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Causes of Financial Instability: Don’t Forget Finance


  • Dirk J. Bezemer


Given the economy's complex behavior and sudden transitions as evidenced in the 2007–08 crisis, agent-based models are widely considered a promising alternative to current macroeconomic practice dominated by DSGE models. Their failure is commonly interpreted as a failure to incorporate heterogeneous interacting agents. This paper explains that complex behavior and sudden transitions also arise from the economy's financial structure as reflected in its balance sheets, not just from heterogeneous interacting agents. It introduces "flow-of-funds" and "accounting" models, which were preeminent in successful anticipations of the recent crisis. In illustration, a simple balance-sheet model of the economy is developed to demonstrate that nonlinear behavior and sudden transition may arise from the economy’s balance-sheet structure, even without any microfoundations. The paper concludes by discussing one recent example of combining flow-of-funds and agent-based models. This appears a promising avenue for future research.

Suggested Citation

  • Dirk J. Bezemer, 2011. "Causes of Financial Instability: Don’t Forget Finance," Economics Working Paper Archive wp_665, Levy Economics Institute.
  • Handle: RePEc:lev:wrkpap:wp_665

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    References listed on IDEAS

    1. Till van Treeck, 2009. "A synthetic, stock--flow consistent macroeconomic model of 'financialisation'," Cambridge Journal of Economics, Oxford University Press, vol. 33(3), pages 467-493, May.
    2. Claudio H. Dos Santos & Gennaro Zezza, 2008. "A Simplified, 'Benchmark', Stock-Flow Consistent Post-Keynesian Growth Model," Metroeconomica, Wiley Blackwell, vol. 59(3), pages 441-478, July.
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    Cited by:

    1. Eugenio Caverzasi & Antoine Godin, 2013. "Stock-flow Consistent Modeling through the Ages," Economics Working Paper Archive wp_745, Levy Economics Institute.
    2. Jo Michell, 2014. "A Steindlian account of the distribution of corporate profits and leverage: A stock-flow consistent macroeconomic model with agent-based microfoundations," Working Papers PKWP1412, Post Keynesian Economics Study Group (PKSG).
    3. Tanya ARAUJO & Sofia TERLICA & Samuel ELEUTERIO & Francisco LOUCA, 2014. "Does evidence challenge the DSGE model," International Journal of Entrepreneurial Knowledge, VSP Ostrava, a. s., vol. 2(2), pages 15-24, December.

    More about this item


    Credit Crisis; Finance; Complex Systems; DSGE; Agent-based Models; Stock-flow Consistent Models;

    JEL classification:

    • B52 - Schools of Economic Thought and Methodology - - Current Heterodox Approaches - - - Historical; Institutional; Evolutionary
    • C63 - Mathematical and Quantitative Methods - - Mathematical Methods; Programming Models; Mathematical and Simulation Modeling - - - Computational Techniques
    • E32 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Business Fluctuations; Cycles
    • E37 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Forecasting and Simulation: Models and Applications
    • E44 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Financial Markets and the Macroeconomy

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