumer well-being would also account for the "now and in the 1930s" exceptions.

But this is all kind of off the top of my head.

jim said...

Hi Art,

In your graph I'm not seeing any clear relation of interest rates to saving rate. Sometimes they move together and sometimes they move in opposite directions.

I also question the validity of the data on personal saving. I suspect that if a person in a given month puts $100 in savings and in the same month borrows by credit card $100 to
buy things that counts as saving $100 even though it clearly is saving nothing. As a result total spending and saving don't add up to disposable income if credit is expanding or contracting. That means that when credit is expanding actual spending is greater than disposable income minus saving and when credit contracts spending is less than disposable income minus saving.

Here is a graph that suggests the above analysis is correct.

The red is disposable income minus what is saved as a ratio to retail sales. The blue is debt service. The combination of both lines suggests that about 5%-6% of non saved income is being spent on something other than interest and retail. But I don't believe. There was just more of retail sales and interest being paid for by credit expansion before 2008.

In terms of the effect on the economy, when people pay back debt that is the same as saving and when they go deeper in debt that is dis-saving.

Before 2007