An Institutional Approach to Post-Keynesian Financial Instability Model

Abstract

The purpose of this paper is to explain how a bank-based system affects macro-economic stability. A bank-based system is a financial system in which corporate finance largely depends on a bank loan. Roughly speaking, Japan and continental European nations (for example, Germany and France) adopt this financial system. In post-Keynesian economics the performance of macro-economy with a bank-based system has been analyzed by assuming endogenous money supply hypothesis. Most of these analyses depend on these assumptions: 1) Loaned money is proportional to a firm's cash flow, and 2) Apart from a fixed loan interest rate no other restrictions are imposed on the bank loan. However, in a real bank-based system, as Schaberg [1999] says, a bank loan is in inverse proportion to cash flow and the bank loan, being adjusted to the loan interest rate, is decided by assessing the firm's management situation (in this pa per we suppose that the firm's management situation is assessed by the firm's output-capital ratio and debt-capital ratio). Taking into account the relevance of those specified features of a bank-based system, we reconstruct a post-Keynesian financial instability model useful to explain the stability condition of macro-economy. Some of our results are as follows. First, the fact that a bank loan is in inverse proportion to a firm's cash flow has both positive and negative effects. A positive effect is that a bank loan of that type can control real-side instability caused by long-term employment (note that long-term employment is easy to lead to so-called profit squeeze). A negative effect is that the bank loan may cause financial instability of macro-economy through three processes mentioned in the text. Second, in order to stabilize macro-economy, loan supply should not be sensitive to changes in the firm's output-capital ratio and debt-capital ratio. For example, if loan supply is restrained in face of the increase in debt-capital ratio of the firms, macro-economy will fall into a vicious spiral. Third, when applied to a real economy, our results seem to suggest that the regal control of the loan interest rate in Japan has contributed to its stable growth until 1980's.