D B S －０８－０１

Open Macroeconomies as
A Closed Economic System– SD Macroeconomic Modeling Completed –Kaoru Yamaguchi *Doshisha Business School
Doshisha University
Kyoto 602-8580, Japan
E-mail: kaoyamag@mail.doshisha.ac.jp

Abstract
This paper completes the series of macroeconomic modeling that tries
to model macroeconomic dynamics on the basis of the principle of accounting system dynamics developed by the author. Money supply andcreation processes of deposits were modeled in the first paper, while thesecond paper built dynamic determination processes of GDP, interest rate
and price level. In the third paper, these two separate models were integrated to present a complete macroeconomic dynamic model consisting ofreal and monetary sectors. The fourth paper presented a model of a dynamic determination of foreign exchange rate in an open macroeconomy
in which goods and services are freely traded and financial capital flows
efficiently for higher returns. This fifth and final paper in the series tries
to expand the integrated model in the third paper to the open macroeconomies according to the framework developed in the forth paper. It
provides a complete generic model of open macroeconomies as a closed
system, consisting of two economies, a foreign economy as an image ofdomestic economy. As a demonstration of its analytical capability, a caseof credit crunch is examined to show how domestic macroeconomic behaveeiors influence foreign macroeconomy through trade and financial capital
flows.

1

Open Macroeconomic System Overview

This is the fifth and final paper of a series of macroeconomic modeling that tries
to model macroeconomic dynamics on the basis of the principle of accounting* This paper is submitted to the 26th International Conference of the System Dynamics
Society, Athens, Greece, July 23-27, 2008. It is partly supported by the grant awarded by theJapan Society for the Promotion of Science.

1

DBS Discussion Paper Series supported by the OMRON Foundation.DBS

system dynamics developed by the author in [3]. In the first paper [4], money
supply and creation processes of deposits were modeled. In the second paper[5], dynamic determination processes of GDP, interest rate and price level weremodeled. For this analysis four sectors of macroeconomy were introduced suchas producers, consumers, banks and government. The third paper [6] integrated
real and monetary sectors that had been analyzed separately in the previous
two papers; in other words, by adding central bank, five sectors of the macroeconomy were fully integrated together with a labor market. The fourth paper[7] built a model of a dynamic determination of foreign exchange rate in open
macroeconomies in which goods and services are freely traded and financial
capital flows efficiently for higher returns. For this purpose a new method wasneeded contrary to a standard method of dealing with a foreign sector as adjunct to macroeconomy; that is, an introduction of another macroeconomy as aforeign sector as illustrated in Figure 1.
For ei gn Sec t or as an I mage of Domes t i c Mac r oec onomy

Cent r al BankFor ei gn Cent r al BankFor ei gn
Money
Suppl yMoney Suppl y

Expor tCommer ci al Banks

For ei gn Commer ci al Banks
For ei gn
Savi ng

Loan

Savi ng

For ei gn
Loan

I mpor t
Wages & Di vi dens
( I ncome)Cons umpt i on

Cons umer( Hous ehol d)

Gr os sDomes t i c
Pr oduct s( GDP)For ei gn Wages &Di vi dens ( I ncome)Pr oductn io

For ei gn
Cons umpt i on

For ei gn
Cons umer( Hous ehol d)

Pr oducer( Fi r m)

Di r ect andFi nanci al
I nves t ment

Publ i c
Ser vi ces

I ncome Tax

Nat i onal
Weal t h( Capi t al
Accumul at i on)

For ei gn
I nves t ment
( Hous i ng)

I nves t ment
( PP&E)For ei gn
I nves t ment

I nves t ment
( Publ i c
Faci l i t i es )Gover nment

For ei gn
Pr oduct i on

For ei gn
Pr oducer( Fi r m)

For ei gn Labor& Capi t al

Labor & Capi t al

I nves t ment
( Hous i ng)

For ei gn
Gr os sDomes t i c
Pr oduct s( GDP)

Publ i c
Ser vi ces

For ei gn Publ i c
Ser vi ces
For ei gn I nves t ment
( Publ i c Faci l i t i es )For ei gn
I ncome Tax

Cor por at e Tax

For ei gn
Nat i onal
Weal t h( Capi t al
Accumul at i on)

For ei gn Gover nment

For ei gn
I nves t ment
( PP&E)For ei gn Publ i c
Ser vi ces

For ei gn
Cor por at e Tax

Figure 1: Open Macroeconomic System Overview
In this paper, the integrated macroeconomy in the third paper is opened
to foreign economy through trade and financial capital flows according to theframework developed in the fourth paper. In other words, a complete mirror
economy is created as a foreign economy except for banking sectors such as commercial and central banks. Specifically, it is assumed that all foreign exchangetransactions are done through domestic banks to meet the demand for foreignexchange services by consumers and producers. To make our model a little bit
more realistic, Japanese yen is used as a unit of domestic currency from now on,
and dollar is used as a key currency of international trade issued by a foreigncountry, say, the United States.

2

2

The Integrated Model Revisited

Before expanding the integrated economy in the third paper to an open economy,
we have revisited the previous integrated model and found that some revisions
to it are required as stated below.

Wage Rate Adjustment
In the integrated model, a dynamic mechanism of wage rate determination was
not considered. Nominal wage rate is now assumed to be determined in thelabor market as follows:dw= φ(L∗ − Ls )(1)
dt
where L∗ denotes demand for desired labor, while Ls indicates supply of labor
forces. Labor demand and net employment is in return determined by a real
wage rate such that R = w/P . Whenever labor market becomes tight andunemployment rate approaches to zero, an expected wage rate we , as a functionof wage rate w and inflation rate, will increase, causing desired demand forlabor to decrease. It decreases as the unemployment rate increases, causing thedesired demand for labor to increase. These changes are reflected in Figure 18
below.

Price Adjustment by Cost-push ForceIn the integrated model, price is assumed to be adjusted by the demand-pullforces generated by a discrepancy between desired aggregate demand and full
capacity output such thatdP
= Ψ(Y D − Yf ull ).
dt(2)With the introduction of wage determination in equation (1), it now becomes
possible to add cost-push forces to the price adjustment process. Theses forces
are represented by a change in the nominal wage rate such thatdlog(w)(3)dt
The price adjustment process is now influenced by demand-pull and costpush forces as well such thatwg =dP
= Ψ1 (Y D − Yf ull ) + Ψ2 (wg )dtThese changes are reflected in Figure 18 below.

3(4)Investment Order Placement and Delay
To reflect the fact that investment process takes time, a capital stock underconstruction is newly added to the capital accumulation process. That is, newinvestment is accumulated to the capital stock under construction, out of which
capital stock (property, plant & equipment) is accumulated after a completionof capital under construction. This revision is illustrated in Figure 17.

Credit Loans by the Central Bank
In the integrated model, banks are assumed to make loans to producers as muchas desired. This unlimited loans by banks caused their vault cash to be negative,and eventually could have forced them to go bankrupt unless they could raise
additional fund. This serious flaw of the model was utterly overlooked in ourprevious analysis.
It turned out that banks are persistently in a state of shortage of cash aswell as producers. This point is neglected in many textbooks. In the caseof producers, they could borrow enough fund from banks. From whom, then,should the banks borrow in case of cash shortage? In a closed economic system,
money or currency has to be created within the system. Only the central bank isendowed with a power to create currency within the system, and make loans tothe commercial banks as a last resort of currency provider to avoid bankruptciesof the whole economic system. This process of lending money by creating (orprinting) currency is known as money out of nothing.
Figure 2 indicates unconditional amount of annual loans and its growthrate by the central bank at the request of desired borrowing by banks. In otherwords, currency has to be incessantly created and put into circulation in order tosustain an economic growth under mostly equilibrium states. Roughly speaking,a growth rate of credit creation has to be in average equal to or slightly greaterthan the economic growth rate as suggested by the right hand diagram of Figure
2.
Growth Rate of Credit
0.2

300

0.1
Dmnl

Yen/YearLending (Central Bank)
400

200

0

-0.1
100
-0.2
0

0
0

5

10

15

20
25
30
Time (Year)

35

40

45

50

5

10

15

20
25
30
Time (Year)

35

40

45

50

Growth Rate of Credit : Equilibrium
Growth Rate : Equilibrium"Lending (Central Bank)" : Equilibrium

Figure 2: Lending by the Central Bank and its Growth Rate
In this way, the central bank begins to exert an enormous power over the
economy through credit control. What happens if the central bank fails to4

supply enough currency intentionally or unintentionally? An influential roleof the central bank which caused economic bubbles and the following burst
in Japan during 90’s is completely analyzed by Warner in [1]. Our revised
macroeconomic model might give an analytical foundation to support his new
findings in the role of the central bank.

Four Types of Interest Rates
With the introduction of credit loan by the central bank, another type of interest
rate needs to be applied to the transaction, which is called discount rate. The
central bank is given a power to set its rate as a part of its monetary policies
whenever making loans to commercial banks. It is set to be 0.8%, or 0.008 in
our model.
Now the economy has four different types of interest rates; discount rate,
real rate of interest, nominal rate of interest, and prime rate. How are they
related one another? It is assumed that the initial value of the real rate ofinterest (which is set to be 0.02 in our model) is increased by the amount of
discount rate such that
Initial value = initial interest rate + discount rate

(5)

Nominal rate of interest and prime rate are assumed to be determined in ourprevious models as
Interest rate (nominal) = real interest rate + inflation rate

(6)

Prime rate = interest rate (nominal) + prime rate premium,

(7)

and
where prime rate premium is set to be 0.03 in our model to attain positive profits
to the banks. Accordingly, discount rate affect all of the other three types ofinterest rate, giving a legitimacy of monetary policies to the central bank.

3

Behaviors of the Revisited Model

Mostly Equilibria
An equilibrium state has been defined as a full capacity aggregate demand equilibrium if the following three output and demand levels are met:
Full Capacity GDP = Desired Output = Aggregate Demand(8)

If the economy is not in the equilibrium state, then, actual GDP is determinedby
GDP = MIN (Full Capacity GDP, Desired Output )(9)
In other words, if desired output is greater than full capacity GDP, then actual
GDP is constrained by the production capacity, meanwhile in the opposite case,5GDP is determined by the amount of desired output which producers wish to
produce, leaving the capacity idle.
Even though full capacity GDP is attained, full employment may not berealized unless
Potential GDP = Full Capacity GDP(10)
Does the equilibrium state, then, exist in the sense of full capacity GDP andfull employment? By trial and error, mostly equilibrium states are acquired in
the revisited model whenever price is flexibly adjusted by setting its coefficient
to be 0.5, as illustrated in Figure 3.

GDP, Aggregate Demand and Growth Rate
1,500
0.2

YenReal/Year
1/Year

1,125-3.72529e-009

YenReal/Year
1/Year

750 YenReal/Year-0.2 1/Year
375 YenReal/Year-0.4 1/Year
0 YenReal/Year-0.6 1/Year
0

10

20
30
Time (Year)

Potential GDP : Equilibrium"GDP (real)" : Equilibrium"Aggregate Demand (real)" : Equilibrium"Consumption (real)" : Equilibrium"Investment (real)" : Equilibrium
Growth Rate : Equilibrium

40

50

YenReal/Year
YenReal/Year
YenReal/Year
YenReal/Year
YenReal/Year
1/YearFigure 3: Mostly Equilibrium States
In what follows, these equilibrium states are used as a benchmarking stateof the comparison, and illustrated by red lines in Figures.

Fixprice Disequilibria
We are now in a position to make some analytical simulations for the revisitedmodel before opening it to the foreign economy. First, let us show that without
price flexibility it’s hard to attain mostly equilibrium states. When price is fixed;that is, price coefficient is set to be zero, disequilibria begin to appear all over theperiod. Figure 4 illustrates how fixprice causes disequilibria everywhere. The
economy seems to stagger; that is, GDP stops growing and economic growthrate becomes closer to zero.

6

Growth Rate
0.04

600

0.0295
1/Year

YenReal/YearGDP (real)
800

400

200

0.019

0.00850-0.002
0

5

10

15

20
25
30
Time (Year)

35

40

45

50

0

"GDP (real)" : Fixprice"GDP (real)" : Equilibrium

5

10

15

20
25
30
Time (Year)

35

40

45

50

Growth Rate : Fixprice
Growth Rate : Equilibrium

Figure 4: Fixprice and Mostly Equilibrium States

Business Cycles by Inventory Coverage
In the third paper business cycles are shown to be triggered by inventory coverage and price fluctuation. Let us first examine if similar business cycles arise
when producers decide to keep some amount of inventory. Specifically, suppose
the normal inventory coverage is now set to be 0.25 or 3 months instead of
no inventory coverage. The economy, then, begins to be troubled with a shortperiod of business cycle as Figure 5 portrays.
Growth Rate
0.1

600

0.05
1/Year

YenReal/YearGDP (real)
800

400

200

0

-0.05

0

-0.1
0

5

10

15

20
25
30
Time (Year)

35

40

45

50

"GDP (real)" : Inventory"GDP (real)" : Equilibrium

0

5

10

15

20
25
30
Time (Year)

35

40

45

50

Growth Rate : Inventory
Growth Rate : Equilibrium

Figure 5: Business Cycles by Inventory Coverage

Business Cycles by Price Fluctuation
Next let us see if business cycles surface when price begins to fluctuate more
fiercely. Since price adjustment process is revised in equation (4), let us assume
that this time price is affected by the cost-push changes in nominal wage rate.
Specifically, cost-push(wage) coefficient is set to be 0.5 from 0. Again, theeconomy is thrown into business cycle as depicted in Figure 6.

Economic Recession by Credit CrunchWith the introduction of credit loans to banks, the central bank seems to haveacquired an almighty power to control credit. This power has been overlooked7

Growth Rate
0.4

600

0.2
1/Year

YenReal/YearGDP (real)
800

400

200

0

-0.2

0

-0.4
0

5

10

15

20
25
30
Time (Year)

35

40

45

50

0

"GDP (real)" : Cost-push"GDP (real)" : Equilibrium

5

10

15

20
25
30
Time (Year)

35

40

45

50

Growth Rate : Cost-push
Growth Rate : Equilibrium

Figure 6: Business Cycles by Cost-push Price Fluctuationin our previous analysis, as it is not well explained in standard textbooks. Thishidden exerting power has been known in Japan as “window guidance”.
To demonstrate how influential the power is, let us suppose that the central
bank reduces the amount of credit loans by 30%; that is, window guidance value
is reduced to 0.7 from 1. In other words, banks can borrow only 70% of thedesired amount of borrowing from the central bank.
Growth Rate
0.08

600

0.04
1/Year

YenReal/YearGDP (real)
800

400

200

0

-0.04

0

-0.08
0

5

10

15

20
25
30
Time (Year)

35

40

45

50

"GDP (real)" : Credit Crunch"GDP (real)" : Equilibrium

0

5

10

15

20
25
30
Time (Year)

35

40

45

50

Growth Rate : Credit Crunch
Growth Rate : Equilibrium

Figure 7: Economic Recession by Credit Crunch
Figure 7 illustrates the economy is now deeply triggered into recession in thesense that the GDP under credit crunch is always below the equilibrium GDP.
It is unexpected to see that the economic recession is provoked by the credit
crunch rather than the business cycles as shown above. Economic recessions
caused by the credit crunch can be said to be worse than the recessions causedby other business cycles.
As discussed above, growing economy needs new currencies to be incessantly
put into circulation. If the central bank, instead of the government, is historically endowed with this important role, savvy control of credits by the central
bank becomes crucial for the stability and growth of macroeconomy as demonstrated here by our revisited model.

84Open Macroeconomies (Transactions)

We are now in a position to open our integrated macroeconomy to foreign tradeand direct and financial investment abroad. According to our method in the
fourth paper, this is nothing but a process of creating another macroeconomy as
an image economy of domestic macroeconomy. All variables of the foreign economy, then, are renamed with a suffix of .f; for instance, GDP.f, consumption.f,etc.
To avoid analytical complication, we have picked up the existing currency
units of yen and dollar, among which dollar is assumed to plays a role of key
currency. We have further assumed that a domestic economy has yen currency,
and a foreign economy has dollar currency.
Nominal foreign exchange rate FE (merely called foreign exchange rate here)
is now the amount of yen in exchange for one unit of foreign currency; that is,dollar as assumed above, and has a unit of Yen/Dollar. At this stage of building
a generic open macroeconomies, initial foreign exchange rate is set to be one;that is, one yen is exchanged for one dollar. Foreign exchange rate thus defineddoes not absolutely reflect that of the current exchange rate in a real world
economy.
Real foreign exchange rate (RFE) is the amount of real goods worth per unitof the equivalent foreign real goods such that
RF E =F E ∗ PfP

(11)

which has a unit of YenReal/DollarReal.
Let us now describe main transactions of the open macroeconomies by producers, consumers, government, banks and the central bank.

Producers
Main transactions of producers are summarized as follows. They are also illustrated in Figure 19 in which stocks of gray color are newly added for open
economies.
• Out of the GDP revenues producers pay excise tax, deduct the amount ofdepreciation, and pay wages to workers (consumers) and interests to thebanks. The remaining revenues become profits before tax.
• They pay corporate tax to the government out of the profits before tax.
• The remaining profits after tax are paid to the owners (that is, consumers)
as dividends, including dividends abroad. However, a small portion of
profits is allowed to be held as retained earnings.
• Producers are thus constantly in a state of cash flow deficits. To makenew investment, therefore, they have to borrow money from banks andpay interest to the banks.
9• Producers imports goods and services according to their economic activities, the amount of which is assumed to be 10% of GDP in our model,
though actual imports are also assumed to be affected by their demand
curves.
• Similarly, their exports are determined by the economic activities of aforeign economy, the amount of which is also assumed to be 10% of foreign
GDP.
• Produces are also allowed to make direct investment abroad as a portionof their investment, 10% is assumed in our model. Investment income
from these investment abroad are paid by foreign producers as dividends
directly to consumers as owners of assets abroad. Meanwhile, producers
are required to pay foreign investment income (returns) as dividends toforeign investors (consumers) according to their foreign financial liabilities.
• Foreign producers are assumed to behave in a similar fashion as a mirror
image of domestic producers

Consumers
Main transactions of consumers are summarized as follows. They are also illustrated in Figure 20 in which stocks of gray color are newly added for open
economies.
• Sources of consumers’ income are their labor supply, financial assets theyhold such as bank deposits, shares (including direct assets abroad), anddeposits abroad. Hence, consumers receive wages and dividends fromproducers, interest from banks and government, and direct and financial
investment income from abroad.
• Financial assets of consumers consist of bank deposits and government
securities, against which they receive financial income of interests frombanks and government.
• In addition to the income such as wages, interests, and dividends, consumers receive cash whenever previous securities are partly redeemed annually by the government.
• Out of these cash income as a whole, consumers pay income taxes, andthe remaining income becomes their disposal income.
• Out of their disposable income, they spend on consumption. The remaining amount is either spent to purchase government securities or saved.
• Consumers are now allowed to make financial investment abroad out of
their financial assets consisting of stocks, bonds and cash. For simplicity,
however, their financial investment are assumed to be made out of deposits. Hence, returns from financial investment are uniformly evaluatedin terms of deposit returns.
10• Consumers now receive direct and financial investment income. Similar
investment income are paid to foreign investors by producers and banks.
The difference between receipt and payment of those investment income
is called income balance. When this amount is added to the GDP revenues, GNP (Gross National Product) is calculated. If capital depreciation
is further deducted, the remaining amount is called NNP (Net National
Product).
• NNP thus obtained is completely paid out to consumers, consisting ofworkers and shareholders, as wages to workers and dividends to shareholders, including foreign shareholders.
• Foreign consumers are assumed to behave in a similar fashion as a mirror
image of domestic consumers.

Government
Transactions of the government are illustrated in Figure 21, some of which aresummarized as follows.
• Government receives, as tax revenues, income taxes from consumers andcorporate taxes from producers.
• Government spending consists of government expenditures and payments
to the consumers for its partial debt redemption and interests against its
securities.
• Government expenditures are assumed to be endogenously determinedby either the growth-dependent expenditures or tax revenue-dependent
expenditures.
• If spending exceeds tax revenues, government has to borrow cash fromconsumers and banks by newly issuing government securities.
• Foreign government is assumed to behave in a similar fashion as a mirror
image of domestic government.

Banks
Main transactions of banks are summarized as follows. They are also illustrated
in Figure 22 in which stocks of gray color are newly added for open economies.
• Banks receive deposits from consumers and consumers abroad as foreign
investors, against which they pay interests.
• They are obliged to deposit a portion of the deposits as the required
reserves with the central bank.
• Out of the remaining deposits, loans are made to producers and banksreceive interests for which a prime rate is applied.
11• If loanable fund is not enough, banks can borrow from the central bankfor which discount rate is applied.
• Their retained earnings thus become interest receipts from producers lessinterest payment to consumers and to the central bank. Positive earnings
will be distributed among bank workers as consumers.
• Banks buy and sell foreign exchange at the request of producers, consumers and the central bank.
• Their foreign exchange are held as bank reserves and evaluated in termsof book value. In other words, foreign exchange reserves are not deposited
with foreign banks. Thus net gains realized by the changes in foreignexchange rate become part of their retained earnings (or losses).
• Foreign currency (dollars in our model) is assumed to play a role of key
currency or vehicle currency. Accordingly foreign banks need not set up
foreign exchange account. This is a point where a mirror image of open
macroeconomic symmetry breaks down.

Central Bank
Main transactions of the central bank are summarized as follows. They are also
illustrated in Figure 23 in which stocks of gray color are newly added for open
economies.
• The central bank issues currencies against the gold deposited by the public.
• It can also issue currency by accepting government securities through open
market operation, specifically by purchasing government securities fromthe public (consumers) and banks. Moreover, it can issue currency bymaking credit loans to commercial banks. (These activities are sometimes
called money out of nothing.)• It can similarly withdraw currencies by selling government securities to the
public (consumers) and banks, and through debt redemption by banks.
• Banks are required by law to reserve a certain amount of deposits withthe central bank. By controlling this required reserve ratio, the central
bank can control the monetary base directly.
• The central bank can additionally control the amount of money supply
through monetary policies such as open market operations and discountrate.
• Another powerful but hidden control method is through its direct influence
over the amount of credit loans to banks (known as window guidance inJapan.)

12• The central bank is allowed to intervene foreign exchange market; that is,
it can buy and sell foreign exchange to keep a foreign exchange ratio stable(though this intervention is actually exerted by the Ministry of Finance inJapan, it is regarded as a part of policy by the central bank in our model).
• Foreign exchange reserves held by the central bank is usually reinvested
with foreign deposits and foreign government securities, which are, however, not assumed here as inessential.

Missing Loops Fixed
In the fourth paper five loops below are pointed out as missing.
• Imports and exports are assumed to be determined by the economic activities of GDPs, which are in turn affected by the size of trade balance.
Yet, they are missing.
• Foreign exchange intervention by the central bank (and the government)such as the purchase or sale of foreign exchange surely changes the amountof currency outstanding and money supply, which in turn must affect aninterest rate and a price level. Yet, they are being fixed.
• A change in interest rates affects investment, which in turn determines
the level of GDP. Yet, investment is not playing such a role.
• A change in price level must also affect consumption spending and hence
real GDP. Yet, these loops are missing.
• Official intervention must influence speculations and estimations on foreign exchange and investment returns among international financial investors. Yet, these fluctuations are only given by outside random normal
distribution.
Our open macroeconomies have successfully augmented these missing feedback loops except the last loop of speculation. Figure 8 illustrates newly fixed
feedback loops.

5

Behaviors of Open Macroeconomies

Mostly Equilibria under Trade and Capital FlowsThe construction of open macroeconomies is now completed. There are threechannels to open a domestic economy to a foreign economy. Trade channel isopened by allowing producers to import a portion of its GDP for domestic production and distribution. Capital flows have two channels. First, producers areallowed to make direct investment abroad as a portion of their domestic investment. Secondly, consumers are allowed to make deposits abroad out of theirdomestic deposits as a financial portfolio investment. (For simplicity, portfolios
13

Money Supply

Net Exchange
Reserves

Official
Invervention

Price (Pf)Interest
Rate (if)Price (P)

Trade
Balance

Foreign
Exchange
Rate

Net
Capital
Flow

Interest
Rate (i)GDP (Y)GDP (Yf)
Expected
Foreign
Exchange
Rate<Official
Invervention>
Random Normal
Distribution

Investment

Figure 8: Fixed Missing Loops in the Foreign Exchange Dynamics Modelamong deposits, shares and securities are not considered here.) These capital
flows by direct and financial investment are determined by the interest arbitrage
as analyzed in the fourth paper.
Let us now open all three channels by setting the values of import coefficient, direct investment ratio, and financial investment ratio to be the same
10%, respectively. Under the international activities of such trade and capital
flows, Figure 9 demonstrates that our open macroeconomies can attain mostly
equilibrium states.
Mostly equilibrium states thus obtained, however, do not imply balancesof trade and capital flows. In fact, a small amount of trade imbalance is stillobserved as illustrated in Figure 10. Moreover, alternating interest arbitrages
generate small amounts of capital inflows and outflows as illustrated in Figure
11 due to the different interest rates prevailing over two economies, and random
normal distribution that is exerted on the expected foreign exchange rate.

Credit Crunch under Trade and Capital FlowsOur generic model of open macroeconomies could be applied in many different
ways for the economic analyses of specific issues. In the above section of therevisited macroeconomic behaviors, two types of business cycles and economic
recession are triggered out of the mostly equilibrium states. It would be interesting, as a continuation of our discussions, to examine how these domestic
business cycles and recession affect foreign macroeconomies through trade andcapital flows.
14

GDP, Aggregate Demand and Growth Rate
1,500
0.2

YenReal/Year
1/Year

1,125-3.72529e-009

YenReal/Year
1/Year

750 YenReal/Year-0.2 1/Year
375 YenReal/Year-0.4 1/Year
0-0.6

YenReal/Year
1/Year0

10

20
30Time (Year)

40

Potential GDP : Equilibrium(Trade)"GDP (real)" : Equilibrium(Trade)"Aggregate Demand (real)" : Equilibrium(Trade)"Consumption (real)" : Equilibrium(Trade)"Investment (real)" : Equilibrium(Trade)
Growth Rate : Equilibrium(Trade)

50
YenReal/Year
YenReal/Year
YenReal/Year
YenReal/Year
YenReal/Year
1/YearFigure 9: Mostly Equilibria under Trade and Capital Flows
Balance of Payments
4

2

2
Yen/Year

Yen/Year

Trade Balance
4

0

0

-2

-2

-4

-4
0

5

10

15

20
25
30
Time (Year)

35

40

45

0

50

5

10

15

20
25
30
Time (Year)

35

40

45

50

35

40

45

50

Current Account : Equilibrium(Trade)"Capital & Financial Account" : Equilibrium(Trade)
Changes in Reserve Assets : Equilibrium(Trade)
Balance of Payments : Equilibrium(Trade)

Trade Balance : Equilibrium(Trade)"Trade Balance.f" : Equilibrium(Trade)

Figure 10: Trade Balance and Balance of Payments
Finacial Investment
4

0.005

2
Yen/Year

1/YearInterest Arbitrage
0.01

0-0.005

0

-2

-0.01

-4
0

5

10

15

20
25
30
Time (Year)

35

40

45

50

Interest Arbitrage Adjusted : Equilibrium(Trade)"Interest Arbitrage Adjusted.f" : Equilibrium(Trade)

0

5

10

15

20
25
30
Time (Year)

Financial Investment Abroad : Equilibrium(Trade)
Foreign Financial Investment Abroad : Equilibrium(Trade)

Figure 11: Interest Arbitrage and Financial Investment15

Due to a limited space of the paper, our analysis is confined only to theeconomic recession triggered by the credit crunch. For this purpose, let us now
assume that the central bank reduces the amount of credit loans by 40%, insteadof 30% in the above case. As already demonstrated above, an economic recession
is similarly generated again in the domestic economy as illustrated in Figure 12.
(Compare this with Figure 7 above.)
Growth Rate
0.2

600

0.1
1/Year

YenReal/YearGDP (real)
800

400

200

0

-0.1

0

-0.2
0

5

10

15

20
25
30
Time (Year)"GDP (real)" : Credit Crunch(Trade)"GDP (real)" : Equilibrium(Trade)

35

40

45

50

0

5

10

15

20
25
30
Time (Year)

35

40

45

50

Growth Rate : Credit Crunch(Trade)
Growth Rate : Equilibrium(Trade)

Figure 12: Credit Crunch under Trade and Capital Flow
Does this domestic recession affect the foreign economy? Figure 13 illustrates
the foreign country’s GDP and its growth rate. It clearly displays that economic
recession is being exported to the foreign economy through trade and capital
flows. This means vice versa that our domestic economy cannot be also freefrom the influence of foreign economic behaviors. In this sense, open macroeconomies can be said to be mutually interdependent and constitute indeed aclosed economic system as a whole.
Growth Rate.f
0.08

600

0.05
1/Year

DollarReal/YearGDP (real).f
800

400

200

0.02

-0.01

0

-0.04
0

5

10

15

20
25
30
Time (Year)

35

40

45

50

"GDP (real).f" : Credit Crunch(Trade)"GDP (real).f" : Equilibrium(Trade)

0

5

10

15

20
25
30
Time (Year)

35

40

45

50

"Growth Rate.f" : Credit Crunch(Trade)"Growth Rate.f" : Equilibrium(Trade)

Figure 13: Credit Crunch Affecting Foreign Macroeconomy

6

Where to Go from Here?

Robust Foundation of the Model
Our macroeconomic model building is based on the following two well-establishedscientific methods;
16• Double-entry accounting system: foundation of social science• Theory of differential equations: foundation of natural science
Accounting system has been said to be the most rigorous methodology insocial science, and widely used since the ancient days to keep orderly recordsof chaotic market transactions. Differential equations have been, since Newton,
widely applied to describe dynamic movements in natural science, and have been
the most fundamental tool for dynamical analysis. System dynamics is in a sense
a computer-based tool for the numerical analysis of differential equations.
These two well-established scientific methods are consolidated as the methodof accounting system dynamics [3], and have been applied in our model buildingof macroeconomic system. Hence, our model could be said to have been built
on the robust foundation, and in this sense may provide a generic frameworkfor further analysis in macroeconomic theory. Where should we go from here
then? At least three roads seem to lie ahead of us.
Road 1: Unified Macroeconomic Systems View
By its nature as a generic model, our model could be refined to clarify the fundamental causes of disputes among different schools of economic thoughts; forinstance, in the line of unification among Neoclassical, Keynesian and Marxian
schools in [2]. It is our belief that their differences are those of the assumptions
made in the model, not the framework of the model itself. If this is right, themodel could provide a common framework for further theoretical discussions
among economists. Accordingly, depending on the economic issues for clarification the model could be fine-tuned for sharing various economic views.
Following are some of these fine-tuning directions for further analysis of theeconomic issues if they are the focus of macroeconomic controversies.
1. Portfolio decisions for financial assets and wealth among cash, shares andsecurities are not yet incorporated.
2. Housing investment and real estate transactions by consumers are nottreated.
3. Consumption is a function of basic consumption C0 , income Y and Price
P , but interest i and wealth effect We are still not considered such thatC = C(C0 , Y, P, i, We )(12)

4. An interdependent relation between money supply and inflation is weak,
and only the following causal route is covered; Money(↑) −→ Investment(↑) −→ Desired Output(↑) −→ Price(↑).
Moreover, inflation in financial assets and real estate is not treated.
5. Proportionate movement of price and wages is weak.
6. Comparative advantage theory of international trade is not handled.
17

Road 2: Japanese and US Macroeconomic Modeling
The series of macroeconomic modeling was originally intended to construct aJapanese macroeconomic model for strategic applications among business executives and policy makers. And we still believe it’s the road we should take as anext step. Specifically, we’d like to analyze the world largest and second largest
economies in terms of GDP simultaneously; that is, Japanese macroeconomy
as a domestic economy and US macroceonomy as a foreign economy along theframework of our open macroeconomies.
For this purpose, then, actual macroeconomic data have to be incorporated
into the model. It would be very interesting to see, out of many possible behaviors the model can produce like chaos out of a simple deterministic equation,
which possibility is to be chosen historically by the real economy.
Road 3: Systems of National AccountOur modeling method turns out to be along the United Nations System of
National Accounts 1993, known as ‘the SNA93’, though in a more wholistic
way. Accordingly, it could be extended closer to the complete SNA93 in asystemic way.

7

Conclusion

This is the fifth and final paper that completes the series of building macroeconomic system. The integrated macroeconomic model developed in the third
paper is firstly revisited to make several revisions. One new addition to themodel is the credit creation process of the central bank. And it is newly shownthat credit crunch triggers economic recession in addition to the previously analyzed business cycles caused by inventory coverage and price fluctuation.
The revisited model is, then, extended to the open macroeconomies on thebasis of the balance of payment in the fourth paper. Its main feature is that two
similar macroeconomies are needed to analyze international trade and capital
flows through direct and financial investment.
With a completion of building the open macroeconomies, many possibilities
are made available for the analysis of economic issues. Due to the limited space,
our analysis is confined only to the issue of credit crunch. Then, it is shownthat an economic recession triggered by the domestic credit crunch also causes
a similar recession in a foreign economy through the transactions of trade andcapital flows. In this sense, open macroeconomies are indeed demonstrated to
be a closed system in which economic behaviors are reciprocally interrelated.
The idea of modeling macroeconomic system came up while I was visiting
the Univ. of California at Berkeley as a visiting scholar for 8 months after
the presentation of the paper on the principle of accounting system dynamics
at the SD conf. in New York, July, 2003. Since then almost five years havepassed for completing the series of SD macroeconomic modeling in this current
paper. Though the model is still far from being complete and genetic by its
18

nature, it’s time, I believe, to make it open to the public for further fine-tunings
and revisions by the SD peers and macroeconomists as well as those who areinterested in our approach.

19

MacroDynamics Model Illustrated1
Title

M acr oeconomic Dynamics M odel

Overview
Population
Labor Force

Population
Labor Force.f

C urrency
C irculation

C urrency
C irculation.f< MacroDynamics 1.0 >

GDP

GDP.f

- A ccounting System Dynamics A ppr oach -Interest, Price& WageInterest, Price& Wage.f

Producer

Producer.f

C onsumer

C onsumer.f

Government

Government.f

Banks

Banks.f(c) All R ights R eserved.

Por f. K aor u Y amaguchi, Ph.D.
Doshisha B usiness School
Doshisha University
K yoto, Japan

C entral Bank C entral Bank.f
Foreign
Exchange Rate

Balance ofPayments

GDP
Simulation

GDP
Simulation.f

kaoyamag@ mail.doshisha.ac.jp
T his model provides a generic system on which
various schools of economic thoughts can be built.
Your comments and suggestions are most welcome.

Fiscal Policy Fiscal Policy.f
Monetary
PolicyMonetary
Policy.f

Trade & Investment Abroad
Simulation
Economic
Indicators

Economic
Indicators.f

B/S
C heckB/S C
heck.f(c) Prof. K aoru Yamaguchi
Doshisha B usiness School
J apanFigure 14: Title Page of the MacroDynamics Model

1 In this illustrated section of the model, only domestic macroeconomy is presented. The
model called MacroDynamics version 1.0 is now available for educational use through thecontact with the author. It runs on the Vensim Model Reader (freeware) which can be
downloaded from http://www.vensim.com

20

Figure 15: Model Overview

21

GDP
Simulation.f

GDP
Simulation

Monetary
Policy.f

B/S C
heck.fB/S
C heck(c) Prof. K aoru Yamaguchi
Doshisha B usiness School
J apanEconomic
Indicators.f

Economic
Indicators

Trade & Investment Abroad
Simulation

Monetary
PolicyFiscal Policy Fiscal Policy.f

Balance ofPayments

Foreign
Exchange Rate

C entral Bank C entral Bank.f

Banks.f

Government.f

Government

Banks

Producer.f

C onsumer.f

ProducerInterest, Price& Wage.f

Interest, Price& WageC onsumer

GDP.f

C urrency
C irculation.f

C urrency
C irculation

GDP

Population
Labor Force.f

Population
Labor Force

Overview

Title

Income Tax

C onsumer(H ousehold)Public Services

Investment(Housing)

C onsumption

SavingP opulation / L abor F orce

G overnment

Investment (Public
Facilities)

National Wealth(C apital
A ccumulation)

Labor & C apitalG rossDomestic
Products(G DP)

Wages & Dividens (Income)B anksMoney Supply

C entral B ank

Public Services

Investment (PP& E)

ProductionLoan

M acr oeconomic System M odeling O ver view

C orporate Tax

P roducer(F irm)Direct and Financial
Investment Abroad

ImportExportIncome Tax

C onsumer(H ousehold).f

Public Services

Investment(Housing)

C onsumption

SavingP opulation / L abor F orce.f

G overnment.f

Investment (Public
Facilities)

National Wealth(C apital
A ccumulation)

Labor & C apitalG rossDomestic
Products(G DP).f

Wages & Dividens (Income)B anks.f

Money Supply

C entral B ank.f

Public Services

Investment (PP& E)

Production

Loan

P roducer(F irm).f

C orporate Tax

M acr oeconomic System M odeling O ver view (F or eign C ountr y)

Figure 16: Population and Labor Force22

births<C ollege
Education>High
SchoolC ollege
Educationcollege
attendance
ratio

HS Graduation

deaths15 to 44

Population
15 To 44

initialpopulation
15 to 44

<Labor Force>

Going toC ollegeHighschoolingtime<V oluntary
Unemployed>maturation
14 to 15

Productive
Populationmortality
0 to 14deaths0 to 14

Population
0 To 14<High School>

total fertility tabletotal fertility

reproductive
lifetime

initialpopulation
0 to 14

C ollegeschoolingtime

C ollege
Graduation

Total
Graduationmortality
15 to 44maturation
44 to 45

Population
15 to 64

Portion to
15 to 44

Population

V oluntary
Unemployed

Initially
Unemployed
Labor

New
Unemployment

Unemployment rate

New
Employment

mortality
45 to 64

deaths 45
to 64

Population
45 To 64initialpopulation
45 to 64

Labor
Force

UnemployedLabor

initialpopulation
65 plusTime to Adjust
Labor

DesiredLabor

Initially
Employed
Labor

deaths 65
plus

mortality 65 plus

<Expected Wage
Rate>

<Price><Desired
Output(real)><Excise Tax
Rate><Exponenton Labor><C apacity
Idleness>

Labor Market
Flexibility

Retired(Employed)

Population
65 PlusNet
Employment

EmployedLabor

labor force
participation ratio

Retired(V oluntary)

maturation
64 to 65

initialpopulation
15 to 64

Figure 17: GDP Determination

23<GDP (real)>

C apacity
Idleness

InitialPotential
GDP

TechnologicalC hange

Potential
GDP

Initial
Labor
Force

<Excise Tax
Rate>

Exponent
on C apital

Full C apacity
GDP

Exponenton Labor<Labor Force>

InitialC apital(real)<Employed
Labor>

DesiredC apital-Output Ratio

Depreciation Rate

Depreciation(real)

C apital-Output
Ratio

Desired Output(real)<C apital-Output
Ratio>

DesiredInvestment (real)

C apital under
C onstruction

C hange in AD
Forecasting

Time to Adjust
C apital

Investment(real)<Price>Time to Adjust
Forecasting

Aggregate
Demand (real)

Gross Domestic
Expenditure (real)<Investment>

Normal Inventory
C overage

Net Investment(real)

Interest
Sensitivity

Desired C apital(real)<Initial C apital(real)>

C apital
C ompletion

C onstruction
PeriodAggregate
DemandForecasting

Desired Inventory<Interest Rate>

Sales (real)Time for Inventory
Sales
Desired Inventory
Investment
Time to Adjust
Inventory

Inventory (real)

C apital (PP & E)
(real)GDP (real)

Inventory
Investment

Aggregate
DemandForecasting(Long-run)<Full C apacity
GDP>

Time to Adjust
Forecasting (Long-run)

C hange in AD
Forecasting (Long-run)Long-run
Production Gap

GrowthC overtion to %Growth Rate (%)

Growth Rate
<GDP (real)>

Production(-1)

Growth Unit

<Real Foreign
Exchange Rate><Price>Government
Expenditure<Imports (real)>

Government
Expenditure (real)

Net Exports(real)<Imports (real).f><Normalized
Demand C urve>

C onsumption

Exports (real)<Investment(real)>

C onsumption(real)<Price>Figure 18: Interest Rate, Price and Wage Rate

24

<V ault C ash(Banks)>C urrency inC irculation
Money
SupplyC ost-push (Wage)
C oefficient

Supply of
Money(real)<Desired
Output (real)>

Wage Rate (-1)

Wage Rate
C hange

Initial Price
level

Price

Initial Wage
Rate

Wage Rate

Inflation Rate

Price (-1)

Demandfor Money<Discount Rate>

Real Wage
Rate

Demand for
Money(real)C hange inWage Rate

Expected
Wage Rate<Government Debt
Redemption><Interest paid by theGovernment><C ash Demand><Saving><C onsumption><Income Tax><Dividends><Interest paid by Producer><Desired Investment><Payment by Producer><Labor Force>

Wage Rate
C oefficient<C ash Demand><Government Expenditure>
Interest Sensitivityof Money DemandSpeculative
Demand for
Money

Demand for
Money by theGovernment

Demand for
Money by
C onsumers

Demand for
Money by
Producers<Inflation Rate><Desired Labor>

Interest Rate(nominal)

Interest Rate

Initial Interest Rate

ActualV elosity ofMoney

C hange in Interest Rate

C hange in Price<Full C apacity
GDP>

Price C oefficient<Deposits (Banks)><C ash (Government)><C ash (Producer)><C ash (C onsumer)>

V elosity of
Money

Interest C oefficientFigure 19: Transactions of Producers

25
C ash Flow Deficit(Producer).f<Initial Foreign
Exchange Rate><Lending(Banks).f><New C apital
Shares.f>

C ash
Flow.f<Producer Debt
Redemption.f>

Imports(real).f

Demand Index
for Imports.f<Dividends.f><Interest paid by
Producer.f>

Imports
DemandC urve.fImports
C oefficient.f<GDP (real).f>

Trade Balance.f<Exports.f>

C ash Flow from
Financing Activities.f

C ash Flow from
Investing Activities.f

C ash Flow fromOperating Activities.f

Sales.f3<Lending(Banks).f>

New C apital
Shares.f<Exports (real).f>

Exports.f
Investing
Activities

Operating
Activities<Interest paid by
Producer.f>

Financing
Activities

C ash (Producer).f<Producer Debt
Redemption.f><Direct Investment
Abroad.f><DesiredInvestment.f><Payment by
Producer.f><Sales.f>

1<Price.f><Dividends.f>

Inventory.f

Direct Financing
Ratio.f<Price.f>

Desired Borrowing(Producer).f

DesiredFinancing.f<Price><Foreign
Exchange Rate>

Imports.f<GDP(Revenues).f><Sales (real).f>

Direct Investment
Index.f

Direct Investment
Abroad.fDirect Investment.f

Investment.f

DesiredInvestment.f<C orporate
Tax.f><Producer Debt
Redemption.f><Interest Arbitrage
Adjusted.f><Interest paid by
Producer.f>

Direct Investment
Index Table.f

Direct Assets
Abroad.fDirect Investment
Ratio.f<Initial C apital(real).f><C orporate
Tax.f><Wage Rate.f><Employed
Labor.f><Price.f><Interest Rate(nominal).f>

Dividends
Abroad.f

Dividends.f<Dividends
Abroad.f>

Wages.fTax onProduction.f

Excise Tax Rate.f<Time for Fiscal
Policy>Producer Debt
Redemption.f

Producer Debt
Period.f

C hange in Excise
Rate.f<Depreciation(real).f>

Depreciation.f<Direct
Investment
Abroad (FE)>1<Wages.f>

C apital (PP& E).f

<Price.f><DesiredInvestment (real).f><Imports.f>

Payment by
Producer.f<Tax on
Production.f>

Profits for
Dividends.f

Retained Earnings(Producer).f

Initial C apital
Shares.f

C apital Shares.f<Lending(Banks).f>

Profits.f

Dividends Ratio.f

C orporate Tax.f

C orporate Tax
Rate.fProfits before
Tax.f

GDP (Revenues).f<Price.f><Depreciation.f><Interest paid by
Producer.f><Wages.f><Tax on
Production.f><GDP (real).f><Foreign
Exchange Rate><Direct Investment
Abroad>3

Initial C apital
Liabilities Abroad.f<New C apital
Shares.f>

C apital Shares
Newly Issued.f

Direct Investment
Abroad (FE)Initial Debt (Producer).f

Debt (Producer).f

C apital Liabilities
Abroad.fInitial Direct
Assets Abroad.f

Figure 20: Transactions of Consumers

26<Securities soldby C onsumer><GoldC ertificates><Interest Arbitrage
Adjusted>

C ashing
Time

Financial
Investment Index

Financial
Investment

C urrency
Ratio

C ash
DemandSaving<Disposable
Income>Initial Financial
Assets Abroad<Debt Redemption
Ratio by Banks>

Debt Redemption
Ratio by C onsumer

Initial Security
Holding Ratio
held by
C onsumer

Government
Securities(C onsumer)<Initial C apital
Shares>Shares(held by
C onsumer)<Price>Initial Gold heldby the Public

C onsumer Equity

Distributed
IncomeIncomeDistribution
by Producers<Open Market
Purchase (Public Sale)><Government Debt
Redemption>

Securities soldby C onsumer<Time for Fiscal Policy>

C hange in Income Tax RateNDC Table<Government
Securities Newly
Issued>Securities purchased
by C onsumer<Open Market Sale
(Public Purchase)>

Financial
Investment(Shares)<C apital Shares
Newly Issued>

Normalized
Demand C urve

Government
Transfers

Financial
Investment
AbroadDeposits
Abroad(C onsumer)

1

2

Deposits(C onsumer)

Marginal Propensity
to C onsume

C onsumption

Income Tax

Basic
C onsumption

Financial
Investment Ratio<Interest Rate(nominal)>

C urrency Ratio
Table<Initial C urrency
Outstanding>

C ash(C onsumer)

Financial Investment
Index Table

Money put into
C irculation<Income Abroad(C onsumer)>

3<Income>

Disposable
IncomeIncome Tax
Rate

Lump-sum Taxes

C hange in
Lump-sum Taxes

Income Abroad(C onsumer)

1

Income<Wages><Interest paid by theGovernment><Interest paid by Banks><Dividends><Wages (Banks)><Direct and Financial
Investment Income><Gold Deposit><Depreciation><Interest paid by
Producer><Income><C orporate Tax><Dividends><Wages>Figure 21: Transactions of Government

27
Government
Deficit<Government
Securities><Tax Revenues><Interest paid by theGovernment><Government Debt
Redemption>

Government
Borrowing

Cash (Government)

Base Expenditure

Change in
Expenditure

Change in Government
Expenditure

Primary
Balance<Tax Revenues>
Change inPrimary
Balance
Ratio

Growth-dependent
Expenditure

Time for Fiscal
PolicyPrimary
BalanceTime

Revenue-dependent
Expenditure

Government
Expenditure

SwitchInterest paid by theGovernment<Interest Rate(nominal)><Growth Rate>

Government Debt
Redemption

Government
Debt Period

Retained Earnings(Government)

Initial Government
Debt

Debt (Government)

Debt-GDP ratio

Tax Revenues

Government
Securities<GDP(Revenues)><Income Tax>

<Corporate Tax>

<Tax on
Production><Government
Deficit>Figure 22: Transactions of Banks

28

2<Foreign
Exchange(FE)><Foreign
Exchange
Rate><Interest on
Financial Liabilities
Abroad.f><Dividends
Abroad.f><AdjustingReserves>2

2

2

Desired
Borrowing(Banks)<Payment by
Banks><Exports><Securities
purchased by
Banks><Reserves
Deposits><Foreign C ash
out><C ash out>

C ash in<Foreign
Exchange Sale>

Net Gains by
C hanges in
Foreign Exchange
Rate

Foreign
Exchange in<Lending(C entral Bank)><Desired
Borrowing(Producer)>C ash Flow
Deficit(Banks)<Dividends
Abroad><Direct Investment
Abroad><Imports><Interest Income(Banks)><Producer Debt
Redemption><Securities soldby Banks><Deposits in>

Net Gain
Adjustment Time

Foreign
Exchange(Book V alue)

Direct and Financial
Investment Income<Foreign Financial
Investment
Abroad><Foreign Direct
Investment Abroad>

V ault C ash(Banks)Foreign
Exchange(Banks)3

Foreign C ash out

Payment
by Banks<Desired
Borrowing(Producer)>

Lending (Banks)<Government Securities
Newly Issued>

Government
Securities(Banks)Excess Reserve
Ratio<Exports><Foreign Direct
Investment Abroad><Direct and Financial
Investment Income>3<Producer Debt
Redemption>

Securities sold by
Banks

Interest paidby Banks(C onsumer)

Deposits(Banks)Wages (Banks)

Interest paidby Banks
Retained
Earnings(Banks)Interest paidby Producer

Profits (Banks)<Net Gains by
C hanges in Foreign
Exchange Rate>

Interest Income(Banks)<Debt (Banks)><Exports><Saving>

Prime Rate

Deposits in

Borrowing(Banks)<Lending (C entralBank)>

Foreign Financial
Investment Abroad

Discount Rate

<Interest Rate(nominal)>

Interest paidby Banks(C entral Bank)

2

Deposits out

Debt(Banks)Financial
Liabilities
AbroadInterest on Financial
Liabilities Abroad

Net Deposits<Interest on
Financial Liabilities
Abroad><Financial
Investment Abroad><Government Debt
Redemption><Open Market Sale
(Banks Purchase)><Financial
Investment(Shares)><Securities
purchased by
C onsumer><C ashDemand>Banks Debt
Period<Initial Required Reserve Ratio>

Banks Debt
Redemption<Interest Rate(nominal)>

RR Ratio C hange TimeRR Ratio C hange

Excess Reserves<Foreign
Exchange Sale><Open Market Purchase(Banks Sale)><Banks Debt
Redemption>

Loan(Banks)RequiredReserve
Ratio

RequiredReserves

Reserves out

Open Market
Operations

Reserves(Banks)3<Direct Investment
Abroad><Financial
Investment Abroad>3<Imports>

Debt Redemption
Ratio by Banks<Excess
Reserves>

Securities
purchased by
Banks

Reserves
AT

AdjustingReserves

Reserves
Deposits<Deposits out>

C ash out

3

<Interest on Financial
Liabilities Abroad><Foreign Exchange
Purchase>

Foreign
Exchange out

Foreign Direct and
Financial Investment
Income<Dividends
Abroad><Interest paid byBanks><Interest paid by theGovernment (Banks)><Loan (Banks)>

Prime Rate
Premium<Foreign
Exchange Rate><Financial Investment
Abroad.f>Figure 23: Transactions of Central Bank

29

<Government Securities(C onsumer)>Open Market
Purchase (Public Sale)

Lending Time

Lending by
C entral Bank

Open Market
Purchase Time

Open Market
Purchase Operation

Open Market
Purchase

Lending Period

Lending(C entral Bank)Gold

Foreign
Exchange
Reserves

Foreign Exchange
Sales AmountOpen Market Sale
Operation

Open Market Sale

<Banks Debt
Redemption>

Monetary Base

Open Market
Sale Time

Open Market Sale
(Banks Purchase)

Decrease in
Reserves<Foreign
Exchange Sale>

Open Market Public
Sales Rate

Open Market Sale
(Public Purchase)

Notes Withdrown<Interest Income(C entral Bank)>

Foreign Exchange
Upper boundGold C ertificates

Foreign Exchange
Sale<Government Securities(Banks)>Open Market
Purchase (Banks Sale)

Government
Securities(C entral Bank)

Initial Sequrity Holding
Ratio by C entral Bank

Loan
(C entral
Bank)

Initial Gold held by
the Public
Window GuidanceGold Deposit

Foreign Exchange
Purchase<Desired Borrowing(Banks)>

Deposit TimeGold Deposit by
the PublicGold Standard

Foreign Exchange
Lower Bound

Foreign Exchange
Purchase Amount<Foreign
Exchange Rate>

Retained
Earnings(C entral Bank)

Reserves(C entral Bank)

Reserves by
Banks

C urrency
Outstanding<Lending(C entralBank)><Interest paid by theGovernment (C entral Bank)><Interest paid byBanks (C entral Bank)>

Interest Income(C entral Bank)

Increase in
Reserves<Foreign Exchange
Purchase><AdjustingReserves><Reserves
Deposits>

Notes Newly
Issued<Open Market
Purchase (PublicSale)>

Figure 24: Foreign Exchange Market

30<Imports.f>

Foreign Exchangein (FE)<Foreign
Exchange Sale>

C hange in Foreing
Exchange Rate

Excess Demand for
Foreign Exchange

Initial Foreign
Exchange Rate

seeds

standard
deviation

Adjustment Time of
Foreign Exchange
Expectation

mean

Demand for Foreign
Exchange<Financial
Investment
Abroad (FE)><Direct
Investment
Abroad (FE)>

Imports (Foreign
Exports)

C hange in Expected
Foreign Exchange Rate

Expected
C hange in
FER<Foreign Exchange
Purchase>

Foreign Exchange
Purchase (FE)Foreign Direct and
Financial Investment
Income (FE)Foreign Exchangeout (FE)

Expected
Foreign
Exchange Rate

<Price.f>Real Foreign
Exchange Rate

<Price>Initial Foreign
Exchange (FE)Foreign
Exchange(FE)

Foreign
Exchange Rate

Foreign Exchange
Sale (FE)Direct and Financial
Investment Income (FE)Foreign Exchange
C oefficient

Supply of Foreign
Exchange<Financial
Investment
Abroad.f><Direct
Investment
Abroad.f>Exports (Foreign
Imports)<Exports.f><Arbitrate
Adjustment Time>Interest
Arbitrage.f

Expected Return on
Deposits Abroad.f

Expected Return on
Deposits Abroad

Interest
Arbitrage

Arbitrate
Adjustment Time

Initial Foreign Exchange(FE) by Domestic Economy

Interest
Arbitrage
Adjusted.f<Interest
Rate.f><Expected Foreign
Exchange Rate><Foreign
Exchange Rate><Interest
Rate>

Interest
Arbitrage
Adjusted<Initial Foreign
Exchange (FE)><Initial Foreign Exchange
Reserves (FE)>Figure 25: Balance of Payment

31

Balance ofPayments

C urrent AccountC apital &Financial
Account

Goods &
Services

Financial
Account<Financial
Investment
Abroad><Direct
Investment
Abroad><Foreign
Exchange
Purchase><Foreign Direct
and Financial
Investment
Income>Earnings out<Imports><C hanges inReserve Assets><OtherInvestment>

Liabilities
AbroadAssetsAbroad<Foreign
Exchange Sale>

Direct and Portfolio Investment

Income Balance<Direct and
Financial
Investment
Income><Foreign
DirectInvestment
Abroad><Foreign
Financial
Investment
Abroad><Direct and Financial
Investment Income>Retained
Earnings andC onsumer
Equity<Foreign Direct
Investment Abroad><Exports><Foreign Financial
Investment Abroad>Earnings in<Exports>

Foreign
Exchange in<Foreign
Exchange Sale>
C hanges inReserve Assets

Foreign
Exchange(Banks)Other Investment<Net Gains by C hanges in
Foreign Exchange Rate>

Other Investment(Debit)(FE R eceipts from
Abroad)<Foreign Exchange
Purchase>

Foreign
Exchange out

Other Investment(C redit)<Foreign Direct and
Financial Investment
Income><Financial
Investment Abroad><Direct Investment
Abroad><Imports>(FE Deposits Abroadfor Payment)

Debit (- Foreign Payment)______________ C redit (+ Foreign R eceipt)

Service Income

Inventory(Trade)Trade Balance

Debit (- Payment)________________________ C redit (+ R eceipt)

Figure 26: Simulation Panel of GDP

32

Banks.f

Banks

GDP
Simulation.f

Balance ofPayments

Monetary
Policy.f

B/S C
heck.fB/S
C heck(c) Prof. K aoru Yamaguchi
Doshisha B usiness School
J apanEconomic
Indicators.f

Economic
Indicators

Trade & Investment Abroad
Simulation

Monetary
PolicyFiscal Policy Fiscal Policy.f

GDP
Simulation

Foreign
Exchange Rate

C entral Bank C entral Bank.f

C onsumer.f

Government.f

C onsumer

Producer.f

Producer

Government

GDP.f

Interest, Price& Wage.fGDP

C urrency
C irculation.f

C urrency
C irculation

Interest, Price& WagePopulation
Labor Force.f

Population
Labor Force

Overview

Title

200

0

0

0

0

YenReal/Year
1/Year

1,125-3.72529e-009

0

5

0

Initial Potential GDP

Depreciation Rate

Exponent on Labor

Exponent on C apital

Technological C hange

Full Capacity GDP : run"Desired Output (real)" : run
Price : run
Wage Rate : run

0 YenReal/Year
0 Yen/YenReal
2 Yen/(Year*Person)

400 YenReal/Year
1 Yen/YenReal
4 Yen/(Year*Person)

800 YenReal/Year
2 Yen/YenReal
6 Yen/(Year*Person)

Potential GDP : run"GDP (real)" : run"Aggregate Demand (real)" : run"Consumption (real)" : run"Investment (real)" : run
Growth Rate : run

0 YenReal/Year-0.6 1/Year

375 YenReal/Year-0.4 1/Year

750 YenReal/Year-0.2 1/Year

YenReal/Year
1/Year

1,500
0.2

10

10

0.8

0.5

0.04

600

0.06

15

15

1

0.1

1

0.1

0

40

45

50

25
Time (Year)Time to Adjust Forecasting

Time to Adjust C apitalTime to Adjust Inventory

Normal Inventory C overage

YenReal/Year
YenReal/Year
Yen/YenReal
Yen/(Year*Person)

35

20"Time to Adjust Forecasting (Long-run)"

20
25
30
Time (Year)

Price-Wage Rate

5

GDP, Aggregate Demand and Growth Rate

35

25

3

30

2

0

0.5

0

0

Labor Force : run
Desired Labor : run
Wage Rate : run
Unemployment rate : run

40 Person
2 Yen/(Year*Person)
0 Dmnl70 Person
4 Yen/(Year*Person)
0.04 Dmnl

250

YenReal/Year
YenReal/Year
YenReal/Year
YenReal/Year
YenReal/Year
1/Year45

1/Year0

10

15

Basic C onsumption

Interest Sensitivity

5

Initial Financial Assets

3,000

1

150

1

20
25
30
Time (Year)

Marginal Propensity to C onsume

0

5

40

50

15

0

0

0

0

PersonPersonYen/(Year*Person)
Dmnl

35

45

10

YenReal/Year
1/Year

YenReal/Year
1/Year

YenReal/Year
1/Year

YenReal/Year
1/Year

35

0

40

5

45

Labor Market Flexibility

Wage Rate C oefficient"C ost-push (Wage) C oefficient"

Price C oefficient

10

10

2

2.4

"Supply of Money (real)" : run"Demand for Money (real)" : run
Interest Rate : run"Interest Rate (nominal)" : run-600 YenReal/Year
0 1/Year

1,050
0.015

2,700
0.03

4,350
0.045

6,000
0.06

20
25
30
Time (Year)

Growth Rate, Inflation and Wage

Growth Rate : run
Inflation Rate : run
Wage Rate Change : run-0.1

Wage Rate and Unemployment Rate

40

100 Person
6 Yen/(Year*Person)
0.08 Dmnl

30

-0.05

0

0.05

0.1

10

15

0

5

10

15

35

45

50

20 25 30
Time (Year)

YenReal/Year
YenReal/Year
1/Year
1/Year40

Currency Outstanding : run
Currency in Circulation : run"Cash (Consumer)" : run"Cash (Producer)" : run"Cash (Government)" : run"Vault Cash (Banks)" : run-6e-014

500

1,000

1,500

2,000

35

40

Currency Outstanding and in Circulation

20
25
30
Time (Year)

Interest Rate

50

Yen

45

50

Figure 27: Simulation Panel of Trade and Investment Abroad

33

Title

C urrency
C irculation.f

GDP.f

Interest, Price& Wage.f

Producer.f

C onsumer.f

Government.f

Banks.f

C urrency
C irculation

GDP

Interest, Price& WageProducerC onsumer

Government

Banks

GDP
Simulation.f

GDP
Simulation

Monetary
Policy.f

B/S C
heck.fB/S
C heck(c) Prof. K aoru Yamaguchi
Doshisha B usiness School
J apanEconomic
Indicators.f

Economic
Indicators

Trade & Investment Abroad
Simulation

Monetary
PolicyFiscal Policy Fiscal Policy.f

Balance ofPayments

Foreign
Exchange Rate

C entral Bank C entral Bank.f

Population
Labor Force.f

Population
Labor ForceYen/Year

YenReal/Year
1/Year
5

-6

-3

0

3

6

0

5

10

15

12.2
seeds

305 -0.1
mean

Foreign Exchange C oefficient"Imports C oefficient.f"

Imports C oefficient

20 25 30
Time (Year)

Trade Balance

0.1

0.1

0.2

0.2

35

Potential GDP : Equilibrium(Trade)"GDP (real)" : Equilibrium(Trade)"Aggregate Demand (real)" : Equilibrium(Trade)"Consumption (real)" : Equilibrium(Trade)"Investment (real)" : Equilibrium(Trade)
Growth Rate : Equilibrium(Trade)0-0.6

375 YenReal/Year-0.4 1/Year

Trade Balance : Equilibrium(Trade)"Trade Balance.f" : Equilibrium(Trade)

0

0

0

YenReal/Year
1/Year

0

40

10

45

15

50

0

0

0

0

35

45

50

0

0.2

0.2

0.2

0.2

10

"Financial Investment Ratio.f"

Financial Investment Ratio"Direct Investment Ratio.f"

Direct Investment Ratio

Exports : Equilibrium(Trade)
Imports : Equilibrium(Trade)
Trade Balance : Equilibrium(Trade)

0 Yen/Year-6 Yen/Year

20 Yen/Year-4.5 Yen/Year

40 Yen/Year-3 Yen/Year

60 Yen/Year-1.5 Yen/Year

Yen/Dollar

2

0

5

10

15

0

0

50

0

5

3,000

3,000

40

10 15

20 25 30
Time (Year)

45

35 40

Balance of Payments

35

Current Account : Equilibrium(Trade)"Capital & Financial Account" : Equilibrium(Trade)
Changes in Reserve Assets : Equilibrium(Trade)
Balance of Payments : Equilibrium(Trade)

Initial Financial Assets

Yen/Year
Yen/Year
Yen/Year"Initial Financial Assets.f"

40

-6

-3

0

3

6

20
25
30
Time (Year)

Foreign Exchange Rate

Foreign Exchange Rate : Equilibrium(Trade)
Expected Foreign Exchange Rate : Equilibrium(Trade)
Real Foreign Exchange Rate : Equilibrium(Trade)

0

0.5

1

1.5

20
30
Time (Year)

Exports-Imports

YenReal/Year
YenReal/Year
YenReal/Year
YenReal/Year
YenReal/Year
1/Year40

80 Yen/Year
0 Yen/Year

20
25 30
Time (Year)

GDP, Aggregate Demand and Growth Rate
YenReal/Year
1/Year

750 YenReal/Year-0.2 1/Year

1,125-3.72529e-009

1,500
0.2

Yen/Year

Overview

45

50

50

-0.01

-0.005

0

0.005

0.01

0

5

10

15

20 25 30
Time (Year)

Interest Arbitrage

0

5

10

15

20 25 30
Time (Year)

Finacial Investment

Financial Investment Abroad : Equilibrium(Trade)
Foreign Financial Investment Abroad : Equilibrium(Trade)

-4

-2

0

2

4

Interest Arbitrage Adjusted : Equilibrium(Trade)"Interest Arbitrage Adjusted.f" : Equilibrium(Trade)

Yen/Year

1/Year

35

35

40

40

45

45

50

50

References[1] Richard A. Werner. new paradigm in macroeconomics: solving the riddleof japanese macroeconomic performance. Palgrave Macmillan, New York,2005.
[2] Kaoru Yamaguchi. Beyond Walras, Keynes and Marx – Synthesis in Economic Theory Toward a New Social Design. Peter Lang Publishing, Inc.,New York, 1988.
[3] Kaoru Yamaguchi. Principle of Accounting System Dynamics – ModelingCorporate Financial Statements –. In Proceedings of the 21st International
Conference of the System Dynamics Society, New York, 2003. System Dynamics Society.
[4] Kaoru Yamaguchi. Money Supply and Creation of Deposits : SD Macroeconomic Modeling (1). In Proceedings of the 22nd International Conferenceof the System Dynamics Society, Oxford, England, 2004. The System Dynamics Society.
[5] Kaoru Yamaguchi. Aggregate Demand Equilibria and Price Flexibility :SD Macroeconomic Modeling (2). In Proceedings of the 23nd International
Conference of the System Dynamics Society, Boston, USA, 2005. The System
Dynamics Society.
[6] Kaoru Yamaguchi. Integration of Real and Monetary Sectors with Labor
Market: SD Macroeconomic Modeling (3). In Proceedings of the 24th International Conference of the System Dynamics Society, Nijmegen, The Netherlands, 2006. The System Dynamics Society.
[7] Kaoru Yamaguchi. Balance of Payments and Foreign Exchange Dynamics:
SD Macroeconomic Modeling (4). In Proceedings of the 25th International
Conference of the System Dynamics Society, Boston, USA, 2007. The System
Dynamics Society.

34