Credit, Capital Flows and Monetary Policy: A Post-Keynesian Analysis

The credit channel literature implicitly relies on the fact that capital spending requires and depends on financing and that credit is the main form of financing. The mainstream model tries to avoid this implication by recourse to artificial concepts and variables such as the “external finance” premium. We, by contrast, explicitly model capital expenditures as a function of the credit volume along with other relevant variables. This formulation has roots in the Post-Keynesian logico-temporal ordering of production and the realization of income. The inclusion of credit in expenditure functions result in a simple income determination model making the roles of credit and monetary policy transparent. A financial block is added to the model to determine the interest rates and credit aggregates. Principles of consistent macro modelling on Post-Keynesian principles are carefully delineated. In particular, the principle of Keynesian dichotomy and necessity of an appropriate lead-lag structure in simultaneous equation models compatible with the logico-temporal ordering of production is stressed. A comparative static/dynamic example based on the model demonstrates the ability of the model in generating a reasonable account of possible outcomes in response to changes to underlying conditions.