Portfolio Decision

Mirroring: Godley, W & Lavoie, M, Monetary Economics: An Integrated Approach to Credit, Money, Income, Production and Wealth, pp.103-105

Households make a two stage decision. In the first step, households decide how much they will save out of their income. In the second step, households decide how they will allocate their wealth, including their newly acquired wealth. The two decisions are made within the same model iteration. However, the two decisions are distinct and of a hierarchical form. The consumption decision determines the size of the end of period stock of wealth; the portfolio decision determines the allocation of the stock of wealth.

How is wealth allocated between money and bonds? Two traditions have prevailed. One related to the quantity theory of money, links money balances to the flow of income and the other, of more recent vintage, makes money balances some proportion of total wealth. The latter is related to the Keynesian notion of liquidity preference. The lower is liquidity preference, the lower is the money to wealth ratio.

The transactions demand for money and the liquidity preference story may both be comprised within a single model. Households wish to hold a certain proportion λ0 of their wealth in the form of bills, and hence, because there is no third asset, a proportion equal to (1 - λ0) in the form of money. This proportion, however, is modulated by two elements, the rate of return on Treasury bills and the level of disposable income relative to wealth.

Wealth Allocation Functions

Allocation function 'Bhd_01' described in portfolioFunction-01 is an interpretation of G&L's Brainard-Tobin formula, slightly amended. The function serves ABMPC when running one producer and one household agent. 'Bhd_01' serves a system with one, and only one, household agent.

ABMPC can run with multiple producer and household agents. The paper by Dynan et al. (2000) influences the initial development of allocation function 'Bhd_02', described in portfolioFunction-02; a wealth allocation function for a multiple household agent system.

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