Introduction to the Cambridge Journal of Economics Virtual Special Issue Stock-flow consistent macroeconomics – the foundations Alan Shipman The usefulness of taking a stock-flow consistent (SFC) approach to medium- and long-term analysis of the economy, and assessment of policy impacts, is now gaining recognition well beyond the small post- Keynesian circle that first developed them. New SFC contributions appear regularly in a range of heterodox journals, with the approach also finding important applications in the natural sciences. But for its first three decades, SFC theorising and empirical investigation were a minority pursuit, carried largely by the CJE. This virtual special issue traces its emergence from unresolved Keynesian debates, by drawing together some of the pioneering contributions. In contrast to innovations that start with a single paper or debate, the quest for SFC took shape gradually, its origins remaining hard to pinpoint. The problem of conventional macro models (and representations of Keynes) yielding potentially misleading results, because they did not follow through all investment flows into capital-stock changes and credit flows into debt-stock changes, or include the effect of changed stocks on subsequent expenditure flows, was occasionally noted by mainstream authors (notably Patinkin 1965 and Christ 1968). Philip Davis (1987a, b), then at the Bank of England, set out the groundwork for SFC macro modelling and assessed its main challenges, in a year when stock-market crashes highlighted its usefulness. But it was those working in the Keynesian and Kaleckian tradition, and seeking to link short-term national- income determination to longer-term growth and distribution, who became most aware of the unanswered questions from analyses that were not SFC. This drove them to build an alternative framework that could take full account of stock changes, and their balance sheet impact, in a trade-exposed monetary economy with large, deregulated financial markets. Stuck (without stock) in the short run, 1937-1983 Keynes’ (1936) emphasis on investment generating saving, via its multiplier effect on aggregate income, opened up a route into the long run via the capacity-building and income-generating effects, promptly followed up by Roy Harrod (1939). It also left room for the wage/profit distribution to influence the channelling of income into saving, an exploration pioneered by Pasinetti (1962) and Kaldor (1966). Kalecki’s (1933) introduction of a financial circuit, through which capitalists’ investment and consumption can collectively generate their profits, offered a way to reconnect Keynes’ ideas to classical theory and dynamic structural change beyond Harrod’s one-commodity world. But Kaleckian and Keynesian approaches depend on there being a financial system that can fully finance expenditures in advance of the income they generate. In the combined ‘real’ and ‘monetary’ equilibrium approach presented by Hicks (1937), distilled into ‘IS- LM’ by Hansen (1953:143-53), the long-term consequences of investment spending and fiscal imbalances largely disappeared. Keynes’ was confined to a short-run analysis in which fixed investment could take place without adding to capacity, and firms could invest more than their income (and governments spend more than their tax revenue) without any reference to the financing of these deficits. There were no changes to the private or public capital stock, and no counterpart changes in private or public debt. Hicks personally found his eponymous cross too heavy to bear, admitting the inadequacy of mixing goods- market flow and financial-market stock equilibria in his final published work (Hicks 1980). But IS-LM’s usefulness in reducing Keynesian ‘aggregate demand failure’ to a wage rigidity or liquidity trap, and ascribing monetary policy at least comparable in power to fiscal policy, gave it an enduring pre-eminence in undergraduate textbooks. The attention drawn in Cambridge to the problem of aggregating fixed capital, in real or monetary terms (Cohen & Harcourt 2003), did little to correct the imbalance. For those focused on longer-term growth and change in the real economy, the easiest escape was often to analyse it – even in the long term - as a system of flows, in which capital was used-up and re-created in each period (Pasinetti 1980). Ironically, when (in 1952) the US began publishing a full set of flow-of-funds tables, showing all the financial flows implied by changes in balance-sheets between years, the ‘Keynesian’ heirs to those who had devised them in the 1940s no longer knew what to do with them (dos Santos 2006: 546). National income accounting – heavily shaped by Sir Richard Stone’s group, and its early decision to ignore capital gains as a source of income – became focused on the annual income flow, with no regular assessment of balance sheets, and no need to assess the pattern of flows that that served to reconcile the two. Re-connecting stocks and flows, 1983-1999 Keynes and Kalecki both recognised that production takes time, requiring investment (in working people and working capital) even when there are no fixed-capital purchases. Even if they have savings, employees’ wages must be paid in advance, as must raw materials whose costs are only recovered when outputs are sold. So during the production process firms’ balance sheets will deteriorate, through running-down assets or taking out new debts. The financing of production and investment was not fully explored in early versions of their models, and left open the possibility that capitalists’ initial outlay could still be constrained by lack of liquidity. This missing element in post-Keynesian analysis was brought back to attention by Tom Asimakopulos (1983) in his first CJE contribution. His review examined the investment and saving flows in Kalecki’s models, and their impact on private-sector and central-bank balance sheets, in a way that anticipates the stock and flow matrices now standard in SFC analysis. Investment might be held back by the objective constraint of finance being unavailable, or the subjective constraint of downbeat expectations deterring firms from making use of it. When the multiplier takes time to unfold, there may be moments when firms lack the revenue to finance all their planned investment (or when, in effect, this is forcibly deflected from intended fixed investment into unintended investment in unsold stocks). Asimakopulos’ article coincided with the attempt by Wynne Godley and Francis Cripps (1983), after a decade leading the Cambridge Economic Policy Group at the Department of Applied Economics (DAE), to rebuild macroeconomics in a way that paid full attention to the financing of working capital when goods could only be sold at the end of the production period. There were numerous responses to Asimakopulos’ challenge, but five years later Peter Skott (1988) addressed it by putting some existing Kalecki-inspired models into a fuller SFC framework. The starting- point was Kaldor’s (1966) Pasinetti-inspired framework in which households and firms saving at different rates. But there was now a wider range of financial assets through which households could save and firms finance investment; and the consequent saving and investment flows were fully traced through to assess the pattern and impact of changes in the respective stocks. Investment, treated as exogenous, could lead to a flow of dividends to households if it fell below the level of profits or a flow of bank lending to firms if it moved above this. The model featured monopolistic firms that maintain excess capacity to deter entry, allowing for examination of Josef Steindl’s (1955) arguments about stagnation arising from growing oligopoly and declining wage share; and banks that met all credit demand rather than restricting it for their own profit, making the money supply endogenous. It also featured households that receive a combination of wage and investment income - allowing underconsumption to be checked if profit distributions offset the effects of a falling wage share (but opening the way to its exacerbation if firms raise prices ahead of wages and do not distribute the resultant higher profits, forcing households to borrow for consumption and thereafter pay back interest). The model is open to various types of investment behaviour by firms, of which Skott investigated two: expansion when expected returns on invested capital exceeds its costs (and Tobin’s q exceeds 1), with a fixed mark-up, or use of a discretionary mark-up to generate the profits required for target investment (similar to the theory developed Adrian Wood (1975) along lines inspired by Kaldor and Robin Marris). Skott’s model could be solved algebraically, and used to analyse the medium term, when short-term changes in investment or saving decisions have had time to impact on real and financial stocks, and expenditures have fully adjusted to income changes. It contributed to the immediate debate by showing that any savings constraint on investment acted only in the very short term, but also had implications for wider debates - including a demonstration that the neoclassical transmission of higher saving to higher investment could in principle occur through the revaluation of financial capital stocks in a multi-asset model, and that firms’ tendency to respond to increased output with increased investment (to preserve their capacity margin) could counter any instability in Harrod’s warranted rate of growth. Marcello Messori (1991) returned to the