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Innovation and finance: a stock flow consistent analysis of great surges of development


The present work aims at contributing to the recent stream of literature which attempts to link the Neo-Schumpeterian/Evolutionary and the Post-Keynesian theory. The paper adopts the Post-Keynesian Stock Flow Consistent modeling approach to analyze the process of development triggered by the emergence of a new-innovative productive sector into the economic system. The model depicts a multi-sectorial economy composed of consumption and capital goods industries, a banking sector and two households sectors: capitalists and wage earners. Furthermore, it provides an explicit representation of the stock market. In line with the Schumpeterian tradition, our work highlights the cyclical nature of the development process and stresses the relevance of the finance-innovation nexus, analyzing the feed-back effects between the real and financial sides of the economic system. In this way we aim at setting the basis of a comprehensive and coherent framework to study the relationship between technological change, demand and finance along the structural change process triggered by technological innovation.

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  1. 1.

    This intuition has found increasing support in a number of recent empirical studies (see Mazzucato 2003; Pastor 2009, among others).

  2. 2.

    See Caverzasi and Godin (2013) for historical reviews of the emergence of SFC and Godley and Lavoie (2007) for extensive modeling examples.

  3. 3.

    See, among the others, Zezza (2008), van Treeck (2009), Le Heron et al. (2012).

  4. 4.

    Schumpeter in fact argued that ”the carrying into effect of an innovation involves, not primarily an increase in existing factors of production, but the shifting of existing factors from old to new uses” (Schumpeter 1964/1939, p.110). Production of the innovative good takes time to come into effect. Hence the first effect of the appearance of entrepreneurial demand is an increase in the demand for traditional capital goods.

  5. 5.

    We adopt the convention of using capital letters to refer to nominal variables and lowercase letters for real variables.

  6. 6.

    Following Foley (1975) and many PK-SFC authors, the level of financial assets held might not be equal to their desired level, due to discrepancies between expected income, on which consumption is based, and actual income. We thus need one asset which will absorb the difference between aggregate level and aggregate desired level. In our model, as in most PK-SFC models, cash is the buffer stock asset.

  7. 7.

    In the model, we fix only λ 10 while λ 20,λ 30,λ 40 are endogenously determined, each one being defined equal to the ratio between the potential output of the related sector and total potential output. Hence, these parameters roughly reflect the changing weight of each industry on the whole economy. Furthermore, in order to satisfy the horizontal adding-up constraints on the 4 × 4 matrix of coefficients λ 11 to λ 44, we adopt a more stringent symmetry constraint (see Godley and Lavoie 2007, p. 145).

  8. 8.

    In fact, the overall capital stock of the innovative sector includes both kinds of capital, till the stock of traditional capital bought when entering the market depreciated.

  9. 9.

    Since firms invest in both capital goods, rr l,x is defined as the nominal interest rate r l,x deflated by capital price inflation.

  10. 10.

    For an extended review of the empirical literature in this field, see Lazonick et al. (2010).

  11. 11.

    We follow Bhaduri (1972) and use a non-linear depreciation function: d(k,t) = k e (tn).

  12. 12.

    Indeed, contrary to most mainstream works in which money is exogenous and credit is conceived as a multiplier of deposits (i.e., of money already in the system), the theory of endogenous money argues that money is created ex novo by the banking sector, dependent on demand for credit coming from the economy. This new amount of monetary means must ends up in a rise of deposits so that the reversal causal link “loans make deposits” holds. See Graziani (2003)

  13. 13.

    Of course, the opposite choice could affect the results of the simulations, as the emergence of entrepreneurs could exert a different initial impact on the demand of each sector, and thus on employment, wealth and stock market prices. However, notice that in order to investigate such a case, we would only have to change our assumption concerning the initial finance of the innovative sector, while the model’s structure and behavioral equations would remain unaffected.

  14. 14.

    Notice that in Eq. 2.44, we assumed that the innovative sector initially pays a salary equal to that of the traditional capital sector. In the following period nominal wages will be updated following the rule already explained in Section 2.2.1

  15. 15.

    The innovative firms use both type of capital until the traditional capital bought in the first period of their life is fully depreciated.

  16. 16.

    This is a standard result of a pure credit money system like the one described in our model (Graziani 2003).

  17. 17.

    The product of the leverage ratio for the real interest rate charged on loans is roughly constant in this phase and thus plays a minor role.

  18. 18.

    This assumption is very reasonable since the innovative sector, when entering the market, used only bank credit to buy its initial stock of capital and to hire workers. Consequently, its leverage ratio was initially equal to one, by far the highest in the system (almost five times that of other sectors).

  19. 19.

    It is interesting to note that in these three cases, the preferences of the innovative sectors move from external equity finance to bank loans as a consequence of the gradual reduction in the interest rate charged by banks.

  20. 20.

    The interest rate increases by approximately 40 % compared to that charged at steady state, while the leverage ratio increases up to ten times between period 100 and period 153.

  21. 21.

    Capitalists consumption does not fall at once since it is a function of wealth (which remains positive) and of expected disposable income (defined as the average of disposable income over the last 4 periods). Consumption remains thus roughly constant in period 153 and shrinks only in the following periods.

  22. 22.

    Or rather, the consumption sector q converges to its original value, the innovative sector Tobin’s q converges to the original value of the traditional capital sector.

  23. 23.

    Remember that, since we adopted an exponential depreciation function over 20 periods, rather than a less realistic linear one, the portion of capital depreciating in each period is exponentially increasing with its age.

    Fig. 5

    a - Innovative sector output and b - leverage in the Baseline (solid) and BaF (dashed) scenarios


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Corresponding author

Correspondence to Alessandro Caiani.

Additional information

We want to thank Carlota Perez, Domenico Delli Gatti, Roberto Fontana, Gennaro Zezza and an anonymous referee for their valuable comments. All remaining errors are ours.

Appendix: Parameters

Appendix: Parameters

Table 1 Parameters
Table 2 Robustness check

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Caiani, A., Godin, A. & Lucarelli, S. Innovation and finance: a stock flow consistent analysis of great surges of development. J Evol Econ 24, 421–448 (2014).

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  • Schumpeter
  • Innovation
  • Stock flow consistent models
  • Monetary circuit

JEL Classifications

  • E11
  • E32
  • O31