Modelling, simulation and control of macro economic systems

The assignment in this report is motivated by the current financial crisis, which equally, or maybe even more accurately should be called a debt crisis. The research problem to be solved in this report is therefore to assess four conceptual different macroeconomic systems, including today’s Basel-type banking system, to find advantages and disadvantages in these systems compared to each other. Advantages and disadvantages are found in terms of how debt crisis dynamics are compared to economic growth dynamics around what is found to be a sound value of debt to GDP. The two first conceptual different macroeconomic systems to be assessed is the Basel-type banking regime we have today and a 100% reserve system. These two systems are then assessed one more time, but with negative interest rate on deposits and zero borrowing rate, as proposed by Silvio Gesell. The assessment is done for these systems in terms of gross domestic product (GDP), debt burden on households and firms, and bank net lending to government net spending. The models are built in Mathwork’s Simulink for simulation, and are made from differential equations for money flows and aggregation in, and in between the different economic units. This report is built step by step, starting with the theoretical smallest economic unit of a household or firm. All these basic kinds of household and firm units are then aggregated into a sector with the same essential dynamics as the units it is made of. The dynamics for this sector of households and firms can be compared with the dynamics of a generic tank with fluid inflow, outflow and aggregate of fluid. The model is then expanded to include a private bank sector subject to the Basel rule which enforces a certain maximum limit of bank capital to asset ratio in order to make the private banks robust against insolvency. A simulation of this system is then done to see how the system evolves through time without government control. The motivation for government control is thereby made because debt grows faster, and to a not durable ratio compared to money deposits for households and firms. To complete the general macroeconomic model a Central Bank (CB) with government control action is included to fix the total debt to GDP ratio to a certain level, which is found from historical levels of debt to GDP ratio in Australia and the U.S. to be about 60%. Government control action to fix the debt to GDP ratio is government net deficit spending. After the inclusion of a government with a Central Bank (CB) the rest of the complete model now consists of total debt and total bank deposits of households and firms, and a private bank sector. The private bank sector is represented with a bank net lending controller and bank assets and liabilities that is the total debt and deposits of households and firms, respectively. The results from simulations are GDP, debt service (DS) to GDP ratio and bank net lending to government net spending for the four conseptual different economic systems. These results essentially shows that in order to increase economic growth in a Basel-type system and 100% reserve system with normal positive interest rate on deposits, the DS/GDP ratio also needs to be increased thus debt crisis and liquidity trap could occur. The two systems enforced with negative interest rate as proposed by Silvio Gesell has the inversed relationship between economic growth GDP and the DS/GDP ratio compared to the systems with “normal” interest rates. This means that for Gesell interest rates, increased GDP growth leads to decreased DS/GDP ratio, thus the two Gesell systems are robust against debt crisis and not prone to the liquidity trap. Therefore the conclusion advocates for the Gesell-Basel-type regime system because it can increase economic growth measured by GDP side-by-side with a decrease in DS/GDP ratio. This is regarded as a good property compared to today’s Basel-type regime, and the 100% reserve system which needs to increase DS/GDP ratio in order to increase economic growth, according to the models in thin report. The reasons for introducing this system, or at least work on this idea more thoroughly should be interesting and taken into consideration for anyone interested in conceptually changing today’s macro economic system to avoid debt crisis, and at the same time have a high macroeconomic growth (GDP growth). Furthermore, this suggested system should also be considered because the main generic macro economic elements for a country are incorporated in our model in a reasonable way.