Research Programs
Monetary Policy and Financial Structure
This program explores the structure of markets and institutions operating in the financial sector. Research builds on the work of the late Distinguished Scholar Hyman P. Minsky—notably, his financial instability hypothesis—and explores the institutional, regulatory, and market arrangements that contribute to financial instability. Research also examines policies—such as changes to the regulatory structure and the development of new types of institutions—necessary to contain instability.Recent research has concentrated on the structure of financial markets and institutions, with the aim of determining whether financial systems are still subject to the risk of failing. Issues explored include the extent to which domestic and global economic events (such as the crises in Asia and Latin America) coincide with the types of instabilities Minsky describes, and involve analyses of his policy recommendations for alleviating instability and other economic problems.
Other subjects covered include the distributional effects of monetary policy, central banking and structural issues related to the European Monetary Union, and the role of finance in small business investment.
Program Publications
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Working Paper No. 1058 | November 2024
Retracing European and Chinese Monetary Thoughts on Chartalism, Nominalism, and the Origins of Monetary Systems
A monetary approach that combines Chartalism, Nominalism, and Command origins of monetary systems is often deemed to have emerged only recently, while the Aristotelian approach (Commodity, Metallism, and Market origins of monetary systems) is the only one that existed until the end of the eighteenth/early-nineteenth century. In the major studies of the history of monetary thought, the Chartalism-Nominalism-Command approach is mostly left unmentioned, or at best reduced to an incoherent banality. The paper shows that this approach has a long and rich intellectual history among European monetary thinkers. In Europe, Plato was its first exponent, albeit in a very rudimentary way, and so one may call it the “Platonic approach.” It is developed by Roman legists (such as Javolenus, Paulus, and Ulpian) and Medieval legists (such as Du Moulin, Hotman, and Butigella) who note that coins are similar to securities and that debts are serviced when nominal sums are paid rather than specific coins tendered. During the Renaissance and early modern period, a series of scholars and financial practitioners (such as Law, Dutot, Thomas Smith, and James Taylor) emphasize the financial logic behind monetary mechanics and the similarity of coins and notes. In the twentieth century, authors such as Innes, Knapp, Keynes, and Commons build onto the groundwork provided by these past scholars. In China, the Chartalism-Nominalism-Command approach develops independently and dominates from the beginning under Confucian and Legist thoughts. They emphasize the statecraft origins of monetary systems, the role of tax redemption, and the irrelevance of the material used to make monetary instruments. Clay, lead, paper, iron, copper, and tin are normal and convenient means to make monetary instruments, they are not special/emergency materials. The essence of a monetary instrument is not defined by its materiality but rather by its chartality, that is, by the promise it embeds. The Platonic approach rejects the categories and conceptualizations used by the Aristotelian approach and develops new ones, which leads to a different set of inquiries and understanding of monetary phenomena, problems, and history.Download:Associated Program:Author(s):Related Topic(s):
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Working Paper No. 1057 | October 2024This working paper contrasts the neo-Keynesian and post-Keynesian theories of monetary policy for an open economy, highlighting the irrelevance of the orthodox theory and the explanatory capacity of heterodoxy for an emerging economy such as Mexico. It focuses on the role of the central bank and the case of the Mexican currency during the economic recovery after the Great Lockout. In the first section, we criticize two proposals of the 3-Equation New-Keynesian model, concluding that, implicitly, both models reaffirm the extreme neutrality of money and the exchange rate in both the short and the long runs. In contrast, we analyze the post-Keynesian exchange rate model proposed by John T. Harvey (2009). In addition, we rely on the fundamentals of the heterodox school of thought such as the financial instability hypothesis of Hyman Minsky (1994) and the relevance of capital flows for the determination of the exchange rate and its implications for economic growth and prices by Jan Kregel (2008). Finally, the erratic behavior of the excessive appreciation of the Mexican Super Peso against the dollar after the recovery of the COVID-19 crisis and in the context of global risk is presented.Download:Associated Program:Author(s):Laura Lisset Montiel-OrozcoRelated Topic(s):
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Working Paper No. 1055 | September 2024This paper looks at the relationship between government budget deficits and the growth rate of GDP. While orthodox economic theory offers several reasons to believe that growing deficits might be associated with slower growth, and would ultimately be unsustainable, Keynesians assert that deficits could stimulate growth—at least in the short run—implying the relation between deficits and growth could be positive. Modern Money Theory, adopting Godley’s sectoral balance approach, Lerner’s functional finance approach, and Minsky’s theory of financial instability takes a more nuanced approach. Historical data for a number of countries is presented, showing that there is no obvious relation between the deficit ratio and economic growth over long time periods. However, there is a predictable path of the relationship over the course of the business cycle for all countries examined.
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Working Paper No. 1052 | June 2024For Matías Vernengo and Esteban Pérez Caldentey (2020), the MMT literature overemphasizes the choice of the exchange rate regime and the relevance of a flexible exchange rate regime, as well as the ultimate effect of that choice upon the policy space. In addition, they argue that the role of capital flows is underexplored, and that the relevance of the balance-of-payments constraint is often underestimated. Vernengo and Pérez’s criticism fails to consider that exchange-rate flexibility makes it possible to use flexible fiscal and monetary policies as well, to boost growth and employment, and to reduce the balance-of-payments constraint.Download:Associated Program(s):Author(s):Arturo Huerta G.Related Topic(s):Capital mobility Currency regimes Exchange rates Fiscal policy Foreign exchange Government expenditure Interest rates Monetary policyRegion(s):United States, Latin America
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Working Paper No. 1051 | May 2024This paper examines the dynamics of euro-denominated (EUR) long-term interest rate swap yields. It shows that the short-term interest rate has an economically and statistically significant effect on EUR swap yields of different maturity tenors, after controlling for various key macroeconomic variables. It presents several autoregressive distributive lag (ARDL) models of the dynamics of EUR swap yields. The estimated econometric models of EUR swap yields of different maturity tenors imply that the European Central Bank (ECB) exerts substantial influence on interest rate swap yields, primarily through the effect of its actions on the current short-term interest rate. Examining the case of EUR interest rate swaps, the findings of the paper lend additional credence to John Maynard Keynes’s hypothesis concerning the ability of a central bank to influence long-term market interest rates.Download:Associated Program:Author(s):Tanweer Akram Khawaja MamunRelated Topic(s):
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One-Pager No. 72 | May 2024Recently, the neglected question of why the US government borrows, given that it can print money, has arisen in the context of discussions surrounding a new documentary, Finding the Money. As L. Randall Wray observes in this one-pager, Modern Money Theory has been providing answers to this question for some time; and, he argues, it is a topic that mainstream economists are ill-equipped to address, since very few concern themselves with the monetary operations that underlie the question of why a currency-issuing government issues debt.Download:Associated Program(s):Author(s):Related Topic(s):
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Working Paper No. 1050 | May 2024The Guyana government, from 2015 to 2021, accumulated a large overdraft on its central bank account. It owed this overdraft to a binding debt ceiling limit and fractious political environment that prevented an increase in the ceiling, allowing for the auctioning of Treasury bills to create the liquidity reflux necessary to refill the account. This paper studies the macroeconomic effects of reflux (one-sided sales of Treasury bills) and broken or incomplete reflux (base money expansion) by focusing on domestic inflation, the foreign exchange (FX) rate, and the quantity of FX traded in the local market. The empirical results suggest that the inflation rate is largely driven by foreign price and oil shocks. Nevertheless, the broken reflux adversely affected the local FX market by increasing the demand for foreign currencies, marginally depreciating the exchange rate, and slightly increasing the inflation rate. The latter finding has important implications for the enormous post-2020 budget spending since the discovery of offshore oil. However, reflux was found to have a stabilizing effect on the demand for FX and inflation. Granger predictability tests provide strong evidence that the government spends first from its central bank account before reflux occurs. Finally, the paper discusses a few novel institutional features of Guyana which resemble the monetary circuit framework (with government) of neo-chartalists.Download:Associated Program:Author(s):Tarron KhemrajRelated Topic(s):
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Working Paper No. 1048 | April 2024This paper econometrically models the dynamics of Swedish government bond (SGB) yields. It examines whether the short-term interest rate has a decisive influence on long-term SGB yields, after controlling for other macroeconomic and financial variables, such as consumer price inflation, the growth of industrial production, the stock price index, the exchange rate of the Swedish krona, and the balance sheet of Sweden’s central bank, Sveriges Riksbank. It applies an autoregressive distributive lag (ARDL) approach using monthly data to model SGB yields across the Treasury yield curve. The results of the estimated models show that the short-term interest rate has a marked influence on the long-term SGB yield. Such findings reaffirm John Maynard Keynes’s view that the central bank’s monetary policy affects long-term government bond yields through the current short-term interest rate. It also shows that the interest rate behavior observed in Sweden is in concordance with empirical patterns discerned in previous studies related to government bond yields in both advanced countries and emerging markets.Download:Associated Program:Author(s):Tanweer Akram Mahima YadavRelated Topic(s):
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Working Paper No. 1046 | March 2024This paper offers a retrospective view of the key pillar of Solow’s neoclassical growth model, namely the aggregate production function. We review how this tool came to life and how it has survived until today, despite three criticisms that undermined its raison d’être. They are the Cambridge Capital Theory Controversies, the Aggregation Problem, and the Accounting Identity. These criticisms were forgotten by the profession, not because they were wrong but because of the key role played by Robert Solow in the field. Today, these criticisms are not even mentioned when students are introduced to (neoclassical) growth theory, which is presented in most economics departments and macroeconomics textbooks as the only theory worth studying.
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Working Paper No. 1044 | February 2024This paper econometrically models the dynamics of long-term Chinese government bond (CGB) yields based on key macroeconomic and financial variables. It deploys autoregressive distributive lag (ARDL) models to examine whether the short-term interest rate has a decisive influence on the long-term CGB yield, after controlling for various macroeconomic and financial variables, such as inflation or core inflation, the growth of industrial production, the percentage change in the stock price index, the exchange rate of the Chinese yuan, and the balance sheet of the People’s Bank of China (PBOC). The findings show that the short-term interest rate has an economically and statistically significant effect on the long-term CGB yield of various maturity tenors. John Maynard Keynes claimed that the central bank’s policy rate exerts an important influence over long-term government bond yields through the short-term interest rate. The paper’s findings evince that Keynes’s claim holds for China, implying that the PBOC’s actions are a driver of the long-term CGB yield. This means that policymakers in China have considerable leeway in fiscal and monetary operations, government deficit finance, and central government debt management.Download:Associated Program:Author(s):Tanweer Akram Shahida PervinRelated Topic(s):Bond markets Central bank policy Central banking China Interest rates John Maynard Keynes Long-term interest rates Short-term interest ratesRegion(s):Asia
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Working Paper No. 1043 | February 2024This paper critically reviews both mainstream and Keynesian empirical studies of interest rate dynamics. It assesses the key findings of a selected number of these studies, surveying the debates between the mainstream and the Keynesian schools. It also explores the debates on interest rate dynamics within the Post Keynesian school of thought. Lastly, the paper identifies the critical questions relevant for future empirical research.Download:Associated Program:Author(s):Tanweer Akram Khawaja MamunRelated Topic(s):
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Working Paper No. 1035 | January 2024In this paper, we discuss the balance sheet mechanics of the Swedish government. We examine spending, government bond purchases, and tax payments. As long as the Swedish central bank, which is created through Swedish laws, supports the Swedish central government, it cannot run out of money. The Swedish government therefore plays a large role in the Swedish economy. It can and should target full employment and price stability, bringing to bear its fiscal power.Download:Associated Program:Author(s):Dirk Ehnts Jussi OraRelated Topic(s):Region(s):Europe
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Working Paper No. 1034 | December 2023This paper models the month-over-month change in euro-denominated (EUR) long-term interest rate swap yields. It shows that the change in the short-term interest rate has an economically and statistically significant effect on the change in EUR swap yields of different maturity tenors, after controlling for various macroeconomic and financial variables, such as the month-over-month change in inflation or core inflation and the growth of industrial production, and the percentage change in the equity price index, the exchange rate, and the size of the European Central Bank’s (ECB) balance sheet. It uses a generalized autoregressive conditional heteroskedasticity (GARCH) approach to model the dynamics of the monthly change in EUR swap yields and their volatility. The results of the estimated models of EUR swap yields of different maturity tenors extend the Keynesian view that the central bank’s monetary policy actions have a decisive influence on long-term government bond yields and long-term market interest rates, primarily through their effects on the current short-term interest rate.Download:Associated Program:Author(s):Tanweer Akram Khawaja MamunRelated Topic(s):
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Working Paper No. 1025 | August 2023
A Financial Post-Keynesian Comparison
The purpose of public policy, expansionary or contractionary, is to encourage the expansion of income, output, and employment. Theory decides the nature and kind of policy, and the underlying mechanics that result in expansion. Keynes (1964) brings money and a monetary production economy to the forefront of economic analysis, yet in the General Theory, he is skeptical of the efficacy of monetary policy. This paper analyzes how prices of assets, liabilities, and commodities interact in response to unconventional monetary policy and fiscal policy (namely automatic stabilizers) to create conditions that stimulate private investment and economic activity. Modern economics, after accepting the need for intervention, tends to attempt to use monetary policy to steer aggregate demand. “Unconventional” monetary policy such as zero and negative interest rates, and quantitative easing have been instituted in an attempt to fight slumps and stimulate economic activity without increasing government deficits. In this paper, we point out—using Davidson’s (1972) financial post-Keynesian framework—how unconventional monetary policy is not sufficient to create the conditions of backwardation that stimulate production. Finally, we explain how automatic stabilizers, using the Kalecki profits (price) equation, are the best avenue to create the conditions for backwardation that stimulate economic activity. We conclude, like Keynes, that fiscal policy is the reliable path to economic expansion.
Download:Associated Program:Author(s):Nitin NairRelated Topic(s): -
Working Paper No. 1024 | July 2023
A Stock-Flow Consistent Approach to the Currency Hierarchy
Underdevelopment is often conceived as being reproduced domestically. This paper emphasizes the international forces that enable the persistence of underdevelopment. We first explore how the currency hierarchy imposes a dependency relation between developed and underdeveloped economies. We improvise and quantify the currency hierarchy using ratios from the consolidated sovereign balance sheet. Using the improvisation of the currency hierarchy, we identify that a weak currency must compensate its position by resorting to three mechanisms: changes in interest rates, changes in exchange rates, and accumulation of international reserves to improve balance sheet structure. We employ these relationships to formulate two novel, financial post-Keynesian behavioral equations: an international reserves function and a domestic interest rate function. These equations are simulated in a stock-flow consistent model. We simulate the transmission of international shocks and domestic fiscal expansion. The key findings are (1) that the intensity of economic activity in the emerging economy is reliant on the level of economic activity (and policy) i n the developed economy and (2) that any attempts to stimulate—through government spending—the emerging economy benefit primarily the developed economy while harming the emerging economy’s private sector, assuming free capital and goods mobility. This indicates the existence of a balance-of-payment constrained expansion originating from the demand for international reserves as a margin of safety. Simulations show import controls to be a solution. We find government spending complemented by import substitution to be the most appropriate response to a crisis of international origin and suggest the need for international cohesion between emerging economies to create a more conducive international financial and trade system, halting the reproduction of underdevelopment.Download:Associated Program:Author(s):Nitin NairRelated Topic(s): -
Policy Note 2023/3 | July 2023In recalling John Maynard Keynes’s revolutionary theory of interest, reviewing the doctrines Keynes sought to overthrow, and analyzing the structural transformations of the US economy, James K. Galbraith maintains there is no alternative to a policy of low interest rates. However, such a policy cannot be effective, he argues, without a radical restructuring of the US economy as a whole.Download:Associated Program:Author(s):Related Topic(s):
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Working Paper No. 1021 | June 2023
The Role of Profits in Banking Regulation
Since the nineties, crises have punctuated financial markets, shattering the conventional wisdom about how these markets work and how to regulate them, and forcing a deep rethinking of the supervisory framework that, however, did not change much of the banks’ behavior and incentives. In particular, banking regulation did not face the nexus profitability-riskiness. Based on Minsky’s financial instability hypothesis, we discuss the literature on banks’ profitability and its relation to the originate-to-distribute model. We also propose a different strategy for banking regulation, based on a profitability cap that prevents financial innovation from overwhelming supervision. Finally, we discuss the data for the US case, confirming the importance of profitability as a signal of incoming troubles and the possibility of using the profitability cap to greatly simplify banking regulation.Download:Associated Program:Author(s):Lorenzo Esposito Giuseppe MastromatteoRelated Topic(s): -
Working Paper No. 1020 | June 2023This paper econometrically models the dynamics of Indian rupee (INR) swap yields based on key macroeconomic factors using the autoregressive distributive lag (ARDL) approach. It examines whether the short-term interest rate has a decisive influence on long-term INR swap yields after controlling for other factors, such as core inflation, the growth of industrial production, the logarithm of the equity price index, and the logarithm of the INR exchange rate. The estimated models show that the short-term interest rate has an important influence on the swap yields. This implies that the Reserve Bank of India (RBI) can sway borrowing and lending rates not just on Indian government bonds but also INR-denominated private-market financial instruments, such as swaps and swaptions.Download:Associated Program:Author(s):Tanweer Akram Khawaja MamunRelated Topic(s):
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Working Paper No. 1019 | May 2023This paper econometrically models Japanese yen (JPY)–denominated interest rate swap yields. It examines whether the short-term interest rate exerts an influence on the long-term JPY swap yield after controlling for several key macroeconomic variables, such as core inflation, the growth of industrial production, the percentage change in the equity price index, and the percentage change in the exchange rate. It also tests whether there are structural breaks in the dynamics of Japanese swap yields and related variables. The estimated econometric models show that the short-term interest rate exerts an important influence on the long-term swap yield in some periods but not in other periods in which core inflation exerts a marked influence on the swap yield. The findings from the econometric models reveal a discernable relationship between the call rate and the swap yield of different maturity tenors clearly held prior to April 2014 but did not in the subsequent period. These findings highlight the limits and scope of John Maynard Keynes’s contention that the central bank’s policy rate commands a decisive influence over the long-term market rate through the short-term interest rate. The policy implications of the estimated models’ results are discussed.Download:Associated Program:Author(s):Tanweer Akram Khawaja MamunRelated Topic(s):
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Working Paper No. 1014 | February 2023This paper models the dynamics of Chinese yuan (CNY)–denominated long-term interest rate swap yields. The financial sector plays a vital role in the Chinese economy, which has grown rapidly in the past several decades. Going forward, interest rate swaps are likely to have an important role in the Chinese financial system. This paper shows that the short-term interest rate exerts a decisive influence on the long-term swap yield after controlling for various macro-financial variables, such as inflation or core inflation, the growth of industrial production, percent change in the equity price index, and the percentage change in the CNY exchange rate. The autoregressive distributed lag (ARDL) approach is applied to model the dynamics of the long-term swap yield. The empirical findings show that the People’s Bank of China’s influence extends even to the over-the-counter derivative products, such as CNY interest rate swap yields, through the short-term interest rate. The findings reinforce and extend John Maynard Keynes’s notion that the central bank’s actions have a decisive role in setting the long-term interest rate in emerging market economies, such as China.Download:Associated Program:Author(s):Tanweer Akram Khawaja MamunRelated Topic(s):
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Working Paper No. 1012 | December 2022John Maynard Keynes argued that the central bank influences the long-term interest rate through the effect of its policy rate on the short-term interest rate. However, Keynes's claim was confined to the behavior of the long-term government bond yield. This paper investigates whether Keynes's claim holds for the yields of spread products and over-the-counter financial derivatives by econometrically modeling the dynamics of the pound sterling–denominated long-term interest rate swap yield. It uses the generalized autoregressive conditional heteroskedasticity (GARCH) modeling approach to examine the relationship between the month-over-month changes in the short-term swap yield and the month-over-month change in the long-term swap yield, while controlling for several key macroeconomic and financial variables. The month-over-month change in the short-term interest rate has a positive and statistically significant effect on the month-over-month change in the long-term swap yield. This finding reinforces Keynes's conjecture concerning the central bank's influence over the long-term interest rate. The investigation's empirical findings and their policy implications are discussed from a Keynesian perspective.Download:Associated Program:Author(s):Tanweer Akram Khawaja MamunRelated Topic(s):
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One-Pager | December 2022While the trigger for the Covid recession was unusual—a collapse of the supply side that produced a drop in demand—the inflation the US economy is now facing is not atypical, according to L. Randall Wray. In this one-pager, he explores the causes of the current inflationary environment, arguing that continuing inflation pressures come mostly from the supply side.
Wray warns that, given federal spending had already been declining substantially before the Fed started raising interest rates, rate hikes make a recession—and potentially stagflation—even more likely. A key part of our fiscal policy response should be focused on well-designed public investment addressing the substantial supply constraints still affecting the US economy—constraints that are not just due to the Covid crisis, but also decades of underinvestment in infrastructure. Such an approach, in Wray's view, would reduce inflationary pressures while supporting growth.
Download:Associated Program(s):The State of the US and World Economies Monetary Policy and Financial Structure Federal Budget PolicyAuthor(s):Related Topic(s):Region(s):United States -
Working Paper No. 1011 | September 2022
A Keynesian Perspective
John Maynard Keynes (1930) asserted that the central bank sways the long-term interest rate through the influence of its policy rate on the short-term interest rate. Recent empirical research shows that Keynes's conjecture holds for long-term Treasury yields in the United States. This paper investigates whether Keynes's conjecture also holds for the monthly changes in US long-term swap yields by econometrically modeling its dynamics using an autoregressive distributed lag (ARDL) approach. The econometric modeling reveals that there is statistically significant effect on the monthly changes in the Treasury bill rate on the monthly changes in swap yields of different maturity tenors after controlling for a host of macroeconomic and financial control variables. The findings from the econometric models that are estimated render a perspicacious Keynesian perspective on key policy questions and contemporary debates in macroeconomics and finance.Download:Associated Program:Author(s):Tanweer Akram Khawaja MamunRelated Topic(s): -
Working Paper No. 1008 | May 2022This paper econometrically models the dynamics of the Chilean interbank swap yields based on macroeconomic factors. It examines whether the month-over-month change in the short-term interest rate has a decisive influence on the long-term swap yield after controlling for other factors, such as the change in inflation, change in the growth of industrial production, change in the log of the equity price index, and change in the log of the exchange rate. It applies the generalized autoregressive conditional heteroskedasticity (GARCH) approach to model the dynamics of the long-term swap yield. The change in the short-term interest rate has an economically meaningful and statistically significant effect on the change of the interbank swap yield. This means that the Banco Central de Chile’s (BCCH) monetary policy exerts an important influence on interbank swap yields in Chile.Download:Associated Program:Author(s):Tanweer Akram Khawaja MamunRelated Topic(s):
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Working Paper No. 1002 | February 2022
Empirical Evidence from India
Against the backdrop of the COVID-19 pandemic, this paper analyzes the economic stimulus packages announced by the Indian national government and tries to identify some plausible fiscal and monetary policy coordination. The shrinking fiscal space due to revenue uncertainties has led to a theoretical plausibility of a reemergence of finite monetization of deficits in India. However, the empirical evidence confirms no direct monetization of the deficit. -
Working Paper No. 996 | December 2021Modern Money Theory (MMT) has generated considerable scrutiny and discussions over the past decade. While it has gained some acceptance in the financial sector and among some politicians, it has come under strong criticisms from all sides of the academic spectrum and from conservative political circles. MMT has been argued to be both fascist and communist, orthodox and heterodox, dangerous and benign, unworkable and obvious, and unrealistic and clearly nothing new. The contradictory aspects of the range of criticisms suggest that there is at best a superficial understanding of the MMT framework. MMT relies on a well-established theoretical framework and is not inherently about changing the economic system; it is about changing the policymaking praxis to implement a given public purpose. That public purpose can be small or large and can be conservative or progressive; it ought not to be narrowly determined but rather should be set as democratically as possible. While MMT proponents tend to favor a public purpose that deals with what they see as major drawbacks of capitalist economies (persistent nonfrictional unemployment, unfair inequalities, and financial instability), their policy proposals do not lead to a major shift of domestic resources to the public purpose. If a major increase in government spending is implemented, MMT provides some guidance on how to do that in the least disruptive manner by drawing on past economic experiences. The point is to implement the public purpose at a pace that recognizes the potential constraint that comes from domestic resource availability and potential inflationary pressures from bottlenecks, rising import prices, and exchange rate depreciation, among others. In most cases, economies have more flexibility than what is admitted. In all cases, when monetary sovereignty prevails, the fiscal position and the public debt are poor metrics for judging the viability of a public purpose and its pace of implementation.
As such, applying MMT to policymaking does not mean that a government ought to be encouraged to record fiscal deficits or that the relation between the central bank and the treasury ought to be radically changed to allow direct financing. The fiscal balance is not a proper policy goal because it leads to irrelevant or incorrect policymaking and because it is largely outside the control of policymakers. The financial praxis of monetarily sovereign governments already conforms to MMT. Central banks and treasuries routinely coordinate their financial operations. Some governments have allowed direct financing of the treasury by the central bank; others have not but have developed equivalent ways to coordinate their fiscal and monetary operations that work around existing political constraints. Such routine coordination ensures an elastic financing of government operations that at least deals with domestic resources and is not intrinsically inflationary.Download:Associated Program(s):Author(s):Related Topic(s): -
Public Policy Brief No. 156 | December 2021
The Federal Reserve’s Continuing Experiments with Unobservables
Institute President Dimitri B. Papadimitriou and Senior Scholar L. Randall Wray contend that the prevailing approach to monetary policy and inflation is influenced by a set of concepts that are a poor guide to action. In this policy brief, they examine two previous cases in which the Federal Reserve misread the data and raised rates too soon, as well as the evolution of the Fed’s thought and practice over the past three decades—a period in which the central bank has increasingly turned to unobservable indicators that are supposed to predict inflation. Noting that their criticisms have now been raised by the Fed’s own members and research staff, the authors highlight the ways in which we need to rethink our overall framework for monetary and fiscal policy. The Fed has far less control over inflation than is presumed, they argue, and, at worst, might have the whole inflation-fighting strategy backwards. Managing inflation, they conclude, should not be left entirely in the hands of central banks.Download:Associated Program:Author(s):Related Topic(s): -
Working Paper No. 992 | August 2021
Government as the Source of the Price Level and Unemployment
Many of the claims put forth by Modern Monetary Theory (MMT) center around the state’s monopoly over its own currency. In this paper I interrogate the plausibility of two claims: 1) MMT’s theory of the price level—that the price level is a function of prices paid by government when it spends—and 2) the claim that the cause of deficient effective demand is the state’s failure to supply government liabilities so as to meet the demand for net financial assets. I do so by building a model of “monopoly money” capable of producing these two outcomes.Download:Associated Program:Author(s):Sam LeveyRelated Topic(s): -
e-pamphlets | August 2021Modern Money Theory (MMT) has been frequently mentioned in recent media—first as “crazy talk” that if followed would bankrupt the nation and then, after the COVID-19 pandemic hit, as a way to finance an emergency response. In recent months, however, Washington seems to have returned to the old view that government spending must be “paid for” with new taxes. This raises the question: Has MMT really made headway with policymakers? This e-pamphlet examines the extraordinary interview given recently by Representative John Yarmuth’s (D, KY-03), Chair of the House Budget Committee, in which he explicitly adopts an MMT approach to budgeting. Chairman Yarmuth also lays out a path for realizing the major elements of President Biden’s proposals. Finally, Wray summarizes a recent presentation he gave to the Congressional Budget Office’s Macroeconomic Analysis section that urged reconsideration of the way that fiscal policy impacts are assessed.Download:Associated Program(s):Monetary Policy and Financial Structure Economic Policy for the 21st Century The State of the US and World EconomiesAuthor(s):Related Topic(s):Region(s):United States
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Working Paper No. 991 | July 2021This paper presents multifactor Keynesian models of the long-term interest rate. In recent years there have been a proliferation of empirical studies based on the Keynesian approach to interest rate modeling. However, standard multifactor models of the long-term interest rate in quantitative finance have not been yet incorporated Keynes’s insights about interest rate dynamics. Keynes’s insights about the influence of the current short-term interest rate are introduced in two different multifactor models of the long-term interest rate to illustrate how the long-term interest rate relates to the short-term interest rate, the central bank’s policy rate, inflation expectations, the central bank’s inflation target, volatility in financial markets, and Wiener processes.Download:Associated Program:Author(s):Tanweer AkramRelated Topic(s):
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Working Paper No. 988 | June 2021There are several widely used benchmark models of the long-term interest rate in quantitative finance. However, these models have yet to incorporate Keynes’s valuable insights about interest rate dynamics. The Keynesian approach to interest rate dynamics can be readily incorporated in the benchmark models of the long-term interest rate. This paper modifies several benchmark interest rate models. In these modified models the long-term interest rate is related to the short-term interest rate and a Wiener process. The Keynesian approach to interest rate dynamics can be useful in addressing theoretical and policy issues.Download:Associated Program:Author(s):Tanweer AkramRelated Topic(s):
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One-Pager No. 66 | April 2021According to Frank Veneroso, a broad subset of today’s US stock market has become what he calls a “pure price-chasing bubble.” Examination of the history of comparable pure price-chasing bubbles shows there has been a set of key causal factors that contributed to these rare market events. The most extreme such case was an over-the-counter market in Kuwait called the “Souk al-Manakh.” This exemplar of a pure price-chasing phenomenon may shed light—albeit unflattering—on the current US equity market, Veneroso contends.Download:Associated Program:Author(s):Frank VenerosoRelated Topic(s):
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Working Paper No. 987 | March 2021
The Anatomy of a Pure Price-Chasing Bubble
It is widely agreed that the Nasdaq during the dot-com era 20 years ago was a full-fledged stock market bubble. Recently, the US stock market according to many metrics has become significantly more speculative and overvalued than it was at the dot-com peak 20 years ago. In both instances, a very broad subset of stocks became so highly valued that speculation in them had to be untethered from all fundamentals: the essence of what we call a “pure price-chasing bubble.”
This paper, drawn from a book in progress, examines the history of stock markets for comparable pure price-chasing bubbles, finding nine or so which have ever reached such a speculative extreme, with an over-the-counter market in Kuwait in the early 1980s called the “Souk al-Manakh” representing the most extreme example. Based on personal exposure to this Souk al-Manakh almost 40 years ago, we describe this anatomy and thereby make transparent the recurrent dynamics—on the way up and on the way down—of these greatest asset bubbles in human history. When one applies this framework to the current US stock market, one sees that the stock market in the US today will likely follow the disastrous path of the dot-com market.Download:Associated Program:Author(s):Frank Veneroso Mark PasqualiRelated Topic(s): -
Working Paper No. 986 | March 2021
Evolution and Contemporary Relevance
This paper traces the evolution of John Maynard Keynes’s theory of the business cycle from his early writings in 1913 to his policy prescriptions for the control of fluctuations in the early 1940s. The paper identifies six different “theories” of business fluctuations. With different theoretical frameworks in a 30-year span, the driver of fluctuations—namely cyclical changes in expectations about future returns—remained substantially the same. The banking system also played a pivotal role throughout the different versions, by financing and influencing the behavior of return expectations. There are four major changes in the evolution of Keynes’s business cycle theories: a) the saving–investment framework to understand changes in economic fluctuations; b) the capabilities of the banking system to moderate the business cycle; c) the effectiveness of monetary policy to fine tune the business cycle through the control of the short-term interest rate or credit conditions; and d) the role of a comprehensive fiscal policy and investment policy to attenuate fluctuations. Finally, some conclusions are drawn about the present relevance of the policy mix Keynes promoted for ensuring macroeconomic stability.Download:Associated Program(s):Author(s):Pablo Gabriel BortzRelated Topic(s): -
Working Paper No. 985 | February 2021
No! And Yes.
Modern Money Theory (MMT) economists have used Japan as an example of a country that demonstrates that high deficits and debt do not lead to insolvency, high interest rates, or inflation. MMT insists that governments that issue their own sovereign currency cannot be forced into insolvency, that they can make all payments as they come due, and that they do not really spend tax revenue or borrow in their own currency—with Japan serving as an example of a country that does not face financial budget constraints as normally defined. In this paper we evaluate whether Japan is the poster child of MMT and argue that policy-wise Japan is not following MMT recommendations; in fact, it is generally adopting policies that are precisely the opposite of those proposed by MMT, consistently adopting the path of stop-go fiscal measures and engaging in inadequate and temporary fiscal stimuli in the face of recessions, followed by austerity whenever the economy has seemed to recover.Download:Associated Program(s):Author(s):Related Topic(s): -
Working Paper No. 984 | February 2021This paper presents empirical models of Mexican government bond (MGB) yields based on monthly macroeconomic data. The current short-term interest rate has a decisive influence on MGB yields, after controlling for inflation and growth in industrial production. John Maynard Keynes claimed that government bond yields move in lockstep with the short-term interest rate. The models presented in the paper show that Keynes’s claim holds for MGB yields. This has important policy implications for Mexico. The empirical findings of the paper are also relevant for ongoing debates in macroeconomics.Download:Associated Program:Author(s):Tanweer Akram Syed Al-Helal UddinRelated Topic(s):
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Public Policy Brief No. 154 | February 2021
Let Us Look Seriously at the Clearing Union
This policy brief explores a route to remaking the international financial system that would avoid the contradictions inherent in some of the prevailing reform proposals currently under discussion. Senior Scholar Jan Kregel argues that the willingness of central banks to consider electronic currency provides an opening to reconsider a truly innovative reform of the international financial system, and one that is more appropriate to a digital monetary world: John Maynard Keynes’s original clearing union proposal.
Kregel investigates whether such a clearing system could be built up from an already-existing initiative that has emerged in the private sector. He analyzes the operations of a private, cross-border payment system that could serve as a real-world blueprint for a more politically palatable equivalent of Keynes’s international clearing union.Download:Associated Program(s):Author(s):Jan KregelRelated Topic(s):Region(s):United States, Europe -
Working Paper No. 982 | January 2021The success of alternative payment systems has led to discussion of various proposals to replace money with a new technology-based system, though many lack a clear idea of what exactly is the “money” they seek to replace. We begin by presenting the explanation of money’s role in the economy embraced by most mainstream economists and policy analysts, based on the idea that money evolved out of the process of market exchange. An alternative explanation that looks on money as a part of the organization of production and distribution based on network clearing systems across balance sheets expressed in a common unit of account is then presented, distinguishing between a purely notional unit of account and means of settlement or discharge of debt. The final section addresses the possibility of a fundamentally different modern extension of this alternative approach that is not inspired by digital technology, distributed ledger accounting, or application operating on a mobile/cell phone system, but rather the actually existing system available from an internet telephone service provider that currently offers subsidiary domestic and international payment services whose operating procedures come close to replicating the alternative explanation of money mentioned above, with the potential to provide all the services of the existing payments system at lower costs and greater stability.Download:Associated Program:Author(s):Jan KregelRelated Topic(s):
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Policy Note 2021/1 | January 2021While governments may consider implementation of John Maynard Keynes’s original clearing union proposal for the international financial architecture too difficult or radical, Senior Scholar Jan Kregel notes that the private sector has already produced a virtual equivalent of an international global monetary system. Currently, this system is employed as an extension of the international mobile telephone services provided by a private company, rather than a financial institution. The clearing system he describes provides an example of a possible solution that retains national currencies without requiring the substitution of the dollar with another national currency or basket of national currencies.Download:Associated Program:Author(s):Jan KregelRelated Topic(s):
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Working Paper No. 977 | November 2020This paper relates Keynes’s discussions of money, the state theory of money, financial markets, investors’ expectations, uncertainty, and liquidity preference to the dynamics of government bond yields for countries with monetary sovereignty. Keynes argued that the central bank can influence the long-term interest rate on government bonds and the shape of the yield curve mainly through the short-term interest rate. Investors’ psychology, herding behavior in financial markets, and uncertainty about the future reinforce the effects of the short-term interest rate and the central bank’s monetary policy actions on the long-term interest rate. Several recent empirical studies that examine the dynamics of government bond yields substantiate the Keynesian perspective that the long-term interest rate responds markedly to the short-term interest rate. These empirical studies not only vindicate the Keynesian perspective but also have relevance for macroeconomic theory and policy.Download:Associated Program:Author(s):Tanweer AkramRelated Topic(s):
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Policy Note 2020/6 | October 2020As COVID-19 infection and test positivity rates rise in the United States and federal stimulus plans expire, Senior Scholar Jan Kregel articulates an alternative approach to analyzing the economic problems raised by the pandemic and organizing an appropriate policy response. In contrast to both the mainstream and some Keynesian-inspired approaches, Kregel advocates a central role for direct social provisioning as a means of equitably sharing the costs of quarantine under conditions of strict lockdown.Download:Associated Program(s):Author(s):Jan KregelRelated Topic(s):Region(s):United States
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Working Paper No. 974 | October 2020
Financial Instability and Crises in Keynes’s Monetary Thought
This paper revisits Keynes’s writings from Indian Currency and Finance (1913) to The General Theory (1936) with a focus on financial instability. The analysis reveals Keynes’s astute concerns about the stability/fragility of the banking system, especially under deflationary conditions. Keynes’s writings during the Great Depression uncover insights into how the Great Depression may have informed his General Theory. Exploring the connection between the experience of the Great Depression and the theoretical framework Keynes presents in The General Theory, the assumption of a constant money stock featuring in that work is central. The analysis underscores the case that The General Theory is not a special case of the (neo-)classical theory that is relevant only to “depression economics”—refuting the interpretation offered by J. R. Hicks (1937) in his seminal paper “Mr. Keynes and the Classics: A Suggested Interpretation.” As a scholar of the Great Depression and Federal Reserve chairman at the time of the modern crisis, Ben Bernanke provides an important intellectual bridge between the historical crisis of the 1930s and the modern crisis of 2007–9. The paper concludes that, while policy practice has changed, the “classical” theory Keynes attacked in 1936 remains hegemonic today. The common (mis-)interpretation of The General Theory as depression economics continues to describe the mainstream’s failure to engage in relevant monetary economics.Download:Associated Program(s):Author(s):Related Topic(s): -
Working Paper No. 973 | October 2020
An Open Economy Perspective
This paper is focused on Modern Monetary Theory’s (MMT) treatment of inflation from an open economy perspective. It analyzes how the inflation process is explained within the MMT framework and provides empirical evidence in support of this vision. However, it also makes use of a stock-flow consistent (open economy) model to underline some limits of the theory when it is applied in the context of a non-US (relatively) open economy with a flexible exchange rate regime. The model challenges the contention made by MMTers that measures such as the job guarantee program can achieve full employment without facing an inflation-unemployment trade-off.Download:Associated Program:Author(s):Emilio Carnevali Matteo DeleidiRelated Topic(s): -
Working Paper No. 972 | September 2020
On the Nature and Outcomes of the Beauty Contest
Since the 2008 crisis, the economics literature has shown a renewed interest in Keynes’s “beauty contest” (BC) as a fundamental aspect of the functioning of financial markets. We argue that to understand the importance of the BC, psychological and informational factors are of small importance, and a dynamic-structural approach should be followed instead: the BC framework is paramount because it is rooted in the historical trajectory of capitalism and it is not simply a consequence of “irrational” (i.e., biased) agents. In this genuine form, the BC mechanism allows one to understand the main trends of a financialized world. Moreover, the conventional nature of financial markets provides a sound method for assessing different economic policies whose effectiveness depends on how much they can influence the convention itself. This alternative understanding of the BC can be used to start the needed rethinking of economics, urged by the crisis, that is for now reduced to studying the financial and psychological “imperfections” of the market.Download:Associated Program:Author(s):Lorenzo Esposito Giuseppe MastromatteoRelated Topic(s): -
Working Paper No. 971 | September 2020In a seminal 1972 paper, Robert M. May asked: “Will a Large Complex System Be Stable?” and argued that stability (of a broad class of random linear systems) decreases with increasing complexity, sparking a revolution in our understanding of ecosystem dynamics. Twenty-five years later, May, Levin, and Sugihara translated our understanding of the dynamics of ecological networks to the financial world in a second seminal paper, “Complex Systems: Ecology for Bankers.” Just a year later, the US subprime crisis led to a near worldwide “great recession,” spread by the world financial network. In the present paper we describe highlights in the development of our present understanding of stability and complexity in network systems, in order to better understand the role of networks in both stabilizing and destabilizing economic systems. A brief version of this working paper, focused on the underlying theory, appeared as an invited feature article in the February 2020 Society for Chaos Theory in Psychology and the Life Sciences newsletter (Hastings et al. 2020).Download:Associated Program(s):Author(s):Related Topic(s):Region(s):United States
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Working Paper No. 969 | September 2020This paper analyzes the nominal yields of UK gilt-edged securities (“gilts”) based on a Keynesian perspective, which holds that the short-term interest rate is the primary driver of the long-term interest rate. Quarterly data are used to model gilts’ nominal yields. These models bring to light the complex dynamics relating the nominal yields on gilts to the short-term interest rate, inflation, the growth of industrial production, and the government debt ratio. The results show that the short-term interest rate has a crucial influence on the nominal yields on gilts, even after controlling for various factors. Contrary to widely held views, a higher government debt ratio does not lead to higher nominal yields.Download:Associated Program:Author(s):Tanweer Akram Huiqing LiRelated Topic(s):
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Working Paper No. 968 | September 2020
A Minskyan Approach to Mapping and Managing the (Western?) Financial Turmoil
The COVID-19 crisis paralyzed huge parts of the planet in weeks. It not only infected the population but injected a gargantuan dose of uncertainty into the system. In that regard, as in many others, it is a phenomenon without precedent. As of the time of writing (May–June 2020), we are witnessing, simultaneously, a health crisis, an economic crisis, and a crisis of global governance as well. In the forthcoming months, it could well turn into a set of financial, social, and political crises most governments and international organizations are ill-prepared to handle. In this paper, what concerns us is the financial dimension of the crisis. The paper is divided into four sections. Following the introduction, the second section maps the financial dimension of the pandemic through an extension of Hyman Minsky’s financial fragility analysis. The result is a three-pronged analytical framework that encompasses financial fragility, financial instability, and insolvency-triggered asset-liability restructuring processes. These are seen as three distinct but interconnected processes advancing financial fragility. The third section dissects how these three processes have been managed as they have unfolded since March 2020, underlining the key policy interventions and institutional innovations introduced so far, and suggesting further measures for addressing the forthcoming stages of the financial turmoil. The fourth section concludes the paper by pointing out the results as of June 2020 and highlights our intended analytical contribution to Minsky’s theoretical framework.Download:Associated Program:Author(s):Leonardo Burlamaqui Ernani T. Torres FilhoRelated Topic(s): -
One-Pager No. 64 | August 2020As congressional negotiations stall and state governments are poised to enact significant austerity, Alex Williams argues that fiscal aid to state governments should be tied to economic indicators rather than the capriciousness of federal legislators. Building this case for reform requires confronting a common objection: that state fiscal aid creates situations of moral hazard. This objection misconstrues the agency of state governments and misunderstands the incentives of federal politicians, according to Williams. There is a serious moral hazard problem involved here—but it is not the one widely claimed.Download:Associated Program(s):Author(s):Alex WilliamsRelated Topic(s):
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Public Policy Brief No. 152 | August 2020The mainstream fiscal federalism literature has led to an instinctive belief that states receiving fiscal aid during a recession are taking advantage of the federal government in pursuit of localized benefits with dispersed costs. This policy brief by Alex Williams challenges this unreflective argument and, in response, offers a novel framework for understanding the relationship between the business cycle and fiscal federalism in the United States.
Utilizing the work of Michael Pettis, Williams demonstrates that a government unable to design its own capital structure is not meaningfully an agent with respect to the business cycle. As such, they cannot be considered agents in a moral hazard problem when receiving support from the federal government during a recession.
From the perspective of this policy brief, the operative moral hazard problem is one in which federal-level politicians reap a political benefit from a seemingly principled refusal to increase federal spending, while avoiding blame for crisis and austerity at the state and local government level. Williams’ proposed solution is to impose macroeconomic discipline on federal policymakers by creating automatic stabilizers that take decisions about the level of state fiscal aid in a recession out of their hands.Download:Associated Program(s):Author(s):Alex WilliamsRelated Topic(s): -
Working Paper No. 962 | July 2020This paper models the dynamics of Japanese government bond (JGB) nominal yields using daily data. Models of government bond yields based on daily data, such as those presented in this paper, can be useful not only to investors and market analysts, but also to central bankers and other policymakers for assessing financial conditions and macroeconomic developments in real time. The paper shows that long-term JGB nominal yields can be modeled using the short-term interest rate on Treasury bills, the equity index, the exchange rate, commodity price index, and other key financial variables.Download:Associated Program:Author(s):Tanweer Akram Huiqing LiRelated Topic(s):
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Working Paper No. 961 | July 2020Modern money theory (MMT) synthesizes several traditions from heterodox economics. Its focus is on describing monetary and fiscal operations in nations that issue a sovereign currency. As such, it applies Georg Friedrich Knapp’s state money approach (chartalism), also adopted by John Maynard Keynes in his Treatise on Money. MMT emphasizes the difference between a sovereign currency issuer and a sovereign currency user with respect to issues such as fiscal and monetary policy space, ability to make all payments as they come due, credit worthiness, and insolvency. Following A. Mitchell Innes, however, MMT acknowledges some similarities between sovereign and nonsovereign issues of liabilities, and hence integrates a credit theory of money (or, “endogenous money theory,” as it is usually termed by post-Keynesians) with state money theory. MMT uses this integration in policy analysis to address issues such as exchange rate regimes, full employment policy, financial and economic stability, and the current challenges facing modern economies: rising inequality, climate change, aging of the population, tendency toward secular stagnation, and uneven development. This paper will focus on the development of the “Kansas City” approach to MMT at the University of Missouri–Kansas City (UMKC) and the Levy Economics Institute of Bard College.Download:Associated Program(s):Author(s):Related Topic(s):
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Policy Note 2020/5 | July 2020In this policy note, Jan Toporowski provides an analysis of government debt management using fiscal principles derived from the work of Michał Kalecki. Dividing the government’s budget into a “functional” and “financial” budget, Toporowski demonstrates how a financial budget balance—servicing government debt from taxes on wealth and profits that do not affect incomes and expenditures in the economy—allows a government to manage its debts without compromising the macroeconomic goals set in the functional budget. By splitting the budget into a functional budget that affects the real economy and a financial budget that just maintains debt payments and the liquidity of the financial system, the government can have two independent instruments that can be used to target, respectively, the macroeconomy and government debt—overcoming a dilemma that makes fiscal policy ineffective. This analysis also explains how pursuit of supply-side policies that result in a financial budget deficit and functional budget surplus can lead to slow growth, rising government debt, and financial instability.Download:Associated Program(s):Author(s):Jan ToporowskiRelated Topic(s):
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Public Policy Brief No. 150 | June 2020According to Senior Scholar Jan Kregel and Paolo Savona, attempting to maintain the status quo in the face of the introduction of some recent technological innovations—chiefly cryptocurrencies and associated instruments based on distributed ledger technology, the deployment of artificial intelligence, and the use of data science in financial markets—will create risks that increase instability and threaten national financial systems. In this policy brief, they analyze the impacts of these innovations on the present institutional environment and outline an appropriate regulatory framework. Kregel and Savona argue that a public monopoly on the issuance of cryptocurrency could promote financial stability and help repair the dissociation between finance and the real economy.Download:Associated Program:Author(s):Jan Kregel Paolo SavonaRelated Topic(s):
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Working Paper No. 956 | May 2020This paper empirically models the dynamics of Brazilian government bond (BGB) yields based on monthly macroeconomic data in the context of the evolution of Brazil’s key macroeconomic variables. The results show that the current short-term interest rate has a decisive influence on BGBs’ long-term interest rates after controlling for various key macroeconomic variables, such as inflation and industrial production or economic activity. These findings support John Maynard Keynes’s claim that the central bank’s actions influence the long-term interest rate on government bonds mainly through the short-term interest rate. These findings have important policy implications for Brazil. This paper relates the findings of the estimated models to ongoing debates in fiscal and monetary policies.Download:Associated Program:Author(s):Tanweer Akram Syed Al-Helal UddinRelated Topic(s):Bond markets Brazil Central bank policy Long-term interest rates Monetary policy Short-term interest ratesRegion(s):Latin America
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One-Pager No. 63 | April 2020As governments around the world explore ambitious approaches to fiscal and monetary policy in their responses to the COVID-19 crisis, Modern Money Theory (MMT) has been thrust into the spotlight once again. Unfortunately, many of those invoking the theory have misrepresented its central tenets, according Yeva Nersisyan and L. Randall Wray.
MMT provides an analysis of fiscal and monetary policy applicable to national governments with sovereign, nonconvertible currencies. In the context of articulating the elements of that analysis, Nersisyan and Wray draw out one of the lessons to be learned from the pandemic and its policy responses: that the government’s ability to run deficits is not limited to times of crisis; that we must build up our supplies, infrastructure, and institutions in normal times, and not wait for the next crisis to live up to our means.Download:Associated Program(s):Author(s):Related Topic(s): -
Working Paper No. 951 | April 2020This paper presents a simple model of the long-term interest rate. The model represents John Maynard Keynes’s conjecture that the central bank’s actions influence the long-term interest rate primarily through the short-term interest rate, while allowing for other important factors. It relies on the geometric Brownian motion to formally model Keynes’s conjecture. Geometric Brownian motion has been widely used in modeling interest rate dynamics in quantitative finance. However, it has not been used to represent Keynes’s conjecture. Empirical studies in support of the Keynesian perspective and the stylized facts on the dynamics of the long-term interest rate on government bonds suggest that interest rate models based on Keynes’s conjecture can be advantageous.Download:Associated Program:Author(s):Tanweer AkramRelated Topic(s):
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Press Releases | April 2020Download:Associated Program(s):Author(s):Mark PrimoffRelated Topic(s):
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Policy Note 2020/2 | April 2020The federal government appears to have abandoned the idea of a coordinated public health response to the COVID-19 pandemic, leaving the entirety to state and local governments. Meanwhile, the economic standstill resulting from necessary public health measures will soon cripple state and local budgets. Alexander Williams outlines a proposal for an intragovernmental automatic stabilizer program that would provide a backstop for state and local finances—both during the pandemic and beyond. Without this program, states will be severely constrained in their ability to respond to COVID-19, and balanced budget requirements will force them to cut jobs and raise taxes during the deepest recession in living memory.Download:Associated Program(s):Author(s):Alex WilliamsRelated Topic(s):
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Policy Note 2020/1 | March 2020
The Economic Implications of the Pandemic
The spread of the new coronavirus (COVID-19) is a major shock for the US and global economies. Research Scholar Michalis Nikiforos explains that we cannot fully understand the economic implications of the pandemic without reference to two Minskyan processes at play in the US economy: the growing divergence of stock market prices from output prices, and the increasing fragility in corporate balance sheets.
The pandemic did not arrive in the context of an otherwise healthy US economy—the demand and supply dimensions of the shock have aggravated an inevitable adjustment process. Using a Minskyan framework, we can understand how the current economic weakness can be perpetuated through feedback effects between flows of demand and supply and their balance sheet impacts.Download:Associated Program(s):Author(s):Related Topic(s):COVID-19 Economic crisis Financial crisis Hyman Minsky Instability Private sector debt Recession Stock markets Stock-flow consistencyRegion(s):United States -
Working Paper No. 948 | February 2020This paper analyzes recent macroeconomic developments in the eurozone, particularly in Germany. Several economic indicators are sending signals of a looming German recession. Geopolitical tensions caused by trade disputes between the United States and China, plus the risk of a disorderly Brexit, began disrupting the global supply chain in manufacturing. German output contraction has been centered on manufacturing, particularly the automobile sector. Despite circumstances that call for fiscal intervention to rescue the economy, Chancellor Angela Merkel’s government was overdue with corrective measures. This paper explains Germany’s hesitancy to protect its economy, which has been based on a political and historical ideology that that rejects issuing new public debt to increase public spending, thus leaving the economy exposed to the doldrums. The paper also considers serious shortcomings in the European Union’s (EU) foreign and defense policies that recently surfaced during the Syrian refugee crisis. The eurocrisis revealed near-fatal weaknesses of the European Monetary Union (EMU), which is still incomplete without a common fiscal policy, a common budget, and a banking union. Unless corrected, such deficiencies will cause both the EU and the EMU to dissolve if another asymmetric shock occurs. This paper also analyzes recent geopolitical developments that are crucial to the EU/eurozone’s existential crisis.Download:Associated Program(s):Author(s):George Zestos Rachel N. CookeRelated Topic(s):Region(s):Europe
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Working Paper No. 947 | February 2020Starting from the mid-nineteenth century, this paper analyzes two periods of financial instability connected with financial globalization. The first culminates with the 1929 crisis, while the second characterizes the more recent experience starting from the 1970s. The period in between is divided into two subperiods. The first goes up to World War II and sees a retrenchment from globalization and the affirmation of a statist approach to national policy autonomy in pursuing domestic goals, for which we take as examples the New Deal, financial regulation, and the new international cooperative approach finally leading to Bretton Woods. The second subperiod, marked by the new international monetary order and limited globalization, although appearing as a relatively calm interlude, conceals the seeds of a renewed push toward financial fragility. The above periods are synthetically analyzed in terms of the development and mutual fertilization of theories, institutions, and vested public and private interests. The narrative is based on two interpretative keys: the Minskyan theory of financial fragility and changes in the public-private partnership, mainly with reference to the financial sector for which the role of the state as guarantor of last resort necessarily ensues. The lesson that can be derived is that a laissez-faire approach to globalization strengthens asymmetric powers and necessarily leads to overglobalization, as well as to financial and economic instability, rendering it extremely difficult and socially costly for the state to comply with its role as financial guarantor.Download:Associated Program:Author(s):Mario TonveronachiRelated Topic(s):
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Working Paper No. 944 | January 2020Keynes argued that the short-term interest rate is the main driver of the long-term interest rate. This paper empirically models the relationship between short-term interest rates and long-term government securities yields in Canada, after controlling for other important financial variables. The statistical analysis uses high-frequency daily data from 1990 to 2018. It applies both the cointegration technique and Granger causality within the vector error correction (VEC) framework. The empirical results suggest that the action of the monetary authority is an important determinant of Canadian government securities yields, which supports the Keynesian perspective. These findings have important implications for investors, financial analysts, and policymakers.Download:Associated Program:Author(s):Tanweer Akram Anupam DasRelated Topic(s):
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Working Paper No. 942 | January 2020This paper emphasizes the need for understanding the interdependencies between the real and financial sides of the economy in macroeconomic models. While the real side of the economy is generally well explained in macroeconomic models, the financial side and its interaction with the real economy remains poorly understood. This paper makes an attempt to model the interdependencies between the real and financial sides of the economy in Denmark while adopting a stock-flow consistent approach. The model is estimated using Danish data for the period 1995–2016. The model is simulated to create a baseline scenario for the period 2017–30, against which the effects of two standard shocks (fiscal shocks and interest rate shocks) are analyzed. Overall, our model is able to replicate the stylized facts, as will be discussed. While the model structure is fairly simple due to different constraints, the use of the stock-flow approach makes it possible to explain several transmission mechanisms through which real economic behavior can affect the balance sheets, and at the same time capture the feedback effects from the balance sheets to the real economy. Finally, we discuss certain limitations of our model.Download:Associated Program(s):Author(s):Mikael Randrup Byrialsen Hamid RazaRelated Topic(s):
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Testimony | November 2019
Reexamining the Economic Costs of Debt
On November 20, 2019, Senior Scholar L. Randall Wray testified before the House Committee on the Budget on the topic of reexamining the economic costs of debt:
"In recent months a new approach to national government budgets, deficits, and debts—Modern Money Theory (MMT)—has been the subject of discussion and controversy. [. . .]
In this testimony I do not want to rehash the theoretical foundations of MMT. Instead I will highlight empirical facts with the goal of explaining the causes and consequences of the intransigent federal budget deficits and the growing national government debt. I hope that developing an understanding of the dynamics involved will make the topic of deficits and debt less daunting. I will conclude by summarizing the MMT views on this topic, hoping to set the record straight."
Update 1/7/2020: In an appendix, L. Randall Wray responds to a Question for the Record submitted by Rep. Ilhan OmarDownload:Associated Program(s):Author(s):Related Topic(s): -
Working Paper No. 938 | October 2019Nominal yields for Japanese government bonds (JGBs) have been remarkably low for several decades. Japanese government debt ratios have continued to increase amid a protracted period of stagnant nominal GDP, low inflation, and deflationary pressures. Many analysts are puzzled by the phenomenon of JGBs’ low nominal yields because Japanese government debt ratios are elevated. However, this paper shows that the Bank of Japan’s (BoJ) highly accommodative monetary policy is primarily responsible for keeping JGB yields low for a protracted period. This is consistent with Keynes’s view that the short-term interest rate is the key driver of the long-term interest rate. This paper also relates the BoJ’s monetary policy and economic developments in Japan to the evolution of JGBs’ long-term interest rates.Download:Associated Program(s):Author(s):Tanweer Akram Huiqing LiRelated Topic(s):Government bond yields Japan Japanese government bonds (JGBs) John Maynard Keynes Long-term interest rates Monetary policy Nominal bond yieldsRegion(s):Asia
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Working Paper No. 936 | September 2019
The Modern Money Theory Approach
This paper will present the Modern Money Theory approach to government finance. In short, a national government that chooses its own money of account, imposes a tax in that money of account, and issues currency in that money of account cannot face a financial constraint. It can make all payments as they come due. It cannot be forced into insolvency. While this was well understood in the early postwar period, it was gradually “forgotten” as the neoclassical theory of the household budget constraint was applied to government finance. Matters were made worse by the development of “generational accounting” that calculated hundreds of trillions of dollars of government red ink through eternity due to “entitlements.” As austerity measures were increasingly adopted at the national level, fiscal responsibility was shifted to state and local governments through “devolution.” A “stakeholder” approach to government finance helped fuel white flight to suburbs and produced “doughnut holes” in the cities. To reverse these trends, we need to redevelop our understanding of the fiscal space open to the currency issuer—expanding its responsibility not only for national social spending but also for helping to fund state and local government spending. This is no longer just an academic debate, given the challenges posed by climate change, growing inequality, secular stagnation, and the rise of Trumpism.Download:Associated Program(s):Author(s):Related Topic(s): -
Working Paper No. 935 | August 2019
A Liquidity Preference Theoretical Perspective
This paper investigates the peculiar macroeconomic policy challenges faced by emerging economies in today’s monetary (non)order and globalized finance. It reviews the evolution of the international monetary and financial architecture against the background of Keynes’s original Bretton Woods vision, highlighting the US dollar’s hegemonic status. Keynes’s liquidity preference theory informs the analysis of the loss of policy space and widespread instabilities in emerging economies that are the consequence of financial hyperglobalization. While any benefits promised by mainstream promoters remain elusive, heightened vulnerabilities have emerged in the aftermath of the global crisis.Download:Associated Program(s):Author(s):Related Topic(s): -
Working Paper No. 934 | August 2019This paper analyzes the dynamics of long-term US Treasury security yields from a Keynesian perspective using daily data. Keynes held that the short-term interest rate is the main driver of the long-term interest rate. In this paper, the daily changes in long-term Treasury security yields are empirically modeled as a function of the daily changes in the short-term interest rate and other important financial variables to test Keynes’s hypothesis. The use of daily data provides a long time series. It enables the extension of earlier Keynesian models of Treasury security yields that relied on quarterly and monthly data. Models based on higher-frequency daily data from financial markets—such as the ones presented in this paper—can be valuable to investors, financial analysts, and policymakers because they make it possible for a real-time fundamental assessment of the daily changes in long-term Treasury security yields based on a wide range of financial variables from a Keynesian perspective. The empirical findings of this paper support Keynes’s view by showing that the daily changes in the short-term interest rate are the main driver of the daily changes in the long-term interest rate on Treasury securities. Other financial variables, such as the daily changes in implied volatility of equity prices and the daily changes in the exchange rate, are found to have some influence on Treasury yields.Download:Associated Program(s):Author(s):Tanweer Akram Anupam DasRelated Topic(s):Government bond yields Long-term interest rates Monetary policy Securities markets Short-term interest ratesRegion(s):United States
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Working Paper No. 933 | July 2019
Making Sense of the Barro-Ricardo Equivalence in a Financialized World
The 2008 crisis created a need to rethink many aspects of economic theory, including the role of public intervention in the economy. On this issue, we explore the Barro-Ricardo equivalence, which has played a decisive role in molding the economic policies that fostered the crisis. We analyze the equivalence and its theoretical underpinnings, concluding that: (1) it declares, but then forgets, that it does not matter whether the nature of debt and investment is public or private; (2) its most problematic assumption is the representative agent hypothesis, which does not allow for an explanation of financialization and cannot assess dangers coming from high levels of financial leverage; (3) social wealth cannot be based on any micro-foundation and is linked to the role of the state as provider of financial stability; and (4) default is always the optimal policy for the government, and this remains true even when relaxing many equivalence assumptions. We go on to discuss possible solutions to high levels of public debt in the real world, inferring that no general conclusions are possible and every solution or mix of solutions must be tailored to each specific case. We conclude by connecting different solutions to the political balance of forces in the current era of financialization, using Italy (and, by extension, the eurozone) as a concrete example to better illustrate the discussion.Download:Associated Program(s):Author(s):Lorenzo Esposito Giuseppe MastromatteoRelated Topic(s): -
Working Paper No. 932 | June 2019Local government debt in China is increasing and presents a great threat to China’s financial stability. In China’s fiscal system, the central government often prioritizes reducing its fiscal deficit and can determine to a great extent the distribution of revenue and expenditure between itself and local governments. There is therefore a tendency for the fiscal burden to be shifted from the central government to the local governments. Resolving China’s local government debt problem requires not only strengthening regulation, but also abandoning the central government’s fiscal balance target, because this target may make regulation hard to sustain in times of economic downturn. This paper discusses central-local fiscal relations in the framework of Modern Money Theory, suggesting that, because a government with currency sovereignty can always afford any spending denominated in its own currency, China’s central government should bear a greater fiscal burden.Download:Associated Program:Author(s):Zengping He Genliang JiaRelated Topic(s):
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Working Paper No. 929 | May 2019Increases in the federal funds rate aimed at stabilizing the economy have inevitably been followed by recessions. Recently, peaks in the federal funds rate have occurred 6–16 months before the start of recessions; reductions in interest rates apparently occurred too late to prevent those recessions. Potential leading indicators include measures of labor productivity, labor utilization, and demand, all of which influence stock market conditions, the return to capital, and changes in the federal funds rate, among many others. We investigate the dynamics of the spread between the 10-year Treasury rate and the federal funds rate in order to better understand “when to ease off the (federal funds) brakes.”Download:Associated Program(s):Author(s):Related Topic(s):Region(s):United States
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Policy Note 2019/2 | May 2019Against the background of an ongoing trade dispute between the United States and China, Senior Scholar Jan Kregel analyzes the potential for achieving international adjustment without producing a negative impact on national and global growth. Once the structure of trade in the current international system is understood (with its global production chains and large imbalances financed by international borrowing and lending), it is clear that national strategies focused on tariff adjustment to reduce bilateral imbalances will not succeed. This understanding of the evolution of the structure of trade and international finance should also inform our view of how to design a new international financial system capable of dealing with increasingly large international trade imbalances.Download:Associated Program(s):Author(s):Jan KregelRelated Topic(s):Capital flows Current account imbalances International finance International trade Tariffs Trade imbalancesRegion(s):United States, Asia
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Working Paper No. 928 | May 2019In the Western interpretation of democracy, governments exist in order to manage relations of property, with absence of property ownership leading to exclusion from participation in governance and, in many cases, absence of equal treatment before the law. Democratizing money will therefore ensure equal opportunity to the ownership of property, and thus full participation in the democratic governance of society, as well as equal access to the banking system, which finances the creation of capital via the creation of money. If the divergence between capital and labor—between rich and poor—is explained by the monopoly access of capitalists to finance, then reducing this divergence is crucially dependent on the democratization of money. Though the role of money and finance in determining inequality between capital and labor transcends any particular understanding of the process by which the creation of money leads to inequity, specific proposals for the democratization of money will depend on the explanation of how money comes into existence and how it supports capital accumulation.Download:Associated Program(s):Author(s):Jan KregelRelated Topic(s):
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Working Paper No. 926 | April 2019
Lessons for Monetary Unions
The debate about the use of fiscal instruments for macroeconomic stabilization has regained prominence in the aftermath of the Great Recession, and the experience of a monetary union equipped with fiscal shock absorbers, such as the United States, has often been a reference. This paper enhances our knowledge about the degree of macroeconomic stabilization achieved in the United States through the federal budget, providing a detailed breakdown of the different channels. In particular, we investigate the relative importance and stabilization impact of the federal system of unemployment benefits and of its extension as a response to the Great Recession. The analysis shows that in the United States, corporate income taxes collected at the federal level are the single most efficient instrument for providing stabilization, given that even with a smaller size than other instruments they can provide important effects, mainly against common shocks. On the other hand, Social Security benefits and personal income taxes have a greater role in stabilizing asymmetric shocks. A federal system of unemployment insurance, then, can play an important stabilization role, in particular when enhanced by a discretionary program of extended benefits in the event of a large shock, like the Great Recession.Download:Associated Program(s):Author(s):Plamen Nikolov Paolo PasimeniRelated Topic(s): -
Policy Note 2019/1 | April 2019While a consensus has formed that the eurozone’s economic governance mechanisms must be reformed, and some progress has been made on this front, what has been agreed to so far falls short of what is needed to address the central imbalances caused by the eurozone setup, according to Paolo Savona.
The key elements that are missing from the current package of reforms are interrelated: a common insurance scheme for bank deposits, the possible regulation of banks’ sovereign exposure, and the existence of a common safe asset. Savona outlines a proposal to increase the supply of safe assets provided by a common European issuer (the European Stability Mechanism) and explains how the plan could be made economically and politically satisfactory to all member states while facilitating progress on the deposit insurance and sovereign exposure issues.Download:Associated Program(s):Author(s):Paolo SavonaRelated Topic(s):Region(s):Europe -
Working Paper No. 925 | April 2019This paper traces the history of China’s reform of its monetary policy framework and analyzes its success and problems. In the context of financial marketization and the failure of the quantity-targeting framework, the People’s Bank of China transformed its monetary policy framework toward one that targets interest rates. The reform includes two important institutional changes: establishing an interest rate corridor and decreasing the difficulty the Open Market Operations room faces in estimating the market demand for reserves. The new monetary policy framework successfully stabilizes the interbank offered rate. However, this does not mean that the new framework is sufficient. One important problem remaining to be solved is how to manage the effects of fiscal activities on monetary policy operations. This paper analyzes the fiscal effects on reserves in China’s Treasury Single Account system. The missing role of the Treasury in monetary policy operations increases the difficulty for the central bank to achieve its interest rate target. A further reform is therefore needed to provide a coordination mechanism between the Treasury and the People’s Bank of China.Download:Associated Program:Author(s):Zengping He Genliang JiaRelated Topic(s):
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Public Policy Brief No. 147 | March 2019As global market integration collides with growing demands for national political sovereignty, Senior Scholar Jan Kregel contrasts two diametrically opposed approaches to managing the tensions between international financial coordination and national autonomy. The first, a road not taken, is John Maynard Keynes’s proposal to reform the postwar international financial system. The second is the approach taken in the establishment of the eurozone and the development of its settlement and payment system. Analysis of Keynes’s clearing union proposal and its underlying theoretical approach highlights the flaws of the current eurozone setup.Download:Associated Program(s):Author(s):Jan KregelRelated Topic(s):Banking principle Clearing union Creditor countries Debtor countries Euro Eurozone Gold standard John Maynard Keynes Monetary theory TARGET2Region(s):Europe
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Working Paper No. 923 | February 2019
The New Deal and Postwar France Experiments
By the beginning of the 20th century, the possibility and efficacy of economic planning was believed to have been proven by totalitarian experiments in Germany, the Soviet Union, and, to a lesser degree, Fascist Italy; however, the possibilities and limitations of planning in capitalist democracies was unclear. The challenge in the United States in the 1930s and in postwar France was to find ways to make planning work under capitalism and democratic conditions, where private agents were free to not accept its directives.
This paper begins by examining the experience with planning during the first years of the New Deal in the United States, centered on the creation and operation of the National Recovery Administration (NRA) and the Agricultural Adjustment Administration (AAA), and continues with a discussion of the French experience with indicative planning in the aftermath of World War II. A digression follows, touching on the proximity between the matters treated in this paper and Keynes’s view that macroeconomic stabilization could require a measure of socialization of investments, following James Tobin’s hunch that French indicative planning, as well as some social democrat experiences in Northern Europe, could be playing precisely that role. The paper concludes by identifying the lessons one can draw from the two experiences.Download:Associated Program(s):Related Topic(s): -
Working Paper No. 918 | December 2018Divergent trends, as observed, between growth in the financial and real sectors of the global economy entail the need for further research, especially on the motivations behind investment decisions. Investments in market economies are generally guided by call-put option pricing models—which rely on an ergodic notion of probability that conforms to a normal distribution function. This paper considers critiques of the above models, which include Keynes’s Treatise on Probability (1921) and the General Theory (1936), as well as follow-ups in the post-Keynesian approaches and others dealing with “fundamental uncertainty.” The methodological issues, as can be pointed out, are relevant in the context of policy issues and social institutions, including those subscribed to by the ruling state. As it has been held in variants of institutional economics subscribed to by John Commons, Thorstein Veblen, Geoffrey Hodgeson, and John Kenneth Galbraith, social institutions remain important in their capacity as agencies that influence individual behavior with their “informational-cognitive” functions in society. By shaping business concerns and strategies, social institutions have a major impact on investment decisions in a capitalist system. The role of such institutions in investment decisions via policy making is generally neglected in strategies based on mainstream economics, which continue to rely on optimization of stock market returns based on imprecise estimations of probability.Download:Associated Program:Author(s):Related Topic(s):
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Policy Note 2018/5 | November 2018
Minsky’s Forgotten Lessons Ten Years after Lehman
Ten years after the fall of Lehman Brothers and the collapse of the US financial system, most commentaries remain overly focused on the proximate causes of the last crisis and the regulations put in place to prevent a repetition. According to Director of Research Jan Kregel, there is a broader set of lessons, which can be unearthed in the work of Distinguished Scholar Hyman Minsky, that needs to play a more central role in these debates on the 10th anniversary of the crisis.
This insight begins with Minsky's account of how crisis is inherent to capitalist finance. Such an account directs us to shore up those government institutions that can serve as bulwarks against the inherent instability of the financial system—institutions that can prevent that instability from turning into a prolonged crisis in the real economy.
Download:Associated Program:Author(s):Jan KregelRelated Topic(s): -
Working Paper No. 917 | October 2018
Lauchlin Currie and Hyman Minsky on Financial Systems and Crises
In November 1987, Hyman Minsky visited Bogotá, Colombia, after being invited by a group of professors who at that time were interested in post-Keynesian economics. There, Minsky delivered some lectures, and Lauchlin Currie attended two of those lectures at the National University of Colombia. Although Currie is not as well-known as Minsky in the American academy, both are outstanding figures in the development of non-orthodox approaches to monetary economics. Both alumni of the economics Ph.D. program at Harvard had a debate in Bogotá. Unfortunately, there are no formal records of this, so here a question arises: What could have been their respective positions? The aim of this paper is to discuss Currie’s and Minsky’s perspectives on monetary economics and to speculate on what might have been said during their debate.Download:Associated Program:Author(s):Iván D. VelasquezRelated Topic(s): -
Working Paper No. 916 | October 2018
Seigniorage as Fiscal Revenue in the Aftermath of the Global Financial Crisis
This study investigates the evolution of central bank profits as fiscal revenue (or: seigniorage) before and in the aftermath of the global financial crisis of 2008–9, focusing on a select group of central banks—namely the Bank of England, the United States Federal Reserve System, the Bank of Japan, the Swiss National Bank, the European Central Bank, and the Eurosystem (specifically Deutsche Bundesbank, Banca d’Italia, and Banco de España)—and the impact of experimental monetary policies on central bank profits, profit distributions, and financial buffers, and the outlook for these measures going forward as monetary policies are seeing their gradual “normalization.”
Seigniorage exposes the connections between currency issuance and public finances, and between monetary and fiscal policies. Central banks’ financial independence rests on seigniorage, and in normal times seigniorage largely derives from the note issue supplemented by “own” resources. Essentially, the central bank’s income-earning assets represent fiscal wealth, a national treasure hoard that supports its central banking functionality. This analysis sheds new light on the interdependencies between monetary and fiscal policies.
Just as the size and composition of central bank balance sheets experienced huge changes in the context of experimental monetary policies, this study’s findings also indicate significant changes regarding central banks’ profits, profit distributions, and financial buffers in the aftermath of the crisis, with considerable cross-country variation.Download:Associated Program:Author(s):Related Topic(s): -
Working Paper No. 913 | August 2018There is no disputing Germany’s dominant economic role within the eurozone (EZ) and the broader European Union. Economic leadership, however, entails responsibilities, especially in a world system of monetary production economies that compete with each other according to political and economic interests. In the first section of this paper, historical context is given to the United States’ undisputed leadership of monetary production economies following the end of World War II to help frame the broader discussion developed in the second section on the requirements of the leading nation-state in the new system of states after the war. The second section goes on further to discuss how certain constraints regarding the external balance do not apply to the leader of the monetary production economies. The third section looks at Hyman P. Minsky’s proposal for a shared burden between the hegemon and other core industrial economies in maintaining the stability of the international financial system. Section four looks at Germany’s leadership role within the EZ and how it must emulate some of the United States’ trade policies in order to make the EZ a viable economic bloc. The break up scenario is considered in the fifth section. The last section summarizes and concludes.Download:Associated Program(s):Author(s):Ignacio Ramirez CisnerosRelated Topic(s):Region(s):Europe
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Working Paper No. 911 | August 2018This paper reviews the performance of the euro area since the euro’s launch 20 years ago. It argues that the euro crisis has exposed existential flaws in the euro regime. Intra-area divergences and the corresponding buildup of imbalances had remained unchecked prior to the crisis. As those imbalances eventually imploded, member states were found to be extremely vulnerable to systemic banking problems and abruptly deteriorating public finances. Debt legacies and high unemployment continue to plague euro crisis countries. Its huge current account surplus highlights that the euro currency union, toiling under the German euro and trying to emulate the German model, has become very vulnerable to global developments. The euro regime is flawed and dysfunctional. Europe has to overcome the German euro. Three reforms are essential to turn the euro into a viable European currency. First, divergences in competitiveness positions must be prevented in future. Second, market integration must go hand in hand with policy integration. Third, the euro is lacking a safe footing for as long as the ECB is missing a federal treasury partner. Therefore, establishing the vital treasury–central bank axis that stands at the center of power in sovereign states is essential.Download:Associated Program(s):Author(s):Related Topic(s):Region(s):Europe
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Working Paper No. 910 | August 2018
An Empirical Analysis
The short-term interest rate is the main driver of the Commonwealth of Australia government bonds’ nominal yields. This paper empirically models the dynamics of government bonds’ nominal yields using the autoregressive distributed lag (ARDL) approach. Keynes held that the central bank exerts decisive influence on government bond yields because the central bank’s policy rate and other monetary policy actions determine the short-term interest rate, which in turn affects long-term government bonds’ nominal yields. The models estimated here show that Keynes’s conjecture applies in the case of Australian government bonds’ nominal yields. Furthermore, the effect of the budget balance ratio on government bond yields is small but statistically significant. However, there is no statistically discernable effect of the debt ratio on government bond yields.Download:Associated Program(s):Author(s):Tanweer Akram Anupam DasRelated Topic(s):Region(s):Pacific Rim -
Press Releases | June 2018Download:Associated Program(s):Author(s):Mark PrimoffRegion(s):Europe
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One-Pager No. 56 | June 2018The European Commission's proposal for the regulation of sovereign bond-backed securities (SBBSs) follows the release of a high-level taskforce report, sponsored by the European Systemic Risk Board, on the feasibility of an SBBS framework. The proposal and the SBBS scheme, Mario Tonveronachi argues, would fail to yield the intended results while undermining financial stability.
Tonveronachi articulates his alternative, centered on the European Central Bank's issuance of debt certificates along the maturity spectrum to create a common yield curve and corresponding absorption of a share of each eurozone country’s national debts. Alongside these financial operations, new reflationary but debt-reducing fiscal rules would be imposed.Download:Associated Program(s):Author(s):Mario TonveronachiRelated Topic(s):Debt certificates Debt sustainability Europe European Central Bank (ECB) Eurozone Financial market integration Fiscal policy Single marketRegion(s):Europe -
Public Policy Brief No. 145 | June 2018
An Assessment and an Alternative Proposal
In response to a proposal put forward by the European Commission for the regulation of sovereign bond-backed securities (SBBSs), Mario Tonveronachi provides his analysis of the SBBS scheme and attendant regulatory proposal, and elaborates on an alternative approach to addressing the problems that have motivated this high-level consideration of an SBBS framework.
As this policy brief explains, it is doubtful the SBBS proposal would produce its intended results. Tonveronachi’s alternative, discussed in Levy Institute Public Policy Briefs Nos. 137 and 140, not only better addresses the two problems targeted by the SBBS scheme, but also a third, critical defect of the current euro system: national sovereign debt sustainability.Download:Associated Program(s):Author(s):Mario TonveronachiRelated Topic(s):Debt certificates Debt sustainability Europe European Central Bank (ECB) Eurozone Financial market integration Fiscal policy Single marketRegion(s):Europe -
Working Paper No. 908 | June 2018
Rethinking the Role of Money and Markets in the Global Economy
Many of the hopes arising from the 1989 fall of the Berlin Wall were still unrealized in 2010 and remain so today, especially in monetary policy and financial supervision. The major players that helped bring on the 2008 financial crisis still exist, with rising levels of moral hazard, including Fannie Mae, Freddie Mac, the too-big-to-fail banks, and even AIG. In monetary policy, the Federal Reserve has only just begun to reduce its vastly increased balance sheet, while the European Central Bank has yet to begin. The Dodd-Frank Act of 2010 imposed new conditions on but did not contract the greatly expanded federal safety net and failed to reduce the substantial increase in moral hazard. The larger budget deficits since 2008 were simply decisions to spend at higher levels instead of rational responses to the crisis. Only an increased reliance on market discipline in financial services, avoidance of Federal Reserve market interventions to rescue financial players while doing little or nothing for households and firms, and elimination of the Treasury’s backdoor borrowings that conceal the real costs of increasing budget deficits can enable the American public to achieve the meaningful improvements in living standards that were reasonably expected when the Berlin Wall fell.Download:Associated Program:Author(s):W. Lee Hoskins Walker F. ToddRelated Topic(s): -
Working Paper No. 907 | May 2018The paper discusses the Sraffian supermultiplier (SSM) approach to growth and distribution. It makes five points. First, in the short run the role of autonomous expenditure can be appreciated within a standard post-Keynesian framework (Kaleckian, Kaldorian, Robinsonian, etc.). Second, and related to the first, the SSM model is a model of the long run and has to be evaluated as such. Third, in the long run, one way that capacity adjusts to demand is through an endogenous adjustment of the rate of utilization. Fourth, the SSM model is a peculiar way to reach what Garegnani called the “Second Keynesian Position.” Although it respects the letter of the “Keynesian hypothesis,” it makes investment quasi-endogenous and subjects it to the growth of autonomous expenditure. Fifth, in the long run it is unlikely that “autonomous expenditure” is really autonomous. From a stock-flow consistent point of view, this implies unrealistic adjustments after periods of changes in stock-flow ratios. Moreover, if we were to take this kind of adjustment at face value, there would be no space for Minskyan financial cycles. This also creates serious problems for the empirical validation of the model.Download:Associated Program(s):The State of the US and World Economies Monetary Policy and Financial Structure Explorations in Theory and Empirical AnalysisAuthor(s):Related Topic(s):Region(s):United States
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Working Paper No. 906 | May 2018This paper employs a Keynesian perspective to explain why Japanese government bonds’ (JGBs) nominal yields have been low for more than two decades. It deploys several vector error correction (VEC) models to estimate long-term government bond yields. It shows that the low short-term interest rate, induced by the Bank of Japan’s (BoJ) accommodative monetary policy, is mainly responsible for keeping long-term JGBs’ nominal yields exceptionally low for a protracted period. The results also demonstrate that higher government debt and deficit ratios do not exert upward pressure on JGBs’ nominal yields. These findings are relevant to ongoing policy debates in Japan and other advanced countries about government bond yields, fiscal sustainability, fiscal policy, functional finance, monetary policy, and financial stability.Download:Associated Program(s):Author(s):Tanweer Akram Huiqing LiRelated Topic(s):Banking Japanese government bonds (JGBs) John Maynard Keynes Long-term interest rates Monetary policy Nominal bond yieldsRegion(s):Asia
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Working Paper No. 904 | May 2018This paper provides an empirical analysis of nonfinancial corporate debt in six large Latin American countries (Argentina, Brazil, Chile, Colombia, Mexico, and Peru), distinguishing between bond-issuing and non-bond-issuing firms, and assessing the debt’s macroeconomic implications. The paper uses a sample of 2,241 firms listed on the stock markets of their respective countries, comprising 34 sectors of economic activity for the period 2009–16. On the basis of liquidity, leverage, and profitability indicators, it shows that bond-issuing firms are in a worse financial position relative to non-bond-issuing firms. Using Minsky’s hedge/speculative/Ponzi taxonomy for financial fragility, we argue that there is a larger share of firms that are in a speculative or Ponzi position relative to the hedge category. Also, the share of hedge bond-issuing firms declines over time. Finally, the paper presents the results of estimating a nonlinear threshold econometric model, which demonstrates that beyond a leverage threshold, firms’ investment contracts while they increase their liquidity positions. This has important macroeconomic implications, since the listed and, in particular, bond-issuing firms (which tend to operate under high leverage levels) represent a significant share of assets and investment. This finding could account, in part, for the retrenchment in investment that the sample of countries included in the paper have experienced in the period under study and highlights the need to incorporate the international bond market in analyses of monetary transmission mechanisms.Download:Associated Program(s):Author(s):Esteban Pérez Caldentey Nicole Favreau-Negront Luis Méndez LobosRelated Topic(s):Region(s):Latin America
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Conference Proceedings | April 2018A conference organized by the Levy Economics Institute of Bard College
The proceedings include the 2017 conference program, transcripts of keynote speakers’ remarks, synopses of the panel sessions, and biographies of the participants.Download:Associated Program(s):Author(s):Michael StephensRelated Topic(s):Region(s):United States, Latin America, Europe -
Working Paper No. 903 | April 2018
An Abstract of an Excerpt
The dominant postwar tradition in economics assumes the utility maximization of economic agents drives markets toward stable equilibrium positions. In such a world there should be no endogenous asset bubbles and untenable levels of private indebtedness. But there are.
There is a competing alternative view that assumes an endogenous behavioral propensity for markets to embark on disequilibrium paths. Sometimes these departures are dangerously far reaching. Three great interwar economists set out most of the economic theory that explains this natural tendency for markets to propagate financial fragility: Joseph Schumpeter, Irving Fisher, and John Maynard Keynes. In the postwar period, Hyman Minsky carried this tradition forward. Early on he set out a “financial instability hypothesis” based on the thinking of these three predecessors. Later on, he introduced two additional dynamic processes that intensify financial market disequilibria: principal–agent distortions and mounting moral hazard. The emergence of a behavioral finance literature has provided empirical support to the theory of endogenous financial instability. Work by Vernon Smith explains further how disequilibrium paths go to asset bubble extremes.
The following paper provides a compressed account of this tradition of endogenous financial market instability.Download:Associated Program:Author(s):Frank VenerosoRelated Topic(s): -
Working Paper No. 901 | March 2018
A Critical Assessment
During the period leading up to the recession of 2007–08, there was a large increase in household debt relative to income, a large increase in measured consumption as a fraction of GDP, and a shift toward more unequal income distribution. It is sometimes claimed that these three developments were closely linked. In these stories, the rise in household debt is largely due to increased borrowing by lower-income households who sought to maintain rising consumption in the face of stagnant incomes; this increased consumption in turn played an important role in maintaining aggregate demand. In this paper, I ask if this story is consistent with the empirical evidence. In particular, I ask five questions: How much household borrowing finances consumption spending? How much has monetary consumption spending by households increased? How much of the rise in household debt-income ratios is attributable to increased borrowing? How is household debt distributed by income? And how has the distribution of consumption spending changed relative to the distribution of income? I conclude that the distribution-debt-demand story may have some validity if limited to the housing boom period of 2002–07, but does not fit the longer-term rise in household debt since 1980.Download:Associated Program(s):Author(s):J. W. MasonRelated Topic(s): -
One-Pager No. 54 | February 2018The outgoing governor of the People’s Bank of China recently warned of a possible Chinese “Minsky moment”—Paul McCulley’s term, most recently applied to the 2007 US real estate crash that reverberated around the world as a global financial crisis. Although Western commentators have weighed in on both sides of the debate about the likelihood of China’s debt bubble bursting, Senior Scholar L. Randall Wray argues that too little attention is being paid to the far more probable repeat of a US Minsky moment. US prospects for growth, as well as for successfully handling the next financial meltdown, are dismal, he concludes.
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Policy Note 2018/1 | February 2018It is beginning to look a lot like déjà vu in the United States. According to Senior Scholar L. Randall Wray, the combination of overvalued stocks, overleveraged banks, an undersupervised financial system, high indebtedness across sectors, and growing inequality together should remind one of the conditions of 1929 and 2007. Comparing the situations of the United States and China, where the outgoing central bank governor recently warned of the fragility of China’s financial sector, Wray makes the case that the United State is far more likely to “win” the race to the next “Minsky moment.” Instead of sustainable growth, we have “bubble-ized” our economy on the back of an overgrown financial sector—and to make matters worse, he concludes, US policymakers are ill-prepared to deal with the coming crisis.Download:Associated Program:Author(s):Related Topic(s):
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Working Paper No. 900 | January 2018
A Comparison of the Evolution of the Positions of Hyman Minsky and Abba Lerner
This paper examines the views of Hyman Minsky and Abba Lerner on the functional finance approach to fiscal policy. It argues that the main principles of functional finance were relatively widely held in the immediate postwar period. However, with the rise of the Phillips curve, the return of the Quantity Theory, the development of the notion of a government budget constraint, and accelerating inflation at the end of the 1960s, functional finance fell out of favor. The paper compares and contrasts the evolution of the views of Minsky and Lerner over the postwar period, arguing that Lerner’s transition went further, as he embraced a version of Monetarism that emphasized the use of monetary policy over fiscal policy. Minsky’s views of functional finance became more nuanced, in line with his Institutionalist approach to the economy. However, Minsky never rejected his early beliefs that countercyclical government budgets must play a significant role in stabilizing the economy. Thus, in spite of some claims that Minsky should not be counted as one of the “forefathers” of Modern Money Theory (MMT), this paper argues that it is Minsky, not Lerner, whose work remains essential for the further development of MMT.Download:Associated Program:Author(s):Related Topic(s): -
Working Paper No. 897 | September 2017Ever since the Great Recession, central banks have supplemented their traditional policy tool of setting the short-term interest rate with massive buyouts of assets to extend lines of credit and jolt flagging demand. As with many new policies, there have been a range of reactions from economists, with some extolling quantitative easing’s expansionary virtues and others fearing it might invariably lead to overvaluation of assets, instigating economic instability and bubble behavior. To investigate these theories, we combine elements of the models in chapters 5, 10, and 11 of Godley and Lavoie’s (2007) Monetary Economics with equations for quantitative easing and endogenous bubbles in a new model. By running the model under a variety of parameters, we study the causal links between quantitative easing, asset overvaluation, and macroeconomic performance. Preliminary results suggest that rather than being pro- or countercyclical, quantitative easing acts as a sort of phase shift with respect to time.
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Public Policy Brief No. 144 | September 2017
A Radical Proposal Based on Keynes’s Clearing Union
In light of the problems besetting the eurozone, this policy brief examines the contributions of John Maynard Keynes and Richard Kahn to early debates over the design of the postwar international financial system. Their critical engagement with the early policy challenges associated with managing international settlements offers a perspective from which to analyze the flaws in the current euro-based financial system, and Keynes’s clearing union proposal offers a template for a better approach. A system of regional federations employing a clearing system in which members either retained their own currency or used a common currency as a unit of account in registering debits and credits for settlement purposes would preserve domestic policy independence and retain regional diversity.
Download:Associated Program(s):Author(s):Jan KregelRelated Topic(s):Banking principle Bretton Woods Clearing union Creditor countries Debtor countries Euro Eurozone Gold standard John Maynard KeynesRegion(s):Europe -
Working Paper No. 896 | September 2017
An Empirical Analysis of Electricity Distribution Companies in Brazil (2007–15)
The present paper applies Hyman P. Minsky’s insights on financial fragility in order to analyze the behavior of electricity distribution companies in Brazil from 2007 to 2015. More specifically, it builds an analytical framework to classify the firms operating in this sector into Minskyan risk categories and assess how financial fragility evolved over time, in each firm and in the sector as a whole. This work adapts Minsky’s financial fragility indicators and taxonomy to the conditions of the electricity distribution sector and applies them to regulatory accounting data for more than 60 firms. This empirical application of Minsky’s theory for analyzing firms engaged in the provision of public goods and services is a novelty. The results show an increase in the financial fragility of those firms (as well as the sector) throughout the period, especially between 2008 and 2013, even though the number of firms operating at the highest level of financial risk hardly changed.Download:Associated Program:Author(s):Ernani Teixeira Torres Filho Norberto Montani Martins Caroline Yukari MiagutiRelated Topic(s): -
Working Paper No. 894 | August 2017This paper undertakes an empirical inquiry concerning the determinants of long-term interest rates on US Treasury securities. It applies the bounds testing procedure to cointegration and error correction models within the autoregressive distributive lag (ARDL) framework, using monthly data and estimating a wide range of Keynesian models of long-term interest rates. While previous studies have mainly relied on quarterly data, the use of monthly data substantially expands the number of observations. This in turn enables the calibration of a wide range of models to test various hypotheses. The short-term interest rate is the key determinant of the long-term interest rate, while the rate of core inflation and the pace of economic activity also influence the long-term interest rate. A rise in the ratio of the federal fiscal balance (government net lending/borrowing as a share of nominal GDP) lowers yields on long-term US Treasury securities. The short- and long-run effects of short-term interest rates, the rate of inflation, the pace of economic activity, and the fiscal balance ratio on long-term interest rates on US Treasury securities are estimated. The findings reinforce Keynes’s prescient insights on the determinants of government bond yields.
Download:Associated Program(s):Author(s):Tanweer Akram Huiqing LiRelated Topic(s):Central banking Government bond yields John Maynard Keynes Long-term interest rates Monetary policy Short-term interest ratesRegion(s):United States -
Working Paper No. 893 | July 2017
If Adam Smith Is the Father of Economics, It Is a Bastard Child
Neoclassical economists of the current era frequently pay lip service to Adam Smith’s theories to certify the validity of natural-laws-based, laissez-faire policies. However, neoclassical theories are fundamentally disconnected from Adam Smith’s notion of value, his understanding of the economic individual and their interactions in society, his methodology, and the field of study he afforded to political economy. Instead, early neoclassical economists parted ways with the theories of Adam Smith in an effort to construct economic laws that would validate the existing capitalist order as universal, natural, and harmonious.
Download:Associated Program:Author(s):Oscar Valdes VieraRelated Topic(s): -
Policy Note 2017/2 | July 2017If the Trump administration is to fulfill its campaign promises to this age’s “forgotten” men and women, Director of Research Jan Kregel argues, it should embrace the broader lesson of the 1930s: that government regulation and fiscal policy are crucial in addressing changes in the economic and financial structure that have exacerbated the problems faced by struggling communities.
In this policy note, Kregel explains how overcoming the economic and financial challenges we face today, just as in the 1930s, requires avoiding what Walter Lippmann identified as an “obvious error”: the blind belief that reducing regulation and the role of government will somehow restore a laissez-faire market liberalism that never existed and is inappropriate to the changing structure of production of both the US and the global economy.
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Working Paper No. 892 | June 2017
Standing on the Shoulders of Minsky
Since the death of Hyman Minsky in 1996, much has been written about financialization. This paper explores the issues that Minsky examined in the last decade of his life and considers their relationship to that financialization literature. Part I addresses Minsky’s penetrating observations regarding what he called money manager capitalism. Part II outlines the powerful analytical framework that Minsky used to organize his thinking and that we can use to extend his work. Part III shows how Minsky’s observations and framework represent a major contribution to the study of financialization. Part IV highlights two keys to Minsky’s success: his treatment of economics as a grand adventure and his willingness to step beyond the world of theory. Part V concludes by providing a short recap, acknowledging formidable challenges facing scholars with a Minsky perspective, and calling attention to the glimmer of hope that offers a way forward.
Download:Associated Program:Author(s):Charles J. WhalenRelated Topic(s): -
Working Paper No. 890 | May 2017
Linking the State and Credit Theories of Money through a Financial Approach to Money
The paper presents a financial approach to monetary analysis that links the credit and state theories of money. A premise of the functional approach to money is that “money is what money does.” In this approach, monetary and mercantile mechanics are conflated, which leads to the conclusion that unconvertible monetary instruments are worthless. The financial approach to money strictly separates the two mechanics and argues that major monetary disruptions occurred when the two were conflated. Monetary instruments have always been promissory notes. As such, their financial characteristics are central to their value and liquidity. One of the main financial requirements of any monetary instrument is that it be redeemable at any time. As long as this is the case, the fair value of an unconvertible monetary instrument is its face value. While the functional approach does not recognize the centrality of redemption, the paper shows that redemption plays a critical role in the state and credit views of money. Payments due to issuer and/or convertibility on demand are central to the possibility of par circulation. The paper shows that this has major implications for monetary analysis, both in terms of understanding monetary history and in terms of performing monetary analysis.
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Working Paper No. 889 | May 2017
This paper investigates the determinants of nominal yields of government bonds in the eurozone. The pooled mean group (PMG) technique of cointegration is applied on both monthly and quarterly datasets to examine the major drivers of nominal yields of long-term government bonds in a set of 11 eurozone countries. Furthermore, autoregressive distributive lag (ARDL) methods are used to address the same question for individual countries. The results show that short-term interest rates are the most important determinants of long-term government bonds’ nominal yields, which supports Keynes’s (1930) view that short-term interest rates and other monetary policy measures have a decisive influence on long-term interest rates on government bonds.
Download:Associated Program(s):Author(s):Tanweer Akram Anupam DasRelated Topic(s):Region(s):Europe -
Press Releases | May 2017Download:Associated Program(s):Author(s):Mark PrimoffRegion(s):United States
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Conference Proceedings | April 2017
A conference organized by the Levy Economics Institute of Bard College with support from the Ford Foundation
The 2016 Minsky Conference addressed whether what appears to be a global economic slowdown will jeopardize the implementation and efficiency of Dodd-Frank regulatory reforms, the transition of monetary policy away from zero interest rates, and the “new” normal of fiscal policy, as well as the use of fiscal policies aimed at achieving sustainable growth and full employment. The proceedings include the conference program, transcripts of keynote speakers’ remarks, synopses of the panel sessions, and biographies of the participants.
Download:Associated Program(s):Author(s):Barbara Ross Michael StephensRegion(s):United States -
Working Paper No. 886 | March 2017
This paper investigates the (lack of any lasting) impact of John Maynard Keynes’s General Theory on economic policymaking in Germany. The analysis highlights the interplay between economic history and the history of ideas in shaping policymaking in postwar (West) Germany. The paper argues that Germany learned the wrong lessons from its own history and misread the true sources of its postwar success. Monetary mythology and the Bundesbank, with its distinctive anti-inflationary bias, feature prominently in this collective odyssey. The analysis shows that the crisis of the euro today is largely the consequence of Germany’s peculiar anti-Keynesianism.
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Working Paper No. 881 | January 2017
This paper investigates the long-term determinants of Indian government bonds’ (IGB) nominal yields. It examines whether John Maynard Keynes’s supposition that short-term interest rates are the key driver of long-term government bond yields holds over the long-run horizon, after controlling for various key economic factors such as inflationary pressure and measures of economic activity. It also appraises whether the government finance variable—the ratio of government debt to nominal income—has an adverse effect on government bond yields over a long-run horizon. The models estimated here show that in India, short-term interest rates are the key driver of long-term government bond yields over the long run. However, the ratio of government debt and nominal income does not have any discernible adverse effect on yields over a long-run horizon. These findings will help policymakers in India (and elsewhere) to use information on the current trend in short-term interest rates, the federal fiscal balance, and other key macro variables to form their long-term outlook on IGB yields, and to understand the implications of the government’s fiscal stance on the government bond market.
Download:Associated Program(s):Author(s):Tanweer Akram Anupam DasRelated Topic(s):Region(s):Asia -
In the Media | December 2016
By Vidhu Shekhar
Swarajya, December 30, 2016. All Rights Reserved.
With the end of demonetisation in sight, and partial remonetisation underway, it may be a good time to reassess the much-maligned economics of demonetisation.
Over this 50-day period, several economists have denounced demonetisation as poor economics, so much so that reading them has made us feel like we were experiencing mass famine. This, despite the fact that even the hard, early days were nearly-incident-free in spite of the enormity of the scale of operations....
Read more: http://swarajyamag.com/economy/assessing-demonetisation-minsk-provides-the-link-that-traditional-economics-missesAssociated Program: -
Working Paper No. 878 | December 2016
A Post-Keynesian/Evolutionist Critique
This paper provides a critical analysis of expansionary austerity theory (EAT). The focus is on the theoretical weaknesses of EAT—the extreme circumstances and fragile assumptions under which expansionary consolidations might actually take place. The paper presents a simple theoretical model that takes inspiration from both the post-Keynesian and evolutionary/institutionalist traditions. First, it demonstrates that well-designed austerity measures hardly trigger short-run economic expansions in the context of expected long-lasting consolidation plans (i.e., when adjustment plans deal with remarkably high debt-to-GDP ratios), when the so-called “financial channel” is not operative (i.e., in the context of monetarily sovereign economies), or when the degree of export responsiveness to internal devaluation is low. Even in the context of non–monetarily sovereign countries (e.g., members of the eurozone), austerity’s effectiveness crucially depends on its highly disputable capacity to immediately stabilize fiscal variables.
The paper then analyzes some possible long-run economic dynamics, emphasizing the high degree of instability that characterizes austerity-based adjustments plans. Path-dependency and cumulativeness make the short-run impulse effects of fiscal consolidation of paramount importance to (hopefully) obtaining any appreciable medium-to-long-run benefit. Should these effects be contractionary at the onset, the short-run costs of austerity measures can breed an endless spiral of recession and ballooning debt in the long run. If so, in the case of non–monetarily sovereign countries debt forgiveness may emerge as the ultimate solution to restore economic soundness. Alternatively, institutional innovations like those adopted since mid-2012 by the European Central Bank are required to stabilize the economy, even though they are unlikely to restore rapid growth in the absence of more active fiscal stimuli.
Download:Associated Program(s):Author(s):Alberto BottaRelated Topic(s): -
Working Paper No. 877 | November 2016
Against the background of modern-day monetary proposals, ranging from a return to the gold standard to the wholesale abolition of currency, this paper seeks to draw implications from David Ricardo’s Proposals for an Economical and Secure Currency for plans to reform the operation of central banks and extraordinary monetary policy. Although 200 years old, the “Ingot plan,” proposed during a period in which gold convertibility was suspended, appears to be applicable to modern monetary conditions and suggests possible avenues of reform.
Download:Associated Program:Author(s):Jan KregelRelated Topic(s): -
Working Paper No. 876 | October 2016
The Fed’s Unjustified Rationale
In December 2015, the Federal Reserve Board (FRB) initiated the process of “normalization,” with the objective of gradually raising the federal funds rate back to “normal”—i.e., levels that are “neither expansionary nor contrary” and are consistent with the established 2 percent longer-run goal for the annual Personal Consumption Expenditures index and the estimated natural rate of unemployment. This paper argues that the urgency and rationale behind the rate hikes are not theoretically sound or empirically justified. Despite policymakers’ celebration of “substantial” labor market progress, we are still short some 20 million jobs. Further, there is no reason to believe that the current exceptionally low inflation rates are transitory. Quite the contrary: without significant fiscal efforts to restore the bargaining power of labor, inflation rates are expected to remain below the Federal Open Market Committee’s long-term goal for years to come. Also, there is little empirical evidence or theoretical support for the FRB’s suggestion that higher interest rates are necessary to counter “excessive” risk-taking or provide a more stable financial environment.
Download:Associated Program(s):Author(s):Flavia DantasRelated Topic(s): -
Working Paper No. 875 | September 2016
A Global Cap to Build an Effective Postcrisis Banking Supervision Framework
The global financial crisis shattered the conventional wisdom about how financial markets work and how to regulate them. Authorities intervened to stop the panic—short-term pragmatism that spoke volumes about the robustness of mainstream economics. However, their very success in taming the collapse reduced efforts to radically change the “big bank” business model and lessened the possibility of serious banking reform—meaning that a strong and possibly even bigger financial crisis is inevitable in the future. We think an overall alternative is needed and at hand: Minsky’s theories on investment, financial stability, the growing weight of the financial sector, and the role of the state. Building on this legacy, it is possible to analyze which aspects of the post-2008 reforms actually work. In this respect, we argue that the only effective solution is to impose a global cap on the absolute size of banks.
Download:Associated Program(s):Author(s):Giuseppe Mastromatteo Lorenzo EspositoRelated Topic(s): -
In the Media | August 2016Manhattan Neighborhood Network, August 25, 2016. All Rights Reserved.
"Radical Imagination" host Jim Vrettos talks to Senior Scholar L. Randall Wray about what the US economy might look like under a Stein, Clinton, Trump, or Johnson administration.
Full video of the interview is available here. -
In the Media | August 2016
By Jeff Spross
The Week, August 22, 2016. All Rights Reserved.
The election isn't here yet, but it's looking more and more likely Hillary Clinton will trounce Donald Trump in November. Speculation over who she might appoint as advisors and agency heads has already commenced. And like anyone else, I have got my own opinions about who Clinton should pick, particularly when it comes to the economics positions….
Read more: http://theweek.com/articles/643874/hillary-clintons-economic-dream-team
Associated Program: -
In the Media | July 2016The Economist, July 28, 2016. All Rights Reserved.
From the start of his academic career in the 1950s until 1996, when he died, Hyman Minsky laboured in relative obscurity. His research about financial crises and their causes attracted a few devoted admirers but little mainstream attention: this newspaper cited him only once while he was alive, and it was but a brief mention. So it remained until 2007, when the subprime-mortgage crisis erupted in America. Suddenly, it seemed that everyone was turning to his writings as they tried to make sense of the mayhem....
Read more: http://www.economist.com/news/economics-brief/21702740-second-article-our-series-seminal-economic-ideas-looks-hyman-minskys />Associated Program: -
In the Media | July 2016
Andrea Terzi
Public Debt Project, July 14, 2016. All Rights Reserved.
Twice in the second half of the twentieth century, in the midst of a robust economy, economists optimistically talked about the taming and even “the death of the business cycle” based on the belief that advances in macroeconomics had reached a point of perfection. Yet, both times, the economy underwent serious turbulence and the policies that seemed to have “solved the problem” proved inadequate to the challenges presented by unexpected realities. In the 1970s, the “neo-classical synthesis,” with its faith in forecasting and macroeconomic “fine tuning,” succumbed to stagflation and a new theory, the Monetarist paradigm, came to prominence....
Read more: http://privatedebtproject.org/view-articles.php?Connecting-the-Dots-Debt-Savings-and-the-Need-for-a-Fiscal-Growth-Policy-21
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Working Paper No. 869 | June 2016
Phases of Financialization within the 20th Century in the United States
This paper explores from a historical perspective the process of financialization over the course of the 20th century. We identify four phases of financialization: the first, from the 1900s to 1933 (early financialization); the second, from 1933 to 1940 (transitory phase); the third, between 1945 and 1973 (definancialization); and the fourth period begins in the early 1970s and leads to the Great Recession (complex financialization). Our findings indicate that the main features of the current phase of financialization were already in place in the first period. We closely examine institutions within these distinct financial regimes and focus on the relative size of the financial sector, the respective regulation regime of each period, and the intensity of the shareholder value orientation, as well as the level of financial innovations implemented. Although financialization is a recent term, the process is far from novel. We conclude that its effects can be studied better with reference to economic history.
Download:Associated Program(s):Author(s):Apostolos Fasianos Diego Guevara Christos PierrosRelated Topic(s):Region(s):United States -
Working Paper No. 868 | June 2016
The ECB’s Belated Conversion?
This paper investigates the European Central Bank’s (ECB) monetary policies. It identifies an antigrowth bias in the bank’s monetary policy approach: the ECB is quick to hike, but slow to ease. Similarly, while other players and institutional deficiencies share responsibility for the euro’s failure, the bank has generally done “too little, too late” with regard to managing the euro crisis, preventing protracted stagnation, and containing deflation threats. The bank remains attached to the euro area’s official competitive wage–repression strategy, which is in conflict with the ECB’s price stability mandate and undermines its more recent, unconventional monetary policy initiatives designed to restore price stability. The ECB needs a “Euro Treasury” partner to overcome the euro regime’s most serious flaw: the divorce between central bank and treasury institutions.
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Working Paper No. 867 | May 2016
This paper examines the issue of the Greek public debt from different perspectives. We provide a historical discussion of the accumulation of Greece’s public debt since the 1960s and the role of public debt in the recent crisis. We show that the austerity imposed since 2010 has been unsuccessful in stabilizing the debt while at the same time taking a heavy toll on the Greek economy and society. The experience of the last six years shows that the country’s public debt is clearly unsustainable, and therefore a bold restructuring is needed. An insistence on the current policies is not justifiable either on pragmatic or on moral or any other grounds. The experience of Germany in the early post–World War II period provides some useful hints for the way forward. A solution to the Greek public debt problem is a necessary but not sufficient condition for the solution of the Greek and wider European crisis. A broader agenda that deals with the malaises of the Greek economy and the structural imbalances of the eurozone is of vital importance.
Download:Associated Program(s):The State of the US and World Economies Monetary Policy and Financial Structure Economic Policy for the 21st CenturyAuthor(s):Related Topic(s):Region(s):Europe -
In the Media | May 2016Bloomberg, May 12, 2015. All Rights Reserved.
Senior Scholar L. Randall Wray discusses the US national debt and inflation with Bloomberg’s Joe Weisenthal on “What’d You Miss?”
Full video of the interview is available here. -
In the Media | May 2016
By Michelle Jamrisko
Bloomberg, May 11, 2016. All Rights Reserved.
Donald Trump’s about-face on the relevance of a ballooning U.S. debt continues his campaign’s hallmark of zigging and zagging on policy issues, landing him now on economic proposals favored by economists to the left of Bernie Sanders.
The billionaire businessman has advocated for the federal government to take advantage of cheap interest rates by boosting spending on initiatives such as rebuilding infrastructure -- a position shared by traditional Keynesian economists and skewered by budget hawks who say his numbers won’t add up. Now, Trump’s post-Keynesian approach is throwing out budget balancing, and declaring American immunity to a default....
Read more: http://www.bloomberg.com/politics/articles/2016-05-11/trump-is-now-running-to-the-left-of-sanders-on-federal-debtAssociated Program: -
In the Media | May 2016
Reviewed by William J. Bernstein
Seeking Alpha, May 5, 2016. All Rights Reserved.
A few decades ago, Paul Samuelson wrote a letter to Robert Shiller and John Campbell, in which he discussed the notion that while the stock market was “micro efficient,” it was also “macro inefficient,” by which he meant that although profitable security choices were swiftly arbitraged away, the stock market as a whole irrationally swung between extremes of valuation.
Hyman Minsky would have made a similar point about the economy: While it is highly efficient, it is also unstable….
Read more: http://seekingalpha.com/article/3971589-book-review-minsky-mattersAssociated Program: -
Working Paper No. 864 | April 2016
In this paper we analyze options for the European Central Bank (ECB) to achieve its single mandate of price stability. Viable options for price stability are described, analyzed, and tabulated with regard to both short- and long-term stability and volatility. We introduce an additional tool for promoting price stability and conclude that public purpose is best served by the selection of an alternative buffer stock policy that is directly managed by the ECB.
Download:Associated Program(s):Author(s):Warren Mosler Damiano B. SilipoRelated Topic(s): -
In the Media | April 2016
By Peter Eavis
The New York Times, April 14, 2016. All Rights Reserved.
Bank regulators on Wednesday sent a message that big banks are still too big and too complex. They rejected special plans, called living wills, that the banks have to submit to show they can go through an orderly bankruptcy.
The thinking behind the regulators’ call for living wills is that if a large bank crash is orderly, there will be no need to save it and no need for taxpayer bailouts....
Read more: http://www.nytimes.com/2016/04/15/upshot/how-regulators-mess-with-bankers-minds-and-why-thats-good.htmlAssociated Program(s):Region(s):United States -
In the Media | April 2016
Von Tom Fairless
Finanz Nachrichten, 14 April 2016. Alle Rechte vorbehalten.
Für das Instrument der negativen Zinsen gibt es nach Aussage des EZB-Vizepräsidenten Vitor Constancio "klare Grenzen". Die Schwelle, an der die Leute anfangen, Geld abzuziehen, um die Negativzinsen zu umgehen, scheine aber noch weit weg zu sein, sagte Constancio in einer Rede beim Bard College in New York....
Weiterlesen: http://www.finanznachrichten.de/nachrichten-2016-04/37060417-ezb-constancio-instrument-der-negativzinsen-hat-grenzen-015.htm
Associated Program(s):Region(s):United States, Europe -
In the Media | April 2016Foreign Affairs, April 14, 2016. All Rights Reserved.
Speech by Vítor Constâncio, Vice-President of the ECB, at the 25th Annual Hyman P. Minsky Conference on the State of the U.S. and World Economies at the Levy Economics Institute of Bard College, Blithewood, Annandale-on-Hudson, New York, 13 April 2016
Ladies and Gentlemen,
I want to start by thanking the Levy Institute for inviting me again to address this important conference honouring Hyman Minsky, the economist that the Great Recession justifiably brought into the limelight. His work provides crucial insights not only identifying the key mechanisms by which periods of financial calm sow the seeds for ensuing crises, but also the specific challenges that economies face in recovering from such crises....
Read more: http://foreignaffairs.co.nz/2016/04/14/speech-vitor-constancio-international-headwinds-and-the-effectiveness-of-monetary-policy/
Associated Program(s):Region(s):United States, Europe -
In the Media | April 2016
By Alessandro Speciale and Matthew Boesler
The Washington Post, April 14, 2016. All Rights Reserved.
European Central Bank Vice President Vitor Constancio on Wednesday said there was only so much that negative interest rates can do to boost the economy and defended the central bank’s strategy as positive for the euro area as a whole.
It is “important to recall that there are clear limits to the use of negative deposit facility rates as a policy instrument,” he said in a speech at the Levy Economics Institute of Bard College in New York state. “Tier systems that simply pass direct costs at the margin can mitigate this concern but cannot dispel it altogether.” ...
Read more: http://washpost.bloomberg.com/Story?docId=1376-O5LE8T6TTDS101-597LUN1M75BN1J81FK32I14G7R
Associated Program(s):Region(s):United States -
In the Media | April 2016
By Richard Leong
Reuters, April 14, 2016. All Rights Reserved.
Negative deposit rates are not required as a monetary fix for the United States at the moment, in contrast with the euro zone, which is struggling with deflation risk, a top European Central Bank official said on Wednesday.
The U.S. economy, while far from robust, has been growing at a steady pace, and has seen some improvement in price growth since hitting a post-crisis low earlier this year.
Read more: http://uk.reuters.com/article/uk-ecb-policy-constancio-negativerates-idUKKCN0XA2Q4
Associated Program(s):Region(s):United States -
In the Media | April 2016Bloomberg, 14 Nisan 2016. Her Hakkı Saklıdır.
Avrupa Merkez Bankası (AMB) Başkan Yardımcısı Vitor Constancio Çarşamba günü yaptığı açıklamada, negatif faiz oranının ekonomiyi destekleme konusunda yapabileceklerinin sınırlı olduğunu söyleyerek AMB'nin stratejisinin euro bölgesinin tamamı için olumlu olduğunu söyledi.
Constancio, New York eyaletinde Bard College'de Levy Economics Institute'de yaptığı konuşmada, "Negatif mevduat faiz oranını bir politika aracı olarak kullanmanın açık sınıları olduğunu hatırlamak önemli, kademeli faiz sistemi bu endişeyi azaltabilir ama tamamen yok edemez" dedi....
Daha fazla oku: http://www.bloomberght.com/haberler/haber/1872569-ambconstancio-negatif-faiz-politikasinin-limitleri-var
Associated Program(s):Region(s):Europe -
In the Media | April 2016
By Richard Leong
Yahoo! Finance, April 13, 2016. All Rights Reserved.
Negative deposit rates are not required as a monetary fix for the United States at the moment, in contrast with the euro zone, which is struggling with deflation risk, a top European Central Bank official said on Wednesday.
Read more: http://finance.yahoo.com/news/negative-rates-not-needed-u-225239865.html
Associated Program(s):Region(s):United States -
In the Media | April 2016
By Richard Leong
Reuters, April 13, 2016. All Rights Reserved.
Negative deposit rates are not required as a monetary fix for the United States at the moment, in contrast with the euro zone, which is struggling with deflation risk, a top European Central Bank official said on Wednesday.
The U.S. economy, while far from robust, has been growing at a steady pace, and has seen some improvement in price growth since hitting a post-crisis low earlier this year....
Read more: http://www.reuters.com/article/ecb-policy-constancio-negativerates-idUSL2N17G2GK
Associated Program(s):Region(s):United States -
In the Media | April 2016Finanzen 100, 13 April 2016. Alle Rechte vorbehalten.
Die vielumstrittenen Negativzinsen der EZB haben klare Grenzen der Wirksamkeit. Obwohl der EZB-Vizepräsident Vítor Constâncio die Strategie der Notenbank am Mittwochabend als positiv für die Eurozone verteidigt hat, gab er zu, dass negative Zinsen die Konjunktur nur beschränkt ankurbeln können....
Weiterlesen: http://www.finanzen100.de/finanznachrichten/wirtschaft/geldpolitik-ezb-vizepraesident-negativzinsen-sind-kein-allheilmittel_H609679858_263944/
Associated Program(s):Region(s):Europe -
In the Media | April 2016
By Alessandro Speciale and Matthew Boesler
Bloomberg, April 13, 2016. All Rights Reserved.
European Central Bank Vice President Vitor Constancio on Wednesday said there was only so much that negative interest rates can do to boost the economy and defended the central bank’s strategy as positive for the euro area as a whole.
It is “important to recall that there are clear limits to the use of negative deposit facility rates as a policy instrument,” he said in a speech at the Levy Economics Institute of Bard College in New York state. “Tier systems that simply pass direct costs at the margin can mitigate this concern but cannot dispel it altogether.” ...
Read more: http://www.bloomberg.com/news/articles/2016-04-13/ecb-s-constancio-says-negative-rate-policy-has-clear-limits
Associated Program(s):Region(s):United States -
In the Media | April 2016
By Richard Leong
The Fiscal Times, April 13, 2016. All Rights Reserved.
Negative deposit rates are not required as a monetary fix for the United States at the moment, in contrast with the euro zone, which is struggling with deflation risk, a top European Central Bank official said on Wednesday....
Read more: http://www.thefiscaltimes.com/latestnews/2016/04/13/Negative-rates-not-needed-US-now-ECBs-Constancio
Associated Program(s):Region(s):United States -
Working Paper No. 863 | March 2016
US government indebtedness and fiscal deficits increased notably following the global financial crisis. Yet long-term interest rates and US Treasury yields have remained remarkably low. Why have long-term interest rates stayed low despite the elevated government indebtedness? What are the drivers of long-term interest rates in the United States? John Maynard Keynes holds that the central bank’s actions are the main determinants of long-term interest rates. A simple model is presented where the central bank’s actions are the key drivers of long-term interest rates through short-term interest rates and various monetary policy measures. The empirical findings reveal that short-term interest rates, after controlling for other crucial variables such as the rate of inflation, the rate of economic activity, fiscal deficits, government debts, and so forth, are the most important determinants of long-term interest rates in the United States. Public finance variables, such as government fiscal balances or government indebtedness, as a share of nominal GDP appear not to have any discernable effect on long-term interest rates.
Download:Associated Program:Author(s):Tanweer Akram Huiqing LiRelated Topic(s): -
Public Policy Brief No. 141 | March 2016To the extent that policymakers have learned anything at all from the Great Depression and the policy responses of the 1930s, the lessons appear to have been the wrong ones. In this public policy brief, Director of Research Jan Kregel explains why there is still a great deal we have to learn from the New Deal. He illuminates one of the New Deal’s principal objectives—quelling the fear and uncertainty of mass unemployment—and the pragmatic, experimental process through which the tool for achieving this objective—directed government expenditure—came to be embraced.
In the search for a blueprint from the 1930s, Kregel suggests that too much attention has been paid to the measures deployed to shore up the banking system, and that the approaches underlying the emergency financial policy measures of the recent period and those of the 1930s were actually quite similar. The more meaningful divergence between the 1930s and the post-2008 policy response, he argues, can be uncovered by comparing the actions that were taken (or not taken, as the case may be) to address the real sector of the economy following the resolution of the respective financial crises.Download:Associated Program:Author(s):Jan KregelRelated Topic(s): -
Working Paper No. 862 | March 2016
Japan has experienced stagnation, deflation, and low interest rates for decades. It is caught in a liquidity trap. This paper examines Japan’s liquidity trap in light of the structure and performance of the country’s economy since the onset of stagnation. It also analyzes the country’s liquidity trap in terms of the different strands in the theoretical literature. It is argued that insights from a Keynesian perspective are still quite relevant. The Keynesian perspective is useful not just for understanding Japan’s liquidity trap but also for formulating and implementing policies that can overcome the liquidity trap and foster renewed economic growth and prosperity. Paul Krugman (1998a, b) and Ben Bernanke (2000; 2002) identify low inflation and deflation risks as the cause of a liquidity trap. Hence, they advocate a credible commitment by the central bank to sustained monetary easing as the key to reigniting inflation, creating an exit from a liquidity trap through low interest rates and quantitative easing. In contrast, for John Maynard Keynes (2007 [1936]) the possibility of a liquidity trap arises from a sharp rise in investors’ liquidity preference and the fear of capital losses due to uncertainty about the direction of interest rates. His analysis calls for an integrated strategy for overcoming a liquidity trap. This strategy consists of vigorous fiscal policy and employment creation to induce a higher expected marginal efficiency of capital, while the central bank stabilizes the yield curve and reduces interest rate volatility to mitigate investors’ expectations of capital loss. In light of Japan’s experience, Keynes’s analysis and proposal for generating effective demand might well be a more appropriate remedy for the country’s liquidity trap.
Download:Associated Program(s):Author(s):Tanweer AkramRelated Topic(s):Region(s):Asia -
In the Media | March 2016In an American election season that’s turned into a bonfire of the orthodoxies, one taboo survives pretty much intact: Budget deficits are dangerous.
A school of dissident economists wants to toss that one onto the flames, too....
Read more: http://www.bloomberg.com/news/articles/2016-03-13/ignored-for-years-a-radical-economic-theory-is-gaining-converts
Associated Program: -
Working Paper No. 861 | March 2016
Money, in this paper, is defined as a power relationship of a specific kind, a stratified social debt relationship, measured in a unit of account determined by some authority. A brief historical examination reveals its evolving nature in the process of social provisioning. Money not only predates markets and real exchange as understood in mainstream economics but also emerges as a social mechanism of distribution, usually by some authority of power (be it an ancient religious authority, a king, a colonial power, a modern nation state, or a monetary union). Money, it can be said, is a “creature of the state” that has played a key role in the transfer of real resources between parties and the distribution of economic surplus.
In modern capitalist economies, the currency is also a simple public monopoly. As long as money has existed, someone has tried to tamper with its value. A history of counterfeiting, as well as that of independence from colonial and economic rule, is another way of telling the history of “money as a creature of the state.” This historical understanding of the origins and nature of money illuminates the economic possibilities under different institutional monetary arrangements in the modern world. We consider the so-called modern “sovereign” and “nonsovereign” monetary regimes (including freely floating currencies, currency pegs, currency boards, dollarized nations, and monetary unions) to examine the available policy space in each case for pursuing domestic policy objectives.
This working paper is also available in Spanish and Catalan.Download:Associated Program(s):Author(s):Related Topic(s): -
Policy Note 2016/1 | January 2016A complementary currency circulates within an economy alongside the primary currency without attempting to replace it. The Swiss WIR, implemented in 1934 as a response to the discouraging liquidity and growth prospects of the Great Depression, is the oldest and most significant complementary financial system now in circulation. The evidence provided by the long, successful operation of the WIR offers an opportunity to reconsider the creation of a similar system in Greece.
The complementary currency is a proven macroeconomic stabilizer—a spontaneous money creator with the capacity to sustain and increase an economy’s aggregate demand during downturns. A complementary financial system that supports regional development and employment-targeted programs would be a U-turn toward restoring people’s purchasing power and rebuilding Greece’s desperate economy.Download:Associated Program(s):Author(s):Related Topic(s):Complementary currency Economic stability Greece Greek economic crisis Parallel financial system Switzerland WIR currencyRegion(s):Europe -
In the Media | January 2016
By Sheyna Steiner
Federal Reserve Blog, January 27, 2016. All Rights Reserved.
After raising interest rates in December for the first time since the financial crisis and Great Recession, the Federal Reserve has gone into a January freeze. The central bank on Wednesday announced no change in interest rates, meaning the target for the Fed's benchmark federal funds rate will remain between 0.25% and 0.50%, the range set last month.
For consumers, the outcome of this week's meeting means more of the same. Savers will continue to suffer low interest rates on savings while debtors continue to enjoy extremely low borrowing costs....
Read more: http://www.bankrate.com/financing/federal-reserve/the-fed-puts-rates-on-ice/
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In the Media | January 2016
By William J. Bernstein
CFA Institute, January 20, 2016. All Rights Reserved.
A few decades ago, Paul Samuelson wrote a letter to Robert Shiller and John Campbell in which he discussed the notion that while the stock market was “micro efficient,” it was also “macro inefficient,” by which he meant that although profitable security choices were swiftly arbitraged away, the stock market as a whole irrationally swung between extremes of valuation.
Hyman Minsky would have made a similar point about the economy: While it is highly efficient, it is also unstable....
Read more: http://www.cfapubs.org/doi/full/10.2469/br.v11.n1.2
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In the Media | December 2015
By Joseph P. Joyce
EconoMonitor, December 14, 2015. All Rights Reserved.
The seventh edition of Manias, Panics, and Crashes has recently been published by Palgrave Macmillan. Charles Kindleberger of MIT wrote the first edition, which appeared in 1978, and followed it with three more editions. Robert Aliber of the Booth School of Business at the University of Chicago took over the editing and rewriting of the fifth edition, which came out in 2005. (Aliber is also the author of another well-known book on international finance, The New International Money Game.) The continuing popularity of Manias, Panics and Crashes shows that financial crises continue to be a matter of widespread concern.
Kindleberger built upon the work of Hyman Minsky, a faculty member at Washington University in St. Louis. Minsky was a proponent of what he called the “financial instability hypothesis,” which posited that financial markets are inherently unstable. Periods of financial booms are followed by busts, and governmental intervention can delay but not eliminate crises. Minsky’s work received a great deal of attention during the global financial crisis (see here and here; for a summary of Minsky’s work, see Why Minsky Matters by L. Randall Wray of the University of Missouri-Kansas City and the Levy Economics Institute)….
Read more: http://www.economonitor.com/blog/2015/12/the-enduring-relevance-of-manias-panics-and-crashes/
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One-Pager No. 51 | December 2015Until market participants across the euro area face a single risk-free yield curve rather than a diverse collection of quasi-risk-free sovereign rates, financial market integration will not be complete. Unfortunately, the institution that would normally provide the requisite benchmark asset—a federal treasury issuing risk-free debt—does not exist in the euro area, and there are daunting political obstacles to creating such an institution.
There is, however, another way forward. The financial instrument that could provide the foundation for a single market already exists on the balance sheet of the European Central Bank (ECB): legally, the ECB could issue “debt certificates” (DCs) across the maturity spectrum and in sufficient amounts to create a yield curve. Moreover, reforming ECB operations along these lines may hold the key to addressing another of the euro area’s critical dysfunctions. Under current conditions, the Maastricht Treaty’s fiscal rules create a vicious cycle by contributing to a deflationary economic environment, which slows the process of debt adjustment, requiring further deflationary budget tightening. By changing national debt dynamics and thereby enabling a revision of the fiscal rules, the DC proposal could short-circuit this cycle of futility.Download:Associated Program(s):Author(s):Mario TonveronachiRelated Topic(s):Debt certificates Debt sustainability Europe European Central Bank (ECB) Eurozone Financial market integration Fiscal policy Single marketRegion(s):Europe -
Working Paper No. 855 | November 2015
Debt, Central Banks, and Functional Finance
The scientific reassessment of the economic role of the state after the crisis has renewed interest in Abba Lerner’s theory of functional finance (FF). A thorough discussion of this concept is helpful in reconsidering the debate on the nature of money and the origin of the business cycle and crises. It also allows a reevaluation of many policy issues, such as the Barro–Ricardo equivalence, the cause of inflation, and the role of monetary policy.
FF, throwing a different light on these issues, can provide a sound foundation for discussing income, fiscal, and monetary policy rules in the right context of flexibility in the management of national budgets, assessing what kind of policies should be awarded priority, and the effectiveness of tackling the crisis with the different part of public budget. It also allows us to understand ways of increasing efficiency through public investment while reducing the total operational costs of firms. In the specific context of the eurozone, FF is useful for assessing the institutional framework of the euro and how to improve it in the face of protracted low growth, deflation, and weak public finances.
Download:Associated Program(s):Author(s):Giuseppe Mastromatteo Lorenzo EspositoRelated Topic(s):Central bank independence Debt Eurozone debt crisis Functional finance Growth Sustainability of public financeRegion(s):Europe -
In the Media | November 2015
By Edward Chancellor
Reuters, November 27, 2015. All Rights Reserved.
Forget the living canon of great economists – Paul Krugman, Joe Stiglitz, Larry Summers and the rest. Hyman Minsky was the only contemporary thinker to have predicted with uncanny precision the global financial crisis. This is no small achievement since Minsky died more than a decade before Lehman Brothers filed for bankruptcy. Minsky’s unorthodox vision of capitalism, with its emphasis on the central role of finance and the system’s inherent tendency to crash, was vindicated by the subprime crisis.
In a new book, “Why Minsky Matters: An Introduction to the Work of a Maverick Economist,” L. Randall Wray suggests that he would have approved of policymakers’ initial response to the crisis precipitated by Lehman’s collapse in the fall of 2008. However, by now, Minsky would be fretting that another “Minsky moment” is not far away and pondering what lies ahead....
Read more: http://blogs.reuters.com/breakingviews/2015/11/27/review-another-minsky-moment-may-be-on-the-way/Associated Program: -
Public Policy Brief No. 140 | November 2015
Mario Tonveronachi, University of Siena, builds on his earlier proposal (The ECB and the Single European Financial Market) to advance financial market integration in Europe through the creation of a single benchmark yield curve based on debt certificates (DCs) issued by the European Central Bank (ECB). In this policy brief, Tonveronachi discusses potential changes to the ECB’s operations and their implications for member-state fiscal rules. He argues that his DC proposal would maintain debt discipline while mitigating the restrictive, counterproductive fiscal stance required today, simultaneously expanding national fiscal space while ensuring debt sustainability under the Maastricht limits, and offering a path out of the self-defeating policy regime currently in place.
Download:Associated Program(s):Author(s):Mario TonveronachiRelated Topic(s):Debt certificates Debt sustainability Europe European Central Bank (ECB) Eurozone Financial market integration Fiscal policy Single marketRegion(s):Europe -
Press Releases | November 2015
Download:Associated Program(s):Author(s):Mark PrimoffRegion(s):Europe -
Conference Proceedings | November 2015
A conference organized by the Levy Economics Institute of Bard College with support from the Ford Foundation
The 2015 Minsky Conference addressed, among other issues, the design, flaws, and current status of the Dodd-Frank Wall Street Reform Act, including implementation of the operating procedures necessary to curtail systemic risk and prevent future crises; the insistence on fiscal austerity exemplified by the recent pronouncements of the new Congress; the sustainability of the US economic recovery; monetary policy revisions and central bank independence; the deflationary pressures associated with the ongoing eurozone debt crisis and their implications for the global economy; strategies for promoting an inclusive economy and a more equitable income distribution; and regulatory challenges for emerging market economies. The proceedings include the conference program, transcripts of keynote speakers’ remarks, synopses of the panel sessions, and biographies of the participants.
Download:Associated Program(s):Author(s):Barbara Ross Michael StephensRegion(s):United States, Europe -
Working Paper No. 853 | November 2015
The Case of Colombia
In recent years, Colombia has grown relatively rapidly, but it has been a biased growth. The energy sector (the “locomotora minero-energetica,” to use the rhetorical expression of President Juan Manuel Santos) grew much faster than the rest of the economy, while the manufacturing sector registered a negative rate of growth. These are classic symptoms of the well-known “Dutch disease,” but our purpose here is not to establish whether or not the Dutch disease exists, but rather to shed some light on the financial viability of several, simultaneous dynamics: (1) the existence of a traditional Dutch disease being due to a large increase in mining exports and a significant exchange rate appreciation; (2) a massive increase in foreign direct investment, particularly in the mining sector; (3) a rather passive monetary policy, aimed at increasing purchasing power via exchange rate appreciation; (4) and more recently, a large distribution of dividends from Colombia to the rest of the world and the accumulation of mounting financial liabilities. The paper shows that these dynamics constitute a potential danger for the stability of the Colombian economy. Some policy recommendations are also discussed.
Download:Associated Program(s):Author(s):Alberto Botta Antoine Godin Marco MissagliaRelated Topic(s):Region(s):Latin America -
Book Series | November 2015
Edited by Rainer Kattel, Jan Kregel, and Mario Tonveronachi
Have past and more recent regulatory changes contributed to increased financial stability in the European Union (EU), or have they improved the efficiency of individual banks and national financial systems within the EU? Edited by Rainer Kattel, Tallinn University of Technology, Director of Research Jan Kregel, and Mario Tonveronachi, University of Siena, this volume offers a comparative overview of how financial regulations have evolved in various European countries since the introduction of the single European market in 1986. The collection includes a number of country studies (France, Germany, Italy, Spain, Estonia, Hungary, Slovenia) that analyze the domestic financial regulatory structure at the beginning of the period, how the EU directives have been introduced into domestic legislation, and their impact on the financial structure of the economy. Other contributions examine regulatory changes in the UK and Nordic countries, and in postcrisis America.
Published by: Routledge
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Book Series | November 2015
By L. Randall Wray
Perhaps no economist was more vindicated by the global financial crisis than Hyman P. Minsky (1919–1996). Although a handful of economists raised alarms as early as 2000, Minsky’s warnings began a half century earlier, with writings that set out a compelling theory of financial instability. Yet even today he remains largely outside mainstream economics; few people have a good grasp of his writings, and fewer still understand their full importance. Why Minsky Matters makes the maverick economist’s critically valuable insights accessible to general readers for the first time. Author L. Randall Wray shows that by understanding Minsky we will not only see the next crisis coming but we might be able to act quickly enough to prevent it.
As Wray explains, Minsky’s most important idea is that “stability is destabilizing”: to the degree that the economy achieves what looks to be robust and stable growth, it is setting up the conditions in which a crash becomes ever more likely. Before the financial crisis, mainstream economists pointed to much evidence that the economy was more stable, but their predictions were completely wrong because they disregarded Minsky’s insight. Wray also introduces Minsky’s significant work on money and banking, poverty and unemployment, and the evolution of capitalism, as well as his proposals for reforming the financial system and promoting economic stability.
A much-needed introduction to an economist whose ideas are more relevant than ever, Why Minsky Matters is essential reading for anyone who wants to understand why economic crises are becoming more frequent and severe—and what we can do about it.
Published by: Princeton
Associated Program:Author(s):Related Topic(s): -
Working Paper No. 852 | October 2015
Long-term interest rates in advanced economies have been low since the global financial crisis. However, in the United States the Federal Reserve could begin to hike its policy rate, the federal funds target rate, before the end of the year. In the United Kingdom, the Bank of England could follow suit. What is the outlook for global long-term interest rates? What are the risks around interest rates? What can policymakers do to cure the malady of low interest rates? It is argued that global interest rates are likely to stay low in the remainder of this year and the first half of next year due to a combination of domestic and international factors, even if a few central banks gradually begin to tighten monetary policy. The cure for this malady lies in proactive fiscal policy and measures to support job growth. Boosting effective demand and promoting higher wages and real disposable income would help lift inflation rates close to their targets and raise long-term interest rates.
Download:Associated Program:Author(s):Tanweer AkramRelated Topic(s): -
Policy Note 2015/6 | October 2015
The recapitalization of Greek banks is perhaps the most critical problem for the Greek state today. Despite direct cash infusions to Greek banks that have so far exceeded €45 billion, with corresponding guarantees of around €130 billion, credit expansion has failed to pick up. There are two obvious reasons for this failure: first, the massive exodus of deposits since 2010; and second, the continuous recession—mainly the product of strongly deflationary policies dictated by international lenders.
Following the 2012–13 recapitalization, creditors allowed the old, now minority, shareholders and incumbent management (regardless of culpability) to retain effective control of the banks—a decision that did not conform to accepted international practices. Sitting on a ticking time bomb of nonperforming loans (NPLs), Greek banks, rather than adopting the measures necessary to restructure their portfolios, cut back sharply on lending, while the country’s economy continued to shrink.
The obvious way to rehabilitate Greek banking following the new round of recapitalization scheduled for later this year is the establishment of a “bad bank” that can assume responsibility for the NPL workouts, manage the loans, and in some cases hold them to maturity and turn them around. This would allow Greek banks to make new and carefully underwritten loans, resulting in a much-needed expansion of the credit supply. Sound bank recapitalization with concurrent avoidance of any creditor bail-in could help the Greek banking sector return to financial health—and would be an effective first step in returning the country to the path of growth.
Download:Associated Program(s):Author(s):Related Topic(s):"Bad bank" approach Bank recapitalization Banking Eurozone Greece Greek debt crisis Nonperforming loansRegion(s):Europe -
Working Paper No. 851 | October 2015
A Stock-flow Consistent Model
This paper presents a stock-flow consistent model+ of full-reserve banking. It is found that in a steady state, full-reserve banking can accommodate a zero-growth economy and provide both full employment and zero inflation. Furthermore, a money creation experiment is conducted with the model. An increase in central bank reserves translates into a two-thirds increase in demand deposits. Money creation through government spending leads to a temporary increase in real GDP and inflation. Surprisingly, it also leads to a permanent reduction in consolidated government debt. The claims that full-reserve banking would precipitate a credit crunch or excessively volatile interest rates are found to be baseless.
Download:Associated Program:Author(s):Patrizio LainàRelated Topic(s): -
Working Paper No. 849 | October 2015
A Micro- and Macroprudential Perspective
Bank leverage ratios have made an impressive and largely unopposed return; they are mostly used alongside risk-weighted capital requirements. The reasons for this return are manifold, and they are not limited to the fact that bank equity levels in the wake of the global financial crisis (GFC) were exceptionally thin, necessitating a string of costly bailouts. A number of other factors have been equally important; these include, among others, the world’s revulsion with debt following the GFC and the eurozone crisis, and the universal acceptance of Hyman Minsky’s insights into the nature of the financial system and its role in the real economy. The best examples of the causal link between excessive debt, asset bubbles, and financial instability are the Spanish and Irish banking crises, which resulted from nothing more sophisticated than straightforward real estate loans. Bank leverage ratios are primarily seen as a microprudential measure that intends to increase bank resilience. Yet in today’s environment of excessive liquidity due to very low interest rates and quantitative easing, bank leverage ratios should also be viewed as a key part of the macroprudential framework. In this context, this paper discusses the role of leverage ratios as both microprudential and macroprudential measures. As such, it explains the role of the leverage cycle in causing financial instability and sheds light on the impact of leverage restraints on good bank governance and allocative efficiency.
Download:Associated Program(s):Author(s):Related Topic(s):Asset bubbles Banks Debt overhang Financial instability Leverage Leverage cycles Macroprudential regulationRegion(s):Europe -
Working Paper No. 848 | October 2015
A Case Study of the Canadian Economy, 1935–75
Historically high levels of private and public debt coupled with already very low short-term interest rates appear to limit the options for stimulative monetary policy in many advanced economies today. One option that has not yet been considered is monetary financing by central banks to boost demand and/or relieve debt burdens. We find little empirical evidence to support the standard objection to such policies: that they will lead to uncontrollable inflation. Theoretical models of inflationary monetary financing rest upon inaccurate conceptions of the modern endogenous money creation process. This paper presents a counter-example in the activities of the Bank of Canada during the period 1935–75, when, working with the government, it engaged in significant direct or indirect monetary financing to support fiscal expansion, economic growth, and industrialization. An institutional case study of the period, complemented by a general-to-specific econometric analysis, finds no support for a relationship between monetary financing and inflation. The findings lend support to recent calls for explicit monetary financing to boost highly indebted economies and a more general rethink of the dominant New Macroeconomic Consensus policy framework that prohibits monetary financing.
Download:Associated Program:Author(s):Josh Ryan-CollinsRelated Topic(s): -
Working Paper No. 847 | October 2015
A Post-Keynesian Interpretation of the Spanish Crisis
The Spanish crisis is generally portrayed as resulting from excessive spending by households, associated with a housing bubble and/or excessive welfare spending beyond the economic possibilities of the country. We put forward a different hypothesis. We argue that the Spanish crisis resulted, in the main, from a widening deficit position in the nonfinancial corporate sector—the most important explanatory factor behind the country’s rising external imbalance—and a declining trend in profitability under a regime of financial liberalization and loose and unregulated lending practices. This paper argues that the central cause of the crisis is related to the nonfinancial corporate sector’s increasingly fragile financial position, which originated from the financial convergence that followed adoption of the euro.
Download:Associated Program(s):Author(s):Esteban Pérez Caldentey Matías VernengoRelated Topic(s):Region(s):Europe -
In the Media | September 2015
By James M. Larkin and Zach Goldhammer
The Nation, September 30, 2015. All Rights Reserved.
To close out our series on work, produced in partnership with Open Source with Christopher Lydon and The Nation, we’re looking ahead to the big proposals and spiritual realignments that might spell a major change for working- and middle-class people who feel as though the recession never ended.
For proof of the problems we face, look no further than this chart, produced by one of our big thinkers this week, the Bulgarian-American economist Pavlina Tcherneva….
Read more: http://www.thenation.com/article/is-it-time-for-a-new-new-deal/
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Working Paper No. 845 | September 2015
Assessing the ECB’s Crisis Management Performance and Potential for Crisis Resolution
This study assesses the European Central Bank’s (ECB) crisis management performance and potential for crisis resolution. The study investigates the institutional and functional constraints that delineate the ECB’s scope for policy action under crisis conditions, and how the bank has actually used its leeway since 2007—or might do so in the future. The study finds that the ECB may well stand out positively when compared to other important euro-area or national authorities involved in managing the euro crisis, but that in general the bank did “too little, too late” to prevent the euro area from slipping into recession and protracted stagnation. The study also finds that expectations regarding the ECB’s latest policy initiatives may be excessively optimistic, and that proposals featuring the central bank as the euro’s savior through even more radical employment of its balance sheet are misplaced hopes. Ultimately, the euro’s travails can only be ended and the euro crisis resolved by shifting the emphasis toward fiscal policy; specifically, by partnering the ECB with a “Euro Treasury” that would serve as a vehicle for the central funding of public investment through the issuance of common Euro Treasury debt securities.Download:Associated Program(s):Author(s):Related Topic(s):Banking union Currency union Euro Euro crisis Euro Treasury European Central Bank (ECB) Eurozone Lender of last resort (LOLR) Monetary policyRegion(s):Europe -
Book Series | September 2015
By L. Randall Wray
In a completely revised second edition, Senior Scholar L. Randall Wray presents the key principles of Modern Money Theory, exploring macro accounting, monetary and fiscal policy, currency regimes, and exchange rates in developed and developing nations. Wray examines how misunderstandings about the nature of money caused the recent global financial meltdown, and provides fresh ideas about how leaders should approach economic policy. This updated edition also includes new chapters on tax policies and inflation.
Published by: Palgrave Macmillan
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Conference Proceedings | August 2015
A conference coorganized by the Levy Economics Institute of Bard College and Economia Civile with support from the Ford Foundation, the Friedrich-Ebert-Stiftung, and Marinopoulos AE
Athens, Greece
November 21–22, 2014This conference was organized as part of the Levy Institute’s international research agenda and in conjunction with the Ford Foundation Project on Financial Instability, which draws on Hyman Minsky’s extensive work on the structure of financial systems to ensure stability, and on the role of government in achieving a growing and equitable economy.
Among the key topics addressed: systemic instability in the eurozone; proposals for banking union; regulation and supervision of financial institutions; monetary, fiscal, and trade policy in Europe, and the spillover effects for the US and global economies; the impact of austerity policies on US and European markets; and the sustainability of government deficits and debt.
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Policy Note 2015/5 | August 2015
An Assessment in the Context of the IMF Rulings for Greece
Developing countries, led by China and other BRICS members (Brazil, Russia, India, and South Africa), have been successfully organizing alternative sources of credit flows, aiming for financial stability, growth, and development. With their goals of avoiding International Monetary Fund loan conditionality and the dominance of the US dollar in global finance, these new BRICS-led institutions represent a much-needed renovation of the global financial architecture. The nascent institutions will provide an alternative to the prevailing Bretton Woods institutions, loans from which are usually laden with prescriptions for austerity—with often disastrous consequences for output and employment. We refer here to the most recent example in Europe, with Greece currently facing the diktat of the troika to accept austerity as a precondition for further financial assistance.
It is rather disappointing that Western financial institutions and the EU are in no mood to provide Greece with any options short of complying with these disciplinary measures. Limitations, such as the above, in the prevailing global financial architecture bring to the fore the need for new institutions as alternative sources of funds. The launch of financial institutions by the BRICS—when combined with the BRICS clearing arrangement in local currencies proposed in this policy note—may chart a course for achieving an improved global financial order. Avoiding the use of the dollar as a currency to settle payments would help mitigate the impact of exchange rate fluctuations on transactions within the BRICS. Moreover, using the proposed clearing account arrangement to settle trade imbalances would help in generating additional demand within the BRICS, which would have an overall expansionary impact on the world economy as a whole.
Download:Associated Program(s):Author(s):Related Topic(s):BRICS Clearing account arrangement Developing economies Global financial system Greece Trade and development Trade imbalancesRegion(s):Europe -
Working Paper No. 842 | July 2015
The Euro Treasury Plan
The euro crisis remains unresolved and the euro currency union incomplete and extraordinarily vulnerable. The euro regime’s essential flaw and ultimate source of vulnerability is the decoupling of central bank and treasury institutions in the euro currency union. We propose a “Euro Treasury” scheme to properly fix the regime and resolve the euro crisis. This scheme would establish a rudimentary fiscal union that is not a transfer union. The core idea is to create a Euro Treasury as a vehicle to pool future eurozone public investment spending and to have it funded by proper eurozone treasury securities. The Euro Treasury could fulfill a number of additional purposes while operating mainly on the basis of a strict rule. The plan would also provide a much-needed fiscal boost to recovery and foster a more benign intra-area rebalancing.
Download:Associated Program(s):Author(s):Related Topic(s):Economic and Monetary Union (EMU) Economic recovery Euro crisis Euro Treasury Eurozone Fiscal union Public investmentRegion(s):Europe -
Working Paper No. 839 | June 2015
The Unit of Account, Inflation, Leverage, and Financial Fragility
We hope to model financial fragility and money in a way that captures much of what is crucial in Hyman Minsky’s financial fragility hypothesis. This approach to modeling Minsky may be unique in the formal Minskyan literature. Namely, we adopt a model in which a psychological variable we call financial prudence (P) declines over time following a financial crash, driving a cyclical buildup of leverage in household balance sheets. High leverage or a low safe-asset ratio in turn induces high financial fragility (FF). In turn, the pathways of FF and capacity utilization (u) determine the probabilistic risk of a crash in any time interval. When they occur, these crashes entail discrete downward jumps in stock prices and financial sector assets and liabilities. To the endogenous government liabilities in Hannsgen (2014), we add common stock and bank loans and deposits. In two alternative versions of the wage-price module in the model (wage–Phillips curve and chartalist, respectively), the rate of wage inflation depends on either unemployment or the wage-setting policies of the government sector. At any given time t, goods prices also depend on endogenous markup and labor productivity variables. Goods inflation affects aggregate demand through its impact on the value of assets and debts. Bank rates depend on an endogenous markup of their own. Furthermore, in light of the limited carbon budget of humankind over a 50-year horizon, goods production in this model consumes fossil fuels and generates greenhouse gases.
The government produces at a rate given by a reaction function that pulls government activity toward levels prescribed by a fiscal policy rule. Subcategories of government spending affect the pace of technical progress and prudence in lending practices. The intended ultimate purpose of the model is to examine the effects of fiscal policy reaction functions, including one with dual unemployment rate and public production targets, testing their effects on numerically computed solution pathways. Analytical results in the penultimate section show that (1) the model has no equilibrium (steady state) for reasons related to Minsky’s argument that modern capitalist economies possess a property that he called “the instability of stability,” and (2) solution pathways exist and are unique, given vectors of initial conditions and parameter values and realizations of the Poisson model of financial crises.
Download:Associated Program:Author(s):Related Topic(s):Chartalism Climate change Consumer debt Debt deflation Demand-led growth Financial instability hypothesis (FIH) Fiscal policy Margin loans Modern Money Theory (MMT) Money Neo-Kaleckian growth models Nonequilibrium economics Nonlinear dynamics Stagnation Stock-flow consistent (SFC) modeling Wage contour -
In the Media | May 2015
Congress Launches New Attacks on America's Central Bank
The Economist, May 16, 2015. All Rights Reserved.
During a financial panic, said Walter Bagehot, a former editor of The Economist, a central bank should help the deserving and let the reckless go under. Bagehot reckoned that the monetary guardians should follow fourrules: lend freely, but only to solvent firms, against good collateral and at high rates. Many American politicians complain that the Federal Reserve is all too happy to lend, but that it ignores Bagehot's other dictums. On May 13th two senators of very different hues—Elizabeth Warren, a darling of the left, and David Vitter, a southern conservative—joined forces to introduce a bill that would restrict the Fed's ability to lend during the next financial panic. Does that make sense?
Emergency lending under Section 13(3) of the Federal Reserve Act was one of the most controversial policy responses to the financial crisis. In a letter to Janet Yellen, the chair of the Fed, Ms Warren and Mr Vitter say that from 2007 to 2009 the Fed provided over $13 trillion to support financial institutions. The loans were cheap. A study from 2013 by the Levy Institute, a nonpartisan think-tank, found that many of them were "below or at the market rates" (sometimes less than 1%). Many of the banks that benefited were insolvent at the time. And much of the $13 trillion went to just three banks (Citigroup, Merrill Lynch and Morgan Stanley), leading many to suspect that the Fed was indulging favoured firms.
Critics focus on details but miss the big picture, counters the Fed. Elizabeth Duke, a former governor, says that the Fed targeted its lending programmes at the right markets, such that it helped to stop the crisis from getting even worse. Jerome Powell, a current governor, points out that "every single loan we made was repaid in full,on time, with interest."
But whether the Fed should be able to offert his kind of financial support at all is a different question. Choosing certain firms or markets to receive credit over others is inherently problematic, says a recent paper from the Federal Reserve Bank of Richmond. The prospect of easy money encourages firms to take excessive risks. And according to a paper by Alexander Mehra, then of Harvard Law School, the Fed "exceeded the bounds of its statutory authority" when it bought privately issued securities as well as making loans.
The Dodd-Frank Act, passed in 2010, was supposed to ensure that the Fed never again made such large, open-ended commitments. Congress told the Fed's board to ensure that emergency lending propped up the financial system as a whole, not individual firms. However, say Ms Warren and Mr Vitter, the Fed has not implemented the new rules in the spirit of the law. The new bill proposes a number of Bagehot-like changes: to toughen up the definition of insolvency, such that the Fed lends only to viable firms; to offer any lending programme to many different institutions; and to ensure that when the Fed does lend, it charges punitive rates.
This battle is not the only one the Fed faces. On May 12th Richard Shelby, a Republican senator and chair of the Senate Banking Committee, introduced his own bill, which he hopes will rein in the Fed's powers in different ways. It would increase the threshold at which a financial institution became "systemically important" (and thus subject to tougher regulatory scrutiny) from assets of $50 billion to $500 billion. Mr Shelby also wants to shake up the structure of the Federal Reserve System, including changing how the president of the New York Fed, which oversees big banks, is appointed. They may have different complaints, but lots of America's lawmakers agree that the Fed must change.
From the print edition: Finance and economicsAssociated Program: -
Working Paper No. 837 | May 2015
A Keynes-Schumpeter-Minsky Synthesis
This paper discusses the role that finance plays in promoting the capital development of the economy, with particular emphasis on the current situation of the United States and the United Kingdom. We define both “finance” and “capital development” very broadly. We begin with the observation that the financial system evolved over the postwar period, from one in which closely regulated and chartered commercial banks were dominant to one in which financial markets dominate the system. Over this period, the financial system grew rapidly relative to the nonfinancial sector, rising from about 10 percent of value added and a 10 percent share of corporate profits to 20 percent of value added and 40 percent of corporate profits in the United States. To a large degree, this was because finance, instead of financing the capital development of the economy, was financing itself. At the same time, the capital development of the economy suffered perceptibly. If we apply a broad definition—to include technological advances, rising labor productivity, public and private infrastructure, innovations, and the advance of human knowledge—the rate of growth of capacity has slowed.
The past quarter century witnessed the greatest explosion of financial innovation the world had ever seen. Financial fragility grew until the economy collapsed into the global financial crisis. At the same time, we saw that much (or even most) of the financial innovation was directed outside the sphere of production—to complex financial instruments related to securitized mortgages, to commodities futures, and to a range of other financial derivatives. Unlike J. A. Schumpeter, Hyman Minsky did not see the banker merely as the ephor of capitalism, but as its key source of instability. Furthermore, due to “financialisation of the real economy,” the picture is not simply one of runaway finance and an investment-starved real economy, but one where the real economy itself has retreated from funding investment opportunities and is instead either hoarding cash or using corporate profits for speculative investments such as share buybacks. As we will argue, financialization is rooted in predation; in Matt Taibbi’s famous phrase, Wall Street behaves like a giant, blood-sucking “vampire squid.”
In this paper we will investigate financial reforms as well as other government policy that is necessary to promote the capital development of the economy, paying particular attention to increasing funding of the innovation process. For that reason, we will look not only to Minsky’s ideas on the financial system, but also to Schumpeter’s views on financing innovation.
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One-Pager No. 49 | May 2015
Shadow Banking and Federal Reserve Governance in the Global Financial Crisis
The 2008 Federal Open Market Committee (FOMC) transcripts provide a rare portrait of how policymakers responded to the unfolding of the world’s largest financial crisis since the Great Depression. The transcripts reveal an FOMC that lacked a satisfactory understanding of a shadow banking system that had grown to enormous proportions—an FOMC that neither comprehended the extent to which the fate of regulated member banks had become intertwined and interlinked with the shadow banking system, nor had considered in advance the implications of a serious crisis. As a consequence, the Fed had to make policy on the fly as it tried to prevent a complete collapse of the financial system.
Download:Associated Program:Author(s):Matthew BergRelated Topic(s): -
Research Project Reports | April 2015This monograph is part of the Levy Institute’s Research and Policy Dialogue Project on Improving Governance of the Government Safety Net in Financial Crisis, a two-year project funded by the Ford Foundation.
This is the fourth in a series of reports summarizing the findings of the Research and Policy Dialogue Project on Improving Governance of the Government Safety Net in Financial Crisis, directed by Senior Scholar L. Randall Wray. This project explores alternative methods of providing a government safety net in times of crisis. In the global financial crisis that began in 2007, the United States used two primary responses: a stimulus package approved and budgeted by Congress, and a complex and unprecedented response by the Federal Reserve. The project examines the benefits and drawbacks of each method, focusing on questions of accountability, democratic governance and transparency, and mission consistency.
The project has also explored the possibility of reform that might place more responsibility for provision of a safety net on Congress, with a smaller role to be played by the Fed, enhancing accountability while allowing the Fed to focus more closely on its proper mission. Given the rise of shadow banking—a financial system that operates largely outside the reach of bank regulators and supervisors—the Fed faces a complicated problem. It might be necessary to reform finance, through downsizing and a return to what Hyman Minsky called “prudent banking,” before we can reform the Fed.
This report describes the overall scope of the project and summarizes key findings from the three previous reports, as well as additional research undertaken in 2014.Download:Associated Program:Related Topic(s): -
Working Paper No. 834 | March 2015
John Maynard Keynes held that the central bank’s actions determine long-term interest rates through short-term interest rates and various monetary policy measures. His conjectures about the determinants of long-term interest rates were made in the context of advanced capitalist economies, and were based on his views on ontological uncertainty and the formation of investors’ expectations. Are these conjectures valid in emerging markets, such as India? This paper empirically investigates the determinants of changes in Indian government bonds’ nominal yields. Changes in short-term interest rates, after controlling for other crucial variables such as changes in the rates of inflation and economic activity, take a lead role in driving changes in the nominal yields of Indian government bonds. This vindicates Keynes’s theories, and suggests that his views on long-term interest rates are also applicable to emerging markets. Higher fiscal deficits do not appear to raise government bond yields in India. It is further argued that Keynes’s conjectures about investors’ outlooks, views, and expectations are fairly robust in a world of ontological uncertainty.
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Policy Note 2015/1 | February 2015
Financial Fragility and the Survival of the Single Currency
Given the continuing divergence between progress in the monetary field and political integration in the euro area, the German interest in imposing austerity may be seen as representing an attempt to achieve, de facto, accelerated progress toward political union; progress that has long been regarded by Germany as a precondition for the success of monetary unification in the form of the common currency. Yet no matter how necessary these austerity policies may appear in the context of the slow and incomplete political integration in Europe, they are ultimately unsustainable. In the absence of further progress in political unification, writes Senior Scholar Jan Kregel, the survival and stability of the euro paradoxically require either sustained economic stagnation or the maintenance of what Hyman Minsky would have recognized as a Ponzi scheme. Neither of these alternatives is economically or politically sustainable.Download:Associated Program:Author(s):Jan KregelRelated Topic(s): -
One-Pager No. 48 | February 2015The developed world’s policy response to the recent financial crisis has produced complaints from Brazil of “currency wars” and calls from India for increased policy coordination and cooperation. Chinese officials have echoed the “exorbitant privilege” noted by de Gaulle in the 1960s, and Russia has joined China as a proponent of replacing the dollar with Special Drawing Rights. However, none of the proposed remedies are adequate to achieve the emerging market economies’ objective of joining the ranks of industrialized, developed countries.Download:Associated Program:Author(s):Jan KregelRelated Topic(s):
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Public Policy Brief No. 139 | February 2015
Back to the Future
Emerging market economies are taking an ill-targeted and far too limited approach to addressing their ongoing problems with the international financial system, according to Senior Scholar Jan Kregel. In this policy brief, he explains why only a wholesale reform of the international financial architecture can adequately address these countries’ concerns. As a blueprint for reform, Kregel recommends a radical proposal advanced in the 1940s, most notably by John Maynard Keynes. Keynes was among those who were developing proposals for shaping the international financial system in the immediate postwar period. His clearing union plan, itself inspired by Hjalmar Schacht’s system of bilateral clearing agreements, would have effectively eliminated the need for an international reserve currency. Under Keynes’s clearing union, trade and other international payments would be automatically facilitated through a global clearinghouse, using debits and credits denominated in a notional unit of account. The unit of account would have a fixed conversion rate to national currencies and could not be bought, sold, or traded—meaning no market for foreign currency would be required. Clearinghouse credits could only be used to offset debits by buying imports, and if not used within a specified period of time, the credits would be extinguished, giving export surplus countries an incentive to spend them. As Kregel points out, this would help support global demand and enable a shared adjustment burden. Though Keynes’s proposal was not specifically designed for emerging market economies, Kregel recommends combining this plan with current ideas for regionally governed institutions—to create, in other words, “regional clearing unions,” building on existing swaps arrangements. Under such a system, emerging market economies would be able to pursue their development needs without reliance on the prevailing international financial architecture, in which their concerns are, at best, diluted.Download:Associated Program:Author(s):Jan KregelRelated Topic(s): -
Working Paper No. 833 | February 2015
A Blueprint for Reform
If emerging markets are to achieve their objective of joining the ranks of industrialized, developed countries, they must use their economic and political influence to support radical change in the international financial system. This working paper recommends John Maynard Keynes’s “clearing union” as a blueprint for reform of the international financial architecture that could address emerging market grievances more effectively than current approaches.
Keynes’s proposal for the postwar international system sought to remedy some of the same problems currently facing emerging market economies. It was based on the idea that financial stability was predicated on a balance between imports and exports over time, with any divergence from balance providing automatic financing of the debit countries by the creditor countries via a global clearinghouse or settlement system for trade and payments on current account. This eliminated national currency payments for imports and exports; countries received credits or debits in a notional unit of account fixed to national currency. Since the unit of account could not be traded, bought, or sold, it would not be an international reserve currency. The credits with the clearinghouse could only be used to offset debits by buying imports, and if not used for this purpose they would eventually be extinguished; hence the burden of adjustment would be shared equally—credit generated by surpluses would have to be used to buy imports from the countries with debit balances. Emerging market economies could improve upon current schemes for regionally governed financial institutions by using this proposal as a template for the creation of regional clearing unions using a notional unit of account.Download:Associated Program:Author(s):Jan KregelRelated Topic(s): -
Working Paper No. 832 | February 2015
The Contributions of John F. Henry
This paper explores the rise of money and class society in ancient Greece, drawing historical and theoretical parallels to the case of ancient Egypt. In doing so, the paper examines the historical applicability of the chartalist and metallist theories of money. It will be shown that the origins and the evolution of money were closely intertwined with the rise and consolidation of class society and inequality. Money, class society, and inequality came into being simultaneously, so it seems, mutually reinforcing the development of one another. Rather than a medium of exchange in commerce, money emerged as an “egalitarian token” at the time when the substance of social relations was undergoing a fundamental transformation from egalitarian to class societies. In this context, money served to preserve the façade of social and economic harmony and equality, while inequality was growing and solidifying. Rather than “invented” by private traders, money was first issued by ancient Greek states and proto-states as they aimed to establish and consolidate their political and economic power. Rather than a medium of exchange in commerce, money first served as a “means of recompense” administered by the Greek city-states as they strived to implement the civic conception of social justice. While the origins of money are to be found in the origins of inequality, a well-functioning democratic society has the power to subvert the inequality-inducing characteristic of money via the use of money for public purpose, following the principles of Modern Money Theory (MMT). When used according to the principles of MMT, the inequality-inducing characteristic of money could be undermined, while the current trends in rising income and wealth disparities could be contained and reversed. -
Working Paper No. 831 | January 2015
The Market Creating and Shaping Roles of State Investment Banks
Recent decades witnessed a trend whereby private markets retreated from financing the real economy, while, simultaneously, the real economy itself became increasingly financialized. This trend resulted in public finance becoming more important for investments in capital development, technical change, and innovation. Within this context, this paper focuses on the roles played by a particular source of public finance: state investment banks (SIBs). It develops a conceptual typology of the different roles that SIBs play in the economy, which together show the market creation/shaping process of SIBs rather than their mere “market fixing” roles. This paper discusses four types of investments, both theoretically and empirically: countercyclical, developmental, venture capitalist, and challenge led. To develop the typology, we first discuss how standard market failure theory justifies the roles of SIBs, the diagnostics and evaluation toolbox associated with it, and resulting criticisms centered on notions of “government failures.” We then show the limitations of this approach based on insights from Keynes, Schumpeter, Minsky, and Polanyi, as well as other authors from the evolutionary economics tradition, which help us move toward a framework for public investments that is more about market creating/shaping than market fixing. As frameworks lead to evaluation tools, we use this new lens to discuss the increasingly targeted investments that SIBs are making, and to shed new light on the usual criticisms that are made about such directed activity (e.g., crowding out and picking winners). The paper ends with a proposal of directions for future research.
Download:Associated Program:Author(s):Mariana Mazzucato Caetano C.R. PennaRelated Topic(s): -
Working Paper No. 829 | January 2015
Before the global financial crisis, the assistance of a lender of last resort was traditionally thought to be limited to commercial banks. During the crisis, however, the Federal Reserve created a number of facilities to support brokers and dealers, money market mutual funds, the commercial paper market, the mortgage-backed securities market, the triparty repo market, et cetera. In this paper, we argue that the elimination of specialized banking through the eventual repeal of the Glass-Steagall Act (GSA) has played an important role in the leakage of the public subsidy intended for commercial banks to nonbank financial institutions. In a specialized financial system, which the GSA had helped create, the use of the lender-of-last-resort safety net could be more comfortably limited to commercial banks.
However, the elimination of GSA restrictions on bank-permissible activities has contributed to the rise of a financial system where the lines between regulated and protected banks and the so-called shadow banking system have become blurred. The existence of the shadow banking universe, which is directly or indirectly guaranteed by banks, has made it practically impossible to confine the safety to the regulated banking system. In this context, reforming the lender-of-last-resort institution requires fundamental changes within the financial system itself.
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Working Paper No. 828 | January 2015
The Indian Case
Financialization creates space for the financial sector in economies, and in doing so helps to raise the share of financial assets in the portfolios held by market participants. Largely driven by deregulation, the process works to make financial assets relatively attractive as compared to other assets, by offering both better returns and potential capital gains. Both the trend toward a more financialized economy and the expected returns on financial investments have provided incentives to corporate managers to invest larger sums in financial assets, resulting in growth of the share of financial assets relative to other assets held in portfolios. Assets held in the financial sector, however, failed to generate asset growth for the corporates. The need to obtain resources by borrowing in order to meet current liabilities reflects a pattern of Ponzi finance on their part. This paper traces the above pattern in corporate holdings of assets and its implications, with emphasis on the Indian economy.
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Working Paper No. 827 | January 2015
Early Work on Endogenous Money and the Prudent Banker
In this paper, I examine whether Hyman P. Minsky adopted an endogenous money approach in his early work—at the time that he was first developing his financial instability approach. In an earlier piece (Wray 1992), I closely examined Minsky’s published writings to support the argument that, from his earliest articles in 1957 to his 1986 book (as well as a handout he wrote in 1987 on “securitization”), he consistently held an endogenous money view. I’ll refer briefly to that published work. However, I will devote most of the discussion here to unpublished early manuscripts in the Minsky archive (Minsky 1959, 1960, 1970). These manuscripts demonstrate that in his early career Minsky had already developed a deep understanding of the nature of banking. In some respects, these unpublished pieces are better than his published work from that period (or even later periods) because he had stripped away some institutional details to focus more directly on the fundamentals. It will be clear from what follows that Minsky’s approach deviated substantially from the postwar “Keynesian” and “monetarist” viewpoints that started from a “deposit multiplier.” The 1970 paper, in particular, delineates how Minsky’s approach differs from the “Keynesian” view as presented in mainstream textbooks. Further, Minsky’s understanding of banking in those years appears to be much deeper than that displayed three or four decades later by much of the post-Keynesian endogenous-money literature.
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Working Paper No. 825 | January 2015
What Should BNDES Do?
The 2007–8 global financial crisis has shown the failure of private finance to efficiently allocate capital to finance real capital development. The resilience and stability of Brazil’s financial system has received attention, since it navigated relatively smoothly through the Great Recession and the collapse of the shadow banking system. This raises the question of whether it is possible that the alternative approaches followed by some developing countries might provide an indication of more stable regulatory approaches generally. There has been much discussion about how to support private long-term finance in order to meet Brazil’s growing infrastructure and investment needs. One of the essential functions of the financial system is to provide the long-term funding needed for long-lived and expensive capital assets. However, one of the main difficulties of the current private financial system is its failure to provide long-term financing, as the short-termism in Brazil’s financial market is a major obstacle to financing long-term assets. In its current form, the National Economic and Social Development Bank (BNDES) is the main source of long-term funding in the country. However, BNDES has been subject to a range of criticisms, such as crowding out private sector bank lending, and it is said to be hampering the development of the local capital market. This paper argues that, rather than following the traditional approach to justify the existence of public banks—and BNDES in particular, based on market failures—finding an effective answer to this question requires a theory of financial instability.
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Working Paper No. 824 | January 2015
A New Framework for Envisioning and Evaluating a Mission-oriented Public Sector
Today, countries around the world are seeking “smart” innovation-led growth, and hoping that this growth is also more “inclusive” and “sustainable” than in the past. This paper argues that such a feat requires rethinking the role of government and public policy in the economy—not only funding the “rate” of innovation, but also envisioning its “direction.” It requires a new justification of government intervention that goes beyond the usual one of “fixing market failures.” It also requires the shaping and creating of markets. And to render such growth more “inclusive,” it requires attention to the ensuing distribution of “risks and rewards.”
To approach the innovation challenge of the future, we must redirect the discussion, away from the worry about “picking winners” and “crowding out” toward four key questions for the future:- Directions: how can public policy be understood in terms of setting the direction and route of change; that is, shaping and creating markets rather than just fixing them? What can be learned from the ways in which directions were set in the past, and how can we stimulate more democratic debate about such directionality?
- Evaluation: how can an alternative conceptualization of the role of the public sector in the economy (alternative to MFT) translate into new indicators and assessment tools for evaluating public policies beyond the microeconomic cost/benefit analysis? How does this alter the crowding in/out narrative?
- Organizational change: how should public organizations be structured so they accommodate the risk-taking and explorative capacity, and the capabilities needed to envision and manage contemporary challenges?
- Risks and Rewards: how can this alternative conceptualization be implemented so that it frames investment tools so that they not only socialize risk, but also have the potential to socialize the rewards that enable “smart growth” to also be “inclusive growth”?
Download:Associated Program(s):Author(s):Mariana MazzucatoRelated Topic(s): -
Working Paper No. 822 | December 2014
An understanding of, and an intervention into, the present capitalist reality requires that we put together the insights of Karl Marx on labor, as well as those of Hyman Minsky on finance. The best way to do this is within a longer-term perspective, looking at the different stages through which capitalism evolves. In other words, what is needed is a Schumpeterian-like, nonmechanical view about long waves, where Minsky’s financial Keynesianism is integrated with Marx’s focus on capitalist relations of production. Both are essential elements in understanding neoliberalism’s ascent and collapse. Minsky provided crucial elements in understanding the capitalist “new economy.” This refers to his perceptive diagnosis of “money manager capitalism,” the new form of capitalism that came from the womb of the Keynesian era itself. It collapsed a first time with the dot-com crisis, and a second time, and more seriously, with the subprime crisis. The focus is on the long-term changes in capitalism, and especially on what L. Randall Wray appropriately calls Minsky’s “stages approach.” Our aim is to show that this theme has a deep connection with the topic of the socialization of investment, central in the conclusions of the latter’s 1975 book on Keynes.
Download:Associated Program:Author(s):Riccardo BellofioreRelated Topic(s): -
Working Paper No. 821 | December 2014
The Advantages of Owning the Magic Porridge Pot
Over the past two decades there has been a revival of Georg Friedrich Knapp’s “state money” approach, also known as chartalism. The modern version has come to be called Modern Money Theory. Much of the recent research has delved into three main areas: mining previous work, applying the theory to analysis of current sovereign monetary operations, and exploring the policy space open to sovereign currency issuers. This paper focuses on “outside” money—the currency issued by the sovereign—and the advantages that accrue to nations that make full use of the policy space provided by outside money.
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Policy Note 2014/6 | December 2014Criticisms of the Federal Reserve’s “unconventional” monetary policy response to the Great Recession have been of two types. On the one hand, the tripling in the size of the Fed’s balance sheet has led to forecasts of rampant inflation in the belief that the massive increase in excess reserves might be spent on goods and services. And even worse, this would represent an attempt by government to inflate away its high levels of debt created to support the solvency of financial institutions after the September 2008 collapse of asset prices. On the other hand, it is argued that the near-zero short-term interest rate policy and measures to flatten the yield curve (quantitative easing plus "Operation Twist") distort the allocation and pricing in the credit and capital markets and will underwrite another asset price bubble, even as deflation prevails in product markets. Both lines of criticism have led to calls for a return to a more conventional policy stance, and yet there is widespread agreement that this would have a negative impact on the economy, at least in the short-term. However, since the analyses behind both lines of criticism are mistaken, it is probable that the analyses of the impact of the risks of return to more normal policies are also in error.Download:Associated Program:Author(s):Jan KregelRelated Topic(s):
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Book Series | November 2014
Edited by Dimitri B. Papadimitriou
Levy Institute Senior Scholar Jan A. Kregel is a prominent Post-Keynesian economist. This study combines lessons drawn from events and experiences of developing countries and examines them in relation to his ideas on economics and development.
This collection brings together distinguished scholars who have been influenced by Kregel's prodigious contributions to the fields of economic theory and policy. The chapters cover and extend many topics analyzed in Kregel's published work, including monetary economic theory and policy; aspects of the Cambridge (UK and US) controversies; Sraffa's critique on neoclassical value and distribution theory; Post-Keynesianism; employment policy; obstacles in financing development; trade and development theories; causes and lessons from the financial crises in East Asia, Latin America, and Europe; Minskyan-Kregel theories of financial instability; and global governance. Combining rigorous scholarly assessment of the issues, the contributors seek to offer solutions to the debates on economic theory and the problem of continuing high unemployment, to identify the factors that determine economic expansion, and to analyze the impact of financial crises on systemic stability, markets, institutions, and international regulations on domestic and global economic performance.
The scope and comprehensive analyses found in this volume will be of interest to economists and scholars of economics, finance, and development.
Published by: Palgrave Macmillan
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Working Paper No. 820 | November 2014
Challenges for the Art of Monetary Policymaking in Emerging Economies
This paper examines the emerging challenges to the art of monetary policymaking using the case study of the Reserve Bank of India (RBI) in light of developments in the Indian economy during the last decade (2003–04 to 2013–14). The paper uses Hyman P. Minsky’s financial instability hypothesis as the conceptual framework for evaluating the endogenous nature of financial instability and its potential impact on monetary policymaking, and addresses the need to pursue regulatory policy as a tool that is complementary to monetary policy in light of the agenda of reforms put forward by Minsky. It further reviews the extensions to the Minskyan hypothesis in the areas of setting fiscal policy, managing cross-border capital flows, and developing financial institutional infrastructure. The lessons learned from the interplay of policy choices in these areas and their impact on monetary policymaking at the RBI are presented.
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Conference Proceedings | November 2014A conference organized by the Levy Economics Institute with support from the Ford Foundation
In the context of a sluggish economic recovery and global uncertainty, with growth and employment well below normal levels, the 2014 Minsky Conference addressed both financial reform and prosperity, drawing from Hyman Minsky’s work on financial instability and his proposal for achieving full employment. Panels focused on the design of a new, more robust, and stable financial architecture; fiscal austerity and the sustainability of the US and European economic recovery; central bank independence and financial reform; the larger implications of the eurozone debt crisis for the global economic system; the impact of the return to more traditional US monetary policy on emerging markets and developing economies; improving governance of the social safety net; the institutional shape of the future financial system; strategies for promoting an inclusive economy and more equitable income distribution; and regulatory challenges for emerging-market economies. The proceedings include the conference program, transcripts of keynote speakers’ remarks, synopses of the panel sessions, and biographies of the participants.Download:Associated Program(s):Author(s):Barbara Ross Michael StephensRegion(s):United States, Europe -
Policy Note 2014/5 | November 2014
The Fed’s zero interest policy rate (ZIRP) and quantitative easing (QE) policies failed to restore growth to the US economy as expected (i.e., increased investment spending à la John Maynard Keynes or from an expanded money supply à la Ben Bernanke / Milton Friedman). Senior Scholar Jan Kregel analyzes some of the arguments as to why these policies failed to deliver economic recovery. He notes a common misunderstanding of Keynes’s liquidity preference theory in the debate, whereby it is incorrectly linked to the recent implementation of ZIRP. Kregel also argues that Keynes’s would have implemented QE policies quite differently, by setting the bid and ask rate and letting the market determine the volume of transactions. This policy note both clarifies Keynes’s theoretical insights regarding unconventional monetary policies and provides a substantive analysis of some of the reasons why central bank policies have failed to achieve their stated goals.
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In the Media | October 2014
By Ronald Find
Global Finance, October 29, 2014. All Rights Reserved.
Governors of the world’s central banks face difficult choices as they are increasingly tasked with promoting financial stability and providing a boost to growth. Not all central bankers—or other stakeholders—believe this is, or should be, their role. What’s more, the tools at their disposal may have limited effects and unforeseen consequences, leaving the bankers between a rock and a hard place. . . .
Read more: https://www.gfmag.com/magazine/october-2014/central-banks-where-do-they-go-hereAssociated Program: -
Book Series | October 2014
By Jan A. Kregel. Edited by Rainer Kattel. Foreword by G. C. Harcourt.
This volume is the first collection of essays by Jan Kregel focusing on the role of finance in development and growth, and it demonstrates the extraordinary depth and breadth of this economist’s work. Considered the “best all-round general economist alive” (Harcourt), Kregel is a senior scholar and director of the monetary policy and financial structure program at the Levy Economics Institute, and professor of development finance at Tallinn University of Technology. These essays reflect his deep understanding of the nature of money and finance and of the institutions associated with them, and of the indissoluble relationship between these institutions and the real economy—whether in developed or developing economies. Kregel has expanded Hyman Minsky’s original premise that in capitalist economies stability engenders instability, and Kregel’s key works on financial instability, its causes and effects, as well as his discussions of the global financial crisis and Great Recession, are included here.
Published by: Anthem Press
Associated Program:Author(s):Jan Kregel Rainer KattelRelated Topic(s): -
Working Paper No. 818 | October 2014
During the past two decades of economic stagnation and persistent deflation in Japan, chronic fiscal deficits have led to elevated and rising ratios of government debt to nominal GDP. Nevertheless, long-term Japanese government bonds’ (JGBs) nominal yields initially declined and have stayed remarkably low and stable since then. This is contrary to the received wisdom of the existing literature, which holds that higher government deficits and indebtedness shall exert upward pressures on government bonds’ nominal yields. This paper seeks to understand the determinants of JGBs’ nominal yields. It examines the relationship between JGBs’ nominal yields and short-term interest rates and other relevant factors, such as low inflation and persistent deflationary pressures and tepid growth. Low short-term interest rates, induced by monetary policy, have been the main reason for JGBs’ low nominal yields. It is also argued that Japan has monetary sovereignty, which gives the government of Japan the ability to meet its debt obligations. It enables the Bank of Japan to exert downward pressure on JGBs’ nominal yields by allowing it to keep short-term interest rates low and to use other tools of monetary policy. The argument that current short-term interest rates and monetary policy are the primary drivers of long-term interest rates follows Keynes’s (1930) insights.
Download:Associated Program:Author(s):Tanweer Akram Anupam DasRelated Topic(s): -
Working Paper No. 817 | September 2014
The Reemergence of Liquidity Preference and Animal Spirits in the Post-Keynesian Theory of Capital Markets
Since the beginning of the fall of monetarism in the mid-1980s, mainstream macroeconomics has incorporated many of the principles of post-Keynesian endogenous money theory. This paper argues that the most important critical component of post-Keynesian monetary theory today is its rejection of the “natural rate of interest.” By examining the hidden assumptions of the loanable funds doctrine as it was modified in light of the idea of a natural rate of interest—specifically, its implicit reliance on an “efficient markets hypothesis” view of capital markets—this paper seeks to show that the mainstream view of capital markets is completely at odds with the world of fundamental uncertainty addressed by post-Keynesian economists, a world in which Keynesian liquidity preference and animal spirits rule the roost. This perspective also allows us to shed new light on the debate that has sprung up around the work of Hyman Minsky, calling into question to what extent he rejected the loanable funds view of financial markets. When Minsky’s theories are examined against the backdrop of the natural rate of interest version of the loanable funds theory, it quickly becomes clear that Minsky does not fall into the loanable funds camp.
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Press Releases | September 2014
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Public Policy Brief No. 135 | August 2014Contrary to German chancellor Angela Merkel’s recent claim, the euro crisis is not nearly over but remains unresolved, leaving the eurozone extraordinarily vulnerable to renewed stresses. In fact, as the reforms agreed to so far have failed to turn the flawed and dysfunctional euro regime into a viable one, the current calm in financial markets is deceiving, and unlikely to last. The euro regime’s essential flaw and ultimate source of vulnerability is the decoupling of central bank and treasury institutions in the euro currency union. In this public policy brief, Research Associate Jörg Bibow proposes a Euro Treasury scheme to properly fix the regime and resolve the euro crisis. The Euro Treasury would establish the treasury–central bank axis of power that exists at the center of control in sovereign states. Since the eurozone is not actually a sovereign state, the proposed treasury is specifically designed not to be a transfer union; no mutualization of existing national public debts is involved either. The Euro Treasury would be the means to pool future eurozone public investment spending, funded by proper eurozone treasury securities, and benefits and contributions would be shared across the currency union based on members’ GDP shares. The Euro Treasury would not only heal the euro’s potentially fatal birth defects but also provide the needed stimulus to end the crisis in the eurozone.Download:Associated Program:Author(s):Related Topic(s):
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Conference Proceedings | August 2014This conference was organized as part of the Levy Institute’s international research agenda and in conjunction with the Ford Foundation Project on Financial Instability, which draws on Hyman Minsky’s extensive work on the structure of financial systems to ensure stability, and the role of government in achieving a growing and equitable economy.
Among the key topics addressed: the challenges to global growth and employment posed by the continuing eurozone debt crisis; the impact of austerity on output and employment; the ramifications of the credit crunch for economic and financial markets; the larger implications of government deficits and debt crises for US and European economic policies; and central bank independence and financial reform.Download:Associated Program(s):Region(s):United States, Europe -
Research Project Reports | July 2014
A Proposal for Rural Reinvestment and Urban Entrepreneurship
The crisis in Greece is persistent and ongoing. After six years of deepening recession, real GDP has shrunk by more than 25 percent, with total unemployment now standing at 27.2 percent. Clearly, reviving growth and creating jobs should be at the top of the policy agenda.
But banks remain undercapitalized, and lending has been restricted to only the most creditworthy businesses and households. Many start-ups and small- and medium-size enterprises (SMEs) have almost no access to development loans, and for those to whom credit can be extended, it is at disproportionally high interest rates.
The success of micro-lending institutions in developing nations (such as the Grameen Bank in Bangladesh) has highlighted the positive economic performance of community-based credit, and such lending models have proven to be an important poverty policy alternative in areas where transfer payments are limited. Community or co-operative financial institutions (CFIs) can fill the gap when existing institutions cannot adequately perform critical functions of the financial system for SMEs, entrepreneurs, and low-income residents seeking modest financing and other banking services.
We propose expanding the reach and services of CFIs within Greece, drawing upon lessons from the US experience of community development banking and various co-operative banking models in Europe. The primary goals of this nationwide system would be to make credit available, process payments, and offer savings opportunities to communities not well served by the major commercial Greek banks.
Our blueprint includes suggestions on the banks’ organization and a framework within which they would be chartered, regulated, and supervised by a newly created central co-operative bank. It also looks at the possible impact that such a network could have, especially in terms of start-ups, SMEs, and rural redevelopment (agrotourism)—all of which are critical to Greece’s exit from recession.Download:Associated Program:Author(s):Related Topic(s): -
Working Paper No. 802 | May 2014
Policy Challenges for Central Banks
Central banks responded with exceptional liquidity support during the financial crisis to prevent a systemic meltdown. They broadened their tool kit and extended liquidity support to nonbanks and key financial markets. Many want central banks to embrace this expanded role as “market maker of last resort” going forward. This would provide a liquidity backstop for systemically important markets and the shadow banking system that is deeply integrated with these markets. But how much liquidity support can central banks provide to the shadow banking system without risking their balance sheets? I discuss the expanding role of the shadow banking sector and the key drivers behind its growing importance. There are close parallels between the growth of shadow banking before the recent financial crisis and earlier financial crises, with rapid growth in near monies as a common feature. This ebb and flow of shadow-banking-type liabilities are indeed an ingrained part of our advanced financial system. We need to reflect and consider whether official sector liquidity should be mobilized to stem a future breakdown in private shadow banking markets. Central banks should be especially concerned about providing liquidity support to financial markets without any form of structural reform. It would indeed be ironic if central banks were to declare victory in the fight against too-big-to-fail institutions, just to end up bankrolling too-big-to-fail financial markets.
Download:Associated Program:Author(s):Related Topic(s): -
Working Paper No. 801 | May 2014
Debt, Finance, and Distributive Politics under a Kalecki-Goodwin-Minsky SFC Framework
This paper describes the political economy of shadow banking and how it relates to the dramatic institutional changes experienced by global capitalism over past 100 years. We suggest that the dynamics of shadow banking rest on the distributive tension between workers and firms. Politics wedge the operation of the shadow financial system as government policy internalizes, guides, and participates in dealings mediated by financial intermediaries. We propose a broad theoretical overview to formalize a stock-flow consistent (SFC) political economy model of shadow banking (stylized around the operation of money market mutual funds, or MMMFs). Preliminary simulations suggest that distributive dynamics indeed drive and provide a nest for the dynamics of shadow banking.
Download:Associated Program(s):Author(s):Eloy Fisher Javier López BernardoRelated Topic(s):Debt and public finance Kaleckian macrodynamics Political cycles Political economy of finance Political macroeconomic models Shadow banking Stock-flow consistent (SFC) modelingRegion(s):United States -
In the Media | May 2014
By Barry Elias
MoneyNews, May 8, 2014. All Rights Reserved.
Future rises in income inequality will lead to a prolonged period of anemic economic growth and high unemployment.
Income for the bottom 90 percent of households has stagnated during the past 35 years. Strong economic activity in the 1990s and 2000s was largely generated by consumption that was financed by borrowing. The resulting high levels of debt relative to income precipitated the financial and economic crisis.
Since 2008, the bottom 90 percent of households have deleveraged, thereby reducing their debt-to-disposable-income ratio. This ratio for the top 10 percent has remained relatively stable. Should this deleveraging trend continue, by 2017, economic growth will be 1.7 percentage points lower than the post-recession period, and unemployment will rise 1.3 percentage points to 7.6 percent, according to the Levy Economics Institute.
Future economic growth is unlikely to arise from the activities of the top 10 percent of households. Their consumption levels tend to remain relatively stable, and their investments are driven by short-term arbitrage opportunities of financial assets — not long-term direct investment in businesses that generate strong employment and income growth.
Coupled with weak foreign demand and restrictive government fiscal policy, future economic growth may be driven by domestic deficits. This burden will fall primarily on the bottom 90 percent in the private sector and exacerbate income disparity. However, as debt-to-income levels rise, a financial and economic crisis becomes more probable.
The only viable solution to this economic conundrum is greater income equality.
Associated Program: -
Working Paper No. 799 | May 2014
A Financial View
This paper develops the framework of analysis of monetary systems put together by authors such as Macleod, Keynes, Innes, and Knapp. This framework does not focus on the functions performed by an object but rather on its financial characteristics. Anything issued by anybody can be a monetary instrument and any type of material can be used to make a monetary instrument, as these are unimportant determinants of what a monetary instrument is. What matters is the existence of specific financial characteristics. These characteristics lead to a stable nominal value (parity) in the proper financial environment. This framework of analysis leads the researcher to study how the fair value of a monetary instrument changes and how that change differs from changes in the value of the unit of account. It also provides a road map to understanding monetary history and why monetary instruments are held.
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In the Media | April 2014
By Robert Feinberg
MoneyNews, April 30, 2014. All Rights Reserved.
Jason Furman, the brilliant economist who chairs the Council of Economic Advisers, spoke recently at the 23rd Annual Hyman Minsky Conference, sponsored by the Levy Economics Institute of Bard College.
The title of Furman's presentation was "Whatever Happened to the Great Moderation?" He argued that with the right economic policies, as advocated by the administration, this mythical Great Moderation could be restored.
I suspect a priori that the Great Moderation was a result of official policies that suppressed normal adjustments that should have taken place in the economy, for example, by neglecting prudential and consumer protection regulation of "too big to fail" banks, so that when the 2008 episode of the permanent financial crisis erupted, it was much more costly and disruptive than it would otherwise have been.
Ironically, after having written this sentence, I found that a similar suggestion had been made by a famous economist — none other than Hyman Minsky. The very informative Wikipedia entry on the Great Moderation also contains a reference to a 2003 speech by University of Chicago economist Robert Lucas as president of the American Economic Association celebrating the idea that the profession had practically solved "the central problem depression prevention."
Furman defined the Great Moderation as the reduction in the volatility of a wide range of economic variables, and to the associated increase in the longevity of economic expansions and reduction in the frequency and severity of economic contractions. Among the economists cited as having contributed research on this subject are former Federal Reserve Chairman Ben Bernanke (2004) and Douglas Elmendorf (2006), currently director of the Congressional Budget Office.
Furman dated the beginning of the debate over the Great Moderation to the early 1990s. To his credit, Furman took time out to question, as I do, whether "there ever was a 'Great Moderation,' let alone that it has returned and rendered further policy steps unnecessary."
Furman dismissed the idea that policy responses are not needed, because recessions serve a purpose and little can be done, on the ground that while this might be true in "normal times," these times are characterized by a large shortfall in output, and policy responses are needed. He seems not to have considered that maybe these are "normal times," and that the slow growth and shortfall in output are due to previous misguided policies.
Instead, he offered some new misguided policies, a lot of them, under what he calls "The Unfinished Agenda for Economic Stability." This is ironic, because it seems that Minsky himself was highly skeptical that "economic stability" could be achieved by policy.
It almost becomes amusing to consider the grab bag of measures Furman offers as holding out hope of averting or coping with future downturns. He claimed that Obamacare will have a counter-cyclical effect, a notion that is heatedly disputed, and he also pointed to increased progressivity in taxation. Reducing inequality is highly speculative as a counter-cyclical measure, but maybe they can start with salaries of reckless bank executives and their feckless regulators.
Finally, Furman pointed to implementation of Dodd-Frank and Housing and Finance Reform, which are laughable, because neither is likely to happen, and they might not produce the effects he expects even if they do.
As a political document, the speech represents how desperate the administration is to establish a positive legacy as President Obama's popularity declines.
(Archived video can be found here.)
Associated Program: -
In the Media | April 2014
By Robert Feinberg
MoneyNews, April 28, 2014. All Rights Reserved.
Rep. Carolyn Maloney, D-N.Y., spoke at the 23rd Annual Hyman P. Minsky Conference, held in Washington at the National Press Club recently. The conference was sponsored by the Levy Economics Institute of Bard College, an independent group that "encourages diversity of opinion in the examination of economic policy issues while striving to transform ideological arguments into informed debate." The theme of the conference was "Stabilizing Financial Systems for Growth and Full Employment," and it was co-sponsored by the Ford Foundation.
The conferences celebrate the life and work of Minsky, who was an early theorist on the financial crisis and an advocate of government intervention to respond to financial crises that inevitably occur from time to time. This is the first of three articles on speeches delivered at the conference by Maloney and Jason Furman, chairman of the Council of Economic Advisers.
Maloney struggled to deliver the speech due to a cough, and perhaps also due to some form of the flu, she seemed medicated and perhaps to be reading the speech for the first time, although the arguments were very familiar.
Later that day the House was scheduled to vote on what is known as the "Ryan budget," authored by Rep. Paul Ryan, R-Wis., which she rightly stated represents the embodiment of the Republican platform, and she devoted the speech to two provisions related to financial reform that would be affected by the Ryan budget, namely the so-called "Orderly Liquidation" provisions contained in title II of the Dodd-Frank Act, and so-called "Housing Finance Reform" now being tentatively considered in Congress.
In 2008, I predicted privately that there would be a bank bailout, based on a cynical recollection of the deals that were put together in 1988 during the savings and loan crisis to stretch that mess out past the November election at what was then considerable cost to taxpayers. However, this prediction was not nearly cynical enough. The George W. Bush administration, with Henry Paulson as Treasury Secretary, was so incompetent, or the needs of Paulson's former firm, Goldman Sachs, were so pressing, that the bailout could not be put off.
The 2008 election offered a choice between a candidate who had virtually no experience and one who had a lifetime of experience but seemed not to have learned much from it.
Candidate John McCain made a big show of "suspending" a campaign that voters may not have noticed even existed. McCain flew back to Washington, ostensibly to intervene in the crisis, but without any actual plan. Meanwhile, candidate Barack Obama stayed coolly on the sidelines and benefited from the contrast with the manic McCain.
After the failure of Lehman Brothers and the bailouts of Bear Stearns and AIG, the official story line was, not surprisingly, that the reason the crisis happened was that the regulators lacked the authority to resolve nonbanks whose failure threatened the health of the financial system. Title II of Dodd-Frank gives the FDIC the authority to borrow up to $150 billion to fund the resolution of failing institutions through "debtor in possession" financing. The Ryan budget wants to repeal this authority, and Maloney is extremely exercised about this prospect.
Given that this move has engendered such a reaction from bailout apologists like Maloney, legislators seeking to prevent yet another round of bailouts might consider attaching the repeal of title II to any legislation coming out of the Senate that looks promising.
(Archived video can be found here.)
Associated Program: -
In the Media | April 2014
By Robert Feinberg
MoneyNews, April 22, 2014. All Rights Reserved.
Charles Evans, president of the Federal Reserve Bank of Chicago and a leading dove of the Federal Open Market Committee (FOMC), delivered a speech April 9 titled "Monetary Goals and Strategy" to the 23rd annual Hyman Minsky Conference, which is sponsored by the Levy Institute of Bard College and held at the National Press Club in Washington.
With the exception of me, the modest-sized audience was composed of liberals who follow economic policy very closely and believe that governmental authorities should tinker constantly with the economy in order to improve its performance and the distribution of income.
The conference honors Minsky as one of the earliest exponents of this view, who propagated it articulately from the earliest years of the permanent and ongoing financial crisis.
Chicago has traditionally been a hotbed of conservative and even hard money economics, especially at the University of Chicago. However, the Chicago Fed under Evans has placed itself firmly in the dovish camp on monetary policy, and in 2015 Evans will rotate into a voting seat on the FOMC, so that he can back his sentiments with a vote. Evans has taught at the University of Chicago, University of Michigan and University of South Carolina, and he received degrees in economics from the University of Virginia and Carnegie-Mellon University, which is a stronghold of conservative monetary scholarship.
What makes Evans' speech especially significant is that he poses a scholarly challenge to conservative advocates of a monetary rule, particularly in circumstances where the economy has performed so poorly that the federal funds rate has already dropped to the bottom, and he contends that under these conditions, even Milton Friedman would agree that the FOMC should take an aggressive stance in order to keep the economy from slipping into a zone of negative inflation that could cripple economic growth for decades.
The speech was divided into four parts. First, Evans reviewed the "Three Big Events in Fed History," in his order of importance: 1) The Great Depression (1929 to 1938); 2) The Great Inflation (1965 to 1980); and The Treasury Accord (1951). He defended the independence of the Fed, but accepted in a serious way, not just rhetorically, that with the independence must go accountability.
Second, Evans laid out a three-part strategy for achieving the goals the FOMC has set out during the long term.
Third, he used bulls-eye charts to demonstrate that the Fed has missed both its employment and inflation targets.
And finally, he lamented the inability to stimulate the economy by adjusting the federal funds rate once it has reached its lower bound.
He concluded by advocating that the Fed adopt more aggressive policies now to stimulate growth, even at the risk of exceeding the 2 percent inflation target for some time after the employment target has been reached.
He criticized as "timid" the stance of most of his colleagues who argue for a slow glide path to the target so as not to risk touching off another bout of inflation.
(Archived video can be found here. A copy of the speech can be found here.)
Associated Program: -
In the Media | April 2014
By Panos Mourdoukoutas
Forbes, April 14, 2014. All Rights Reserved.
For years, China has been enjoying robust economic growth that has turned it into the world’s second largest economy.
The problem is, however, that China’s growth is in part driven by over investment in construction and manufacturing sectors, fueling asset bubbles that parallel those of Japan in the late 1980s. With one major difference: China’s overinvestment is directed by the systematic efforts of local governments to preserve the old system of central planning, through massive construction and manufacturing projects for the purpose of employment creation rather than for addressing genuine consumer needs.
Major Chinese cities are filled with growing numbers of new vacant buildings. They were built under government mandates to provide jobs for the hundreds of thousands of people leaving the countryside for a better life in the cities, rather than to house genuine business tenants.
China’s real estate bubble is proliferating like an infectious disease from the eastern cities to the inner country. It has spread beyond real estate to other sectors of the economy, from the steel industry to electronics and toys industries. Local governments rush and race to replicate each other’s policies, especially local governments of the inner regions, where corporate managers have no direct access to overseas markets, and end up copying the policies of their peers in the coastal areas.
We all know how the Japanese bubble ended. What should Chinese policy makers do? How can they burst their bubble?
There is a bad way and a good way, according to L. Randall Wray and Xinhua Liu, writing in "Options for China in a Dollar Standard World: A Sovereign Currency Approach.” (Levy Economics Institute, Working Paper No 783, January 2014).
The bad way is to pursue European-style austerity, which reins in central government deficits.
We all know what that means–the Chinese economy is almost certain to be placed in a downward spiral that will jeopardize employment growth. Besides, as the authors observe, China’s fiscal imbalances aren’t with central government, but with local governments. In fact, China’s main imbalance “appears to be a result of loose local government budgets and overly tight central government budgets.”
That’s why the authors propose fiscal restructuring rather than austerity. Rein in local government spending, and expand central government spending.
That’s the good way to burst the bubble. But is it politically feasible? Can Beijing reign over local governments?
That remains to be seen.
Associated Program(s):Region(s):Asia -
Conference Proceedings | April 2014Cosponsored by the Levy Economics Institute of Bard College and MINDS – Multidisciplinary Institute for Development and Strategies, with support from the Ford Foundation
Everest Rio Hotel
Rio de Janeiro, Brazil
September 26–27, 2013
This conference was organized as part of the Levy Institute’s global research agenda and in conjunction with the Ford Foundation Project on Financial Instability, which draws on Hyman Minsky's extensive work on the structure of financial governance and the role of the state. Among the key topics addressed: designing a financial structure to promote investment in emerging markets; the challenges to global growth posed by continuing austerity measures; the impact of the credit crunch on economic and financial markets; and the larger effects of tight fiscal policy as it relates to the United States, the eurozone, and the BRIC countries.Download:Associated Program:Related Topic(s): -
Research Project Reports | April 2014This monograph is part of the Levy Institute’s Research and Policy Dialogue Project on Improving Governance of the Government Safety Net in Financial Crisis, a two-year project funded by the Ford Foundation.
This is the third in a series of reports examining the Federal Reserve Bank’s response to the global financial crisis, with particular emphasis on questions of accountability, democratic governance and transparency, and mission consistency. In this year’s report, we focus on issues of central bank independence and governance, with particular attention paid to challenges raised during periods of crisis. We trace the principal changes in governance of the Fed over its history—changes that accelerate during times of economic stress. We pay special attention to the famous 1951 “Accord” and to the growing consensus in recent years for substantial independence of the central bank from the treasury. In some respects, we deviate from conventional wisdom, arguing that the concept of independence is not usually well defined. While the Fed is substantially independent of day-to-day politics, it is not operationally independent of the Treasury. We examine in some detail an alternative view of monetary and fiscal operations. We conclude that the inexorable expansion of the Fed’s power and influence raises important questions concerning democratic governance that need to be resolved.Download:Associated Program:Author(s): -
In the Media | April 2014The Bond Buyer, April 11, 2014. All Rights Reserved.
Federal Reserve Governor Daniel Tarullo said the central bank shouldn't raise interest rates "preemptively" on a belief the recession cut the supply of ready labor in the economy. "We should remain attentive to evidence that labor markets have actually tightened to the point that there is demonstrable inflationary pressure," Tarullo said today in remarks prepared for a speech in Washington. "We should not rush to act preemptively in anticipation of such pressures based on arguments about the potential increase in structural unemployment in recent years." Tarullo, the central bank's longest-serving governor, backed a March 19 statement in which the Federal Open Market Committee said it will keep the main interest rate below normal long-run levels while attempting to meet its mandate for full employment and stable prices. In a wide-ranging speech, Tarullo cited slower productivity growth, the smaller share of national income accruing to workers, rising inequality and decreasing economic mobility as "serious challenges" for the U.S. economy. Monetary policy, by focusing on the full-employment component of the dual mandate, can "provide a modest countervailing factor to income inequality trends by leading to higher wages at the bottom rungs of the wage scale," Tarullo, 61, said at the 23rd Annual Hyman P. Minsky Conference in Washington. The Fed governor rebuffed concerns about near-term inflation from wages, noting that even as the unemployment rate has fallen to 6.7 percent in March from 7.5 percent in the same month a year earlier, "one sees only the earliest signs of a much-needed, broader wage recovery." "Compensation increases have been running at the historically low level of just over 2 percent annual rates since the onset of the Great Recession, with concomitantly lower real wage gains," Tarullo said. The reasons for that lag in wage gains are not clear, he said. "The issue of how much structural damage has been suffered by the labor market is of less immediate concern today in shaping monetary policy than it might have been had we experienced a period of rapid growth during the recovery," Tarullo said at the event, organized by the Levy Economics Institute of Bard College in Annandale-on-Hudson, N.Y.Associated Program: -
In the Media | April 2014
By Denis MacShane
The OMFIF Commentary, April 11, 2014. All Rights Reserved.
The normal duty of central bankers (especially in Europe) is to denounce inflation as the work of the devil and call for labour market flexibility as a barely disguised code for reducing wages.
But a gathering of academic economists at the annual Minsky Conference this week in Washington heard an impassioned plea from one of America’s top central bankers that it was time to increase wages and let inflation rise again.
Charles Evans is president of the Federal Reserve Bank in Chicago, where he has worked much of his professional life, in addition to stints as an economics professor and author of heavyweight academic articles on monetary policy.
Evans, currently a non-voter, is among the more dovish members of the Federal Open Market Committee. In his paper at the Bard College Levy Institute’s Minsky Conference, commemorating the work of depression-fighting economist Hyman Minsky, Evans said the US economy now needed a serious boost in wages to help business demand.
Evans used moderate, cautious language. However, the message was clear: Deflation and low wages are the new dragons to be slain.
‘Low wage increases are symptomatic of weak income growth and low aggregate demand. Stronger wage growth would likely result in more customers walking through the doors of business establishments and leading to stronger sales, more hiring and capacity expansion,’ Evans said.
He suggested a target wage growth figure of 3.5%, which he argued ‘is sustainable without building inflation pressures.’ This compares with the current range of 2-2.25 in compensation growth, coinciding with labour’s historically low share of national income.
Evans is right to underscore the dramatic change in the amount of US added value that goes to employees. Until 1975, wages normally accounted for more than 50% of American GDP, but this fell to 43.5% by 2012.
Evans said fears about inflation which have hovered over monetary policy-making since the 1970s have been exaggerated. Evans argued: ‘No one can doubt that we [the Fed] are undershooting our 2% [inflation] target. Total personal consumption expenditure (PCE) prices rose just 0.9% over the past 12 months; that is a substantial and serious miss.’
‘Below-target inflation’, said Evans, ‘is a worldwide phenomenon and it is difficult to be confident that all policy-makers around the world have fully taken its challenge on board. Persistent below-target inflation is very costly, especially when it is accompanied by debt overhang, substantial resource slack and weak growth.’
'Despite current low rates, I still often hear people say that higher inflation is just around the corner. I confess that I am somewhat exasperated by these repeated warnings given our current environment of very low inflation. Many times, the strongest concerns are expressed by folks who said the same thing back in 2009 and then in 2010.’
Denis MacShane is former UK Minister for Europe and a member of the OMFIF Advisory Board. He was a speaker on European politics at the Minksy Conference.Associated Program: -
In the Media | April 2014
By Joseph Lawler
Washington Examiner, April 11, 2014. All Rights Reserved.
The so-called "Great Moderation" of low economic volatility between the mid-1980s and the financial crisis of 2008 was not as great as it seemed, and the future likely won't be as pleasant, according to President Obama's top economic adviser.
Jason Furman, the chairman of the Council of Economic Advisers, said in a speech in Washington on Thursday that “the Great Recession certainly does reveal serious limitations of the concept of a great moderation,” and that the U.S. economy shouldn't be expected to return to a pattern of relatively smooth growth now that the banking crisis is in the past.
The "Great Moderation" was a term coined by economists James Stock, another current member of the CEA, and Mark Watson in a 20003 paper. It was meant to describe the decline in volatility in macroeconomic indicators such as gross domestic product growth and inflation since Federal Reserve Chairman Paul Volcker brought the high inflation rates of the 1960s and '70s to an end.
In 2004, Ben Bernanke, then a Fed governor under Chairman Alan Greenspan, popularized the term in a speech that attributed the smoothing out of the business cycle to better monetary policy by the Fed -- although Bernanke also acknowledged that luck may also have played a significant role, and that luck might run out in the future.
Furman, however, suggested that improvements in the private sector and in the government's management of fiscal and monetary policy may not have reduced the risks of severe recessions, but rather pushed the risks out to the tails of the risk distribution. In other words, economic shocks might be rarer, but more dangerous. While the U.S. did not suffer a deep recession in the late '80s and '90s, it was due for one eventually.
Furman illustrated the point with two charts. Looking at deviations in one-year GDP growth from the long-term average, he noted, it appears that there was a Great Moderation, briefly interrupted by the 2007-2009 recession:
But looking at the deviations in 10-year GDP growth from the average, it's a different story. Volatility in economic growth spiked and hasn't returned to normal.
Furman concluded that it "would be foolish to be complacent and fully assume that in the deeper, lower frequency sense there ever was a genuine 'Great Moderation,' let alone that it has returned and renders further policy steps unnecessary."
He proposed four measures for further stabilizing the economy in the future, including automatic fiscal stabilizers to even out government spending and taxing in boom times and downturns, reducing income inequality, improving coordination among countries and promoting financial stability.
Notably, Furman drew special attention to housing finance as a component of financial stability. Although the Obama administration for the most part has left the issue of what should be done with bailed-out government-sponsored mortgage businesses Fannie Mae and Freddie Mac to Congress, Furman did signal support for a bill that Democratic and Republican senators on the Senate Banking Committee have introduced.
The committee "is making promising bipartisan progress and the administration looks forward to continuing to work with Congress to forge a new private housing finance system that better serves current and future generations of Americans," he said.
The event at which Furman was speaking, hosted by the Levy Economics Institute, was named after Hyman Minsky, an American economist whose worked focused on financial crises and their relationship to economic downturns.Associated Program: -
In the Media | April 2014NDTV, April 10, 2014. All Rights Reserved.
Washington (Reuters | Update):
The Federal Reserve will likely wait at least six months after ending a bond-buying program before raising interest rates, and will only act that quickly "if things really go well," a top US central banker said on Wednesday.
"It could be six, it could be 16 months," Chicago Fed President Charles Evans told reporters on the sidelines of a Levy Economics Institute forum.
Last month, Fed Chair Janet Yellen put the wait at "around six months" depending on the economy. Her comment undercut stocks and bonds and prompted economists to revise forecasts. Traders and Wall Street economists now expect the first rate hike to come around the middle of next year.
"If I had my druthers, I'd want more accommodation and I'd push it into 2016," Evans said of the first rate hike, but "the actual, most likely case I think is probably late 2015."
The Fed has kept rates near zero since the depths of the recession in late 2008, and has bought some $3 trillion in bonds to help lower US borrowing costs. It has reduced its bond-buying and expects to wind it down by the fall.
Evans said the current pace of reducing the bond purchases, $10 billion at each Fed policy meeting, is "reasonable" and takes the Fed "into the October timeframe" for shelving the program.
"I am confident that, depending on how the economic circumstances come out, we'll keep interest rates low for quite some period of time," he said.
WOULD WELCOME ECB EASING Evans, a vocal policy dove, has long worried that the Fed has been too timid in its efforts to lower employment and raise inflation toward the central bank's targets.
"We're in a very low inflation global environment," he said. "The eurozone well below 1 per cent and Japan has been very low for a long period of time, and I'm worried that there's something more afoot" than just the US or eurozone experience.
Asked about a possible further easing of policy by the European Central Bank, he said: "Yes I think that would be quite welcome," adding he would welcome "all actions that help generate stronger world growth."
A fellow dove at the central bank, Minneapolis Fed President Narayana Kocherlakota, has proposed lowering the interest rate the Fed pays banks on excess reserves. The aim would be to provide more accommodation and boost inflation from just above 1 per cent currently.
Asked about this idea, Evans said he was willing to look at the possibility, but noted that the Fed's policy-setting Federal Open Market Committee has long considered it and has not acted.Associated Program: -
In the Media | April 2014
By Jonathan Spicer
Manorama Online, April 10, 2014. All Rights Reserved.
WASHINGTON (Reuters) – The Federal Reserve will likely wait at least six months after ending a bond-buying program before raising interest rates, and will only act that quickly "if things really go well," a top U.S. central banker said on Wednesday.
"It could be six, it could be 16 months," Chicago Fed President Charles Evans told reporters on the sidelines of a Levy Economics Institute forum.
Last month, Fed Chair Janet Yellen put the wait at "around six months" depending on the economy. Her comment undercut stocks and bonds and prompted economists to revise forecasts. Traders and Wall Street economists now expect the first rate hike to come around the middle of next year.
"If I had my druthers, I'd want more accommodation and I'd push it into 2016," Evans said of the first rate hike, but "the actual, most likely case I think is probably late 2015."
The Fed has kept rates near zero since the depths of the recession in late 2008, and has bought some $3 trillion in bonds to help lower U.S. borrowing costs. It has reduced its bond-buying and expects to wind it down by the fall.
Evans said the current pace of reducing the bond purchases, $10 billion at each Fed policy meeting, is "reasonable" and takes the Fed "into the October timeframe" for shelving the program.
"I am confident that, depending on how the economic circumstances come out, we'll keep interest rates low for quite some period of time," he said.
WOULD WELCOME ECB EASING
Evans, a vocal policy dove, has long worried that the Fed has been too timid in its efforts to lower employment and raise inflation toward the central bank's targets.
"We're in a very low inflation global environment," he said. "The eurozone well below 1 percent and Japan has been very low for a long period of time, and I'm worried that there's something more afoot" than just the U.S. or eurozone experience.
Asked about a possible further easing of policy by the European Central Bank, he said: "Yes I think that would be quite welcome," adding he would welcome "all actions that help generate stronger world growth."
A fellow dove at the central bank, Minneapolis Fed President Narayana Kocherlakota, has proposed lowering the interest rate the Fed pays banks on excess reserves. The aim would be to provide more accommodation and boost inflation from just above 1 percent currently.
Asked about this idea, Evans said he was willing to look at the possibility, but noted that the Fed's policy-setting Federal Open Market Committee has long considered it and has not acted.
Associated Program: -
In the Media | April 2014Morningstar Advisor, April 10, 2014. All Rights Reserved.
WASHINGTON (MarketWatch) -- The U.S. economy, aided by the Federal Reserve's easy monetary-policy stance, is beginning to look healthier, Federal Reserve Gov. Daniel Tarullo said Wednesday. "While we've not had certainly the pace and pervasiveness of the recovery that we wanted, the unconventional monetary policy have been critical in supporting the moderate recovery we have had, which I think now is looking reasonably well-rounded going forward, and I think that is reflected in the fairly wide expectation growth is going to be picking up over the course of this year," Tarullo said at a conference organized by the Levy Institute of Bard College. Tarullo sounded in no hurry to end the Fed's easy policy stance. He said the Fed "should not rush to act preemptively" in anticipation of inflationary pressures. Tarullo's comments were noteworthy because he rarely speaks about monetary policy -- rather, most of his speeches deal with financial-stability issues given his role as the central bank's point-man on strengthening regulation in the wake of the financial crisis.
Associated Program: -
In the Media | April 2014
By Ann Saphir
Reuters, April 10, 2014. All Rights Reserved.
(Reuters) – Wall Street bond dealers began anticipating an earlier first interest-rate hike from the Federal Reserve after last month's policy meeting, according to the results of a poll by the New York Fed released on Thursday.
That was exactly what Fed policymakers had feared would happen after the central bank published fresh forecasts on interest rates that appeared to map out a more aggressive cycle of rate hikes than previously expected, minutes of the meeting released Wednesday showed.
Dealers who changed their expectations said they did so because of forecasts, and "several pointed to comments made by (Fed) Chair (Janet Yellen) during her press conference," according to the poll, which asked dealers about their rate hike expectations both before and after the Fed's March 18-19 meeting.
At the policy-setting meeting, central bank officials made a widely expected reduction in their bond-buying stimulus and decided to jettison a set of numerical guideposts they were using to help the public anticipate when they would finally raise rates.
The Fed said the change in its rate hike guidance did not point to a shift in policy intentions, but new rate forecasts from the current 16 Fed policymakers suggested the federal funds rate would end 2016 at 2.25 percent, a half percentage point above Fed officials' projections in December.
Adding to the perception of a slightly more hawkish Fed, the Fed said it would wait a "considerable time" following the end of its bond-buying program before finally raising interest rates, a period of time that Yellen in her press conference suggested could be "around six months."
As of March 24, dealers saw a 29 percent chance of a first rate hike in the first half of 2015, up from 24 percent before the March meeting, the poll showed.
Both before and after polls showed dealers attached a 30 percent probability to a rate rise in the second half.
Fed officials have since gone to great pains to point out any rate hike decisions will depend on the state of the economy.
"It could be six, it could be 16 months," Chicago Fed President Charles Evans told reporters on the sidelines of a Levy Economics Institute forum on Wednesday.Associated Program: -
In the Media | April 2014MNI | Deutsche Börse Group, April 9, 2014. All Rights Reserved.
* Chicago Federal Reserve Bank President Charles Evans Wednesday accused the central bank of being "timid" in its attempts to spur faster economic growth, saying the Fed has been "less aggressive" than called for despite being nowhere its employment and inflation goals. In remarks prepared for delivery at the Levy Institute's Hyman Minsky conference, Evans warned that the tentative approach to bolstering the economic recovery could leave it susceptible to unforeseen shocks, and called instead for the Fed to keep most of its ultra-easy monetary policy in place "for some time." "Generally, the evidence points to a still weak labor market. We still have some ways to go to reach our employment mandate," said Evans, who will vote on the policymaking Federal Open Market Committee in 2015.
* Speaking to reporters after his speech, Evans said it would be appropriate for the central bank to hold off raising interest rates until 2016, citing his concerns about the low inflation environment. However, "the actual, most likely case, I think it's probably late 2015." He said he thinks "it's important to remind everybody that we have strong accommodation in place and we need to leave in place in order to do the job that it's intended to do," he said.Associated Program: -
In the Media | April 2014
By Jonathan Spicer
MSN Money, April 9, 2014. All Rights Reserved.
WASHINGTON, April 9 (Reuters) – The Federal Reserve will likely wait at least six months after ending a bond-buying program before raising interest rates, and will only act that quickly "if things really go well," a top U.S. central banker said on Wednesday.
"It could be six, it could be 16 months," Chicago Fed President Charles Evans told reporters on the sidelines of a Levy Economics Institute forum.
Last month, Fed Chair Janet Yellen put the wait at "around six months" depending on the economy. Her comment undercut stocks and bonds and prompted economists to revise forecasts. Traders and Wall Street economists now expect the first rate hike to come around the middle of next year.
"If I had my druthers, I'd want more accommodation and I'd push it into 2016," Evans said of the first rate hike, but "the actual, most likely case I think is probably late 2015."
The Fed has kept rates near zero since the depths of the recession in late 2008, and has bought some $3 trillion in bonds to help lower U.S. borrowing costs. It has reduced its bond-buying and expects to wind it down by the fall.
Evans said the current pace of reducing the bond purchases, $10 billion at each Fed policy meeting, is "reasonable" and takes the Fed "into the October timeframe" for shelving the program.
"I am confident that, depending on how the economic circumstances come out, we'll keep interest rates low for quite some period of time," he said.Would Welcome ECB Easing
Evans, a vocal policy dove, has long worried that the Fed has been too timid in its efforts to lower employment and raise inflation toward the central bank's targets.
"We're in a very low inflation global environment," he said. "The eurozone well below 1 percent and Japan has been very low for a long period of time, and I'm worried that there's something more afoot" than just the U.S. or eurozone experience.
Asked about a possible further easing of policy by the European Central Bank, he said: "Yes I think that would be quite welcome," adding he would welcome "all actions that help generate stronger world growth."
A fellow dove at the central bank, Minneapolis Fed President Narayana Kocherlakota, has proposed lowering the interest rate the Fed pays banks on excess reserves. The aim would be to provide more accommodation and boost inflation from just above 1 percent currently.
Asked about this idea, Evans said he was willing to look at the possibility, but noted that the Fed's policy-setting Federal Open Market Committee has long considered it and has not acted.Associated Program: -
In the Media | April 2014
By Brain Odion-Esene
MNI | Deutsche Börse Group, April 9, 2014. All Rights Reserved.
WASHINGTON (MNI) -–Chicago Federal Reserve Bank President Charles Evans Wednesday accused the central bank of being "timid" in its attempts to spur faster economic growth, saying the Fed has been "less aggressive" than called for despite being nowhere its employment and inflation goals.
In remarks prepared for delivery at the Levy Institute's Hyman Minsky conference, Evans warned that the tentative approach to bolstering the economic recovery could leave it susceptible to unforeseen shocks, and called instead for the Fed to keep most of its ultra-easy monetary policy in place "for some time."
"Generally, the evidence points to a still weak labor market. We still have some ways to go to reach our employment mandate," said Evans, who will vote on the policymaking Federal Open Market Committee in 2015.
As for the Fed's price stability mandate, he said he sees an economy that points to below-target inflation for several years, which underscores the need for easy policy.
"Given today's unacceptably low inflation environment and the wealth of inflation indicators that point to continued below-target inflation, I think we need continued strongly accommodative monetary policy to get inflation back up to 2% within a reasonable time frame," he said.
Instead, "the FOMC has been less aggressive than the policy loss function calls for," Evans said, arguing that "in the current circumstances, accountability and optimal policy mean we should be maintaining a large degree of accommodation for some time."
"It certainly seems that the fallout from the financial crisis and persistent headwinds holding back economic activity are consistent with the equilibrium real interest rate being lower than usual today," he added.
Evans said actions that place the FOMC "on a slow glide path" toward its targets undermine the credibility of the Fed's vow to meet its mandates in a timely fashion.
"Timid policies would also increase the risk of progress being stymied along the way by adverse shocks that might hit before policy gaps are closed," he said. "The surest and quickest way to reach our objectives is to be aggressive."
This also means the FOMC should be open to the idea of overshooting its targets in a manageable fashion.
"Such risks are optimal if the outcome of our policy actions implies smaller average deviations from our targets over the medium term. We should be willing to undertake such policies and clearly communicate our willingness to do so," Evans said.
Making his case for why the economy still needs continued, aggressive monetary policy, Evans said March's 6.7% unemployment rate is still well above the 5.25% percent rate that he considers to be the longer-run normal. As the jobless rate continues to decline, he stressed the importance of assessing a wide range of labor market data "to better gauge the overall health of the labor market."
These would include quit rates, layoffs and a variety of wage measures, as well as broader measures of unemployment that include discouraged workers and those who would like to work more hours.
Evans also argued that the decline in the labor participation rate in recent months cannot be ascribed solely to changing population demographics and other factors outside the Fed's control. The end of extended unemployment insurance benefits, among other things, has also likely decreased the natural rate of unemployment, meaning that "the decline in the unemployment rate likely overstates to some degree the reduction of slack in the labor market over the past year."
On the inflation front, Evans noted that the United States is not the only country struggling with below-target inflation, and that "it is difficult to be confident that all policymakers around the world have fully taken its challenge onboard."
"Persistent below-target inflation is very costly, especially when it is accompanied by debt overhang, substantial resource slack, and weak growth," he added.
Given the low inflation environment, Evans said he is "somewhat exasperated" by those who constantly warn that higher inflation "is just around the corner."
For one thing, he argued that unless there is an unexpected, and positive, shock to the global economy, commodity prices are unlikely to fuel a strong increase in inflation.
To those worried about the inflationary risks posed by the Fed's swollen balance sheet and the massive amounts of excess bank reserves, Evans countered that banks so far have not been lending these reserves nearly enough to generate big increases in broad monetary aggregates.
Even if lending did pick up, he added, "Dramatically higher bank lending would surely be associated with higher loan demand and a generally stronger economy. Strong growth and diminishing resource slack would be part of this story, and a rising rate environment would be a natural force diminishing the rising inflation pressures."
The slow rate of wage growth is another cause for concern, Evans said, as it is "symptomatic of weak income growth and low aggregate demand."
"At today's 2% to 2.25% compensation growth rates and labor's historically low share of national income, there is substantial room for stronger wage growth without inflation pressures building," he said.Associated Program: -
In the Media | April 2014
By Brai Odion-Esene
MNI | Deutsche Börse Group, April 9, 2014. All Rights Reserved.
WASHINGTON (MNI) – Federal Reserve Board Gov. Daniel Tarullo Wednesday night argued that monetary policy can play an important role in helping the nation's long-term unemployment, saying the Fed right now should not be overly concerned with how much of the slow pace of job creation is due to structural factors outside its control.
"The very accommodative monetary policy of the past five years has contributed significantly to the extended, moderate recoveries of gross domestic product (GDP) and employment," Tarullo said in remarks prepared for the Levy Economics Institute's Hyman Minsky Conference.
And to underline that he does not favor tightening monetary policy anytime soon, Tarullo said because of the modest growth in place for several years, "it seems less likely that we will experience a growth spurt in the next couple of years that would engender concerns about rapid wage pressures and changes in inflation expectations."
Voicing his concerns about slow U.S. productivity growth, widening income inequality, and long-term unemployment, Tarullo stressed that while monetary policy "cannot be the only, or even the principal," tool in counteracting these longer-term trends, "that is not to say it is irrelevant."
"Monetary policies directed toward achieving the statutory dual mandate of maximum employment and price stability can help reduce underemployment associated with low aggregate demand," he added, a statement that echoes Fed Chair Janet Yellen's commitment to tackling the nation's jobs crisis.
"To the degree that monetary policy can prevent cyclical phenomena such as high unemployment and low investment from becoming entrenched, it might be able to improve somewhat the potential growth rate of the economy over the medium term," he said.
Appointed to the Fed board by President Barack Obama in 2009, Tarullo has a permanent vote on the Fed's policymaking Federal Open Market Committee.
Yellen said she still sees "considerable slack" in the labor market in a March 31 speech, and Tarullo said reducing labor market slack can help lay the foundation "for a more sustained, self-reinforcing cycle of stronger aggregate demand, increased production, renewed investment, and productivity gains."
"Similarly, a stronger labor market can provide a modest countervailing factor to income inequality trends by leading to higher wages at the bottom rungs of the wage scale," he said.
There is uncertainty among both Fed officials and economists regarding how much the high unemployment is due to cyclical factors like low demand, or more structural issues such as a skills mismatch between jobseekers and would-be employers.
Tarullo argued that there is not "as sharp a demarcation between cyclical and structural problems as is sometimes suggested," as "by promoting maximum employment in a stable inflation environment around the FOMC target rate, monetary policy can help set the stage for a vibrant and dynamic economy."
Still, Tarullo advised the FOMC to proceed pragmatically in crafting policy.
"We should remain attentive to evidence that labor markets have actually tightened to the point that there is demonstrable inflationary pressure that would place at risk maintenance of the FOMC's stated inflation target (which, of course, we are currently not meeting on the downside)," he said. "But we should not rush to act preemptively in anticipation of such pressures based on arguments about the potential increase in structural unemployment in recent years."
"In this regard, the issue of how much structural damage has been suffered by the labor market is of less immediate concern today in shaping monetary policy than it might have been had we experienced a period of rapid growth during the recovery," he said.
Outside of actions being taken by the Fed, Tarullo also called on fiscal policymakers to also take a more forceful approach in helping the economy.
"A pro-investment policy agenda by the government could help address some of our nation's long-term challenges by promoting investment in human capital, particularly for those who have seen their share of the economic pie shrink, and by encouraging research and development and other capital investments that increase the productive capacity of the nation," he said.Associated Program: -
In the Media | April 2014
By Craig Torres
Bloomberg Businessweek, April 9, 2014. All Rights Reserved.
Federal Reserve Governor Daniel Tarullo said the central bank shouldn’t raise interest rates “preemptively” on a belief the recession cut the supply of ready labor in the economy.
“We should remain attentive to evidence that labor markets have actually tightened to the point that there is demonstrable inflationary pressure,” Tarullo said today in remarks prepared for a speech in Washington. “We should not rush to act preemptively in anticipation of such pressures based on arguments about the potential increase in structural unemployment in recent years.”
Tarullo, the central bank’s longest-serving governor, backed a March 19 statement in which the Federal Open Market Committee said it will keep the main interest rate below normal long-run levels while attempting to meet its mandate for full employment and stable prices.
In a wide-ranging speech, Tarullo cited slower productivity growth, the smaller share of national income accruing to workers, rising inequality and decreasing economic mobility as “serious challenges” for the U.S. economy.
Monetary policy, by focusing on the full-employment component of the dual mandate, can “provide a modest countervailing factor to income inequality trends by leading to higher wages at the bottom rungs of the wage scale,” Tarullo, 61, said at the 23rd Annual Hyman P. Minsky Conference in Washington.
The Fed governor rebuffed concerns about near-term inflation from wages, noting that even as the unemployment rate has fallen to 6.7 percent in March from 7.5 percent in the same month a year earlier, “one sees only the earliest signs of a much-needed, broader wage recovery.”
Low Gains
“Compensation increases have been running at the historically low level of just over 2 percent annual rates since the onset of the Great Recession, with concomitantly lower real wage gains,” Tarullo said. The reasons for that lag in wage gains are not clear, he said.
“The issue of how much structural damage has been suffered by the labor market is of less immediate concern today in shaping monetary policy than it might have been had we experienced a period of rapid growth during the recovery,” Tarullo said at the event, organized by the Levy Economics Institute of Bard College in Annandale-on-Hudson, New York.Associated Program: -
In the Media | April 2014
By Jonathan Spicer
Reuters, April 9, 2014. All Rights Reserved.
(Reuters) -–The Federal Reserve will likely wait at least six months after ending a bond-buying program before raising interest rates, and will only act that quickly "if things really go well," a top U.S. central banker said on Wednesday.
"It could be six, it could be 16 months," Chicago Fed President Charles Evans told reporters on the sidelines of a Levy Economics Institute forum.
Last month, Fed Chair Janet Yellen put the wait at "around six months" depending on theeconomy. Her comment undercut stocks and bonds and prompted economists to revise forecasts. Traders and Wall Street economists now expect the first rate hike to come around the middle of next year.
"If I had my druthers, I'd want more accommodation and I'd push it into 2016," Evans said of the first rate hike, but "the actual, most likely case I think is probably late 2015."
The Fed has kept rates near zero since the depths of the recession in late 2008, and has bought some $3 trillion in bonds to help lower U.S. borrowing costs. It has reduced its bond-buying and expects to wind it down by the fall.
Evans said the current pace of reducing the bond purchases, $10 billion at each Fed policy meeting, is "reasonable" and takes the Fed "into the October timeframe" for shelving the program.
"I am confident that, depending on how the economic circumstances come out, we'll keep interest rates low for quite some period of time," he said.
Would Welcome ECB Easing
Evans, a vocal policy dove, has long worried that the Fed has been too timid in its efforts to lower employment and raise inflation toward the central bank's targets.
"We're in a very low inflation global environment," he said. "The euro zone well below 1 percent and Japan has been very low for a long period of time, and I'm worried that there's something more afoot" than just the U.S. or euro zone experience.
Asked about a possible further easing of policy by the European Central Bank, he said: "Yes I think that would be quite welcome," adding he would welcome "all actions that help generate stronger world growth."
A fellow dove at the central bank, Minneapolis Fed President Narayana Kocherlakota, has proposed lowering the interest rate the Fed pays banks on excess reserves. The aim would be to provide more accommodation and boost inflation from just above 1 percent currently.
Asked about this idea, Evans said he was willing to look at the possibility, but noted that the Fed's policy-setting Federal Open Market Committee has long considered it and has not acted.Associated Program: -
In the Media | April 2014
By Victoria MacGrane
The Wall Street Journal, April 9, 2014. All Rights Reserved.
Federal Reserve Governor Daniel Tarullo on Wednesday said policy makers should proceed cautiously in judging when inflationary pressures are building in the economy, given uncertainty that surrounds just how much slack remains in the labor market.
Mr. Tarullo placed himself in the camp of Fed Chairwoman Janet Yellen, saying he believes the labor market is still operating well short of its potential and associating himself with her March 31 speech explaining the reasons why.
Given there is some debate over how to measure labor market slack, “we are well advised to proceed pragmatically,” he said in a dinnertime speech prepared for delivery at a conference organized by the Levy Institute of Bard College.
He stressed Fed officials should await actual evidence that labor markets had tightened enough to trigger inflationary pressures that could push inflation above the Fed’s 2% inflation target. The Commerce Department’s personal consumption expenditures price index, the Fed’s favored measure of inflation, was up 0.9% in February from a year earlier. The Labor Department’s consumer price index, an alternative measure, was up 1.1%.
“But we should not rush to act preemptively in anticipation of such pressures based on arguments about the potential increase in structural unemployment in recent years,” he said.
There is a vigorous debate at the central bank and among economists generally over the extent of remaining slack in the labor market. Minutes from the Fed’s March 18-19 policy meeting released Wednesday showed that while officials generally agreed slack persisted, they disagreed about how much and how well the unemployment rate reflects the degree of slack.
In her March 31 speech, Ms. Yellen pointed to several factors beyond the jobless rate that suggest the labor market is still quite weak, including the large number of long-term jobless and the seven million Americans who are working part-time but would prefer full-time jobs.
Mr. Tarullo suggested he’s not worried economic growth will suddenly take off and leave the Fed flat-footed and fighting rising inflation. “The issue of how much structural damage has been suffered by the labor market is of less immediate concern today in shaping monetary policy than it might have been had we experienced a period of rapid growth during the recovery,” he said.
In light of the economy’s modest performance since the end of the recession, “it seems less likely that we will experience a growth spurt in the next couple of years that would engender concerns about rapid wage pressures and changes in inflation expectations,” Mr. Tarullo said.
Mr. Tarullo’s comments came within the context of a speech raising concerns about “troubling” long-term trends in the U.S. economy, including falling productivity growth and rising inequality.
The Fed’s efforts to battle recession help lay the groundwork for a stronger, more dynamic economy, Mr. Tarullo said. “But there are limits to what monetary policy can do in counteracting” the longer-term trends he is worried about.
Mr. Tarullo said the federal government could address some of the challenges through investment, especially in ways that help “those who have seen their share of the economic pie shrink.” Early childhood education, job training programs, infrastructure and research are areas that could boost the long-term prospects for the U.S. economy, said Mr. Tarullo.Associated Program(s): -
In the Media | April 2014
By Jonathan Spicer
The Chicago Tribune, April 9, 2014. All Rights Reserved.
WASHINGTON (Reuters) - The Federal Reserve will likely wait at least six months after ending a bond-buying program before raising interest rates, and will only act that quickly "if things really go well," a top U.S. central banker said on Wednesday.
"It could be six, it could be 16 months," Chicago Fed President Charles Evans told reporters on the sidelines of a Levy Economics Institute forum.
Last month, Fed Chair Janet Yellen put the wait at "around six months" depending on the economy. Her comment undercut stocks and bonds and prompted economists to revise forecasts. Traders and Wall Street economists now expect the first rate hike to come around the middle of next year.
"If I had my druthers, I'd want more accommodation and I'd push it into 2016," Evans said of the first rate hike, but "the actual, most likely case I think is probably late 2015."
The Fed has kept rates near zero since the depths of the recession in late 2008, and has bought some $3 trillion in bonds to help lower U.S. borrowing costs. It has reduced its bond-buying and expects to wind it down by the fall.
Evans said the current pace of reducing the bond purchases, $10 billion at each Fed policy meeting, is "reasonable" and takes the Fed "into the October timeframe" for shelving the program. "I am confident that, depending on how the economic circumstances come out, we'll keep interest rates low for quite some period of time," he said.
WOULD WELCOME ECB EASING Evans, a vocal policy dove, has long worried that the Fed has been too timid in its efforts to lower employment and raise inflation toward the central bank's targets.
"We're in a very low inflation global environment," he said. "The euro zone well below 1 percent and Japan has been very low for a long period of time, and I'm worried that there's something more afoot" than just the U.S. or euro zone experience.
Asked about a possible further easing of policy by the European Central Bank, he said: "Yes I think that would be quite welcome," adding he would welcome "all actions that help generate stronger world growth."
A fellow dove at the central bank, Minneapolis Fed President Narayana Kocherlakota, has proposed lowering the interest rate the Fed pays banks on excess reserves. The aim would be to provide more accommodation and boost inflation from just above 1 percent currently.
Asked about this idea, Evans said he was willing to look at the possibility, but noted that the Fed's policy-setting Federal Open Market Committee has long considered it and has not acted.Associated Program: -
In the Media | April 2014
By Greg Robb
Fox Business, April 9, 2014. All Rights Reserved.
WASHINGTON – The U.S. economy, aided by the Federal Reserve's easy monetary-policy stance, is beginning to look healthier, Federal Reserve Gov. Daniel Tarullo said Wednesday. "While we've not had certainly the pace and pervasiveness of the recovery that we wanted, the unconventional monetary policy have been critical in supporting the moderate recovery we have had, which I think now is looking reasonably well-rounded going forward, and I think that is reflected in the fairly wide expectation growth is going to be picking up over the course of this year," Tarullo said at a conference organized by the Levy Institute of Bard College. Tarullo sounded in no hurry to end the Fed's easy policy stance. He said the Fed "should not rush to act preemptively" in anticipation of inflationary pressures. Tarullo's comments were noteworthy because he rarely speaks about monetary policy -- rather, most of his speeches deal with financial-stability issues given his role as the central bank's point-man on strengthening regulation in the wake of the financial crisis.Associated Program: -
In the Media | April 2014Money News, April 9, 2014. All Rights Reserved.
Federal Reserve Governor Daniel Tarullo said the central bank shouldn’t raise interest rates “preemptively” on a belief the recession cut the supply of ready labor in the economy.
“We should remain attentive to evidence that labor markets have actually tightened to the point that there is demonstrable inflationary pressure,” Tarullo said Wednesday in remarks prepared for a speech in Washington. “We should not rush to act preemptively in anticipation of such pressures based on arguments about the potential increase in structural unemployment in recent years.”
Tarullo, the central bank’s longest-serving governor, backed a March 19 statement in which the Federal Open Market Committee said it will keep the main interest rate below normal long-run levels while attempting to meet its mandate for full employment and stable prices.
In a wide-ranging speech, Tarullo cited slower productivity growth, the smaller share of national income accruing to workers, rising inequality and decreasing economic mobility as “serious challenges” for the U.S. economy.
Monetary policy, by focusing on the full-employment component of the dual mandate, can “provide a modest countervailing factor to income inequality trends by leading to higher wages at the bottom rungs of the wage scale,” Tarullo, 61, said at the 23rd Annual Hyman P. Minsky Conference in Washington.
The Fed governor rebuffed concerns about near-term inflation from wages, noting that even as the unemployment rate has fallen to 6.7 percent in March from 7.5 percent in the same month a year earlier, “one sees only the earliest signs of a much-needed, broader wage recovery.”
Low Gains “Compensation increases have been running at the historically low level of just over 2 percent annual rates since the onset of the Great Recession, with concomitantly lower real wage gains,” Tarullo said. The reasons for that lag in wage gains are not clear, he said.
“The issue of how much structural damage has been suffered by the labor market is of less immediate concern today in shaping monetary policy than it might have been had we experienced a period of rapid growth during the recovery,” Tarullo said at the event, organized by the Levy Economics Institute of Bard College in Annandale-on-Hudson, New York.Associated Program: -
Public Policy Brief No. 131 | April 2014
In the context of current debates about the proper form of prudential regulation and proposals for the imposition of liquidity and capital ratios, Senior Scholar Jan Kregel examines Hyman Minsky’s work as a consultant to government agencies exploring financial regulatory reform in the 1960s. As Kregel explains, this often-overlooked early work, a precursor to Minsky’s “financial instability hypothesis”(FIH), serves as yet another useful guide to explaining why regulation and supervision in the lead-up to the 2008 financial crisis were flawed—and why the approach to reregulation after the crisis has been incomplete.
Download:Associated Program:Author(s):Jan KregelRelated Topic(s): -
Working Paper No. 796 | April 2014
The Financial Instability Hypothesis in the Era of Financialization
The aim of this paper is to develop a structural explanation of the subprime mortgage crisis, grounded on the combination of two apparently incompatible financial theories: the financial instability hypothesis by Hyman P. Minsky and the theory of capital market inflation by Jan Toporowski. Our thesis is that, once the evolution of the financial market is taken into account, the financial Keynesianism of Minsky is still a valid framework to understand the events leading to the crisis.
Download:Associated Program:Author(s):Eugenio CaverzasiRelated Topic(s): -
In the Media | March 2014
By Duncan Weldon
BBC News Magazine, March 23, 2014. All Rights Reserved.
American economist Hyman Minsky, who died in 1996, grew up during the Great Depression, an event which shaped his views and set him on a crusade to explain how it happened and how a repeat could be prevented, writes Duncan Weldon.
Minsky spent his life on the margins of economics but his ideas suddenly gained currency with the 2007-08 financial crisis. To many, it seemed to offer one of the most plausible accounts of why it had happened.
His long out-of-print books were suddenly in high demand with copies changing hands for hundreds of dollars - not bad for densely written tomes with titles like Stabilizing an Unstable Economy.
Senior central bankers including current US Federal Reserve chair Janet Yellen and the Bank of England's Mervyn King began quoting his insights. Nobel Prize-winning economist Paul Krugman named a high profile talk about the financial crisis The Night They Re-read Minsky.
Here are five of his ideas.
Stability is destabilising
Minsky's main idea is so simple that it could fit on a T-shirt, with just three words: "Stability is destabilising."
Most macroeconomists work with what they call "equilibrium models" - the idea is that a modern market economy is fundamentally stable. That is not to say nothing ever changes but it grows in a steady way.
To generate an economic crisis or a sudden boom some sort of external shock has to occur - whether that be a rise in oil prices, a war or the invention of the internet.
Minsky disagreed. He thought that the system itself could generate shocks through its own internal dynamics. He believed that during periods of economic stability, banks, firms and other economic agents become complacent.
They assume that the good times will keep on going and begin to take ever greater risks in pursuit of profit. So the seeds of the next crisis are sown in the good time.
Three stages of debt
Minsky had a theory, the "financial instability hypothesis", arguing that lending goes through three distinct stages. He dubbed these the Hedge, the Speculative and the Ponzi stages, after financial fraudster Charles Ponzi.
In the first stage, soon after a crisis, banks and borrowers are cautious. Loans are made in modest amounts and the borrower can afford to repay both the initial principal and the interest.
As confidence rises banks begin to make loans in which the borrower can only afford to pay the interest. Usually this loan is against an asset which is rising in value. Finally, when the previous crisis is a distant memory, we reach the final stage - Ponzi finance. At this point banks make loans to firms and households that can afford to pay neither the interest nor the principal. Again this is underpinned by a belief that asset prices will rise.
The easiest way to understand is to think of a typical mortgage. Hedge finance means a normal capital repayment loan, speculative finance is more akin to an interest-only loan and then Ponzi finance is something beyond even this. It is like getting a mortgage, making no payments at all for a few years and then hoping the value of the house has gone up enough that its sale can cover the initial loan and all the missed payments. You can see that the model is a pretty good description of the kind of lending that led to the financial crisis.
Minsky moments
The "Minsky moment", a term coined by later economists, is the moment when the whole house of cards falls down. Ponzi finance is underpinned by rising asset prices and when asset prices eventually start to fall then borrowers and banks realise there is debt in the system that can never be paid off. People rush to sell assets causing an even larger fall in prices.
It is like the moment that a cartoon character runs off a cliff. They keep on running for a while, still believing they're on solid ground. But then there's a moment of sudden realisation - the Minsky moment - when they look down and see nothing but thin air. Then they plummet to the ground, and that's the crisis and crash of 2008.
Finance matters
Until fairly recently, most macroeconomists were not very interested in the finer details of the banking and financial system. They saw it as just an intermediary which moved money from savers to borrowers.
This is rather like the way most people are not very interested in the finer details of plumbing when they're having a shower. As long as the pipes are working and the water is flowing there is no need to understand the detailed workings.
To Minsky, banks were not just pipes but more like a pump - not just simple intermediaries moving money through the system but profit-making institutions, with an incentive to increase lending. This is part of the mechanism that makes economies unstable.
Preferring words to maths and models
Since World War Two, mainstream economics has become increasingly mathematical, based on formal models of how the economy works.
To model things you need to make assumptions, and critics of mainstream economics argue that as the models and maths became more and more complex, the assumptions underpinning them became more and more divorced from reality. The models became an end in themselves.
Although he trained in mathematics, Minsky preferred what economists call a narrative approach - he was about ideas expressed in words. Many of the greats from Adam Smith to John Maynard Keynes to Friedrich Hayek worked like this.
While maths is more precise, words might allow you to express and engage with complex ideas that are tricky to model - things like uncertainty, irrationality, and exuberance. Minsky's fans say this contributed to a view of the economy that was far more "realistic" than that of mainstream economics.
Analysis: Why Minsky Matters is broadcast on BBC Radio 4 at 20:30 GMT, 24 March 2014 or catch up on BBC iPlayer.Associated Program: -
In the Media | March 2014
The Old Lady Fails to Get an "A"
Credit Writedowns, March 21, 2014. All Rights Reserved.
One thing’s for sure: The financial crisis has dealt a deadly blow to what was until recently considered the state-of-the-art of monetary policy. Just compare the 1992 edition of Modern Money Mechanics, published by the Federal Bank of Chicago, with the articles and videos published this month by the Bank of England (BoE).
The former publication explains that a bank’s excess reserves can be used to make loans, that prudent bankers “will not lend more than their excess reserves,” and that there is a “deposit expansion and contraction associated with a given change in bank reserves,” a.k.a. the money multiplier. Ultimately, “the total amount of reserves is controlled by the Federal Reserve.”
In stark contrast to what was considered common knowledge twenty years ago, the BoE now considers the multiplier a mistaken belief. For the Bank of England, a “common misconception is that the central bank determines the quantity of loans and deposits in the economy by controlling the quantity of central bank money — the so-called ‘money multiplier’ approach.” Contrary to a widespread view, “neither are reserves a binding constraint on lending, nor does the central bank fix the amount of reserves that are available.” The BoE further explains: “Loans create deposits, not the other way around”; and bank reserves do not provide incentives for banks to lend “as the money multiplier mechanism would suggest.”
The many professionals in the banking and finance industry who often have trouble with the way academics teach and discuss money and monetary policy will find the new view much closer to their operational experience. The few economists who have long rejected the “state-of-the-art” in their models, and refused to teach it in their classrooms, will feel vindicated. Those lagging behind had better adapt quickly to a changing paradigm, re-write their lecture notes, and avoid describing the stance of monetary policy with the position of a money supply function. For example, the Khan Academy’s course in banking includes several lectures based on the notion of the money multiplier. To serve its users well, the Khan Academy should largely revise those lectures or at least explain that they apply to a monetary system based on gold or some other fixed-rate system.
The views expressed in the BoE publication do not come out of the blue. Several studies have recently challenged the notion of the money multiplier. The fact that this is now stated by a central bank marks good progress in the understanding of monetary operations, especially in light of conventional wisdom having inspired a number of erroneous interpretations during the banking and financial crisis.
It is also a blow to the “Monetarist Keynesian” approach that continues to inspire mainstream macroeconomic models. In a video that is part of a 1980 series called “Free to Choose,” Milton Friedman explains the money multiplier in a fixed-rate monetary system (the gold standard) and argues that the same principle holds in the contemporary U.S. banking system. Friedman concludes that the Great Depression was caused by the U.S. Fed doing a very poor job, forcing the money multiplier to work its way downwards and effectively destroying the money supply. A former graduate student at MIT who had studied Friedman’s view of the Great Depression—named Ben Bernanke—has seemingly dealt with the 2007-08 crisis with one idea in mind: prevent the money supply contraction that caused the Great Depression. This was the theoretical foundation of Helicopter Ben’s QEs.
For the Bank of England, now, there are two common misconceptions about Quantitative Easing: “that QE involves giving banks ‘free money’; and that the key aim of QE is to increase bank lending by providing more reserves to the banking system, as might be described by the money multiplier theory.” The BoE also explains how the amount of central bank money (banknotes and bank reserves) is fixed by the demand of its users and not by the central bank “as it is sometimes described in some economics textbooks.”
And yet, more progress is desirable, and I would not mark the BoE paper with an A.
For all those economists who feel they have been ahead of the curve on this matter, the Bank of England should make an additional effort, especially on two remaining issues.
1. Why money is valuable to its holders
In its account of money and monetary policy, the BoE asks the question: What makes an inconvertible piece of paper valuable? The BoE explains that money is an IOU issued by a single (monopolist) supplier rather than by a variety of individuals. Although a twenty-pound note is no longer convertible into gold, it is “worth twenty pounds precisely because everybody believes it will be accepted as a means of payment both today and in the future… And for everyone to believe that, it is important that money maintains its value over time and is difficult to counterfeit. It’s the central bank’s job to ensure that that is the case.”
Economists have always had a hard time proving how confidence alone could suffice. Money historians dealing with “token money” (not redeemable in gold or silver) and those economists who are aware of the political foundation of money or who have read or heard Warren Mosler have a different answer. It is inaccurate to describe paper currency as an “unredeemable” asset whose value depends on users’ confidence. Paper money gives its holder a credit that is redeemable in a very concrete way, and it is so redeemed every time holders of money use currency to pay their liabilities to the government: taxes, sanctions, and fines. In fact, the national currency is the only means available for making such payments.
The BoE remains silent on this point. Acknowledgement of this fact would entail accepting that the payment of taxes is made possible by government spending and not the other way around. It is tax payers, not governments, that can go broke!
2. How powerful is monetary policy
On this point, the BoE publication does not break much with the past, at the risk of making statements that clash with the rest of the paper.
The BoE makes two accurate statements regarding central bank money (banknotes and bank reserves):
1) it is not chosen or fixed by the central bank;
2) it does not multiply up into loans and bank deposits.
This would seem to imply that a central bank does not control the money supply. More accurately, as the ECB states on its website, “by virtue of its monopoly, a central bank is able to manage the liquidity situation in the money market and influence money market interest rates.”
To the reader’s surprise, however, the BoE concludes that the central bank can:
“influence the amount of money in the economy. It does so in normal times by setting monetary policy — through the interest rate that it pays on reserves held by commercial banks with the Bank of England. More recently, though, with Bank Rate constrained by the effective lower bound, the Bank of England’s asset purchase programme has sought to raise the quantity of broad money in circulation. This in turn affects the prices and quantities of a range of assets in the economy, including money.”
For the BoE, changing interest rates is a powerful means to influence bank lending and thus the money supply and the overall economy. This view that interest rates trigger an effective “transmission mechanism” is one of the Great Faults in monetary management committed during the Great Recession.
There are various channels through which interest rates influence demand, output, and the price level, yet none is empirically strong, and some work in different directions. Bank lending is primarily pro-cyclical, as a famous quote attributed to Mark Twain explains effectively (“A banker is a fellow who lends you his umbrella when the sun is shining, but wants it back the minute it begins to rain”), and the Global Crisis proved central banks to be powerless in trying to reverse this course. The reality is that the level of interest rates affects the economy mildly and in an ambiguous way. To state that monetary policy is powerful is an unsubstantiated claim. -
Working Paper No. 792 | March 2014
An Alternative to Economic Orthodoxy
This paper explores the intellectual history of the state, or chartalist, approach to money, from the early developers (Georg Friedrich Knapp and A. Mitchell Innes) through Joseph Schumpeter, John Maynard Keynes, and Abba Lerner, and on to modern exponents Hyman Minsky, Charles Goodhart, and Geoffrey Ingham. This literature became the foundation for Modern Money Theory (MMT). In the MMT approach, the state (or any other authority able to impose an obligation) imposes a liability in the form of a generalized, social, legal unit of account—a money—used for measuring the obligation. This approach does not require the preexistence of markets; indeed, it almost certainly predates them. Once the authorities can levy such obligations, they can name what fulfills any obligation by denominating those things that can be delivered; in other words, by pricing them. MMT thus links obligatory payments like taxes to the money of account as well as the currency. This leads to a revised view of money and sovereign finance. The paper concludes with an analysis of the policy options available to a modern government that issues its own currency.
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Working Paper No. 791 | March 2014
Myth and Misunderstanding
It is commonplace to speak of central bank “independence” as if it were both a reality and a necessity. While the Federal Reserve is subject to the “dual mandate,” it has substantial discretion in its interpretation of the vague call for high employment and low inflation. Most important, the Fed’s independence is supposed to insulate it from political pressures coming from Congress and the US Treasury to “print money” to finance budget deficits. As in many developed nations, this prohibition was written into US law from the founding of the Fed in 1913. In practice, the prohibition is easy to evade, as we found during World War II, when budget deficits ran up to a quarter of US GDP. If a central bank stands ready to buy government bonds in the secondary market to peg an interest rate, then private banks will buy bonds in the new-issue market and sell them to the central bank at a virtually guaranteed price. Since central bank purchases of securities supply the reserves needed by banks to buy government debt, a virtuous circle is created, so that the treasury faces no financing constraint. That is what the 1951 Accord was supposedly all about: ending the cheap source of US Treasury finance. Since the global financial crisis hit in 2007, these matters have come to the fore in both the United States and the European Monetary Union, with those worried about inflation warning that the central banks are essentially “printing money” to keep sovereign-government borrowing costs low.
This paper argues that the Fed is not, and should not be, independent, at least in the sense in which that term is normally used. The Fed is a “creature of Congress,” created by public law that has evolved since 1913 in a way that not only increased the Fed’s assigned responsibilities but also strengthened congressional oversight. The paper addresses governance issues, which, a century after the founding of the Fed, remain somewhat unsettled. While the Fed should be, and appears to be, insulated from day-to-day political pressures, it is subject to the will of Congress. Further, the Fed cannot really be independent from the Treasury, because the Fed is the federal government’s bank, with almost all payments made by and to the government running through the Fed. As such, there is no “operational independence” that would allow the Fed to refuse to allow the Treasury to spend appropriated funds. Finally, the paper addresses troubling issues raised by the Fed’s response to the global financial crisis; namely, questions about transparency, accountability, and democratic governance.
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Working Paper No. 788 | March 2014
The Case of the United States
One of the main contributions of Modern Money Theory (MMT) has been to explain why monetarily sovereign governments have a very flexible policy space that is unconstrained by hard financial limits. Not only can they issue their own currency to pay public debt denominated in their own currency, but they can also easily bypass any self-imposed constraint on budgetary operations. Through a detailed analysis of the institutions and practices surrounding the fiscal and monetary operations of the treasury and central bank of the United States, the eurozone, and Australia, MMT has provided institutional and theoretical insights into the inner workings of economies with monetarily sovereign and nonsovereign governments. The paper shows that the previous theoretical conclusions of MMT can be illustrated by providing further evidence of the interconnectedness of the treasury and the central bank in the United States.
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Press Releases | February 2014
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Policy Note 2014/2 | February 2014
Lessons for the Current Debate on the US Debt Limit
In 1943, Congress faced unpredictably large war expenditures exceeding the prevailing debt limit. Congressional debates from that time contain an insightful discussion of how the increased expenditures could be financed, dealing with practical and theoretical issues that seem to be missing from current debates. In the '43 debate, Representative Wright Patman proposed that the Treasury should create a nonnegotiable zero interest bond that would be placed directly with the Federal Reserve Banks. As the deadline for raising the US federal government debt limit approaches, Senior Scholar Jan Kregel examines the implications of Patman's proposal. Among the lessons: that the debt can be financed at any rate the government desires without losing control over interest rates as a tool of monetary policy. The problem of financing the debt is not the issue. The question is whether the size of the deficit to be financed is compatible with the stable expansion of the economy.Download:Associated Program:Author(s):Jan KregelRelated Topic(s): -
Public Policy Brief No. 130 | January 2014In our era of global finance, the theory of aggregate demand management is alive and unwell, says Amit Bhaduri. In this policy brief, Bhaduri describes what he regards as a prevalent contemporary approach to demand management. Detached from its Keynesian roots, this “vulgar” version of demand management theory is being used to justify policies that stand in stark contrast to those prescribed by the original Keynesian model. Rising asset prices and private-debt-fueled consumption play the starring roles, while fiscal policy retreats into the background.
Returning to foundations laid down by Keynes and Kalecki, Bhaduri sets out to clarify whether there is any place for traditional demand management policies—featuring an active role for deficit spending and public investment—in the context of financial globalization. His conclusion: such policies are ultimately unavoidable if we are to revitalize the real economy and achieve stability.Download:Associated Program:Author(s):Amit BhaduriRelated Topic(s): -
Working Paper No. 784 | January 2014
Economic Thought and Political Realities
The Federal Reserve has been criticized for not forestalling the financial crisis of 2007–09, and for its unconventional monetary policies that have followed. Its critics have raised questions as to whom, if anyone, reins in the Federal Reserve if and when its policies are misguided or abusive. This paper traces the principal changes in governance of the Federal Reserve over its history. These changes have, for the most part, developed in the wake of economic upheavals, when Fed policy has been challenged. The aim is to identify relevant issues regarding governance and to establish a basis for change, if needed. It describes the governance mechanism established by the Federal Reserve Act in 1913, traces the passing of this mechanism in the 1920s and 1930s, and assays congressional efforts to expand oversight in the 1970s. It also considers the changes in Fed policies induced by the financial crisis of 2007–09 and the impact of the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010. It concludes that the original internal governance mechanism, a system of checks and balances that aimed to protect all the important interest groups in the country, faded in the 1920s and was never adequately replaced. In light of the Federal Reserve’s continued growth in power and influence, this deficiency constitutes a threat not only to “stakeholders” but also to the independence of the Federal Reserve itself.
Download:Associated Program:Author(s):Bernard ShullRelated Topic(s): -
Working Paper No. 783 | January 2014
A Sovereign Currency Approach
This paper examines the fiscal and monetary policy options available to China as a sovereign currency-issuing nation operating in a dollar standard world. We first summarize a number of issues facing China, including the possibility of slower growth, global imbalances, and a number of domestic imbalances. We then analyze current monetary and fiscal policy formation and examine some policy recommendations that have been advanced to deal with current areas of concern. We next outline the sovereign currency approach and use it to analyze those concerns. We conclude with policy recommendations consistent with the policy space open to China.Download:Associated Program(s):Author(s):Related Topic(s):China Financial instability Fiscal policy Hyman Minsky Middle-income trap Modern Money Theory (MMT) Monetary policy Policy space Sectoral balances approach Sovereign currencyRegion(s):Asia -
Working Paper No. 778 | November 2013
A Reply to Critics
One of the main contributions of Modern Money Theory (MMT) has been to explain why monetarily sovereign governments have a very flexible policy space that is unencumbered by hard financial constraints. Through a detailed analysis of the institutions and practices surrounding the fiscal and monetary operations of the treasury and central bank of many nations, MMT has provided institutional and theoretical insights about the inner workings of economies with monetarily sovereign and nonsovereign governments. MMT has also provided policy insights with respect to financial stability, price stability, and full employment. As one may expect, several authors have been quite critical of MMT. Critiques of MMT can be grouped into five categories: views about the origins of money and the role of taxes in the acceptance of government currency, views about fiscal policy, views about monetary policy, the relevance of MMT conclusions for developing economies, and the validity of the policy recommendations of MMT. This paper addresses the critiques raised using the circuit approach and national accounting identities, and by progressively adding additional economic sectors.
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In the Media | September 2013
Mark Dittli
Finanz und Wirtschaft, September 30, 2013. All Rights Reserved.
Hyman Minsky erkannte die Gefahr exzessiver Kreditschöpfung durch die Banken. Er hielt es für eine Torheit der Ökonomie, den Finanzsektor zu ignorieren.
Man stelle sich vor: eine Mischung aus John Maynard Keynes und Joseph Schumpeter, mit einem Schuss Hayek. Das Resultat ist einer der wichtigsten Ökonomen des vergangenen Jahrhunderts, der bis heute in der breiten Öffentlichkeit kaum bekannt ist: Hyman Minsky (1919–1996).
In den Jahren seit dem Ausbruch der Finanzkrise ist der Name des Amerikaners wieder in der ökonomischen Debatte aufgetaucht; als «Minsky Moment» wurde die verhängnisvolle Periode im August 2007 bezeichnet, als das Finanzsystem begann, aus den Fugen zu geraten. Angesichts der heutigen Renaissance Minskys geht leicht vergessen, dass er während seiner akademischen Karriere ein Randdasein fristete, kaum ernst genommen in der Mainstream-Ökonomie.
Das war ein folgenschwerer Fehler. Hyman Minsky befasste sich als Ökonomieprofessor mit dem Finanzsektor und der Rolle, die dieser in der Realwirtschaft spielt. Er zeigte, dass das Finanzsystem inhärent instabil ist, zu Übertreibungen und Krisen neigt. Wer seine hauptsächlich in den Siebziger- und Achtzigerjahren verfassten Schriften liest, findet erschreckend präzise Parallelen zu den Ereignissen von 2007 und danach. Lebte Minsky heute noch, könnte er zu Recht ein «Ich habe es ja gesagt» in die Runde werfen.
Der wahre Keynes
Hyman Philip Minsky, 1919 als Sohn jüdischer weissrussischer Immigranten in Chicago geboren, studierte Mathematik und Ökonomie an der University of Chicago. Master- und Doktortitel in Ökonomie erlangte er an der Harvard University, sein Doktorvater war Joseph Schumpeter. Nach dem Studium folgten Lehraufträge an der Brown University sowie in Berkeley. 1965 übernahm Minsky einen Lehrstuhl an der Washington University in St. Louis, den er bis 1990 behielt. Danach forschte er weitere sechs Jahre bis zu seinem Tod am Levy Economics Institute.
Auf einen simplen Satz reduziert war der Kern von Minskys Lehre die Suche nach dem wahren Keynesianismus. Hierzu ein kurzer Exkurs: John M. Keynes löste 1936 mit der «General Theory of Employment, Interest, and Money» in der Volkswirtschaftslehre eine Revolution aus. Das Werk war jedoch in vielen Belangen bruchstückhaft, und Keynes hatte die Absicht, auf etliche Aspekte näher einzugehen. 1937 erlitt er jedoch einen Herzinfarkt und konnte mehrere Jahre kaum arbeiten. Später absorbierten ihn der Weltkrieg und seine Arbeit an der Konzeption des Bretton-Woods-Systems. 1946 starb Keynes; er kam nicht mehr dazu, die General Theory zu verfeinern. Das Werk blieb eine Art Bibel, deren Interpretation anderen überlassen war.
Diesen Part übernahmen John Hicks und später Alvin Hansen sowie Paul Samuelson. Sie erschufen auf Basis der General Theory die sogenannte neoklassische Synthese, die Lehrbuchökonomie, die ab den Fünfzigerjahren zum Mainstream wurde.
Grundannahme der neoklassischen Synthese ist das Equilibriumsmodell, das besagt, dass die Wirtschaft stets ein Gleichgewicht sucht.
«Die populäre, mathematisch hergeleitete Modellierung der General Theory, besonders in der Gestalt des IS/LM-Modells von Hicks (...), tut sowohl dem Geist als auch dem Gehalt von Keynes’ Werk Gewalt an.»
Herzstück der Hicks’schen Interpretation der General Theory war das IS/LM-Modell, das den Markt für Güter und den Markt für Geld im Gleichgewicht darstellt. In diesem Modell ist Geld eine neutrale Grösse, es entsteht exogen, durch die Entscheide der Zentralbank. Der Finanzsektor wird daher weitgehend ausgeblendet respektive als irrelevant betrachtet. Das Finanzsystem ist nichts anderes als ein Mechanismus, um Geld von Sparern zu Investoren zu transferieren.
Vom Wesen der Ungewissheit
Minsky sah in der neoklassischen Synthese eine Perversion von Keynes’ Lehre. «Die mathematisch hergeleitete Modellierung der General Theory transformierte Keynes’ Theorie in ein das Gleichgewicht suchendes System», schrieb er: «Sie tut sowohl dem Geist wie auch dem Gehalt von Keynes’ Werk Gewalt an.» Die Ausblendung des Finanzsektors hielt er für eine absurde Abstraktion der Realität.
Minsky verstand sich sehr wohl als Keynesianer, aber für ihn lag der Schlüssel in der Interpretation der General Theory in deren Kapitel 12. Dieses befasst sich mit der Rolle der Spekulation an den Märkten, mit Massenpsychologie und Herdentrieb. In ihrer Versessenheit auf mathematische Modelle hätten Hicks und seine Nachfolger vergessen, wie wichtig für Keynes der Begriff der Ungewissheit war und was diese für die Entscheidungsfindung von Investoren bedeute, warnte er.
Schon in den späten Fünfzigerjahren prophezeite Minsky, die populäre Auslegung des «Keynesianismus» werde zu Inflation und finanzieller Instabilität führen. Zwanzig Jahre später sollte sich die Warnung bewahrheiten.
1975, mittlerweile war der populäre Keynesianismus angesichts steigender Inflationsraten diskreditiert, publizierte Minsky sein erstes grosses Werk mit dem Titel «John Maynard Keynes». Er sah es als Versuch, die wahre Substanz der General Theory, die Rolle der Finanzbeziehungen in einem fortgeschrittenen kapitalistischen System, ans Licht zu bringen. Die Mainstream-Ökonomie hatte den Finanzsektor wegrationalisiert: Minsky setzte ihn ins Zentrum seiner Arbeit.
1986 legte er mit seinem zweiten Werk, «Stabilizing an Unstable Economy», nach. Darin formulierte er seine Hypothese der finanziellen Instabilität, die zu seinem Hauptvermächtnis werden sollte.
«Ein komplexes Finanzsystem wie das unsere generiert destabilisierende Kräfte. Depressionen sind natürliche Konsequenz des ungehinderten Kapitalismus (...). Das Finanzsystem kann nicht dem freien Markt überlassen werden.»
Nach Minsky – in diesem Punkt folgt er Schumpeter – ist das kapitalistische System nicht stabil. Es findet kein Equilibrium; das Gleichgewicht ist bloss eine Station auf dem Weg von einem Ungleichgewicht ins nächste. Der Grund dafür liegt im Verhalten der Marktakteure: Gefühlte Stabilität in der Gegenwart verleitet sie dazu, immer risikofreudiger zu werden – was den Grundstein für die nächste Krise legt. «Stabilität führt zu Instabilität», beschrieb Minsky sein Paradoxon.
Die zentrale Rolle in diesem Prozess spielt der Finanzsektor. Nach Minsky – und Schumpeter – entsteht Geld nicht exogen, sondern endogen, innerhalb des Wirtschaftssystems, «aus dem Nichts», durch die Kreditschöpfung der Banken. Diese befeuert den Gang der Wirtschaft und treibt die Spekulation an.
Minsky unterschied zwischen drei Zuständen in der Finanzierungsstruktur von Unternehmen oder Personen: Abgesichert («Hedge»), Spekulativ und Ponzi. Im ersten Stadium erwirtschaften die Schuldner aus ihrer Arbeit genügend Cashflow, um die Zinslast zu bedienen und die Schulden allmählich abzuzahlen. Im zweiten Stadium reicht der Cashflow nur zur Bedienung der Zinsen, aber nicht zur Amortisation der Schuld. Ein spekulativer Schuldner ist darauf angewiesen, dass er seine Kredite am Fälligkeitstermin durch neue ablösen kann. Das letzte Stadium im Zyklus nannte Minsky Ponzi, nach dem Hochstapler Charles Ponzi, der in den Zwanzigerjahren mit einem Pyramidensystem 15 Mio. $ ergaunert hatte. In diesem Stadium reicht der erarbeitete Cashflow des Schuldners nicht einmal mehr, um die Zinsen zu bedienen. Um über Wasser zu bleiben, muss er darauf zählen, dass sich der Wert der Anlagen in seiner Bilanz laufend erhöht.
Mit diesem Modell erklärt sich das Minsky-Paradoxon, wonach Stabilität zu Instabilität führt: In einer gesunden Wirtschaft sind die meisten Kredite an abgesicherte Schuldner verliehen. In der gefühlten Stabilität werden diese jedoch risikofreudiger und nehmen immer mehr Schulden auf, um verheissungsvolle Investitionsprojekte zu realisieren. Die Banken agieren in dieser Phase nicht als Korrektiv, sondern legen ihre Risikoscheu ebenfalls ab und vergeben immer freimütiger Kredit. Der Kreislauf treibt sich in die Höhe, bis die Wirtschaft aus zahlreichen spekulativen oder Ponzi-Schuldnern besteht – und höchst fragil geworden ist.
Die Bändigung des Biestes
Irgendwann kippt dann die Stimmung. Schlagartig können sich Schuldner nicht mehr refinanzieren, die Banken frieren die Kreditvergabe ein, die Preise von Vermögenswerten geraten ins Rutschen, Notverkäufe beschleunigen den Prozess. Die deflationäre Schuldenliquidation beginnt.
Für den Ausbruch der Krise ist kein exogener Schock nötig. «Instabilität entsteht durch die Mechanismen innerhalb des Systems, nicht ausserhalb», schrieb Minsky, «unsere Wirtschaft ist nicht instabil, weil sie durch den Ölpreis oder Kriege geschockt wird. Sie ist instabil, weil das in ihrer Natur liegt.» In beiden Extremen des Ungleichgewichts, im Spekulationsboom wie in der deflationären Schuldenliquidation, entsteht kein Korrektiv: Der Boom nährt sich selbst, genauso wie sich die Wirtschaft in der Depression immer weiter in die Tiefe schraubt.
Minsky sah nur eine Möglichkeit, das Biest zu bändigen. In den extremen Phasen des Ungleichgewichts muss der Staat einspringen. In der Depression bedeutet das fiskal- und geldpolitische Stützung, um die selbstzerstörerische deflationäre Schuldenliquidation zu stoppen. Als Korrektiv im Boom sah Minsky vor allem institutionelle Bremsen im Bankensektor: Er empfahl harte Eigenmittelanforderungen für die Banken sowie Beschränkungen in ihrer Gewinnausschüttung. Grossbanken, deren Bilanz eine winzige Eigenkapitaldecke aufweist, waren Minsky ein Gräuel. «Ein komplexes Finanzsystem wie das Unsere generiert auf endogenem Weg gefährliche destabilisierende Kräfte», schrieb er, «Depressionen sind eine natürliche Konsequenz des ungehinderten Kapitalismus.» Und in letzter Konsequenz: «Das Finanzsystem kann nicht dem freien Markt überlassen werden.»
Das Ende der Geschichte
Es erstaunt kaum, dass Minsky mit diesen Ansichten in den Achtzigern keine Chance hatte. Eine Theorie des Ungleichgewichts war damals weltfremd. Neukeynesianer, Neoklassiker, Monetaristen sowie die Anhänger der österreichischen Schule waren sich in der Annahme einig, dass das Wirtschaftssystem – zumindest in der langen Frist – in ein Gleichgewicht strebt. Es war die Zeit der Theorie der rationalen Erwartungen, der effizienten Finanzmärkte, untermauert mit der Präzision mathematischer Modelle. Es war die Zeit der Deregulierungswellen im Bankensektor, gestartet unter Reagan und Thatcher, fortgesetzt in den USA unter Bill Clinton. Es war die Zeit der «grossen Moderation», mit robustem Wachstum und flachen, harmlosen Rezessionen. Sogar die Inflation war besiegt. Es war das «Ende der Geschichte» in der Ökonomie.
Für Hyman Minsky war in dieser Welt kein Platz mehr. Nur ein verlorenes Grüppchen Post-Keynesianer scharte sich noch um ihn. 1996 starb er an Krebs.
Vier Jahre später war Minsky in den «Essays on the Great Depression» des Princeton-Professors Ben Bernanke nur eine Fussnote wert. Ein exzessiver Schuldenaufbau – wie von Minsky gewarnt – sei in einer freien Marktwirtschaft gar nicht möglich, weil das irrationales Verhalten der Marktteilnehmer voraussetzen würde. «Und das», schrieb der spätere Chef der US-Notenbank, «ist kaum vorstellbar.»
Zur selben Zeit begann am US-Häusermarkt ein beispielloser, von Krediten befeuerter Anstieg der Preise. Dasselbe Muster war in Spanien, England, Irland zu beobachten. Überall explodierte die Kreditschöpfung, überall regierte der spekulative Exzess, bereitwillig angetrieben von den Banken. Überall konnten lehrbuchmässig die drei Stufen von Minskys Instabilitätshypothese beobachtet werden. Und dann kam es zum Knall, der beinahe das globale Finanzsystem in die Tiefe riss. «Hyman Minsky ist der analytischste und überzeugendste aller zeitgenössischen Ökonomen, die in exzessivem Schuldenaufbau die Achillesferse des Kapitalismus sehen», schrieb der Ökonom James Tobin 1987 in einer Besprechung von «Stabilizing an Unstable Economy».
Hätte man bloss auf ihn gehört.Associated Program: -
Press Releases | September 2013
Download:Associated Program:Author(s):Mark Primoff -
One-Pager No. 42 | September 2013Perhaps the most indictable offense that mainstream economists committed, from 1988 through 2008, was to retrace Keynes’s path of discovery from 1924 (A Tract on Monetary Reform) through 1936 (The General Theory). Wholesale deregulation of finance and categorical confidence in a reductionist role for central banks came into being as the conventional wisdom embraced the 1924 view that free markets and stable prices alone give us the best chance for economic stability. In the aftermath of the grand asset market boom-and-bust cycle of 2008–9, we are jettisoning Keynes circa 1924 for the Keynes of 1936. In effect, we study business cycles but seem incapable of extricating the economics profession from reciting its assigned lines as the play unfolds.Download:Associated Program:Author(s):Robert J. BarberaRelated Topic(s):
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One-Pager No. 40 | September 2013Nicola Matthews, University of Missouri–Kansas City, presents the main findings of her research on the Fed’s lending practices following the global financial crisis of 2008. Applying Walter Bagehot’s principles, she finds that the Fed departed from the traditional lender-of-last-resort function of a central bank by lending to insolvent banks without good collateral--and below penalty rates. Most of the Fed’s emergency facilities lent at rates that were, on average, at or below market rates, with the big banks the primary beneficiaries. The Fed went beyond aiding markets to effectively making markets. Reform, Matthews concludes, is the only solution.Download:Associated Program:Author(s):Nicola MatthewsRelated Topic(s):
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Policy Note 2013/8 | August 2013Though it is not widely understood, the Federal Reserve has enormous untapped power to directly stimulate or influence the flows of lending and spending that generate jobs. Doing so would fulfill the Fed’s often neglected “dual mandate”: to strive for maximum employment as well as stable money. Fed technocrats often plead that legal or technical barriers won’t allow them to do this, but their objections reflect an institutional bias that favors finance over industry, capital over labor. The central bank has abundant precedent from its own history for taking more direct actions to aid the economy. And it has ample legal authority to lend to all kinds of businesses that are not banks. This policy note was originally published, in slightly different form, as “Can the Federal Reserve Help Prevent a Second Recession?,” The Nation, November 26, 2012. Reprinted with permission.Download:Associated Program:Author(s):William GreiderRelated Topic(s):
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Policy Note 2013/7 | August 2013Monetary policy is running out of gas. Six years ago, in the heat of crisis, the Federal Reserve’s response was awesome. The Fed created trillions of dollars and flooded the system with easy money—enough to stabilize financial markets and rescue wounded banks. It brought short-term interest rates down to near zero and long-term mortgage rates to bargain-basement levels. It provided a huge backstop for the dysfunctional housing sector, buying $1.25 trillion in mortgage-backed securities, nearly one-fourth of the market.
Flooding Wall Street with money saved the banks, but it didn’t work for the real economy, where most Americans live and toil. And official Washington now appears to have opted for an unspoken policy of complacency.
The Fed knows, even if politicians do not, the danger of sliding into a liquidity trap, which would utterly disarm its monetary tools. So the Fed wants Congress and the White House to borrow and spend more because, when the private sector is stalled and afraid to act, only the federal government can step in and provide the needed jump start. The country needs a stronger Fed—a central bank not afraid to use its awesome powers to help the real economy more directly. One of the ways it can do this is by revisiting—and extending—its bold ideas on debt relief. By harnessing the power of money creation, the Fed can help clear away the overhang of mortgage and student debt holding back the economic recovery. This policy note draws from articles originally published in The Nation. Portions are republished with permission.Download:Associated Program:Author(s):William GreiderRelated Topic(s): -
Conference Proceedings | July 2013A conference organized by the Levy Economics Institute of Bard College with support from the Ford Foundation The 2013 Minsky Conference addressed both financial reform and poverty in the context of Minsky’s work on financial instability and his proposal for a public job guarantee. Panels focused on the design of a new, more robust, and stable financial architecture; fiscal austerity and the sustainability of the US economic recovery; central bank independence and financial reform; the larger implications of the eurozone debt crisis for the global economic system; improving governance of the social safety net; the institutional shape of the future financial system; strategies for promoting poverty eradication and an inclusive economy; sustainable development and market transformation; time poverty and the gender pay gap; and policy and regulatory challenges for emerging-market economies. The proceedings include the conference program, transcripts of keynote speakers’ remarks, synopses of the panel sessions, and biographies of the participants.Download:Associated Program(s):Author(s):Barbara Ross Michael StephensRegion(s):United States
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In the Media | June 2013
By Dimitri B. Papadimitriou
The Huffington Post, June 18, 2013. Copyright © 2013 TheHuffingtonPost.com, Inc. All Rights Reserved.
Remember last summer? The London Whale, that blockbuster adventure thriller, triggered one chill after another as the high-risk action at JPMorgan Chase was revealed. Today, the threats posed by megabanks remain just below the surface—no crisis at the moment—but they’re equally dangerous. A major sequel this year cannot be ruled out.
Dodd-Frank, the law designed to reform the financial system, had already been on the books for two years when JPMorgan’s troubles surfaced. In an effort to figure out how it failed to prevent massive losses by one of the world’s largest banks, a Senate subcommittee investigated. This spring, it issued its report on the outsize positions taken by the bank’s Chief Investment Office (CIO)—with a lead trader known as ‘the London Whale’—and the department’s subsequent six billion dollar crash.
The committee detailed a list of concealed high-risk activities, and determined that the CIO’s so-called ‘hedging’ activities were really just disguised propriety trading, that is, volatile, high-profit trades on behalf of the bank itself, rather than on behalf of its customers in return for commissions.
Levy Economics Institute Senior Scholar Jan Kregel has taken these conclusions a step further, after analyzing the evidence. In a new research paper he makes the case that the primary cause of the bank’s difficulties was not that it engaged in proprietary trading: It was the concealment of this activity through the creation of a ‘shadow bank’, with the express purpose of this hardly-visible bank-within-the-bank being to create profits. What began as a unit to hedge risks—a safeguard—no longer served that purpose. He argues that when megabanks operate across all aspects of finance, this expansion of propriety trading becomes inevitable.
The solution, Kregel says, is not to prevent hedging, but rather to recognize that it can never be consistently profitable. A true hedging unit only generates profits when a bank’s bets on its primary investments are unexpectedly wrong. The legitimate hedge is expected to run losses most of the time, if the bank’s strategy and credit assessments are accurate. And for this reason, hedging activity should never be funded from customer deposits.
Did the London Whale revelations result in protections for bank customers—and their federal insurers—from this kind of gambling?
Dodd-Frank will reach its third anniversary in July. It mandated that Congress write 398 rules. About two-thirds of the deadlines for those rules have been missed. In addition, the hiring of regulators has been stalled in Washington, further undermining implementation of the law.
One rule that limited trading on derivatives contracts, the kind of activity that led to the London Whale debacle, was successfully challenged in the courts by a finance trade group. Another, the “Volcker Rule,” would require banks to separate consumer lending from speculative trading. It was Dodd-Frank’s most ambitious provision. Bank lobbyists have successfully kept regulators way behind schedule on finalizing it. Last week, an anti-regulatory bill to roll back other restrictions on derivatives trading passed in the House (the same bill was shelved last summer while the spotlight was on the London Whale). These are only a few examples. Attempts to reign in the recklessness are relentlessly dismantled as soon as they’re proposed.
A new bill to increase capital standards for the biggest banks has also recently surfaced. The requirement that these institutions hold less debt and more assets, sponsored by Sherrod Brown (D-Ohio) and David Vitter (R-Louisiana), would, in addition, limit the federal safety net to only cover traditional banking activities. It faces tough opposition.
I’ve written before about the limits of Dodd-Frank’s scope, and the fundamental changes we need to make in how we approach financial regulation if it is going to succeed. Kregel’s analysis pinpoints some of the key abuses that urgently need to be addressed. Despite all the obstacles, the responsibility remains to reform banks that are too big to fail, and even, apparently, to regulate.
Meanwhile, the Senate subcommittee’s report has been forwarded to the Justice Department, where no particular indictments are anticipated. Until our increasingly fragile system is strengthened, expect a remake of the London Whale story. Only the cast and crew will change. -
One-Pager No. 38 | June 2013The recent report by the Senate Permanent Subcommittee on Investigations on the operations of JPMorgan Chase’s Synthetic Credit Portfolio unit—aka the London Whale—has brought renewed attention to the risks of proprietary trading for insured banks, and provides depth to the larger risks inherent in the financial system after Dodd-Frank.Download:Associated Program:Author(s):Jan KregelRelated Topic(s):
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Press Releases | May 2013
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In the Media | May 2013
Di Elena Bonanni
FIRSTOnline, 21 Maggio 2013. Tutti i diritti riservati.
Gli azionisti votano oggi in assise sulla separazione delle cariche di presidente e ceo dopo gli scandali—Trema la doppia poltrona di Dimon—Le tre lezioni della balena di Londra dell'economista Jan Kregel (Bard College)—Il caso JPMorgan è diventato il terreno di gioco su cui si sta disputando la sfida sulla Volcker rule tra Senato e lobbies finanziarie
Il regno di Jamie Dimon non è imploso (per ora) sullo scandalo della Balena di Londra (ma non solo). L’ultimo re di Wall Street, come è stato soprannominato dal Financial Times, non dovrà dividere il trono con un nuovo presidente (solo il 32% ha votato a favore della separazione delle poltrone di ceo e presidente). Più scivolosa risulta invece la posizione di tre membri della Commissione sui rischi (David Cote, ceo Honeywell International; James Crown, presidente di Henry Crown and Company; Ellen Futter, presidente del Museo americano di storia naturale) che hanno ottenuto sostegno da meno del 60% dei soci.
CtW Investment group, che rappresenta i fondi pensione dei sindacati, ha già chiesto le loro dimissioni. Tra i soci “ribelli” è diffusa la convinzione che i tre direttori non abbiano le competenze e che la banca abbia bisogno di nuovi manager in grado di supervisionare il risk management. Un cambio della guardia e un miglioramento delle competenze può sempre essere utile. Così come è necessaria la sostituzione di chi non ha supervisionato bene. Oltre al trader Bruno Iksil, soprannominato “la Balena di Londra”, JP Morgan ha infatti già licenziato anche i vertici del Chief Investment Office, la divisione londinese responsabile delle perdite, compresa la numero uno Ina Drew. E ha fatto causa a Javier Martin-Artajo, il supervisore di Iksil.
Ma, nella realtà finanziaria di oggi, non sembra questa una soluzione sufficiente per evitare in futuro una nuova Balena. Né a JPMorgan né in qualsiasi altra istituzione finanziaria. Tutti si sono infatti focalizzati su “chi sapeva cosa e quando” e su chi era responsabile per aver dissimulato la situazione agli azionisti e alla comunità finanziaria. Ma nello studio “More swimming lessons from the london whale”, l’economista Jan Kregel (Bard College-New York), che analizza e amplia le conclusioni del report della Sottocommissione permanente per le indagini del Senato americano, rileva come il caso della Balena di Londra evidenzi implicazioni più importanti la stabilità del sistema finanziario.
Infatti, se i problemi fossero dovuti a incompetenza o stupidità, come suggerito dallo stesso ceo Dimon, allora la questione potrebbe essere risolta con la rimozione dei responsabili. “Da questo punto di vista—rileva Kregel—una volta che i responsabili vengono rimossi (come è successo) e le condizioni ripristinate (lo smantellamento dell’unità), tutta la questione può in effetti essere trattata se non come “una tempesta in una teiera”, come è stata inizialmente descritta da Dimon, come una goccia nel mare dei profitti di JPMorgan complessivi, come è stata successivamente presentata.
Dopo tutto, nessuno è perfetto e tutti fanno errori. Ma questa lettura farebbe perdere di vista le importanti questioni sistemiche sollevate dalle operazioni del Cio in generale e del Scp in particolare”. E che devono invece riportare l’attenzione sui rischi non risolti dalla normativa Dodd-Frank. A partire dalle stesse dimensioni delle istituzioni finanziarie troppo grandi perché il management possa sapere effettivamente cosa succede e troppo grandi per essere regolate, la prima delle tre lezioni che emergono dallo studio di Kregel sul report della Sottocommissione del Senato e che Firstonline ripercorre in una serie di articoli.
TROPPO GRANDE PER ESSERE SUPERVISIONATA
I documenti dell’indagine del Senato hanno dato disclosure aggiuntiva e più dettagliata sulle comunicazioni tra i trader del Synthetic credit Portfolio (Scp), i loro manager del Chief investment office (Cio) e il top management della banca. “Questi scambi—scrive Kregel—non solo riconfermano il fatto che il management ha dato una rappresentazione non corretta agli azionisti e ai regolatori dei dettagli e l’ampiezza delle difficoltà della divisione Chief investment office (Cio), ma ha anche reso chiaro che il management non aveva una comprensione approfondita delle operazioni del Scp o dei motivi delle difficoltà di questa divisione”.
Per l’economista i documenti suggeriscono che è altamente probabile che i diversi livelli di management accusati di aver diffuso false informazioni non avevano la più pallida idea delle operazioni dell’unità Scp e del perché fosse entrata in sofferenza: nessun a quanto pare si era accorto delle difficoltà del Scp fino all’inizio del 2012. “Le comunicazioni del primo trimestre del 2012—rileva Kregel—suggeriscono che il management stesse lottando per capire cosa stesse andando male anche quando approvò misure che nelle intenzioni avrebbero dovuto risolvere il problema”. Ma che invece causarono un deterioramento più veloce del valore del portafoglio dell’unità che chiaramente non era stato compreso.
Kregel rileva come né il Senato né l’indagine interna di JPMorgan sostengano l’idea che la banca fosse semplicemente troppo grande perché qualsiasi manager potesse avere conoscenza diretta delle operazioni multiple della divisione di cui era responsabile. E ovviamente non poteva neanche il boss di JPMorgan quando parlò della famosa “tempesta nella teiera”. Kregel spiega che ogni livello di management faceva affidamento sulle informazioni passate dai subordinati, i quali a loro volta avevano poca conoscenza diretta dell’unità che stavano gestendo, fino ai trader che per loro stessa ammissione non capivano le performance del portafoglio che loro stessi avevano creato e che furono poi sostituiti da individui con ancora meno comprensione delle difficoltà che stavano fronteggiando.
“La spiegazione più probabile della cattiva informazione relativa alla Balena—conclude Kregel—è un enorme fallimento del controllo e della regia manageriale che non è stato il risultato di un inganno deliberato ma piuttosto la risposta naturale di individui che erano pagati generosamente per assumersi la responsabilità ma che semplicemente non sapevano cosa stesse succedendo perché la taglia e la complessità dell’organizzazione lo rendeva impossibile—ancora una volta, la prova di una istituzione troppo grande da gestire efficacemente e a maggior ragione da regolare. Se la complessità è chiaramente una minaccia maggiore alla stabilità finanziaria rispetto alla grandezza, è di solito, ma non solo, la grandezza che porta alla complessità”. -
In the Media | May 2013
Di Elena Bonanni
FIRSTOnline, 21 Maggio 2013. Tutti i diritti riservati.
LE TRE LEZIONI DELLA BALENA DI LONDRA/1 Jamie Dimon ha superato il voto sulla doppia poltrona mentre la fronda degli azionisti "ribelli" chiede le dimissioni dei tre membri della Commissione rischi che non hanno superato il 60% dei consensi— Ma il problema di JPMorgan non è solo la sostituzione dei manager “incompetenti”—Lo spiega l'economista Jan Kregel.
Il regno di Jamie Dimon non è imploso (per ora) sullo scandalo della Balena di Londra (ma non solo). L’ultimo re di Wall Street, come è stato soprannominato dal Financial Times, non dovrà dividere il trono con un nuovo presidente (solo il 32% ha votato a favore della separazione delle poltrone di ceo e presidente). Più scivolosa risulta invece la posizione di tre membri della Commissione sui rischi (David Cote, ceo Honeywell International; James Crown, presidente di Henry Crown and Company; Ellen Futter, presidente del Museo americano di storia naturale) che hanno ottenuto sostegno da meno del 60% dei soci.
CtW Investment group, che rappresenta i fondi pensione dei sindacati, ha già chiesto le loro dimissioni. Tra i soci “ribelli” è diffusa la convinzione che i tre direttori non abbiano le competenze e che la banca abbia bisogno di nuovi manager in grado di supervisionare il risk management. Un cambio della guardia e un miglioramento delle competenze può sempre essere utile. Così come è necessaria la sostituzione di chi non ha supervisionato bene. Oltre al trader Bruno Iksil, soprannominato “la Balena di Londra”, JP Morgan ha infatti già licenziato anche i vertici del Chief Investment Office, la divisione londinese responsabile delle perdite, compresa la numero uno Ina Drew. E ha fatto causa a Javier Martin-Artajo, il supervisore di Iksil.
Ma, nella realtà finanziaria di oggi, non sembra questa una soluzione sufficiente per evitare in futuro una nuova Balena. Né a JPMorgan né in qualsiasi altra istituzione finanziaria. Tutti si sono infatti focalizzati su “chi sapeva cosa e quando” e su chi era responsabile per aver dissimulato la situazione agli azionisti e alla comunità finanziaria. Ma nello studio “More swimming lessons from the london whale”, l’economista Jan Kregel (Bard College-New York), che analizza e amplia le conclusioni del report della Sottocommissione permanente per le indagini del Senato americano, rileva come il caso della Balena di Londra evidenzi implicazioni più importanti la stabilità del sistema finanziario.
Infatti, se i problemi fossero dovuti a incompetenza o stupidità, come suggerito dallo stesso ceo Dimon, allora la questione potrebbe essere risolta con la rimozione dei responsabili. “Da questo punto di vista—rileva Kregel—una volta che i responsabili vengono rimossi (come è successo) e le condizioni ripristinate (lo smantellamento dell’unità), tutta la questione può in effetti essere trattata se non come “una tempesta in una teiera”, come è stata inizialmente descritta da Dimon, come una goccia nel mare dei profitti di JPMorgan complessivi, come è stata successivamente presentata.
Dopo tutto, nessuno è perfetto e tutti fanno errori. Ma questa lettura farebbe perdere di vista le importanti questioni sistemiche sollevate dalle operazioni del Cio in generale e del Scp in particolare”. E che devono invece riportare l’attenzione sui rischi non risolti dalla normativa Dodd-Frank. A partire dalle stesse dimensioni delle istituzioni finanziarie troppo grandi perché il management possa sapere effettivamente cosa succede e troppo grandi per essere regolate, la prima delle tre lezioni che emergono dallo studio di Kregel sul report della Sottocommissione del Senato e che Firstonline ripercorre in una serie di articoli.
TROPPO GRANDE PER ESSERE SUPERVISIONATA
I documenti dell’indagine del Senato hanno dato disclosure aggiuntiva e più dettagliata sulle comunicazioni tra i trader del Synthetic credit Portfolio (Scp), i loro manager del Chief investment office (Cio) e il top management della banca. “Questi scambi—scrive Kregel—non solo riconfermano il fatto che il management ha dato una rappresentazione non corretta agli azionisti e ai regolatori dei dettagli e l’ampiezza delle difficoltà della divisione Chief investment office (Cio), ma ha anche reso chiaro che il management non aveva una comprensione approfondita delle operazioni del Scp o dei motivi delle difficoltà di questa divisione”.
Per l’economista i documenti suggeriscono che è altamente probabile che i diversi livelli di management accusati di aver diffuso false informazioni non avevano la più pallida idea delle operazioni dell’unità Scp e del perché fosse entrata in sofferenza: nessun a quanto pare si era accorto delle difficoltà del Scp fino all’inizio del 2012. “Le comunicazioni del primo trimestre del 2012—rileva Kregel—suggeriscono che il management stesse lottando per capire cosa stesse andando male anche quando approvò misure che nelle intenzioni avrebbero dovuto risolvere il problema”. Ma che invece causarono un deterioramento più veloce del valore del portafoglio dell’unità che chiaramente non era stato compreso.
Kregel rileva come né il Senato né l’indagine interna di JPMorgan sostengano l’idea che la banca fosse semplicemente troppo grande perché qualsiasi manager potesse avere conoscenza diretta delle operazioni multiple della divisione di cui era responsabile. E ovviamente non poteva neanche il boss di JPMorgan quando parlò della famosa “tempesta nella teiera”. Kregel spiega che ogni livello di management faceva affidamento sulle informazioni passate dai subordinati, i quali a loro volta avevano poca conoscenza diretta dell’unità che stavano gestendo, fino ai trader che per loro stessa ammissione non capivano le performance del portafoglio che loro stessi avevano creato e che furono poi sostituiti da individui con ancora meno comprensione delle difficoltà che stavano fronteggiando.
“La spiegazione più probabile della cattiva informazione relativa alla Balena—conclude Kregel—è un enorme fallimento del controllo e della regia manageriale che non è stato il risultato di un inganno deliberato ma piuttosto la risposta naturale di individui che erano pagati generosamente per assumersi la responsabilità ma che semplicemente non sapevano cosa stesse succedendo perché la taglia e la complessità dell’organizzazione lo rendeva impossibile—ancora una volta, la prova di una istituzione troppo grande da gestire efficacemente e a maggior ragione da regolare. Se la complessità è chiaramente una minaccia maggiore alla stabilità finanziaria rispetto alla grandezza, è di solito, ma non solo, la grandezza che porta alla complessità”. -
Working Paper No. 763 | May 2013
This working paper looks at excess reserves in historical context and analyzes whether they constitute a monetary policy problem for the Federal Reserve System (the “Fed”) or a potentially inflationary problem for the rest of us. Generally, this analysis shows that both absolute and relative sizes of excess reserves are a big problem for the Fed as well as the general public be-cause of their inflationary potential. However, like all contingencies, the timing and extent of the damage that reserve-driven inflation might cause are uncertain. It is even possible today to find articles in both scholarly circles and the popular press arguing either that the inflationary blow-off might never happen or that an increasing tendency toward prolonged deflation is the more probable outcome.
Download:Associated Program:Author(s):Walker F. ToddRelated Topic(s): -
Policy Note 2013/4 | April 2013In March of this year, the government of Cyprus, in response to a banking crisis and as part of a negotiation to secure emergency financial support for its financial system from the European Union (EU) and International Monetary Fund (IMF), proposed the assessment of a tax on bank deposits, including a levy (later dropped from the final plan) on insured demand deposits below the 100,000 euro insurance threshold. An understanding of banks’ dual operations and of the relationship between two types of deposits—deposits of customers’ currency and coin, and deposit accounts created by bank loans—helps clarify some of the problems with the Cypriot deposit tax, while illuminating both the purposes and limitations of deposit insurance.Download:Associated Program(s):Author(s):Jan KregelRelated Topic(s):Region(s):Europe
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Public Policy Brief No. 129 | April 2013This policy brief by Senior Scholar and Program Director Jan Kregel builds on an earlier analysis (Policy Note 2012/6) of JPMorgan Chase and the actions of the “London Whale,” and what this episode reveals about the larger risks inherent in the financial system. It is clear that the Dodd-Frank Act failed to prevent massive losses by one of the world’s largest banks. This is undeniable evidence that work remains to be done to reform the financial system. Toward this end, Kregel reviews the findings of a recent report by the Senate Permanent Subcommittee on Investigations and expands on the lessons that we can draw from the evolution of the London Whale episode.Download:Associated Program:Author(s):Jan KregelRelated Topic(s):
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In the Media | April 2013
By David Dayen
The American Prospect, April 24, 2013. All Rights Reserved.
Satisfied with the meager reforms of the Dodd-Frank financial-reform bill, the Treasury is standing in the way of further efforts to rein in mega-banks.
These are heady times for the bipartisan group of reformers seeking a safer and more manageable U.S. financial system. The leaders of this movement, Senators Sherrod Brown and David Vitter, introduced legislation yesterday to force the biggest banks to foot the bill for their own mistakes by imposing higher capital requirements. The bill would increase equity (either retained earnings or stock) in the financial system by $1.1 trillion and incentivize mega-banks to break themselves up, according to a Goldman Sachs report. Brown and Vitter previewed the legislation earlier this week at the National Press Club, insisting that the new regulations on risky mega-banks would diminish threats to the U.S. economy and prevent taxpayers from having to bail out banks in the future. Vitter also said the legislation would “level the playing field and take away a government policy subsidy, if you will, that exists in the market now favoring size.” With momentum, broadening support, and tangible legislation to push, bank reformers feel better positioned for success than they have since the passage of Dodd-Frank.
Or rather, they did until the Treasury Department poured a giant bucket of cold water on their effort. In a speech to the Levy Economics Institute of Bard College's annual Minsky Conference last Thursday, Undersecretary for Domestic Finance Mary Miller claimed that Dodd-Frank had already solved the “Too Big to Fail” problem. Miller indicated that mega-banks do not enjoy an unfair advantage in their borrowing costs and that recent boosts to capital standards were already working to strengthen the financial system. Having a big public speech at an important venue by a top official the week before the release of Brown-Vitter sends a clear message about the Treasury’s position. “She is not going off the cuff in a policy speech like that,” said former Special Inspector General for the Troubled Asset Relief Program (TARP) and persistent bank critic Neil Barofsky. “This seems like a carefully measured response to Brown-Vitter that the regulatory-reform shop, from the Treasury perspective, is closed.”
The resistance should not surprise anyone. Under Timothy Geithner, Treasury was openly hostile to far-reaching congressional proposals to constrain mega-banks. Despite the change in leadership at the department, many holdovers from the Geithner era, including Miller, still hold high-level positions. In his confirmation hearings, Treasury Secretary Jack Lew stated flatly that Dodd-Frank had dealt with the Too Big to Fail problem. Most important, Lew works for President Obama: Reaching an agreement to break up mega-banks by forcing them to carry more capital would represent a tacit admission that Dodd-Frank, widely touted as a centerpiece of the president's first term, failed in its core mission of stabilizing the financial system.
Given that Miller is a 26-year veteran of the investment-management firm T. Rowe Price, it is no surprise that she espouses Wall Street’s worldview.
What’s striking about Miller’s speech is how closely it mirrors the arguments set forth in several recent papers put out by the big banks, their lobbyists, and their allies. This includes the previously mentioned report on Brown-Vitter by Goldman Sachs; a policy brief by the Financial Services Forum and co-signed by the leading lobbyist groups for the banking industry; and a report with the cheery title "Banking on Our Future" by Hamilton Place Strategies (HPS), a public-relations firm staffed by top communications officials from the last three Republican presidential campaigns (HPS has admitted that its clients include large financial institutions). All of these reports were released in the past few months in an effort to derail Brown-Vitter. Given that Miller is a 26-year veteran of the investment-management firm T. Rowe Price, it is no surprise that she espouses Wall Street’s worldview. For example, Miller discounts an influential working paper from the International Monetary Fund (IMF) showing an $83 billion annual subsidy for mega-banks from their Too Big to Fail status by saying its evidence “predates the financial crisis and Dodd-Frank’s reforms.” This is precisely the argument the Financial Services Forum made, ignoring the fact that there are plenty of post-crisis studies hat show the subsidies persist. Miller highlights the resolution authority granted to the Federal Deposit Insurance Corporation (FDIC) under Dodd-Frank, which allows the FDIC to wind down any systemically important financial institution verging on collapse rather than resorting to a bailout. She says that, to the extent that a cost-of-borrowing advantage exists for mega-banks, resolution authority “should help wring it the rest of the way out of the market.” In practically the same language, HPS writes that resolution authority “helps eliminate any potential funding advantage big banks are thought to have.” And in providing statistical support for increased capital, Miller notes, “The 18 largest bank-holding companies … doubled the amount of their Tier 1 common equity capital over the last four years.” Goldman Sachs uses precisely this statistic, writing that “common equity has doubled for U.S. banks” since the financial crisis.
Critics have assailed the bank-industry papers for their unrealistic views about the risks in the current system and over-optimistic evaluations of the impact of the most recent regulatory changes. The truth is that Dodd-Frank has emerged from the gate slowly, bank lobbyists have successfully gutted many of its provisions, and much of it remains in flux. Miller approvingly highlights the Volcker rule as a key financial reform, but the final rule has been delayed nearly a year and has yet to be adopted. The proposed rule to tax systemically important institutions, for example, would cost as little as $28 million, about .2 percent of annual earnings. Other provisions like resolution authority could prove unworkable in an interconnected, global financial system and amid the pressure of catastrophic collapse. Stanford economics professor Anat Admati, author of the book The Banker's New Clothes does not believe Dodd-Frank will hold up in a crisis, comparing it to “preparing for a disaster like an earthquake by putting an ambulance at the corner.”
Since Brown-Vitter relies so heavily on imposing new capital requirements, Miller’s alignment with the industry on capital is the most telling section of her speech. Miller says that recently imposed capital rules—negotiated under an international process in Basel, Switzerland—are sufficient for banks to cover their own losses. But while the Basel rules as much as tripled capital requirements, as the Financial Times’s Martin Wolf quipped, when the standards were released in 2010, “tripling almost nothing does not give one very much.” Critics also argue that current capital rules afford banks far too many opportunities to use creative accounting to game the system. The rules allow banks to calculate their capital needs using “risk-weighted” assets, counting each type of asset differently based on its assumed level of risk. Banks use risk-weighting to sharply reduce the amount of capital they have to hold—by as much as 50 percent, according to some calculations. In the event of a systemic collapse where all assets fail, regardless of the accounting games, banks would not have the funds necessary to stay solvent. Indeed, during the 2008 financial crisis, investment banks like Lehman Brothers were allowed by the Securities and Exchange Commission to risk-weight assets, and nearly all of them failed. Meanwhile, Sheila Bair at the FDIC rejected risk-weighting, and the commercial banks her agency insured fared better. Brown-Vitter would ban risk-weighting in their capital standards, but Miller simply counsels to stay the course.
Treasury’s rejection of Brown-Vitter has serious implications. On Monday, Senate Banking Committee chairman Tim Johnson reacted to Brown-Vitter by saying that regulators should finish implementing Dodd-Frank before Congress moves to enact additional reforms. Johnson didn’t cite Miller’s speech, but he didn’t have to: Democratic leaders in Congress will naturally resist turning against the wishes of their president and his economic team. And many rank-and-file lawmakers will cede to the perceived expertise of the Treasury Department. This gives Treasury outsized control of the financial-reform debate, which they’ve used to weaken and soften reforms at virtually every step of the Dodd-Frank process and beyond. In fact, Treasury officials credit themselves with stopping Sherrod Brown’s 2010 proposal to cap bank size. An anonymous senior official said at the time, “If we’d been for it, it probably would have happened. But we weren’t, so it didn’t.”
This all means that Brown-Vitter is likely to sit on a shelf unless and until Wall Street generates another crisis. With Sherrod Brown in line to potentially take over the Senate Banking Committee in 2014, reformers may benefit from the wait. But it will be a wait.
Financial-reform advocates see Brown-Vitter as a major opportunity for President Obama to “get on the right side of history” and address the continued riskiness and complexity of modern finance. But Treasury’s primary concern appears to be limiting any constraints on the record profits of those mega-banks, rather than protecting the public from threats to the rest of the economy. As Barofsky concluded, “Treasury has defended the status of the Too Big to Fail banks every step of the way, why would they stop now?”Associated Program: -
In the Media | April 2013
For video excerpts from Minneapolis Fed President Narayana Kocherlakota’s speech "Low Real Interest Rates," presented at the Levy Institute’s 22nd Annual Minsky Conference in New York on April 18, click here. Includes audience and press Q&A.
Associated Program: -
In the Media | April 2013
By Caroline Baum
Bloomberg View, April 22, 2013. All Rights Reserved.
It's not every day that a central banker admits that his medicine for curing the last crisis may be laying the groundwork for the next. But that's exactly what Narayana Kocherlakota, President of the Federal Reserve Bank of Minneapolis, said last week at the annual Hyman P. Minsky Conference at the Levy Economics Institute of Bard College.
Kocherlakota said low real interest rates are necessary to achieve the Fed's dual mandate of maximum employment and stable prices. He also said that low real rates lead to inflated asset prices, volatile returns and increased merger activity, all of which are signs of financial market instability. Listen to what he calls his "key conclusion"—and what I'd call a true conundrum:
"I've suggested that it is likely that, for a number of years to come, the FOMC will only achieve its dual mandate of maximum employment and price stability if it keeps real interest rates unusually low. I’ve also argued that when real interest rates are low, we are likely to see financial market outcomes that signify instability. It follows that, for a considerable period of time, the FOMC may only be to achieve its macroeconomic objectives in association with signs of instability in financial markets."
Just think about that for a minute: What the Fed needs to do in order to achieve its macroeconomic objectives will create instability in financial markets. There's more:
"On the one hand, raising the real interest rate will definitely lead to lower employment and prices. On the other hand, raising the real interest rate may reduce the risk of a financial crisis —- a crisis which could give rise to a much larger fall in employment and prices. Thus, the Committee has to weigh the certainty of a costly deviation from its dual mandate objectives against the benefit of reducing the probability of an even larger deviation from those objectives."
Damned if we do, damned if we don't. Other Fed officials have warned about froth in asset markets, but none to my knowledge has been as forthright in describing the Fed's life-saving medicine as systemic poison.
Like his colleagues, Kocherlakota believes effective supervision and regulation of the financial sector are the best ways to address threats to macroeconomic stability. Yeah, and the tooth fairy leaves money under your pillow if you're good.
For central bankers to believe regulation is the answer, they have to ignore history and disregard the tendency for regulators to be co-opted by those they are assigned to regulate, a phenomenon known as "regulatory capture."
The Minsky Conference was the ideal place for Kocherlakota to deliver his remarks. Minsky observed that, during periods of prosperity and financial stability (the Great Moderation), investors are lulled into taking on more risk with borrowed money.
At some point, investors are forced to sell assets to repay loans, sending asset prices into a downward spiral as cash becomes king. This is what's known as a "Minsky moment."
Kocherlakota seems to be saying such an outcome is inevitable. If only he could tell us when.Associated Program: -
In the Media | April 2013
By David Graeber
The Guardian, April 21, 2013. All Rights Reserved.
If Reinhart and Rogoff's 'error' has discredited the prevailing policy dogma, now is the time for an alternative that works
The intellectual justification for austerity lies in ruins. It turns out that Harvard economists Carmen Reinhart and Ken Rogoff, who originally framed the argument that too high a "debt-to-GDP ratio" will always, necessarily, lead to economic contraction – and who had aggressively promoted it during Rogoff's tenure as chief economist for the IMF – had based their entire argument on a spreadsheet error. The premise behind the cuts turns out to be faulty. There is now no definite proof that high levels of debt necessarily lead to recession.
Will we, then, see a reversal of policy? A sea of mea culpas from politicians who have spent the last few years telling disabled pensioners to give up their bus passes and poor students to forgo college, all on the basis of a mistake? It seems unlikely. After all, as I and many others have long argued, austerity was never really an economic policy: ultimately, it was always about morality. We are talking about a politics of crime and punishment, sin and atonement.
True, it's never been particularly clear exactly what the original sin was: some combination, perhaps, of tax avoidance, laziness, benefit fraud and the election of irresponsible leaders. But in a larger sense, the message was that we were guilty of having dreamed of social security, humane working conditions, pensions, social and economic democracy.
The morality of debt has proved spectacularly good politics. It appears to work just as well whatever form it takes: fiscal sadism (Dutch and German voters really do believe that Greek, Spanish and Irish citizens are all, collectively, as they put it, "debt sinners", and vow support for politicians willing to punish them) or fiscal masochism (middle-class Britons really will dutifully vote for candidates who tell them that government has been on a binge, that they must tighten their belts, it'll be hard, but it's something we can all do for the sake of our grandchildren). Politicians locate economic theories that provide flashy equations to justify the politics; their authors, like Rogoff, are celebrated as oracles; no one bothers to check if the numbers actually add up.
If ever proof was required that the theory is selected to suit the politics, one need only consider the reaction politicians have to economists who dare suggest this moralistic framework is unnecessary; or that there might be solutions that don't involve widespread human suffering.
Even before we knew Reinhart and Rogoff's study was simply wrong, many had pointed out their historical survey made no distinction between the effects of debt on countries such as the US or Japan – which issue their own currency and therefore have their debt denominated in that currency – and countries such as Ireland, Greece, that do not. But the real solution to the eurobond crisis, some have argued, lies in precisely this distinction.
Why is Japan not in the same situation as Spain or Italy? It has one of the highest public debt-to-GDP ratios in the world (twice that of Ireland), and is regularly featured in magazines like the Economist as a prima facie example of an economic basket case, or at least, how not to manage a modern industrial economy. Yet they have no problem raising money. In fact the rate on their 10-year bonds is under 1%. Why? Because there's no danger of default. Everyone knows that in the event of an emergency, the Japanese government could simply print the money. And Japanese money, in turn, will always be good because there is a constant demand for it by anyone who has to pay Japanese taxes.
This is precisely what Ireland, or Spain, or any of the other troubled southern eurozone countries, cannot do. Since only the German-dominated European Central Bank can print euros, investors in Irish bonds fear default, and the interest rates are bid up accordingly. Hence the vicious cycle of austerity. As a larger percentage of government spending has to be redirected to paying rising interest rates, budgets are slashed, workers fired, the economy shrinks, and so does the tax base, further reducing government revenues and further increasing the danger of default. Finally, political representatives of the creditors are forced to offer "rescue packages", announcing that, if the offending country is willing to sufficiently chastise its sick and elderly, and shatter the dreams and aspirations of a sufficient percentage of its youth, they will take measures to ensure the bonds will not default.
Warren Mosler and Philip Pilkington are two economists who dare to think beyond the shackles of Rogoff-style austerity economics. They belong to the modern money theory school, which starts by looking at how money actually works, rather than at how it should work. On this basis, they have made a powerful case that if we just get back to that basic problem of money-creation, we may well discover that none of this is ever necessary to begin with. In conjunction with the Levy Institute at Bard College, they propose an ingenious, yet elegant solution to the eurobond crisis. Why not simply add a bit of legal language to, say, Irish bonds, declaring that, in the event of default, those bonds could themselves be used to pay Irish taxes? Investors would be reassured the bonds would remain "money good" even in the worst of crises – since even if they weren't doing business in Ireland, and didn't have to pay Irish taxes, it would be easy enough to sell them at a slight discount to someone who does. Once potential investors understood the new arrangement, interest rates would fall back from 4-5% to a manageable 1-2%, and the cycle of austerity would be broken.
Why has this plan not been adopted? When it was proposed in the Irish parliament in May 2012, finance minster Michael Noonan rejected the plan on completely arbitrary grounds (he claimed it would mean treating some bond-holders differently than others, and ignored those who quickly pointed out existing bonds could easily be given the same legal status, or else, swapped for tax-backed bonds). No one is quite sure what the real reason was, other than perhaps an instinctual bureaucratic fear of the unknown.
It's not even clear that anyone would even be hurt by such a plan. Investors would be happy. Citizens would see quick relief from cuts. There'd be no need for further bailouts. It might not work as well in countries such as Greece, where tax collection is, let us say, less reliable, and it might not entirely eliminate the crisis. But it would almost certainly have major salutary effects. If the politicians refuse to consider it – as they so far have done – it's hard to see any reason other than sheer incredulity at the thought that the great moral drama of modern times might in fact be nothing more than the product of bad theory and faulty data series.Associated Program: -
In the Media | April 2013
By Robert Lenzner
Forbes, April 20, 2013. All Rights Reserved.
The President of the Federal Reserve Bank of Boston, Erick Rosengren, suggested this week that there could still be runs on money market mutual funds, as took place at the peak of the 2008 financial crisis, since these funds have “no capital” and invest in uninsured short term securities of banks and other financial service firms. While debate over potential regulatory solutions for money market funds continues on, the Boston Fed chief, emphasized that the safety of the money market mutual funds are a “significant unresolved issue.”
As of April 13 there was $903.56 billion in retail money market funds sponsored by Fidelity, T. Rowe Price, Dreyfus, Invesco and others, The total amount of all kinds of money market funds, some owned by institutional investors, was $2.6 trillion. The average weekly yield was a record low of only 0.02%.
He also singled out the issue of capital for the broker-dealer fraternity, where he raised the problem of “virtually no change for broker-dealers since the collapse of Lehman Brothers in September, 2008 and the shotgun marriage of Merrill Lynch into BankAmerica. The solution Rosengren recommended was that the “larger(these investment firms) get the higher the capital ratio”: should be imposed on them. The Boston Fed chief executive, speaking at Bard College’s Levy Institute conference on the economy and financial markets, seemed to be suggesting that the cause for this vacuum in policy is that “Regulatory bodies haven’t evolved as much as the financial markets.” In other words, 5 years after the 2008 meltdown we still have a major challenge in trying to make the global financial system secure against runs and speculative bubbles. There is still further to go in the structural reorganization of the danger from derivatives, but he believes clearing derivatives contracts on exchanges and the decline in bilateral transactions has reduced an element of risk.
Nevertheless, Rosengren made crystal clear in conversation after his talk that he “sees no bubbles anywhere, not even in real estate where prices are still below their 2006 peak.” He believes prices of residential real estate in Boston and New York are still 15-20% under their peak—and prices in Miami, Phoenix, Las Vegas, California– are still priced at a steeper discount to the peak in 2006.
As for the economy in general, Rosengren sees “traction” picking up momentum, in which case he would support the “prudent” position of gradually reducing the QE stimulus program. However, he is troubled by the fact that monetary policy(quantitative easing and record low interest rates) are in conflict with fiscal policy, the restraint of sequester and reduction of federal, state and local government spending, ie “the Obama cuts.”
Associated Program(s):Region(s):United States -
In the Media | April 2013
By Robert Lenzner
Forbes, April 19, 2013. All Rights Reserved.
The growing disparity in wealth made the great recession worse and the recovery weaker than ever before. This nation’s wealth disparity widened more than ever before over the last five years because of the steep decline in the value of residential homes and stagnant wages for the lower and middle income groups in the U.S., explained a member of the Federal Reserve Board, Sarah Bloom Raskin, in a speech that explored for the first time a fresh explanation about the obstacles holding back economic growth.
This “financial vulnerability and marginal ability” to recover from the decline in the wealth of lower income and middle income Americans is “undermining our country’s strength,” Governor Raskin emphasized in New York yesterday at an economic conference sponsored by the Levy Institute at Bard College and the Ford Foundation. Raskin admitted to a feeling of frustration at the central bank about the inability of the Fed’s low interest rate policy together with the expansion in the money supply to alleviate this growing disparity between the wealthy and the rest of American families. She admitted there was current exploration at the Board level of the central bank that “our macro models should be adjusted,” because four years into the recovery a confluence of factors have contributed to a weak recovery.
“Inequality contributed to the severity of the recession,” Raskin said flatly, and blamed this inequality- for the “differential expectations” in the future between well-off families– with those families not so well off, who were battered by a plunge in the value of their homes, a high level of debt and a continuance of lower wages. I had never heard that theme so sharply expressed as the blame for the mediocre rate of growth we are experiencing.
Here are the Fed’s latest breakdown on the disparity in wealth. The top 20% of the population own 72% of the nation’s wealth in large part due to their vast holdings in the common shares of publicly held companies. By comparison, the poorest 20% of the U.S. population only own 3% of the wealth, and so were unable to shelter themselves when their homes declined in value, often below the face value of their mortgage and their take-home pay was not growing– or they lost their jobs.
The distribution of wealth inequality is far worse than the disparity in incomes. Nonetheless, the Fed Governor suggested it does explain the lower levels of consumer spending. As to income disparity between 1979 and 2007, the Federal Reserve figures shows the highest income cohort doubled their annual compensation when adjusted for inflation. The top 1% of earners in the nation saw their share of the national income rise from 10% to 20%. Meanwhile the bottom 40% of the nation’s workers saw their share of the national income decline slightly from 13% to 10%.
The middle class average income rose in those 30 years to 2007 by only 20% or less than 1% a year, underscoring just how much middle income Americans have fallen behind their wealthier brethren. Fed Governor Raskin called this performance “sluggishness.”
One hopeful sign is the gradual increase in prices for residential homes throughout the United States. This trend has restored some semblance of household wealth for homeowners from low income and middle income sectors of the population. Another 10% increase in home values, Gov. Raskin suggested, would allow many more low income families to stay in their homes.
More worrisome, however, is the trend for more and more jobs to be only part-time with less pay and less benefits. “We have lost 9 million jobs,” she said and the growing trend for new jobs to be part-time employment or involving contingent work is “no way to upward mobility” in America.Associated Program(s):Region(s):United States -
In the Media | April 2013
By Greg Robb
MarketWatch, April 19, 2013. All Rights Reserved.
WASHINGTON (MarketWatch) – No financial institution, regardless of its size, will be bailed out by taxpayers again, Treasury Undersecretary for Domestic Finance Mary Miller said Thursday. As a result of the Dodd-Frank bank regulatory reform, "shareholders of failed companies will be wiped out; creditors will absorb losses; culpable management will not be retained and may have their compensation clawed back; and any remaining costs associated with liquidating the company must be recovered from disposition of the company's assets and, if necessary, from assessments on the financial sector, not taxpayers," Miller said in a speech at the Levy Economics Institute of Bard College. Miller also said evidence was mixed on whether large financial institutions continue to benefit from lower borrowing costs. The Treasury will continue to work to reduce the risks posed by large financial companies and to put in place measures to wind the companies down if the need arises, Miller said.
Associated Program: -
In the Media | April 2013
By Annalyn Kurtz
CNNMoney, April 19, 2013. All Rights Reserved.
Prices aren't going up very much. Should we celebrate?
Not really. Inflation that's too low could be a bad sign for the U.S. economy, and some Federal Reserve officials are starting to get concerned.
Speaking to reporters on Wednesday, St. Louis Fed President James Bullard pointed to the Fed's preferred measure of inflation—personal consumption expenditures, minus food and energy—which recently has shown that prices are up 1.3% over a year ago.
"That's pretty low," Bullard said at a Levy Economics Institute event. "I'm getting concerned about that, and I think that gives the FOMC some room to maneuver on its monetary policy."
The Fed typically aims to keep inflation around 2% a year. Inflation at that level is considered healthy, coinciding with solid economic growth, a growing job market and gradually rising wages.
"Economic history has shown that economies perform best with slightly higher levels of inflation, such as 2% to 3%," said Bernard Baumohl, chief global economist for the Economic Outlook Group. "Low and dormant inflation translates into a dormant economy."
Why is low inflation bad? There are a few key reasons.
First, when companies don't have any leeway to raise prices, they're more apt to cut costs, which could mean a cutback in hiring. Second, if inflation remains so low, consumers are not as motivated to rush out and spend, Baumohl said.
Third, when inflation is low, it doesn't offer a large buffer against deflation if an economic shock occurs. Deflation—when prices fall—often freezes up spending, because who wants to go out and buy an item now, if they expect it to be cheaper in six months?
Related: The Geeky Debt Fix that Might Work
And fourth, low inflation often comes along with lower wage and revenue growth.
Even with the recent low inflation data, Bullard's comments Wednesday came as a bit of a surprise to Fed watchers. For one, most Fed criticism lately has focused on how the central bank's unprecedented push to stimulate the U.S. economy could eventually lead to rapid inflation or asset bubbles. Fed policies are already cited as a key reason why stocks have recently hovered near five-year highs.
Second, Bullard is known for leaning slightly hawkish. Just minutes before he met with reporters Wednesday, he gave a speech arguing that the Fed's stimulative policies probably won't solve the job market's problems.
"I found Bullard's comments yesterday the most interesting in some time," said Ellen Zentner, senior economist for Nomura. "It suggests that other hawks could follow suit if lower inflation persists."
The Fed has kept its key short-term interest rate near zero since 2008. When that wasn't enough to boost the U.S. economy, it launched several bond-buying sprees, known as quantitative easing, in an attempt to lower long-term interest rates.
The Fed is now running its third such round of asset purchases, buying $85 billion in Treasuries and mortgage-backed securities each month.
The program remains highly controversial, and most of the conversation lately has been speculation about when the Fed will start tapering off, and eventually ending, those bond buys.
But on Wednesday, Bullard went so far as to say that if the inflation rate falls further, the Fed may have to think about increasing its monthly asset purchases, rather than winding them down anytime soon.
His colleague, Minneapolis Fed President Narayana Kocherlakota, backed that sentiment Thursday.
Kocherlakota is considered a Fed dove and has long favored stimulus, but if inflation was to fall even further, he said "that would make me in favor of even more accommodation," he told reporters.
Bullard is a voting member on the Fed's policymaking committee this year, but Kocherlakota is not. Even so, if low inflation persists, expect to hear more Fed officials discuss the issue in the months ahead.Associated Program: -
In the Media | April 2013
By Brai Odion-Esene
MNI | Deutsche Börse Group, April 18, 2013. All Rights Reserved.
NEW YORK (MNI) – Federal Reserve Board Governor Sarah Bloom Raskin Wednesday underlined her support for ongoing aggressive push by the Fed to support economic growth, saying that it will help the recovery gain a more secure foothold, with the measures potentially becoming "increasingly potent" as the housing market rebound continues.
Why? Because the 2008–2009 recession had a disproportionate impact on low- and middle-income American families, the majority of whom have their wealth tied to housing - particularly home prices—she said in remarks prepared for delivery at the Hyman Minsky conference hosted by the Levy Institute.
Many have argued the Fed of pursuing policies that favor a few over the many, but Raskin believes that "accommodative monetary policy that lifts economic activity more generally is expected to increase the odds of good outcomes for American families."
Low- to middle-income families bore the brunt of the recession, and many are still struggling to reduce their debt burdens, she noted, while also seeing the values of their homes plummet.
"Arguably, the FOMC's conduct of monetary policy in recent years has in part been designed to address this particular landscape," she said.
"I believe that the accommodative policies of the FOMC and the concerted effort we have made to ease conditions in the mortgage markets will help the economy continue to gain traction," Raskin added. "And the resulting expansion in employment will likely improve income levels at the bottom of the distribution."
The Fed has kept interest rates at exceptionally low levels since late 2008, but Raskin noted that borrowers that have been through foreclosure or have underwater mortgages are less able to take advantage of the lower interest rates, either for home buying or other purposes, reducing the intended impact of the Fed's policies.
However, "as the housing market recovers, though, I think it is possible that accommodative monetary policy could be increasingly potent," she said.
Raskin spent significant time discussing the growing wealth inequality gap in America, and its implications for the macroeconomy.
She argued that rising inequality and stagnating wages have contributed to the "tepid" recovery, noting that in wage gains in particular "have remained more muted than is typical during a recovery."
Going forward, "it is very likely that, for many households, future labor earnings will be well below what they had anticipated in the years before the recession," Raskin predicted.
Raskin also defended the Fed's focus on boosting the housing market and spurring faster job creation, noting that the house price shock and less than rosy employment prospects have households curtailing their spending in order to rebuild their nest eggs, while also trimming their budgets "in order to bring their debt levels into alignment with their new economic realities."
"In this case, the effects of the plunge in net wealth and the jump in unemployment on subsequent spending have been long lasting and lingering," she said.
Raskin also noted that the recovery has also been hampered by a continuation of longer-term trends that have reduced employment prospects for those at the lower end of the income distribution and produced weak wage growth - such as technological advances and globalization.
"Given the long-standing trends toward greater income and wealth inequalities, it is unlikely that cyclical improvements in the labor markets will do much to reverse these trends," she said.Associated Program: -
In the Media | April 2013
By Jonathan Spicer and Leah Schnurr
Reuters, April 18, 2013. All Rights Reserved.
(Reuters) – Easy money policies are bringing some relief to lower-income Americans hard-hit in the recession and the easing could become increasingly potent as the housing market recovers, a top U.S. Federal Reserve official said on Thursday.
In a speech on equality and the U.S. economy, Fed Governor Sarah Raskin backed the policy accommodation and argued it would continue to help the overall economic recovery. But the long-running trend of inequality and stagnating wages in the United States has slowed that rebound, she said.
"The accommodative policies ... and the concerted effort we have made to ease conditions in the mortgage markets will help the economy continue to gain traction. And the resulting expansion in employment will likely improve income levels at the bottom of the distribution," Raskin said in prepared remarks to the Hyman P. Minsky conference.
"However, given the longstanding trends toward greater income and wealth inequalities, it is unlikely that cyclical improvements in the labor markets will do much to reverse these trends," she said.
Raskin has consistently supported the central bank's policy of low interest rates and large-scale bond-buying, both of which are meant to spur investment, hiring and broader economic growth in the wake of the 2007–2009 recession.
Gross Domestic Product growth was very tepid at the end of last year, but is expected to have rebounded strongly to 3-percent or more in the first quarter of this year. Still, recent economic signals have been weaker and the Fed is concerned that could hamper growth.
Raskin's speech amounted to a in depth look into what effects growing economic inequality, which has been on the rise for decades in the United States, has on the current recovery and on Fed policy.
"As the housing market recovers, I think it is possible that accommodative monetary policy could be increasingly potent," she said.
Still, the recession's plunge in net wealth and jump in unemployment will have "long lasting and lingering" effects on spending.
"Although it is too early to state with certainty what the long-term effect of this recession will be on the earnings potential of those who lost their jobs, given the severity of the job loss and sluggishness of the recovery ... it is very likely that, for many households, future labor earnings will be well below what they had anticipated in the years before the recession," said Raskin, who has a permanent vote on Fed policy.
She noted that the country remains almost 2.5 million jobs short of pre-recession levels.
The U.S. unemployment rate was 7.6 percent last month, down from 10 percent in 2009, but short of the 5-6 percent range to which Americans are accustomed.Associated Program: -
In the Media | April 2013
By Greg Robb
MarketWatch, April 18, 2013. All Rights Reserved.
If economists focused more research on the experiences of less-advantaged households, they might gain new insight on the current struggles of the U.S. economy, said Federal Reserve Governor Sarah Bloom Raskin on Thursday.
“It strikes me that macroeconomists are far from a comprehensive understanding of how wealth and income inequality may affect business cycle dynamics,” Raskin said in a speech on the economy sponsored the Levy Economics Institute of Bard College.
For the sake of simplicity, the typical economic model focuses on “representative” households that focus on average gauges of wealth.
While this might work in certain circumstances, it creates blind spots in research in the wake of the financial crisis, Raskin said.
With real-wage growth stagnant, in the early years of the 2000s, many households had pinned their hopes on advancement on higher home prices, Raskin said. As a result, they were most vulnerable to the rapid decline in house prices and the contraction of credit that followed.
“I am persuaded that because of how hard these lower- and middle-income households were hit, the recession was worse and the recovery has been weaker,” Raskin said.
“The recovery has also been hampered by a continuation of longer-term trends that have reduced employment prospects for those at the lower end of the income distribution and produced weak wage growth,” she noted.
At the moment, it is not part of the Fed’s mandate to address inequality. The distribution of wealth and income has not been a primary consideration in the way most macroeconomists think about business cycles. But if it’s effects are hurting the economy, perhaps our thinking should be adjusted, Raskin said.Associated Program: -
In the Media | April 2013
By Michael S. Derby
The Wall Street Journal, April 18, 2013. All Rights Reserved.
Federal Reserve stimulus aimed at spurring growth will likely grow more powerful as the housing market recovers further, but the trends that have fueled income inequality aren’t likely to change much, a U.S. central bank official said Thursday.
“The accommodative policies of the [Federal Open Market Committee] and the concerted effort we have made to ease conditions in the mortgage markets will help the economy continue to gain traction,” Fed governor Sarah Bloom Raskin said.
“As house prices rise, more and more households have enough home equity to gain renewed access to mortgage credit and the ability to refinance their homes at lower rates,” she said.
“I think it is possible that accommodative monetary policy could be increasingly potent” as the housing market picks up, Ms. Raskin said.
The official said Fed staffers estimate house price increases of 10% or less from current levels would be enough to help around 40% of homeowners who owe more on their homes that the properties are worth to get back into the black. If more households regain a positive equity position, it will help unclog some of the traditional channels monetary policy operates in, which will over time make the stimulus better able to lift growth, Ms. Raskin said.
The central banker is a voting member of the monetary policy setting FOMC. Her comments came from the text of a speech prepared for delivery before a gathering held by the Levy Economics Institute of Bard College in New York. The bulk of Ms. Raskin’s speech was devoted to trying to understand how wealth and income inequality played a role in creating the financial crisis, and how it might be affecting a recovery that has thus far been weak despite four years of mostly positive momentum.
The official allowed that the issue isn’t well understood by mainstream economists. But she said the evidence suggests inequality very likely did play a significant part in the downturn. Ms. Raskin pointed to a long standing and widening gulf between top earners and the rest of the nation. Those who saw incomes stagnate relied more on debt and homeownership to cover the lack of rising wages, and when housing prices began to fall, these households were exposed and without sufficient resources to withstand the storm.
As housing prices turned south, “not only did [these households] receive an unwelcome shock to their net current wealth, but they also undoubtedly have come to realize that house prices will not rise indefinitely and that their labor income prospects are less rosy than they had believed,” Ms. Raskin said.
“As a result, they are curtailing their spending in an effort to rebuild their nest eggs and may also be trimming their budgets in order to bring their debt levels into alignment with their new economic realities,” the official said. Add the unemployed to that mix, and it isn’t much of a surprise the economy has struggled to recover, the official said.
Ms. Raskin also said that even as monetary policy is likely to work better when housing picks up further, it is unlikely it will be able to do much right now for wealth and income inequalities. She said “it is unlikely that cyclical improvements in the labor markets will do much to reverse these trends.”Associated Program: -
In the Media | April 2013CentralBanking.com, April 18, 2013. All Rights Reserved.
The president of the Federal Reserve Bank of Minneapolis, Narayana Kocherlakota, said today that the Federal Open Market Committee (FOMC) will have to live with a "considerable period" of financial instability as the price of meeting the targets of its dual unemployment-price stability mandate.
Speaking at the 22nd Annual Hyman P Minsky Conference, held at the Levy Economics Institute of Bard College, New York, Kocherlakota said the "unusually low" interest rates that he advocates are likely to cause "inflated asset prices, high asset return volatility and heightened merger activity" - all of which "are often interpreted as signifying financial market instability".
However, Kocherlakota - who does not sit on the FOMC in 2013 - said that low interest rates in the US are as necessary a response to poor economic indicators as is putting on a coat when the weather is cold.
He said: "...when I decide what coat to wear, my goal is to keep myself at a temperature that I view as appropriate, given prevailing conditions that I cannot influence. Similarly, when the FOMC decides on a level of the real interest rate, its goal is to keep the macroeconomy at an appropriate ‘temperature', given prevailing conditions that it cannot influence."
Given unemployment is currently significantly above target levels, and inflation is running below the target of 2% per annum, Kocherlakota said the FOMC "needs to put on some more serious 'winter gear' if it is to get the economy back to the right temperature".
"It seems likely", he said, "that the mandate-consistent time path of real interest rates could be unusually low for a considerable period of time".
Volatile prices and more mergers likely
Kocherlakota then discussed three likely financial market outcomes of a sustained low interest rate environment: inflated asset prices, unusually volatile asset returns and high merger activity.
He said mergers will become more common because they "typically involve enduring current costs in exchange for a flow of future benefits". When credit is relatively cheap, businesses "will be more willing to pay the upfront costs of a merger in exchange for the anticipated flow of future benefits".
Asset prices will experience more volatility, he said: "When the real interest rate is very high, only the near term matters to investors. Hence, variations in an asset's price only reflect changes in investors' information about the asset's near-term dividends or risk premiums.
"But when the real interest rate is unusually low, then an asset's price will become correspondingly sensitive to information about dividends or risk premiums in what might seem like the distant future."
Cost-benefit calculation
Kocherlakota said the FOMC has to confront "an ongoing probabilistic cost-benefit calculation" as "raising the real interest rate will definitely lead to lower employment and prices" while "raising the real interest rate may reduce the risk of a financial crisis-a crisis which could give rise to a much larger fall in employment and prices".
Thus, he said, "the committee has to weigh the certainty of a costly deviation from its dual mandate objectives against the benefit of reducing the probability of an even larger deviation from those objectives."Associated Program: -
In the Media | April 2013The Kansas City Star, April 18, 2013. All Rights Reserved.
Federal Reserve Bank of Minneapolis President Narayana Kocherlakota said the central bank’s low interest rate policies, though necessary, will probably generate signs of financial instability.
“Unusually low real interest rates should be expected to be linked with inflated asset prices, high asset return volatility and heightened merger activity,” Kocherlakota said Thursday in the prepared text of a speech in New York. “All of these financial market outcomes are often interpreted as signifying financial market instability.”
Fed Governor Jeremy Stein and Kansas City Fed President Esther George are among those who have voiced concerns that an extended period of low interest rates is heightening the risk of asset bubbles in markets such as junk bonds and farmland.
While George has dissented from this year’s Federal Open Market Committee decisions because of this risk, Kocherlakota is among the strongest supporters of additional monetary stimulus on the committee.
In speeches earlier this month Kocherlakota said he sees an “ongoing modest recovery” with unemployment staying at 7 percent or more through late 2014. The slow recovery calls for “more accommodation,” he said in a speech, repeating his call to postpone consideration of any increase in interest rates. He doesn’t vote on policy this year.
“It is likely that, for a number of years to come, the FOMC will only achieve its dual mandate of maximum employment and price stability if it keeps real interest rates unusually low,” Kocherlakota said at the Levy Economics Institute’s 22nd Annual Hyman P. Minsky Conference.Associated Program: -
In the Media | April 2013MNI | Deutsche Börse Group, April 18, 2013. All Rights Reserved.
NEW YORK (MNI) – The Federal Reserve has lowered interest rates to support an economy battered by the 2008-2009 recession, however the weak macroeconomic outlook suggests the central bank's actions have not been enough, and it has not lowered the real interest rate sufficiently, Minneapolis Federal Reserve Bank Governor Narayana Kocherlakota said Thursday.
In remarks prepared for the Hyman Minsky conference hosted by the Levy Institute, Kocherlakota said the Fed's policy-setting Federal Open Market Committee might have to keep rates at exceptionally low levels for many years to come. Kocherlakota does not hold a voting position on the FOMC this year.
He noted that over the past six years, the demand for safe assets has grown, while the supply of those assets has shrunk. The global supply of assets perceived as safe has also fallen, as the value of American residential land, and assets backed by land, and investors no longer view all forms of European sovereign debt as a safe investment.
"I suggest that these dramatic changes in asset demand and asset supply are likely to persist over a considerable period of time -- possibly the next five to 10 years," Kocherlakota said. "If that forecast holds true, it follows that the FOMC will only be able to meet its congressionally mandated objectives over that time frame by taking policy actions that ensure that the real interest rate remains unusually low."
In addition, using the analogy of deciding what clothes to wear based on weather conditions, Kocherlakota argued that "the truth is that the FOMC's choice of winter garb is actually insufficient to keep the U.S. economy appropriately warm." He pointed to the outlook for both employment and prices, which is too low relative to the FOMC's goals. Unemployment is currently 7.6%, and expected to fall only slowly, while inflation pressures are muted.
"The Committee needs to put on some more serious winter gear if it is to get the economy back to the right temperature," he argued. "More prosaically, the FOMC can only achieve its dual mandate objectives by lowering the real interest rate even further below its 2007 level."
Harking back to his comment on higher demand for safe assets, Kocherlakota said this is being fueled by tighter credit access, heightened perceptions of macroeconomic risk and increased uncertainty about federal fiscal policy. In particular, he said that restrictions on households' and businesses' ability to borrow typically lead them to spend less and save more.
"Thus, the FOMC is confronted with a greater demand for safe assets and tighter supply of safe assets than in 2007. These changes in asset markets mean that, at any given level of real interest rates, households and businesses spend less. Their decline in spending pushes down on both prices and employment. As a result, the FOMC has to lower the real interest rate to achieve its objectives," he said.
Kocherlakota predicted that over the five-to-10-year horizon, credit market access will remain limited relative to what borrowers had available in 2007, businesses will continue to feel a heightened degree of uncertainty about taxes and households will continue to feel a heightened degree of uncertainty about the level of federal government benefits.
"These considerations suggest that, for many years to come, the FOMC will have to maintain low real interest rates to achieve its congressionally mandated goals," he reiterated.
He acknowledged, however, that keeping real interest rates low for a considerable period of time will likely be associated with other "unusual financial market outcomes" - not to mention give rise to "signs of financial market instability."
The "unusual financial market outcomes" are inflated asset prices, unusually volatile asset returns and high merger activity, Kocherlakota said.
These financial market phenomena could pose macroeconomic risks, and he believes that is best addressed using effective supervision and regulation of the financial sector.
"It is possible, though, that these tools may only partly mitigate the relevant macroeconomic risks. The FOMC could respond to any residual risk by tightening monetary policy," he added.
Kocherlakota counseled, however, that the FOMC should only take that action "if the certain loss in terms of the associated fall in employment and prices is outweighed by the possible benefit of reducing the risk of an even larger fall in employment and prices caused by a financial crisis."
Meaning? "The FOMC's decision about how to react to signs of financial instability will necessarily depend on a delicate probabilistic cost-benefit calculation," he said.
The FOMC, Kocherlakota said, has to weigh the certainty of "a costly deviation from its dual mandate objectives" against the benefit of reducing the probability of "an even larger deviation from those objectives."Associated Program: -
In the Media | April 2013
by Jon C. Ogg
24/7 Wall Street, April 18, 2013. All Rights Reserved.
The Federal Reserve may have released its Beige Book on Wednesday showing no real risks to quantitative easing and to the $85 billion per month used for buying bonds. Despite three weak economic readings so far on Thursday, two different speeches from regional presidents of the Federal Reserve are taking different sides of the easy money from quantitative easing and bond buying.
Lacker went on to say that he favors slowing the rate of bond purchases immediately, and he is leaning toward a swift end to the program. He thinks that the continued buying will make a Fed exit that much trickier. One last note is that inflation is tame now, but Lacker is worried that inflation risks will rise once the Federal Reserve and Ben Bernanke get closer to their decision to end quantitative easing.Richmond Fed President Jeffrey Lacker gave an interview to CNBC on Thursday morning saying that the bond-buying efforts have not had much of an impact on the labor market. He thinks that the labor market is struggling due to wider challenges. As a reminder, Lacker was the lone monetary policy hawk throughout 2012, but he is not considered a voting member who gets to cast dissenting public views at each FOMC meeting due to term rotations.
A second speech of caution may be taken out of context from headlines, but Minneapolis Federal Reserve Bank president Narayana Kocherlakota spoke at the Levy Institute in New York this morning. His take was that very low interest rates could persist for close to decade because the economic risks and economic instability will be with us for so long. His take is that the FOMC will have to maintain very low real interest rates to achieve its dual mandate of full employment and low inflation.
Where the Narayana Kocherlakota speech gets interesting is that he thinks this will be met with inflated asset prices, high asset return volatility and even with heightened merger activity. Be advised that Narayana Kocherlakota also is not a voting member of the FOMC, and he is considered dovish as a big supporter of quantitative easing. Kocherlakota even went on to say that he supports lowering the Fed’s unemployment target down to 5.5% rather than 6.5%.
You have to love it when two non-voting Fed presidents offer differing views. Lacker is as hawkish as a member of the Fed can be. Kocherlakota is on the other end of the spectrum.
Associated Program: -
In the Media | April 2013NASDAQ, April 18, 2013. All Rights Reserved.
NEW YORK – Federal Reserve stimulus aimed at spurring growth will likely grow more powerful as the housing market recovers further, but the trends that have fueled income inequality aren't likely to change much, a U.S. central bank official said Thursday.
"The accommodative policies of the [Federal Open Market Committee] and the concerted effort we have made to ease conditions in the mortgage markets will help the economy continue to gain traction," Fed governor Sarah Bloom Raskin said.
"As house prices rise, more and more households have enough home equity to gain renewed access to mortgage credit and the ability to refinance their homes at lower rates," she said.
"I think it is possible that accommodative monetary policy could be increasingly potent" as the housing market picks up, Ms. Raskin said.
The official said Fed staffers estimate house price increases of 10% or less from current levels would be enough to help around 40% of homeowners who owe more on their homes that the properties are worth to get back into the black. If more households regain a positive equity position, it will help unclog some of the traditional channels monetary policy operates in, which will over time make the stimulus better able to lift growth, Ms. Raskin said.
The central banker is a voting member of the monetary policy setting FOMC. Her comments came from the text of a speech prepared for delivery before a gathering held by the Levy Economics Institute of Bard College in New York. The bulk of Ms. Raskin's speech was devoted to trying to understand how wealth and income inequality played a role in creating the financial crisis, and how it might be affecting a recovery that has thus far been weak despite four years of mostly positive momentum.
The official allowed that the issue isn't well understood by mainstream economists. But she said the evidence suggests inequality very likely did play a significant part in the downturn. Ms. Raskin pointed to a long standing and widening gulf between top earners and the rest of the nation. Those who saw incomes stagnate relied more on debt and homeownership to cover the lack of rising wages, and when housing prices began to fall, these households were exposed and without sufficient resources to withstand the storm.
As housing prices turned south, "not only did [these households] receive an unwelcome shock to their net current wealth, but they also undoubtedly have come to realize that house prices will not rise indefinitely and that their labor income prospects are less rosy than they had believed," Ms. Raskin said.
"As a result, they are curtailing their spending in an effort to rebuild their nest eggs and may also be trimming their budgets in order to bring their debt levels into alignment with their new economic realities," the official said. Add the unemployed to that mix, and it isn't much of a surprise the economy has struggled to recover, the official said.
Ms. Raskin also said that even as monetary policy is likely to work better when housing picks up further, it is unlikely it will be able to do much right now for wealth and income inequalities. She said "it is unlikely that cyclical improvements in the labor markets will do much to reverse these trends."Associated Program: -
In the Media | April 2013MNI | Deutsche Börse Group, April 18, 2013. All Rights Reserved.
NEW YORK (MNI) - Treasury Under Secretary Mary Miller Thursday night avoided a specific direct comment on the day's relatively weak $18 billion TIPS 5-year note auction.
But she did tell MNI in an exclusive comment that "over the past week, people have been reassessing their inflation expectations."
She also hailed the cooperation between the Bank of England and the U.S. FDIC on banking regulation.
Miller was answering questions from the audience at the annual Human Minsky Conference where she had delivered a speech saying, as reported earlier, that as much as current commentary ascribes great funding advantages to those banks of a size to be considered "too big to fail," that the perception may be increasingly out of date.
The U.S. TIPS market declined sharply Thursday afternoon after the auction tailed nearly seven basis points although it drew reasonably good indirect bids. The auction size had been increased $2 billion over a similar previous auction. Miller also parried when asked by an audience member if the U.S. regulators such as Treasury should make U.S. banks leave ISDA. "You need to step back and look at the totality of financial regulation," said Miller.
Adapting to the "clarity" of the Dodd-Frank Act about how taxpayers will be spared any future bank bailouts, credit ratings firms that had given the biggest banks a seven-notch uplift beyond their underlying creditworthiness, have now taken back as much as six notches. "One rating agency," she noted "has also recently indicated it may further reduce or eliminate its remaining ratings uplift assumptions by the end of 2013," she said.Associated Program: -
In the Media | April 2013MNI | Deutsche Börse Group, April 18, 2013. All Rights Reserved.
NEW YORK (MNI) - Minneapolis Federal Reserve Bank President Narayana Kocherlakota Thursday called on the central bank to provide even more support to the ongoing economic recovery, arguing concerns about risks to financial stability do not yet supersede the need to spur faster job creation and maintain price stability.
Speaking to reporters on the sidelines of the Hyman Minsky conference in New York, Kocherlakota said , with regard to possible bubbles forming in asset classes, "Right now ... I don't see those kinds of risks out there."
Kocherlakota is not a voter on the policy-setting Federal Open Market Committee this year.
The question to be asked, he said, is do financial stability risks loom large enough to warrant taking monetary policy action to do something about them.
"Is it (monetary policy) effective enough at mitigating that risk to warrant the loss of jobs and the disinflationary pressures? The answer to that is absolutely not at this stage," Kocherlakota said.
"The worry about financial stability is still so tenuous that I would not want to be robbing the immediate stimulus to the economy on that basis," he added.
Kocherlakota said he sees inflation running below target over the next two years, while the unemployment rate remains elevated.
Speaking at the same conference Wednesday, St. Louis Fed President James Bullard has said he would support ramping up the Fed's bond purchases - currently at a pace of $85 billion a month - should inflation continue to decline.
Asked for his thoughts, Kocherlakota said his outlook for inflation has not changed yet although the recent drop "is certainly a cause for concern."
The Fed cannot risk delivering too little inflation relative to what it promises, he said, so it is important to protect the FOMC's 2% inflation target "both from above ... and from below as well."
"I'm in favor of more accommodation," Kocherlakota declared, and so inflation softening "would make me even more in favor of more accommodation."
In his prepared remarks, Kocherlakota had argued that the FOMC needs to put on "some more serious winter gear if it is to get the economy back to the right temperature."
Asked by MNI what would constitute more serious action by the Fed, Kocherlakota again said the FOMC would provide additional stimulus to the economy by lowering its unemployment threshold to 5.5% from 6.5%.
"That would provide even more of a guarantee in terms of how long interest rates were going to remain (exceptionally low), that would push downward further on real interest rates and provide more stimulus to demand," he said.
Kocherlakota was then asked whether "more serious winter gear" also meant upping the scale of the Fed's asset purchases.
"We have to become a lot more clear about what exactly are the metrics associated with that," Kocherlakota said, noting that the FOMC's vow to maintain the aggressive bond purchases until there is a "substantial improvement" in the labor market outlook, is being subjected to different interpretations.
"I think we'd really solve a lot of problems, in terms of the fed funds rate, by being much more explicit about the markers for that (QE3)," Kcoherlakota said.
Kocherlakota added that he feels more confident in the ability of forward guidance to provide the requisite stimulus because the FOMC has been so clear about it.
As to the effectiveness of the Fed's policies, Kocherlakota argued that they are having an impact on the economy, arguing that the Fed's asset purchases have not only pushed down the yields of the securities being bought, but also yields "across the economy."
"So I think that there is evidence that our actions are being effective," he said, before adding, "it would be nice if we did even more."Associated Program: -
In the Media | April 2013
By Michael S. Derby
4-Traders, April 18, 2013. All Rights Reserved.
NEW YORK--A Federal Reserve official said Thursday interest rates are likely to stay very low for years to come, which raises the prospect that chronic financial instability will be an enduring threat.
"For a considerable period of time, the [Federal Open Market Committee] may only be to achieve its macroeconomic objectives in association with signs of instability in financial markets," Federal Reserve Bank of Minneapolis President Narayana Kocherlakota said.
"For many years to come, the FOMC will have to maintain low real interest rates to achieve its congressionally mandated goals," the official said. "Unusually low real interest rates should be expected to be linked with inflated asset prices, high asset return volatility and heightened merger activity," he said.
In an environment where bubbles regularly threaten to form, and other markets see prices move away from fundamentals, the Fed will be confronted with difficult choices. "These potentialities are best addressed through effective supervision and regulation of the financial sector," Mr. Kocherlakota said, although he allowed that it is possible the Fed may also have to employ the blunt tool of monetary policy to cool markets down if risks rise enough.
The official, when asked if he saw any markets devolving into a bubble, responded "the answer is absolutely not at this stage." At the current moment, "I don't see those kind of risks out there."
But he also said that given the importance now placed on financial stability, bank regulators and supervisors face greater challenges as they do their work.
Mr. Kocherlakota's comments came from a speech he gave at a conference held in New York by the Levy Economics Institute of Bard College. He took questions from the audience and spoke with reporters as well. The official is not currently a voting member of the monetary policy setting FOMC.
Mr. Kocherlakota has been one of the biggest supporters of aggressive Fed action to support the economy, and has argued in recent speeches the Fed is not going far enough to aid the economy, and should add more stimulus by saying it wants to achieve a lower unemployment rate before hiking interest rates.
He reiterated that he'd still like to lower the threshold at which the Fed would potentially entertain raising rates, from 6.5% to 5.5%. He said weakening inflation pressures were "definitely a cause for concern" but he hasn't changed his outlook for price pressures. Mr. Kocherlakota said he still expects economic growth of 2.5% this year and 3% next year, and believes that will be enough to help raise inflation over time from its current very low level.
In his speech, the central banker said that the low interest rate world that could persist for "possibly the next five to 10 years" is in part the result of Fed actions over the course of the financial crisis and its aftermath. But the central banker said that other forces are also conspiring to keep rates very low.
The three that are most important beyond Fed policy are tighter credit availability, increased worry about economic risk and uncertainty surrounding the outlook for U.S. government finance, he said.
These factors are causing investors, households and firms to keep their money where it is safest, and it is also causing them to save more. At the same time, those who need better yields will go into riskier assets, creating the risk prices for those markets could go haywire, the official explained.
In as much as Fed policy has helped create the low returns savers are wounded by, so too have market forces, Mr. Kocherlakota said.
"I often hear that the FOMC has created a low interest rate environment that is harmful for savers and others," he said. "That seems about as compelling as blaming me for creating winter in Minnesota by putting on my long johns," Mr. Kocherlakota said.
The official said in his speech he expects unemployment to fall "only slowly," and he said "inflation pressures are muted."Associated Program: -
In the Media | April 2013
By Michael S. Derby
Euroinvestor, April 18, 2013. All Rights Reserved.
NEW YORK – A Federal Reserve official said Thursday interest rates are likely to stay very low for years to come, which raised the prospect that chronic financial instability risks will dog the economy for a long time.
"For a considerable period of time, the [Federal Open Market Committee] may only be to achieve its macroeconomic objectives in association with signs of instability in financial markets," Federal Reserve Bank of Minneapolis President Narayana Kocherlaktoa said.
"For many years to come, the FOMC will have to maintain low real interest rates to achieve its congressionally mandated goals," the official said. "Unusually low real interest rates should be expected to be linked with inflated asset prices, high asset return volatility and heightened merger activity," he said.
In an environment where bubbles regularly threaten to form, and other markets see prices move away from fundamentals, the Fed will be confronted with difficult choices. "These potentialities are best addressed through effective supervision and regulation of the financial sector," Mr. Kocherlakota said, although he allowed that it is possible the Fed may also have to employ the blunt tool of monetary policy to cool markets down if risks rise enough.
Mr. Kocherlakota's comments came from the text of a speech that was to be presented at a conference held in New York by the Levy Economics Institute of Bard College. The official is not currently a voting member of the monetary policy setting FOMC.
Mr. Kocherlakota has been one of the biggest supporters of aggressive Fed action to support the economy, and has argued in recent speeches the Fed is not going far enough to aid the economy, and should add more stimulus by saying it wants to achieve a lower unemployment rate before hiking interest rates.
In his speech, the central banker said that the low interest rate world that could persist for "possibly the next five to 10 years" is in part the result of Fed actions over the course of the financial crisis and its aftermath. But the central banker said that other forces are also conspiring to keep rates very low.
The three that are most important beyond Fed policy are tighter credit availability, increased worry about economic risk and uncertainty surrounding the outlook for U.S. government finance, he said.
These factors are causing investors, households, and firms to keep their money where it is safest, and it is also causing them to save more. At the same time, those who need better yields will go into riskier assets, creating the risk prices for those markets could go haywire, the official explained.
In as much as Fed policy has helped create the low returns savers are wounded by, so too have market forces, Mr. Kocherlakota said.
"I often hear that the FOMC has created a low interest rate environment that is harmful for savers and others," he said. "That seems about as compelling as blaming me for creating winter in Minnesota by putting on my long johns," Mr. Kocherlakota said.
The official said in his speech he expects unemployment to fall "only slowly," and he said "inflation pressures are muted."Associated Program: -
In the Media | April 2013
By Dan Fitzpatrick
The Wall Street Journal, April 18, 2013. All Rights Reserved.
New York Department of Financial Services Superintendent Benjamin Lawski signaled in a speech Thursday that he will not shy away from taking the “lead” among regulators while confronting U.S. financial giants.
Lawsky rankled other regulators last year when he pursued a money laundering case against British bank Standard Chartered that ended with a settlement of $340 million. His agency, which serves as New York’s top banking regulator, was less than a year old at the time.
“A dose of healthy competition among regulators is helpful and necessary to safeguarding the stability of our nation’s financial system,” Lawsky told a crowd in New York gathering for the Hyman P. Minsky Conference on the State of the U.S. and World Economies.
During his talk Lawsky dropped hints about new lines of inquiry for his department. He mentioned a trend of private equity companies buying insurance companies; the use of captive insurance subsidiaries to shift risk and take advantage of looser oversight requirements; and the use of outside consultants to monitor bank abuses.
“The monitors are hired by the banks, they’re embedded physically at the banks, they are paid by the banks and they depend on the banks for future business,” he said.
Lawsky said to expect actions in “the coming weeks and months” on the consultancy issue. “We expect that those actions will help propel reform at both the state and federal levels.”Associated Program: -
In the Media | April 2013Money News, April 18, 2013. All Rights Reserved.
Easy money policies are bringing some relief to lower-income Americans hard-hit in the recession and the easing could become increasingly potent as the housing market recovers, a top U.S. Federal Reserve official said on Thursday.
In a speech on equality and the U.S. economy, Fed Governor Sarah Raskin backed the policy accommodation and argued it would continue to help the overall economic recovery. But the long-running trend of inequality and stagnating wages in the United States has slowed that rebound, she said.
"The accommodative policies ... and the concerted effort we have made to ease conditions in the mortgage markets will help the economy continue to gain traction. And the resulting expansion in employment will likely improve income levels at the bottom of the distribution," Raskin said in prepared remarks to the Hyman P. Minsky conference.
"However, given the longstanding trends toward greater income and wealth inequalities, it is unlikely that cyclical improvements in the labor markets will do much to reverse these trends," she said.
Raskin has consistently supported the central bank's policy of low interest rates and large-scale bond-buying, both of which are meant to spur investment, hiring and broader economic growth in the wake of the 2007-2009 recession.
Gross Domestic Product growth was very tepid at the end of last year, but is expected to have rebounded strongly to 3-percent or more in the first quarter of this year. Still, recent economic signals have been weaker and the Fed is concerned that could hamper growth.
Raskin's speech amounted to an in-depth look into what effects growing economic inequality, which has been on the rise for decades in the United States, has on the current recovery and on Fed policy.
"As the housing market recovers, I think it is possible that accommodative monetary policy could be increasingly potent," she said.
Still, the recession's plunge in net wealth and jump in unemployment will have "long lasting and lingering" effects on spending.
"Although it is too early to state with certainty what the long-term effect of this recession will be on the earnings potential of those who lost their jobs, given the severity of the job loss and sluggishness of the recovery ... it is very likely that, for many households, future labor earnings will be well below what they had anticipated in the years before the recession," said Raskin, who has a permanent vote on Fed policy.
She noted that the country remains almost 2.5 million jobs short of pre-recession levels.
The U.S. unemployment rate was 7.6 percent last month, down from 10 percent in 2009, but short of the 5-6 percent range to which Americans are accustomed.Associated Program: -
In the Media | April 2013
By Jeff Kearns
Bloomberg, April 18, 2013. All Rights Reserved.
Federal Reserve Governor Sarah Bloom Raskin said the Fed should press on with record easing, predicting that current policy will increasingly improve the economic outlook for low-income Americans.
The Fed’s near-zero interest rate policy and asset purchases are growing more effective by supporting the housing market and spurring economic activity, Raskin said today in a speech at a Ford Foundation conference in New York.
“Accommodative monetary policy could be increasingly potent” as the housing market recovers, Raskin said. “As house prices rise, more and more households have enough home equity to gain renewed access to mortgage credit and the ability to refinance their homes at lower rates.”
The Federal Open Market Committee in March agreed to continue buying $85 billion in Treasuries and mortgage bonds per month in an effort to bolster growth and reduce unemployment that was at 7.6 percent last month. Fed officials are debating how to eventually curtail asset purchases that have swollen the central bank’s balance sheet to a record $3.3 trillion.
“The accommodative policies of the FOMC and the concerted effort we have made to ease conditions in the mortgage markets will help the economy continue to gain traction,” Raskin said. “And the resulting expansion in employment will likely improve income levels at the bottom of the distribution.”
Financial Shocks
At the December 2007 start of the 18-month recession, there were an “unusually large” number of low- and middle-income households that were vulnerable to financial shocks after 30 years of “sluggish” wage growth, Raskin said.
“Their exposure to house prices had increased dramatically,” and they were more likely to be affected by lost jobs and reduced savings, Raskin said. That deepened the recession and prolonged the recovery, she said today at the foundation’s 22nd Annual Hyman P. Minsky Conference.
U.S. growth slumped to 0.4 percent in the fourth quarter, the slowest since the first quarter of 2011, amid government budget cuts and military spending that plunged the most since the waning days of the Vietnam War four decades ago.
Economists expect growth to rebound. Gross domestic product probably grew at a 3 percent annualized rate from January through March, according to the median forecast in an April 5-9 Bloomberg survey of 69 economists. That’s up from the 2 percent gain projected by economists last month.
The Standard & Poor’s 500 Index slumped for a second day, dropping 0.7 percent to a six-week low of 1,541.61 as earnings from UnitedHealth Group Inc. to EBay Inc. disappointed investors. The yield on the benchmark 10-year Treasury note decreased 0.01 percentage point to 1.68 percent.
Raskin, 52, was appointed by President Barack Obama in 2010 for a term that expires in 2016. Before joining the Fed she was Maryland’s Commissioner of Financial Regulation, according to the Fed Board website.Associated Program: -
In the Media | April 2013Forbes, April 18, 2013. All Rights Reserved.
Admitting that the Federal Reserve is responsible for creating financial instability, and possibly brewing the next toxic asset bubble, Minneapolis Fed President Narayana Kocherlakota said they have to do more to stimulate the economy, as inflation is too low. Kocherlakota predicted five to ten years of financial instability, as the Fed marches on with unusually low, and currently negative, interest rates, yet suggested the alternative would be “much worse.”
Going much further than Fed Chairman Ben Bernanke. Kocherlakota directly tied high levels of financial instability with the Fed’s policies designed to keep rates “unusually low.” Interestingly, though, he didn’t suggest this was a reason to reverse course, rather, he felt it was an unwanted but tolerable side effect.
Speaking at the Levy Economics Institute’s Minsky conference, Kocherlakota spoke of “incredible demand for safe assets,” which, in conjunction with Fed policy, will conspire to keep real rates very low for possibly five to ten years.
Demand for safety has risen, as tight credit access pushes households and some businesses to increase saving. At the same time, fears of a coming macroeconomic shock diminishes demand for businesses and workers’ products. Add the fiscal situation, where spending and revenues are completely out of whack, and one sees a constant yearning for safety. In part this has helped the dollar remain relatively resilient, while fueling gold’s rise during times of market stress, despite recent weakness.
On the supply side, investors knew where to find it before the crash: in U.S. real state or assets backed by it, in European sovereign debt, and in Treasuries. With the real estate sector obliterated and Europe in shambles, supply of safe assets has fallen dramatically, Kocherlakota explained.
This environment undoubtedly sets the stage for “unusual” events in financial markets. Kocherlakota spoke of Fed policy inflating asset prices, while accelerating volatility; he also mentioned increased merger activity. Indeed, U.S. stock markets have been trading at or near record highs for some time, while stocks in the housing sector, such as KB Home and Lennar, are up near their 52-week highs. Financial stocks like Citigroup, JPMorgan Cahse, and Bank of America are all outperforming the market dramatically over the past six months, while gold, eternally seen as a safe asset, is down hard in the same time period.
The risk of creating another destructive bubble is there, according to Kocherlakota, but he doesn’t see it as imminent. The Fed’s current state of surveillance is vastly superior than it was before the financial crisis, the Minneapolis Fed chief said, giving him comfort that they will be able to anticipate, or at least mitigate, any dangers.
So, the Fed has to do more. Kocherlakota’s two-year inflation projection is well below trend, and fearing deflation, he’s ready to do more. Even after defending quantitative easing, Kocherlakota said he prefers to use forward guidance to affect market perceptions. Specifically, he’d like to lower the unemployment target from 6.5% to 5.5%, signaling that easing will remain in place for longer. QE isn’t as well understood from a metric perspective, he explained.
Asked about diminishing returns, and if Fed policy was at a point where it is increasingly ineffective, while risks continue to mount, Kocherlakota was quick to reject the hypothesis. There’s ample evidence the Fed has been effective, particularly in mortgage markets and in real rates, as seen in TIPS, while raising rates would be destructive, helping a few to the detriment of many, he said.
Kocherlakota echoed comments made by his colleague from St. Louis, James Bullard, who on Wednesday also said inflation was “too low,” arguing for the Fed to do more. While Bullard said forward guidance is ineffective, and asked for a modification in the flow rate of asset purchases (Fed code for more money printing), they both agree the Fed has to do more to stimulate the economy.Associated Program: -
In the Media | April 2013
By Michael S. Derby
Capital.gr, April 18, 2013. All Rights Reserved.
(Adds Kocherlakota's comments on market imbalances, inflation)
NEW YORK--A Federal Reserve official said Thursday interest rates are likely to stay very low for years to come, which raises the prospect that chronic financial instability will be an enduring threat.
"For a considerable period of time, the [Federal Open Market Committee] may only be to achieve its macroeconomic objectives in association with signs of instability in financial markets," Federal Reserve Bank of Minneapolis President Narayana Kocherlakota said.
"For many years to come, the FOMC will have to maintain low real interest rates to achieve its congressionally mandated goals," the official said. "Unusually low real interest rates should be expected to be linked with inflated asset prices, high asset return volatility and heightened merger activity," he said.
In an environment where bubbles regularly threaten to form, and other markets see prices move away from fundamentals, the Fed will be confronted with difficult choices. "These potentialities are best addressed through effective supervision and regulation of the financial sector," Mr. Kocherlakota said, although he allowed that it is possible the Fed may also have to employ the blunt tool of monetary policy to cool markets down if risks rise enough.
The official, when asked if he saw any markets devolving into a bubble, responded "the answer is absolutely not at this stage." At the current moment, "I don't see those kind of risks out there."
But he also said that given the importance now placed on financial stability, bank regulators and supervisors face greater challenges as they do their work.
Mr. Kocherlakota's comments came from a speech he gave at a conference held in New York by the Levy Economics Institute of Bard College. He took questions from the audience and spoke with reporters as well. The official is not currently a voting member of the monetary policy setting FOMC.
Mr. Kocherlakota has been one of the biggest supporters of aggressive Fed action to support the economy, and has argued in recent speeches the Fed is not going far enough to aid the economy, and should add more stimulus by saying it wants to achieve a lower unemployment rate before hiking interest rates.
He reiterated that he'd still like to lower the threshold at which the Fed would potentially entertain raising rates, from 6.5% to 5.5%. He said weakening inflation pressures were "definitely a cause for concern" but he hasn't changed his outlook for price pressures. Mr. Kocherlakota said he still expects economic growth of 2.5% this year and 3% next year, and believes that will be enough to help raise inflation over time from its current very low level.
In his speech, the central banker said that the low interest rate world that could persist for "possibly the next five to 10 years" is in part the result of Fed actions over the course of the financial crisis and its aftermath. But the central banker said that other forces are also conspiring to keep rates very low.
The three that are most important beyond Fed policy are tighter credit availability, increased worry about economic risk and uncertainty surrounding the outlook for U.S. government finance, he said.
These factors are causing investors, households and firms to keep their money where it is safest, and it is also causing them to save more. At the same time, those who need better yields will go into riskier assets, creating the risk prices for those markets could go haywire, the official explained.
In as much as Fed policy has helped create the low returns savers are wounded by, so too have market forces, Mr. Kocherlakota said.
"I often hear that the FOMC has created a low interest rate environment that is harmful for savers and others," he said. "That seems about as compelling as blaming me for creating winter in Minnesota by putting on my long johns," Mr. Kocherlakota said.
The official said in his speech he expects unemployment to fall "only slowly," and he said "inflation pressures are muted."Associated Program: -
In the Media | April 2013Money News, April 18, 2013. All Rights Reserved.
Federal Reserve Bank of Minneapolis President Narayana Kocherlakota said the central bank’s low interest rate policies, though necessary, will probably generate signs of financial instability.
“Unusually low real interest rates should be expected to be linked with inflated asset prices, high asset return volatility and heightened merger activity,” Kocherlakota said in the prepared text of a speech in New York.
“All of these financial market outcomes are often interpreted as signifying financial market instability.”
Fed Governor Jeremy Stein and Kansas City Fed President Esther George are among those who have voiced concerns that an extended period of low interest rates is heightening the risk of asset bubbles in markets such as junk bonds and farmland.
While George has dissented from this year’s Federal Open Market Committee decisions because of this risk, Kocherlakota is among the strongest supporters of additional monetary stimulus on the committee.
In speeches earlier this month Kocherlakota said he sees an “ongoing modest recovery” with unemployment staying at 7 percent or more through late 2014. The slow recovery calls for “more accommodation,” he said in a speech, repeating his call to postpone consideration of any increase in interest rates. He doesn’t vote on policy this year.
“It is likely that, for a number of years to come, the FOMC will only achieve its dual mandate of maximum employment and price stability if it keeps real interest rates unusually low,” Kocherlakota said at the Levy Economics Institute’s 22nd Annual Hyman P. Minsky Conference.
Near Zero
The Minneapolis Fed chief has said the central bank should hold its target interest rate near zero until unemployment falls to 5.5 percent. That’s a full percentage point below the 6.5 percent threshold that has been adopted by the FOMC.
“For a considerable period of time, the FOMC may only be able to achieve its macroeconomic objectives in association with signs of instability in financial markets,” Kocherlakota said. “These financial market phenomena could pose macroeconomic risks. In my view, these potentialities are best addressed using effective supervision and regulation of the financial sector.”Associated Program: -
In the Media | April 2013
By Joshua Zumbrun
Bloomberg, April 18, 2013. All Rights Reserved.
Federal Reserve Bank of Minneapolis President Narayana Kocherlakota said the central bank’s low interest-rate policies, though necessary, will probably generate signs of financial instability.
“Unusually low real interest rates should be expected to be linked with inflated asset prices, high asset return volatility and heightened merger activity,” Kocherlakota said today in the prepared text of a speech in New York. “All of these financial market outcomes are often interpreted as signifying financial market instability.” He told reporters later he doesn’t see financial instability as imminent.
Fed Governor Jeremy Stein and Kansas City Fed President Esther George are among those who have voiced concerns that an extended period of low interest rates is heightening the risk of asset bubbles in markets such as junk bonds and farmland.
While George has dissented from this year’s Federal Open Market Committee decisions because of this risk, Kocherlakota is among the strongest supporters of additional monetary stimulus on the committee.
In speeches earlier this month, Kocherlakota said he sees an “ongoing modest recovery” with unemployment staying at 7 percent or more through late 2014. The slow recovery calls for “more accommodation,” he said in a speech, repeating his call to postpone consideration of any increase in interest rates. He doesn’t vote on policy this year.
Dual Mandate
“It is likely that, for a number of years to come, the FOMC will only achieve its dual mandate of maximum employment and price stability if it keeps real interest rates unusually low,” Kocherlakota said at the Levy Economics Institute’s 22nd Annual Hyman P. Minsky Conference.
The Minneapolis Fed chief has said the central bank should hold its target interest rate near zero until unemployment falls to 5.5 percent. That’s a percentage point below the 6.5 percent threshold that has been adopted by the FOMC.
Answering audience questions, Kocherlakota said the recovery in the housing market is evidence that the Fed’s monthly purchases of $85 billion in Treasuries and mortgage securities are effective.
“They are having an impact on the economy,” he said. “Look at what’s going on in the mortgage market.”
“It would be nice if we did even more along those lines because I think our tools have been effective,” he said. “In the housing market, in particular, you’ve certainly seen direct effects of that kind of stimulus.”
Growth Outlook
Kocherlakota told reporters that the current growth outlook is sufficient to raise inflation, currently measured at 1.3 percent by the Fed’s preferred price gauge, closer to the Fed’s goal of 2 percent.
“It’s very important to protect the target both from above, which gets so much attention, but from below as well,” he said.
“Given the stimulus we’re providing, given the growth I see in the economy, 2.5 percent in 2013, 3 percent in 2014, that kind of growth I see as sufficient to put upward pressure on inflation,” Kocherlakota said.
He said he’s already “in favor of more accommodation” and further declines in the inflation rate would make him “even more” supportive of additional stimulus.
In his speech, Kocherlakota said that “for a considerable period of time,” the FOMC may only be able to “achieve its macroeconomic objectives in association with signs of instability in financial markets. These financial market phenomena could pose macroeconomic risks. In my view, these potentialities are best addressed using effective supervision and regulation of the financial sector.”
“The low interest-rate environment” in coming years “will put even more pressure on the regulatory framework,” Kocherlakota told reporters after his speech.Associated Program: -
In the Media | April 2013
By Elizabeth D. Festa
LifeHealthPro, April 18, 2013. All Rights Reserved.
New York insurance regulators have the captives industry and private equity firms that own annuity companies under a microscope for their effect on financial solvency and stability, and the fear policyholders may be left holding the bag.
The use of captives of insurers places the stability of the broader financial system at greater risk, the New York State Department of Financial Services (DFS) lead supervisor said today in New York.
DFS Superintendent Ben Lawsky even invoked AIG and analogized the use of captives to the same risky practices that precipitated the 2008 financial crisis, issuing subprime mortgage-backed securities (MBS) through structured investment vehicles and writing credit default swaps on higher-risk MBS.
Lawsky also said his state regulators are ramping up their scrutiny of private equity firms that are acquiring insurance companies, particularly fixed and indexed annuity writers. He warned that their failure could put policyholders, retirees and the financial system at risk.
He also suggested that regulators might need to beef up existing regulations to prevent the easy acquisition of annuity-rich insurance companies.
The long term nature of the life insurance business raises similar issues, yet under current regulations it is less burdensome for a private equity firm to acquire an insurer than a bank.
The specific risk DFS is concerned about is whether these private equity firms are more short-term focused when this is a business that’s all about the long haul.
“There can be exceptions, but generally private equity firms follow a model of aggressive risk-taking and high leverage, typically making high-risk investments,” Lawsky said. “Private equity firms typically manage their investments with a much shorter time horizon – for example, three to five years -- than is typically required for prudent insurance company management.”
If they don’t happen to be long-term players in the insurance industry, their short-term focus may result in an incentive to increase investment risk and leverage in order to boost short-term returns.
Private equity-controlled insurers now account for nearly 30 percent of the indexed annuity market (up from 7 percent a year ago) and 15 percent of the total fixed annuity market (up from 4 percent a year ago).
Lawsky said he hopes to “shed light on and further stimulate a national debate on the use of captive insurance companies and special purpose vehicles (SPVs) by some of the world’s largest financial firms.
He hopes to do this though the DFS’ ongoing “serious investigation” into what he believes is not even a true risk transfer. Lawsky, who is superintendent of both banking and insurance in the state, suggested in his remarks the shaky ground of solvency upon which some insurers, he believes, are standing. When the time finally comes for a policyholder to collect their promised benefits, the reserves of insurers have shrunk so there is a smaller buffer available to ensure that the policyholders receive the benefits to which they are legally entitled, he explained.
Lawsky said that many times captives do not actually transfer the risk for policies off the parent company’s books because the parent company is ultimately still on the hook for paying claims if the shell company’s weaker reserves are exhausted.
Lawsky spoke of his concerns with what he terms “shadow insurance” or “financial alchemy” during a speech Thursday in New York City at the annual Hyman P. Minsky conference on the state of the U.S. and world economies organized by the Levy Economics Institute of Bard College.Associated Program: -
In the Media | April 2013Politico, April 18, 2013. All Rights Reserved.
FIRST LOOK III: LAWSKY ON REGULATORY COMPETITION — Excerpts from remarks New York Superintendent of Financial Services Ben Lawsky is to give this morning at the Minsky Conference at the Ford Foundation in NYC on “healthy competition” in financial regulation: “The New York State Department of Financial Services (DFS) is only about 18 months old. So, in many ways, we’re the new regulator on the block. And at DFS, we’re fortunate to work with federal partners who have a deep well of institutional knowledge and expertise — which complements our own. But we also have another key attribute at DFS. We’re nimble. And we’re agile. And we’re able to take a fresh look at issues across the financial industry — both new and old."
Associated Program: -
In the Media | April 2013Reuters, April 18, 2013. All Rights Reserved.
(Reuters) – The Federal Reserve's ultra accommodative policies will inevitably result in financial market instability for years but such risks are necessary to boost employment and inflation, a top U.S. central bank official said on Thursday.
Likening the Fed to a Minnesotan heading out into the winter cold, Minneapolis Fed President Narayana Kocherlakota said low real interest rates are as necessary as wearing a warm parka, and will probably be needed for many more years.
Kocherlakota is probably the most dovish of the 19 policymakers at the Fed, which has kept borrowing costs low for more than four years and is snapping up $85 billion in bonds each month to stimulate the U.S. economic recovery.
Bolstering his argument for yet more easing, the Minneapolis policymaker said the weak economic outlook suggests borrowing costs should be lower for even longer than the Fed now plans despite the inflated asset prices, volatile returns, and higher corporate merger activity that will result.
"For many years to come," he said, the Fed's policy-setting committee "will only be able to achieve its congressionally mandated objectives by following policies that result in signs of financial market instability," Kocherlakota told a Hyman P. Minsky conference.
Financial regulation is the best defense against such instability, he said.
But if the Fed considers raising rates to stabilize things, it has to weigh "the certainty of a costly" departure from achieving maximum employment and price stability against the benefit of reducing "the probability of an even larger" departure those objectives, Kocherlakota warned.
Central bank policymakers would also have to consider the effect a sooner-than-desired rate-rise would have on the Fed's overall credibility, he later told reporters. "That's going be part of the question you have to ask yourself," he said.
Frustrated with the slow and erratic recovery, the central bank has said it will keep short-term rates low until the unemployment rate falls to at least 6.5 percent, from 7.6 percent last month, as long as inflation, now below the Fed's 2-percent target, remains contained.
Meanwhile the Fed's bond-buying is meant to depress longer term rates and encourage investing, hiring and economic growth.
Kocherlakota is alone among policymakers in wanting the central bank to aim to keep rates low until unemployment falls as low as 5.5 percent, a level to which Americans are more accustomed.
Kocherlakota, whose hometown is expecting yet another spring snowfall, said the policy-setting Federal Open Market Committee (FOMC) is responding to forces beyond its control when it decides how long to keep rates low, given it is falling short of both its employment and inflation goals.
"When I decide what coat to wear, my goal is to keep myself at a temperature that I view as appropriate, given prevailing conditions that I cannot influence," he said.
"Similarly, when the FOMC decides on a level of the real interest rate, its goal is to keep the macro economy at an appropriate temperature, given prevailing conditions that it cannot influence," he added. "But the truth is that the FOMC's choice of winter garb is actually insufficient to keep the U.S. economy appropriately warm."
Talking to reporters, he did not go so far as to call for more asset purchases. But he said it was very important that the Fed protects its 2-percent inflation target "both from above, which gets so much attention, but from below as well."
On Wednesday, St. Louis Fed President James Bullard surprised some economists when he said the central bank should ramp up its quantitative easing program if inflation continues to fall. According to the Fed's preferred measure, inflation is at about 1.3 percent.
In his speech, Kocherlakota added he expects credit markets will remain limited over the next five to 10 years, causing headaches for investors seeking safe-haven assets.Associated Program: -
In the Media | April 2013
By Zachary Tracer
The Washington Post, April 18, 2013. All Rights Reserved.
(Updates with Lawsky’s comment in the fourth paragraph.)
April 18 (Bloomberg) -- New York’s financial regulator is scrutinizing what he called the “troubling role” of private equity firms as they expand into the insurance industry through acquisitions, according to a speech today.
Private-equity firms “may not be long-term players in the insurance industry and their short-term focus may result in an incentive to increase investment risk and leverage in order to boost short-term returns,” New York Department of Financial Services Superintendent Benjamin Lawsky said today in prepared remarks. “This type of business model isn’t necessarily a natural fit for the insurance business, where a failure can put policyholders at significant risk.”
Leon Black’s Apollo Global Management LLC has agreed to buy four insurers since 2008, including a $1.8 billion deal in December for Aviva Plc’s U.S. life and annuity business. A firm owned by Guggenheim Partners LLC shareholders agreed the same month to buy a variable-annuity unit from Sun Life Financial Inc. for $1.35 billion.
“DFS is moving to ramp up its activity” monitoring private-equity firms’ role, he said today, without naming companies, at the Hyman P. Minsky Conference in New York. “We hope that other regulators will soon follow suit.”Associated Program: -
In the Media | April 2013
By Michael S. Derby
The Wall Street Journal, April 18, 2013. All Rights Reserved.
A Federal Reserve official said Thursday interest rates are likely to stay very low for years to come, which raised the prospect that chronic financial instability risks will dog the economy for a long time.
“For a considerable period of time, the [Federal Open Market Committee] may only be to achieve its macroeconomic objectives in association with signs of instability in financial markets,” Federal Reserve Bank of Minneapolis President Narayana Kocherlaktoa said.
“For many years to come, the FOMC will have to maintain low real interest rates to achieve its congressionally mandated goals,” the official said. “Unusually low real interest rates should be expected to be linked with inflated asset prices, high asset return volatility and heightened merger activity,” he said.
In an environment where bubbles regularly threaten to form, and other markets see prices move away from fundamentals, the Fed will be confronted with difficult choices. “These potentialities are best addressed through effective supervision and regulation of the financial sector,” Mr. Kocherlakota said, although he allowed that it is possible the Fed may also have to employ the blunt tool of monetary policy to cool markets down if risks rise enough.
Mr. Kocherlakota’s comments came from the text of a speech that was to be presented at a conference held in New York by the Levy Economics Institute of Bard College. The official is not currently a voting member of the monetary policy setting FOMC.
Mr. Kocherlakota has been one of the biggest supporters of aggressive Fed action to support the economy, and has argued in recent speeches the Fed is not going far enough to aid the economy, and should add more stimulus by saying it wants to achieve a lower unemployment rate before hiking interest rates.
In his speech, the central banker said that the low interest rate world that could persist for “possibly the next five to 10 years” is in part the result of Fed actions over the course of the financial crisis and its aftermath. But the central banker said that other forces are also conspiring to keep rates very low.
The three that are most important beyond Fed policy are tighter credit availability, increased worry about economic risk and uncertainty surrounding the outlook for U.S. government finance, he said.
These factors are causing investors, households, and firms to keep their money where it is safest, and it is also causing them to save more. At the same time, those who need better yields will go into riskier assets, creating the risk prices for those markets could go haywire, the official explained.
In as much as Fed policy has helped create the low returns savers are wounded by, so too have market forces, Mr. Kocherlakota said.
“I often hear that the FOMC has created a low interest rate environment that is harmful for savers and others,” he said. “That seems about as compelling as blaming me for creating winter in Minnesota by putting on my long johns,” Mr. Kocherlakota said.
The official said in his speech he expects unemployment to fall “only slowly,” and he said “inflation pressures are muted.”Associated Program: -
In the Media | April 2013
By Joshua Zumbrun
Bloomberg Businessweek, April 18, 2013. All Rights Reserved.
Federal Reserve Bank of Minneapolis President Narayana Kocherlakota said the central bank’s low interest rate policies, though necessary, will probably generate signs of financial instability.
“Unusually low real interest rates should be expected to be linked with inflated asset prices, high asset return volatility and heightened merger activity,” Kocherlakota said today in the prepared text of a speech in New York. “All of these financial market outcomes are often interpreted as signifying financial market instability.”
Fed Governor Jeremy Stein and Kansas City Fed President Esther George are among those who have voiced concerns that an extended period of low interest rates is heightening the risk of asset bubbles in markets such as junk bonds and farmland.
While George has dissented from this year’s Federal Open Market Committee decisions because of this risk, Kocherlakota is among the strongest supporters of additional monetary stimulus on the committee.
In speeches earlier this month Kocherlakota said he sees an “ongoing modest recovery” with unemployment staying at 7 percent or more through late 2014. The slow recovery calls for “more accommodation,” he said in a speech, repeating his call to postpone consideration of any increase in interest rates. He doesn’t vote on policy this year.
“It is likely that, for a number of years to come, the FOMC will only achieve its dual mandate of maximum employment and price stability if it keeps real interest rates unusually low,” Kocherlakota said at the Levy Economics Institute’s 22nd Annual Hyman P. Minsky Conference.
Near Zero
The Minneapolis Fed chief has said the central bank should hold its target interest rate near zero until unemployment falls to 5.5 percent. That’s a full percentage point below the 6.5 percent threshold that has been adopted by the FOMC.
Answering audience questions, Kocherlakota said the recovery in the housing market is evidence that the Fed’s monthly purchases of $85 billion in Treasuries and mortgage securities are effective.
“They are having an impact on the economy,” he said. “Look at what’s going on in the mortgage market.”
“It would be nice if we did even more along those lines because I think our tools have been effective,” he said. “In the housing market in particular you’ve certainly seen direct effects of that kind of stimulus.”
In his speech, Kocherlakota said that “for a considerable period of time, the FOMC may only be to achieve its macroeconomic objectives in association with signs of instability in financial markets. These financial market phenomena could pose macroeconomic risks. In my view, these potentialities are best addressed using effective supervision and regulation of the financial sector.”Associated Program: -
In the Media | April 2013
By Michael S. Derby
The Wall Street Journal, April 18, 2013. All Rights Reserved.
NEW YORK – A Federal Reserve official said Thursday interest rates are likely to stay very low for years to come, which raises the prospect that chronic financial instability will be an enduring threat.
"For a considerable period of time, the [Federal Open Market Committee] may only be to achieve its macroeconomic objectives in association with signs of instability in financial markets," Federal Reserve Bank of Minneapolis President Narayana Kocherlakota said.
"For many years to come, the FOMC will have to maintain low real interest rates to achieve its congressionally mandated goals," the official said. "Unusually low real interest rates should be expected to be linked with inflated asset prices, high asset return volatility and heightened merger activity," he said.
In an environment where bubbles regularly threaten to form, and other markets see prices move away from fundamentals, the Fed will be confronted with difficult choices. "These potentialities are best addressed through effective supervision and regulation of the financial sector," Mr. Kocherlakota said, although he allowed that it is possible the Fed may also have to employ the blunt tool of monetary policy to cool markets down if risks rise enough.
The official, when asked if he saw any markets devolving into a bubble, responded "the answer is absolutely not at this stage." At the current moment, "I don't see those kind of risks out there."
But he also said that given the importance now placed on financial stability, bank regulators and supervisors face greater challenges as they do their work.
Mr. Kocherlakota's comments came from a speech he gave at a conference held in New York by the Levy Economics Institute of Bard College. He took questions from the audience and spoke with reporters as well. The official is not currently a voting member of the monetary policy setting FOMC.
Mr. Kocherlakota has been one of the biggest supporters of aggressive Fed action to support the economy, and has argued in recent speeches the Fed is not going far enough to aid the economy, and should add more stimulus by saying it wants to achieve a lower unemployment rate before hiking interest rates.
He reiterated that he'd still like to lower the threshold at which the Fed would potentially entertain raising rates, from 6.5% to 5.5%. He said weakening inflation pressures were "definitely a cause for concern" but he hasn't changed his outlook for price pressures. Mr. Kocherlakota said he still expects economic growth of 2.5% this year and 3% next year, and believes that will be enough to help raise inflation over time from its current very low level.
In his speech, the central banker said that the low interest rate world that could persist for "possibly the next five to 10 years" is in part the result of Fed actions over the course of the financial crisis and its aftermath. But the central banker said that other forces are also conspiring to keep rates very low.
The three that are most important beyond Fed policy are tighter credit availability, increased worry about economic risk and uncertainty surrounding the outlook for U.S. government finance, he said.
These factors are causing investors, households and firms to keep their money where it is safest, and it is also causing them to save more. At the same time, those who need better yields will go into riskier assets, creating the risk prices for those markets could go haywire, the official explained.
In as much as Fed policy has helped create the low returns savers are wounded by, so too have market forces, Mr. Kocherlakota said.
"I often hear that the FOMC has created a low interest rate environment that is harmful for savers and others," he said.
"That seems about as compelling as blaming me for creating winter in Minnesota by putting on my long johns," Mr. Kocherlakota said.
The official said in his speech he expects unemployment to fall "only slowly," and he said "inflation pressures are muted."Associated Program: -
In the Media | April 2013
By Greg Robb
MarketWatch, April 18, 2013. All Rights Reserved.
WASHINGTON (MarketWatch) – Financial market conditions requiring the Federal Reserve to keep rates unusually low may persist for the next five to 10 years, said Narayana Kocherlakota, the president of the Minneapolis Fed Bank on Thursday. This low-rate environment, and Fed policy, in turn, can be expected to "be associated with financial market phenomena that are seen as signifying instability," such as inflated asset prices, high asset return volatility and heightened merger activity, Kocherlakota said, in a speech at the Levy Economics Institute of Bard College. This instability is best addressed through effective supervision and regulation, Kocherlakota said. However, the Fed may have to confront the dilemma of whether to raise rates to reduce the risks of a financial crisis with the certainty that any tightening would lead to lower employment and prices, he said. The Fed is in a better position to address this challenge than it was in 2007, he said.
Associated Program: -
In the Media | April 2013Hellenic Shipping News, April 18, 2013. All Rights Reserved.
Federal Reserve Bank of St. Louis President James Bullard on Wednesday said he is concerned inflationary pressures may be growing too weakly and the central bank may have to do something about it.
"Inflation is running very low" as measured by the personal consumption expenditures price index, the Fed's favored inflation gauge, the policymaker said. "I'm getting concerned about that," he said, adding that the low rate of price pressure "gives the [Federal Open Market Committee] some room to maneuver" on the monetary-policy front.
The central banker didn't suggest that any move toward a more-stimulative monetary policy was imminent. The Fed is currently pursuing a policy of buying bonds to drive up growth and lower the unemployment rate. While most expect the bond-buying program to continue for some months to come, improving economic conditions have driven some central bankers to say the pace of buying could be reduced at some point.
The Fed wants inflation at 2% and it considers under-target inflation to be undesirable. Central bankers consider a deflationary environment as damaging to the economy.
In his speech, Mr. Bullard also appeared to take issue with the central bank's latest move to provide increased monetary-policy guidance, saying the Fed is limited in what it can do to affect labor-market conditions.
The best and most-effective action the Fed can take is to focus on its traditional mandate of inflation control, the official said. "Frontline research suggests that price stability remains the policy advice even in the face of serious labor-market inefficiencies," Mr. Bullard said. "This research should provide the benchmark for contemporary monetary policy," he explained.
At the same time, "the current high level of unemployment is causing some to suggest that the [FOMC] should put more weight on unemployment in its decision-making process," he said. That would be a mistake, he said, as research shows "monetary policy alone cannot effectively address multiple labor-market inefficiencies...One must turn to more-direct labor-market policies to address those problems."
Monetary policy by itself is "too blunt" to help lower high unemployment levels, the policymaker said. When it comes to aiding the labor market, "it's not that you can't do something about it, it's just that maybe you shouldn't lean on the monetary-policy maker" to do it.
Mr. Bullard is a voting member of the monetary-policy-setting FOMC. His comments came from a speech given before a conference held by the Levy Economics Institute of Bard College, in New York. Much of his talk referenced work by economists Federico Ravenna and Carl Walsh.
Mr. Bullard has long argued that monetary policy faces limits in what it can do to aid the labor market, and he has said that, if the Fed were to target achieving a given unemployment rate, it could lead policy to go seriously wrong. But he also gave his qualified support to the Fed's decision last December to job and inflation thresholds.
At that time, the Fed said it would keep short-term interest rates near 0% so long as the unemployment rate is above 6.5% and expected inflation is below 2.5%. Officials have been careful to note that these levels aren't targets and that they don't promise immediate action if breached. Some have said the Fed could easily keep rates unchanged with a sub-6/5% unemployment rate if inflation remained under the threshold.
The Fed's new policy guidance reflects in large part its congressionally given mandate to keep prices stable and to promote maximum sustainable job growth. The Fed is unique among major central banks in having this goal, with other major central banks charged with pursuing stable inflation alone.
Mr. Bullard's comments Wednesday appeared to reflect an ongoing discomfort with this new policy regime, one that is unlikely to bring a rate increase for several more years if the Fed is right about how the labor market will perform.
In his prepared remarks, Mr. Bullard said the Fed over recent years has done a good job of keeping inflation near the central bank's official target of 2%. He said the unemployment rate "remains high" and, compared to its current 7.6% level, it will likely be in the "low-7% range" by year's end.
Associated Program: -
In the Media | April 2013
By Greg Edwards
St. Louis Dispatch, April 17, 2013. All Rights Reserved.
St. Louis Fed President Jim Bullard said Wednesday the Federal Reserve should keep its focus on inflation instead of putting more weight on high unemployment.
More emphasis on unemployment “may be highly counterproductive,” he said at a conference in New York. Bullard said he expects unemployment, which was 7.6 percent last month, will drop to the low 7 percent range by the end of the year.
He made the remarks at the annual Hyman P. Minsky Conference in New York City, organized by the Levy Economics Institute of Bard College.Associated Program: -
In the Media | April 2013Boston Herald, April 17, 2013. All Rights Reserved.
Federal Reserve Bank of Boston President Eric Rosengren called for more regulation of broker-dealers and money market mutual funds in a speech at a New York conference today, but he began his remarks by acknowledging the victims of Monday’s Marathon attack.
“I want to take a moment to acknowledge that I join you from a community in Boston that on Monday endured a terrible and profoundly cruel tragedy at the Marathon,” Rosengren told the audience at the 22nd annual Hyman P. Minsky Conference on the State of the U.S. and World Economies. “My thoughts are with the many people who were wounded, with those — including Boston Fed staff — who were uninjured but at the scene, and most of all with the families and friends of those whose lives were lost.”
Rosengren told conference-goers that maintaining financial stability has been a key focus since the mortgage meltdown. “The financial crisis of 2008 and its aftermath have significantly increased the attention policymakers devote to financial stability issues. The Dodd-Frank Wall Street Reform and Consumer Protection Act (the Dodd-Frank Act) and a variety of new bank regulatory initiatives, including the Basel III capital accord, are intended to reduce the risk of similar problems in the future,” the Boston Fed chief said. “For commercial banks, the policy changes stemming from the crisis have been increases in bank capital, stress tests to ensure capital is sufficient to weather serious problems, increased attention to liquidity and new measures intended to improve the resolution of large systemically important commercial banks.”
But Rosengren said tougher regulations have not been applied to money market mutual funds and broker-dealers, whose failure was at the center of the financial crisis.
Specifically citing the failure of prominent broker-dealers Bear Stearns and Lehman Brothers at “critical junctures during the crisis,” Rosengren said: “Despite the central role that broker-dealers played in exacerbating the crisis, too little has changed to avoid a repeat of the problem, I am sorry to say. In short, I firmly believe that a reexamination of the solvency risks of large broker-dealers is warranted.”
Because little has changed with regard to broker-dealers, Rosengren direly concluded: “The status quo represents an ongoing and significant financial stability risk.”
To remedy the situation, he suggested: “In my view, then, consideration should be given to whether broker-dealers should be required to hold significantly more capital than depository institutions, which have deposit insurance and pre-ordained access to the central bank’s Discount Window.”Associated Program: -
In the Media | April 2013
By Ylan Q. Mui
Wonkblog, The Washington Post, April 17, 2013. All Rights Reserved.
How much power does monetary policy have to create jobs?
That question is at the heart of the debate over the Federal Reserve’s recent policy decisions. A majority on the Fed’s policy committee has explicitly endorsed keeping low interest rate policies in place until the unemployment rate falls to 6.5 percent (or inflation becomes a problem). But on Wednesday morning, St. Louis Fed President James Bullard warned that focusing on unemployment could put the central bank’s decades of work stabilizing inflation at risk.
The title of his speech at the Levy Economics Institute of Bard College’s annual Minsky Conference said it all: “Unpleasant implications for unemployment targeters.” He cited work by economists Federico Ravenna and Carl Walsh that suggests that keeping prices contained is the best way the central bank can help the economy, even when the labor market is in turmoil.
“The idea that the Fed should put more weight on unemployment does not fare very well in this analysis,” Bullard said. “In fact, such an approach might be counterproductive.”
The problem, Bullard said, is that the Fed really only has one antidote for an ailing economy — adjusting the price of money — and that tool’s impact on unemployment is indirect.
“The monetary guys can really do one thing,” he said. “ It’s not that you don’t want to address unemployment. It’s that it’s not a good way to address unemployment efficiency.”
But while Bullard sees pursuing easy money policies to try get boost hiring as problematic, he is more open to such easing when the inflation rate is falling below the Fed’s 2 percent target. Indeed, Bullard said he is becoming “concerned” that inflation is too low, and that if prices fell further, he would be ready to ratchet up the Fed’s $85-billion-a-month bond-buying program.
Bullard was one of the first Fed officials to push for changing the pace of the central bank’s asset purchases to match economic conditions. He has said he would consider reducing purchases by small amounts, perhaps even at each of the Fed’s policymaking meetings, as the economy improves. But Wednesday was the first time he has broached the policy of increasing bond purchases to reach the inflation goal.
“We should defend our inflation target from the low side,” Bullard said. “If we say 2 percent, we should get 2 percent.”Associated Program: -
In the Media | April 2013
By Annalyn Kurtz
CNNMoney, April 17, 2013. All Rights Reserved.
Cue the flashback to summer 2010. Ben Bernanke and other officials at the Federal Reserve were warning that inflation was approaching dangerous lows, perhaps even flirting with the dreaded "D" word -- deflation. Bernanke gave a key speech in Jackson Hole that August hinting that more Fed stimulus might be in the pipeline. Sure enough, it was. The Fed launched QE2 about two months later.
A similar murmur is starting up again: Could inflation be getting too low? St. Louis Fed President James Bullard thinks so.
"Inflation is pretty low right now, and it's been drifting down," he told reporters at a Levy Economics Institute event Wednesday morning.
"If it doesn't start to turn around soon, I think we'll have to rethink where we stand on our policy," he added.
The Federal Reserve usually aims to keep inflation around 2% a year, but recently has said it would be willing to tolerate inflation up to 2.5% a year in exchange for a lower unemployment rate. (The unemployment rate has been stuck above 7% for more than four years now.)
Where is the inflation rate currently? It was 1.3% as of February, according to the Fed's preferred measure, which strips out gas and food prices.
Should it get any lower, Bullard said he would push his Fed colleagues to ramp up their asset purchases. The Fed is currently buying $85 billion a month in Treasuries and mortgage-backed securities, in an attempt to lower long-term interest rates and stimulate more spending.
The policy has no official end-date, but Bernanke has made it clear that the Fed can adjust its purchasing depending on economic activity. Fed watchers mostly interpreted that language as a sign that the Fed may taper down its purchases later this year. Few have been discussing the possibility that the Fed may do just the opposite, increasing its purchases in the coming months.
Bullard made it clear that he thinks more purchases are a possibility. In his scrum with reporters Wednesday, he repeated multiple times that he's "willing" to "defend" the Fed's inflation target from the low side -- meaning, if inflation gets uncomfortably below the Fed's 2% long-term goal.Associated Program: -
In the Media | April 2013
By Michael S. Derby
Fox Business, April 17, 2013. All Rights Reserved.
The most recent reforms of the financial regulatory system have left Wall Street's broker-dealers largely untouched and a continued threat to the financial stability, a Federal Reserve official said Wednesday.
"Despite this history of failure and substantial government support, little has changed in the solvency requirements of broker-dealers," Federal Reserve Bank of Boston President Eric Rosengren said. "The status quo represents an ongoing and significant financial stability risk."
"Consideration should be given to whether broker-dealers should be required to hold significantly more capital than depository institutions" to help mitigate the threat these institution might pose in a period of renewed financial stress, the central banker said.
Mr. Rosengren is a voting member of the monetary policy Federal Open Market Committee. His comments came from the text of a speech to be delivered before a gathering held by the Levy Economics Institute of Bard College, in New York.
Mr. Rosengren did not address monetary policy or the economic outlook in his formal remarks. The official has in a number of speeches shown a great interest in financial stability and unresolved matters that exist in the wake of the passage of the Dodd-Frank reform legislation. In past speeches, Mr. Rosengren has shown a considerable amount of alarm about money market funds, which he sees as subject to destabilizing runs.
In his speech, the official highlighted the role broker-dealers like Bear Stearns and Lehman Brothers played in the financial crisis. In the current environment, many of these types of operations have been subsumed into bank holding companies with levels of access to the traditional safety net, but he sees still insufficient levels of capital compared to the risks these firms may be exposed to.
"Being housed within a bank holding company should not obviate the need for the broker-dealer subsidiary to hold more capital," Mr. Rosengren said. "Broker-dealers remain vulnerable to losing the confidence of funders and counterparties should the world economy again experience a significant financial crisis."
The official worried that under the status quo, new trouble could force a return of Fed emergency lending facilities that are tailored to support broker-dealer operations. That would be a bad outcome, Mr. Rosengren says.Associated Program: -
In the Media | April 2013Reuters, April 17, 2013. All Rights Reserved.
(Reuters) – The Federal Reserve should buy bonds if inflation continues to fall, a top Fed official said on Wednesday, stressing the U.S. central bank needs to prevent inflation from being too far below its target.
Still, St. Louis Fed President James Bullard cautioned that more monetary policy accommodation is not yet needed and said he does not currently fear deflation.
"If inflation continues to go down, I would be willing to increase the pace of purchases," Bullard told reporters after a speech at the Hyman P. Minsky Conference in New York.
The comments from Bullard, a pragmatic centrist and a voting member of the Fed's policy committee this year, provide an interesting twist to a policy debate that has recently been focused on what level of improvement in the labor market would prompt the central bank to dial down its $85 billion in monthly asset purchases.
The Fed has an official 2-percent inflation target and has said it will keep benchmark interest rates near zero until unemployment falls to at least 6.5 percent, as long as inflation expectations do not breach 2.5 percent.
"I'm very willing to defend the inflation target from the low side. If we say 2 percent, we should hit 2 percent," Bullard said. The Fed's preferred measure of inflation, the Personal Consumption Expenditures or PCE rate, is around 1.3 percent and is not expected to rise much over the next two years, in large part because of the droves of Americans who are unemployed.
"If it doesn't start to turn around here soon, I think we'll have to rethink where we are on the policy," said Bullard.
In the past, Bullard has talked about tapering bond purchases based on where the unemployment level stands.
Asked about this, Bullard said his stance on inflation is in line with that thinking because part of that analysis was watching how far inflation drifts from the central bank's target, which was made official last year.
The Fed is currently buying $45 billion in Treasuries and another $40 billion in mortgage-backed securities through the latest round of quantitative easing, known as "QE3", as it tries to bolster the economic recovery.
The central bank has said it will continue buying bonds until the outlook on jobs improves substantially. Financial markets have started to turn their attention to how long purchases might go on.
Ward McCarthy, chief financial economist at Jefferies, sent a note to clients following the comments that read: "So much for tapering ... upsizing may be in order."
Bullard said he would prefer to ramp the easing up if needed by buying Treasuries rather than mortgage-backed securities, in part because the Fed should aim to have only government bonds in its portfolio in the longer term.
A different measure of inflation, the consumer price index, showed on Tuesday that prices fell last month.
In his speech, Bullard said the Fed should remain focused on inflation and resist putting more weight on the employment part of its dual mandate.
Unlike most central banks in the developed world, the Fed is tasked with both maintaining price stability and achieving full employment. Since the deep recession, it has eased monetary policy to unprecedented levels to lower the unemployment rate, which last month was 7.6 percent.
"People have been focusing on employment a lot, but have maybe gotten a little bit blinded about the inflation numbers that have come in very low," Bullard told reporters.
At the same time, he acknowledged it hurts the central bank's credibility to look past headline inflation in favor of so-called core inflation, which strips out volatile items food and gasoline. He said doing so creates a disconnect between Main Street and policymakers.Associated Program: -
In the Media | April 2013
MNI | Duetsche Börse Group, April 17, 2013. All Rights Reserved.
NEW YORK (MNI) – Many religiously monitor and analyze labor market data for clues on how long the Federal Reserve will maintain its aggressive measures to help the recovery, but one influential Fed official Wednesday said he would support increasing the bond buying program to arrest a continued decline in inflation.
"People have been focusing on unemployment a lot but maybe are a little bit blinded that the inflation numbers have come in very low," St. Louis Federal Reserve Bank James Bullard told reporters on the sidelines of the Minsky conference hosted by the Levy Institute in New York.
During the question and answer session with the audience, Bullard noted that inflation, as measured by the personal consumption expenditures index, is running very low right now.
"I'm getting concerned by that," Bullard said, adding that inflation running below the policy-setting Federal Open Market Committee's price stability target gives the group "room to maneuver."
Pressed by reporters to indicate exactly what "room to maneuver" means, Bullard - a voter on the FOMC this year - said, "I think if inflation continued to go down I'd be willing to increase the pace of (asset) purchases.
"As it stands right now inflation has drifted lower on a PCE basis. This is not what I expected and I think inflation should be closer to target than it is."
Asked by MNI if his decision to adjust the $85 billion a month in bond buying is tied to just price stability, and not the outlook for the labor market as the FOMC has said, Bullard said he looks at all economic data "But I'm going to put a lot of weight on inflation that's for sure, and I'm very willing to defend the inflation target from the low side.
"If we say 2%, we should get 2% and we shouldn't let that lapse," he said. "We should defend our inflation target from the low side."
Bullard said while he is not advocating the FOMC up its asset purchases tomorrow, it does have the capacity to increase the size should it decide to with causing market imbalances.
If Committee where to make such a decision, Bullard said he would favor buying more U.S. Treasury securities.
He stressed that the current fall in prices is not on par with that seen in the summer of 2010, when the Fed unveiled a $600 billion asset purchase program, so it is "too early" for to talk about deflation.
However, "if it doesn't start to turn around here soon, I think we'll have to rethink where we are on our policy," Bullard said.
Bullard has said he favors tying the pace of the current asset purchase program to economic conditions, and argued that where inflation is relative to target is one of those conditions.
At the same time, he cautioned that conditions could turn around and PCE could be back up closer to target. "That is what I expect to happen but so far it hasn't been happening," Bullard said.
Responding to questions from the audience, Bullard said he does not believe there is nothing that can be done to address the problems in the market, but the issue is that "maybe you shouldn't lean on the monetary policymaker to do a lot about it."
What is needed is a more targeted approach to helping those without a job, Bullard said, since the impact of monetary policy is too indirect.Associated Program: -
In the Media | April 2013
By Joshua Zumbrun and Steve Matthews
Bloomberg Businessweek, April 17, 2013. All Rights Reserved.
James Bullard, president of the Federal Reserve Bank of St. Louis, said U.S. inflation has fallen too far below the central bank’s 2 percent goal and a further drop could prompt increased bond buying.
“Inflation should be closer to target than it is and we should defend the inflation target from the low side,” Bullard told reporters today after a speech in New York. “If it doesn’t start to turn around here soon, I think we’ll have to rethink where we are in our policy.”
One option would be for the Federal Open Market Committee to increase monthly purchases from $85 billion, the level reaffirmed in March, Bullard said. The policy group said asset purchases will continue until the labor market outlook improves “substantially” and pledged to keep interest rates near zero as long as unemployment is above 6.5 percent and inflation doesn’t exceed 2.5 percent.
“I think we could do more if we had to,” Bullard said. “I don’t want to give you the impression that I’m willing to do more today.”
Consumer prices rose 1.3 percent in February from a year earlier, according to the Fed’s preferred gauge of inflation. Bullard said the current disinflation is “not quite as bad as it was in the fall of 2010.”
Second Round That year, Bullard initiated calls for a second round of bond buying, which ran from November 2010 until June 2011. Any new purchases should be in Treasury securities rather than mortgage bonds because the market is larger, he said. Bullard said he “would like to see the Fed eventually return to an all-Treasuries portfolio.”
By contrast, minutes of the March 19-20 FOMC meeting showed that a number of Fed officials said the central bank should begin slowing its bond buying program later this year and stop it by year end.
A recent plunge in gold prices doesn’t have implications for forecast inflation though does point to weakness in the global economy, the St. Louis Fed president said.
“Europe is in recession, and China is not growing quite as fast as before so those two factors would seem to suggest global commodity demand would be down some,” Bullard told reporters.
Monetary Policy In his prepared remarks, Bullard said monetary policy should be guided by the central bank’s price-stability goal and it would be a mistake to place a greater focus on high unemployment.
The unemployment rate has been dropping 0.7 percentage point a year since its peak after the recession, and will be in the “low 7 percent range by the end of 2013,” he said at the Hyman Minsky Conference, hosted by the Levy Economics Institute.
In response to audience questions, Bullard cited the example of Germany’s labor-market reforms as a model for U.S. policy makers.
“Germany has been very impressive on the labor market dimension” in recent years, he said. “You could copy their policies” to encourage jobs, while monetary policy itself is a “very blunt instrument” that can’t be targeted.
Among Fed policy makers, Fed Minneapolis Bank President Narayana Kocherlakota has urged more stimulus for economic growth by reducing the threshold for consideration of a policy tightening to a 5.5 percent unemployment rate.
Fed Vice Chairman Janet Yellen yesterday said she favors holding the benchmark interest rate “lower for longer,” while New York Fed President William C. Dudley said a slowdown in the pace of employment growth in March highlights the need to maintain the pace of bond purchases.
Bullard joined the St. Louis Fed’s research department in 1990 and became president of the regional bank in 2008. His district includes all of Arkansas and parts of Illinois, Indiana, Kentucky, Mississippi, Missouri and Tennessee.Associated Program: -
In the Media | April 2013
By Michael S. Derby
Real Time Economics Blog, The Wall Street Journal, April 17, 2013. All Rights Reserved.
Federal Reserve Bank of St. Louis President James Bullard said Wednesday inflationary pressures may be growing too weakly and if they soften further, the central bank may have to boost its asset buying to bring price pressures back up to more desirable levels.
“Inflation is running very low” as measured by the personal consumption expenditures price index, the Fed’s favored inflation gauge, the policymaker said. “I’m getting concerned about that,” he said.
“If inflation [gains] continues to go down, I’d be willing to increase the pace of purchases” of bonds the Fed is now engaged in, Mr. Bullard said. “This is not what I expected, and I think inflation should be closer to the target than it is,” the official said, adding he considers it just as important to defend the Fed’s 2% inflation target from the low side, as it is to keep prices from going over 2%.
The central banker didn’t suggest that any move toward a more-stimulative monetary policy was imminent, and he said it remains possible price pressures could pick up. If the Fed were to have to increase its purchases, he believes it could be done without harming market functioning, and he said he would favor Treasury bonds over mortgages.
The Fed currently is pursuing a policy of buying bonds to drive up growth and lower the unemployment rate. While most expect the bond-buying program to continue for some months to come, improving economic conditions have driven some central bankers to say the pace of buying could be reduced at some point.
The Fed wants inflation at 2%, and it considers under-target inflation to be undesirable. Central bankers consider a deflationary environment as damaging to the economy.
Mr. Bullard is a voting member of the monetary-policy-setting Federal Open Market Committee. His comments came from a speech given before a conference held by the Levy Economics Institute of Bard College, in New York. In his formal speech, Mr. Bullard appeared to take issue with the central bank’s latest move to provide increased monetary-policy guidance, saying the Fed is limited in what it can do to affect labor-market conditions.
“Frontline research suggests that price stability remains the policy advice even in the face of serious labor-market inefficiencies,” Mr. Bullard said.
At the same time, “the current high level of unemployment is causing some to suggest that the [FOMC] should put more weight on unemployment in its decision-making process,” he said. That would be a mistake, he said, as research shows “monetary policy alone cannot effectively address multiple labor-market inefficiencies…One must turn to more-direct labor-market policies to address those problems.”
Monetary policy by itself is “too blunt” to help lower high unemployment levels, the policymaker said. When it comes to aiding the labor market, “it’s not that you can’t do something about it, it’s just that maybe you shouldn’t lean on the monetary-policy maker” to do it.
Mr. Bullard long has argued that monetary policy faces limits in what it can do to aid the labor market, and he has said that, if the Fed were to target achieving a given unemployment rate, it could lead policy to go seriously wrong. But he also gave his qualified support to the Fed’s decision last December to job and inflation thresholds.
At that time, the Fed said it would keep short-term interest rates near 0% so long as the unemployment rate is above 6.5% and expected inflation is below 2.5%. Officials have been careful to note that these levels aren’t targets and that they don’t promise immediate action if breached. Some have said the Fed easily could keep rates unchanged with a sub-6.5% unemployment rate if inflation remained under the threshold.
The Fed’s new policy guidance reflects in large part its congressionally given mandate to keep prices stable and to promote maximum sustainable job growth. The Fed is unique among major central banks in having this goal, with other major central banks charged with pursuing stable inflation alone.
Mr. Bullard’s comments Wednesday appeared to reflect an ongoing discomfort with this new policy regime, one that is unlikely to bring a rate increase for several more years if the Fed is right about how the labor market will perform.
In his prepared remarks, Mr. Bullard said the Fed over recent years has done a good job of keeping inflation near the central bank’s official target of 2%. He said the unemployment rate “remains high” and, compared to its current 7.6% level, it likely will be in the “low-7% range” by year’s end.Associated Program: -
In the Media | April 2013Forbes, April 17, 2013. All Rights Reserved.
St. Louis Fed President James Bullard spoke in New York on Wednesday, warning that inflation remains too low and suggesting he’d be ready to increase the rate of asset purchases, or QE, to defend their target “from below.”
Making sure to dispel any rumors of the Federal Reserve looking to tighten its monetary stance any time soon, St. Louis Fed chief Bullard told academics easy money is here to stay. The Fed has “room to maneuver,” and the capacity to increase its rate of purchases, Bullard explained at the Levy Economic Institute’s Minsky Conference, adding that quantitative easing is a better tool than forward guidance to signal the central bank’s intention to markets.
It’s commonplace these days to attribute recent risk asset strength to the Bernanke Fed. Even the International Monetary Fund is doing it. Market participants have been nervous about the future path of Fed policy, which has sent U.S. stocks to record highs, particularly as recent FOMC minutes seem to suggest consensus within the committee, which has supported Ben Bernanke’s expansive policies consistently, might begin to break.
Bullard was sure to dispel those rumors as well, noting that as Fed transparency has gone up, subtle differences in opinion have surfaced. “I don’t think there has been any breakdown of consensus,” said the St. Louis Fed boss, who didn’t dissent last meeting, adding there are “nuanced positions.”
Interestingly Bullard suggested strong unemployment targets shouldn’t be part of policymakers’ toolkit. “Should the Fed, or any central bank, put more weight on unemployment than price stability?” he asked the crowd, before presenting research by economists Ravenna and Walsh suggesting that those targets would further distort labor markets. The Fed currently has a soft target for both inflation and the unemployment rate.
Instead, central bankers should focus on price stability, as monetary policy is too “blunt” of an instrument to target the intricacies of the labor market. As mentioned above, Bullard did say QE is a more direct, and preferable way, for the Fed to act (given nominal rates in the zero range and forward guidance as the other major tool), but said he sees asset purchases affecting labor markets in the same way as interest rate moves. Bullard’s bullishness wasn’t enough to boost markets, though. Wall Street was a sea of red at 11:32 AM in New York, with all three major equity indexes well in the red. The Nasdaq led the way, down 1.9%, followed by the S&P 500 and the Dow, which lost 1.6% and 1% respectively. Gold slid to $1,385.50 an ounce while the yield on 10-year Treasuries stood at 1.57%. Asked about the huge amount of excess reserves sitting at the Fed, rather than being lent out by the banks, Bullard chose to speak of the possibility to tighten policy through interest. Depositary institutions like JPMorgan Chase, Bank of New York Mellon, and Citigroup, among others, have nearly $1.7 trillion sitting at the Fed, according to the St. Louis Fed, yet they have been criticized for failing to lend those out, given tighter credit markets and lower loan demand amid a slow economy.
The so-called Bernanke put has been one of the major factors helping investors jump back into the market and prop asset prices to new highs. While there has been dissent within the Federal Reserve, Bernanke has always reaffirmed his intention to pursue his easy policies. Bullard seems to agree, even though he does suggest the flow rate, or pace, of asset purchases, should be the way for them to signal their intentions to markets. Still, it seems, QE is here to stay.
Associated Program: -
In the Media | April 2013MNI | Deutsche Börse Group, April 17, 2013. All Rights Reserved.
NEW YORK (MNI) – Boston Federal Reserve Bank President Eric Rosengren Wednesday said the Fed has not yet hit its employment or inflation targets, and he remains a strong supporter of its aggressive measures to spur the economic recovery - which are starting to yield results.
Taking questions from the audience after a speech at the Minsky conference in New York, Rosengren said he has been in favor of the path monetary policy has taken since the 2008 crisis, and continues to be.
Rosengren holds a voting position on the policy-setting Federal Open Market Committee this year, and he said he is "strongly supportive" of the FOMC's buying of $85 billion a month in U.S. Treasury securities and mortgage bonds to support the recovery.
The quantitative easing program is working, he said, although the recovery is still not as fast as he would like to see. Stronger growth than the 2.5% average seen so far during the recovery is needed, but there continue to be some bright spots, he said.
The circumstances have changed in the housing sector, for instance, with the market improving "quite dramatically."
Auto sales are also almost back to their pre-crisis levels, showing that in interest-sensitive sectors where the Fed's actions can have an effect, "our policies are having a big impact, an important impact. We are getting a much better outcome," Rosengren said.
Rosengren focused on the subject of bank regulation in his prepared remarks, and he reiterated that the pace of regulatory reform is not moving as fast as he would like.
He said he believes some regulatory agencies do not view financial stability as part of their mandate but said the work being done now is moving in the right direction.Associated Program: -
In the Media | April 2013
By Greg Robb
MarketWatch, April 17, 2013. All Rights Reserved.
WASHINGTON (MarketWatch) — Inflation might be too low and the Federal Reserve may need to respond, said James Bullard, the president of the St. Louis Fed Bank on Wednesday.
“Inflation is running very low,” as measured by the personal consumption expenditures prices index, Bullard said in a question-and-answer period after a speech at the Levy Economics Institute of Bard College.
“I’m getting concerned about that,” Bullard said, according to Dow Jones Newswires.
Prices of the 10-year benchmark Treasury note rose Wednesday, pushing yields down nearly 3 basis points to 1.699%. The Fed’s preferred measure of inflation, the personal consumption expenditures price index, increased at a 1.3% annual rate in February. This is well below the Fed’s target of 2%.
Earlier this week, an alternate measure of inflation, the consumer price index, posted a surprising 0.2% decline in March. The index rose at 1.5% annual rate, the slowest pace since last July.
Bullard’s comments suggest a growing risk of deflation, a general decline in prices.
The implication is that the Fed will continue its easy-policy stance, and perhaps augment it with other steps, said Michael Moran, chief U.S. economist at Daiwa Securities America Inc.
The Fed’s bond buying has been successful at keeping deflation at bay. It is designed to push down interest rates and boost asset prices, sparking demand that prevents prices from falling.
The asset purchases also influences inflation expectations, Moran said.
Bullard didn’t suggest any move to a more-stimulative policy. But he said the low inflation rate gives the Fed “room to maneuver,” a suggestion that there is no need to hurry to slow down the Fed’s asset purchases.
The Fed is buying $85 billion in Treasurys and mortgage-backed securities each month. Markets are focused on when the Fed might taper or end the purchases because many see this as the first sign that higher interest rates may be in the offing.
In his prepared remarks, Bullard said the goal of Fed policy should be to keep inflation close to its inflation target.
Bullard said new research has found it would be counterproductive for the Fed to “put more weight” on unemployment over price stability in its decision-making process.
Bullard noted that since 1995, the Fed has been following “New Keynesian” advice by keeping inflation close to a 2% target. The problem since the financial crisis is that the New Keynesian model doesn’t take unemployment into account.
Now, cutting-edge research that puts employment into these models has found that monetary policy alone can’t impact the labor market, he said. The best way to help the job market remains direct labor-market policies.
Bullard is a voting member of the Fed’s interest-rate-setting committee this year.
Greg Robb is a senior reporter for MarketWatch in Washington.Associated Program: -
In the Media | April 2013Money News, April 17, 2013. All Rights Reserved.
Boston Federal Reserve President Eric Rosengren said banks should hold more capital if they own a broker-dealer unit because such businesses pose greater risks during periods of financial stress.
“Bank holding companies with large broker-dealer affiliates should hold more capital to reflect the reduced stability of their liabilities during times of stress,” Rosengren said in prepared remarks for a speech in New York.
Rosengren made his call as members of Congress and regulators try to reduce the risk that a large bank failure might result in a taxpayer-funded bailout. Senate Republicans and Democrats are discussing legislation that would boost capital standards. Fed officials are considering ways to curb balance-sheet expansion at the largest banks and toughen capital requirements for the largest firms.
“Despite the central role that broker-dealers played in exacerbating the crisis, too little has changed to avoid a repeat of the problem,” Rosengren said at the 22nd Annual Hyman P. Minsky Conference in New York. “I firmly believe that a reexamination of the solvency risks of large broker-dealers is warranted.”
The Fed-assisted emergency sale of Bear Stearns Cos. to JPMorgan Chase & Co. in March 2008 was the first time since the Great Depression that the U.S. central bank had come to the assistance of a securities firm, as opposed to a bank.
Lehman Bankruptcy
Six months later, the bankruptcy of Bear Stearns’s larger rival, Lehman Brothers Holdings Inc., shocked financial markets and led the three biggest U.S. securities firms — Merrill Lynch & Co., Goldman Sachs Group Inc. and Morgan Stanley — to be acquired by or convert to banks in an effort to get the backing of the Fed.
To help keep the firms afloat during the financial crisis in 2008, the Fed launched the Primary Dealer Credit Facility, which at its peak lent out $156 billion. A second facility, the Term Securities Lending Facility, lent an additional $246 billion at its peak.
“Given that recent history, the assumption that collateralized lenders like broker-dealers are not susceptible to runs has been proven wrong,” Rosengren said at the conference, hosted by the Levy Economics Institute of Bard College and the Ford Foundation.
SEC Regulation
“Broker-dealer capital regulation by the SEC remains largely unchanged, despite the lessons of the financial crisis,” he said. “Consequently, broker-dealers remain vulnerable to losing the confidence of funders and counterparties should the world economy again experience a significant financial crisis.”
The Boston Fed chief, formerly his bank’s head of supervision, has previously taken the lead in calling for additional regulations on the money-market fund industry that were subsequently endorsed by all 12 Fed presidents.
The 2011 bankruptcy of MF Global Holdings Ltd. once again called into question the ability of independent securities firms to survive on funding provided by the capital markets. Jefferies Group Inc., which staved off a run on its own funding in the wake of MF Global’s collapse, agreed in November to combine with its largest shareholder to shore itself up against future market turmoil.
“The status quo represents an ongoing and significant financial-stability risk,” Rosengren said.
Basel Standards
U.S. and international regulators have an analytical approach that requires more capital for risks embedded in large bank holding companies. The Basel Committee on Banking Supervision has decided that systemically important global banks should bear a charge of 1 percent to 2.5 percent more capital to total assets weighted for risk based on their size, complexity and interconnectedness.
The Financial Stability Board in November listed 28 banks that should be subject to the requirement for additional capital. The list is updated annually and a phase-in period begins in 2016.
Global trading banks such as Citigroup Inc., JPMorgan Chase, HSBC Holdings Plc, and Deutsche Bank AG occupy the top tier in the group, bearing a charge of 2.5 percent. Barclays and BNP Paribas are in the second tier, with a charge of 2 percent; Goldman Sachs, Morgan Stanley, Bank of America Corp., Credit Suisse Group AG and four other banking groups are in the third tier, at 1.5 percent.
Stress Tests
In addition, the Fed determines capital adequacy through its stress tests which include a separate diagnostic for firms with large-scale trading operations.
The Fed tested the 19 largest banks this year against three different scenarios with 26 variables including exchange rates, incomes and interest rates. In addition, six bank holding companies with “significant trading activity” — Bank of America, Citigroup, Goldman Sachs, JPMorgan Chase, Morgan Stanley and Wells Fargo & Co. — had their portfolios stressed under conditions of a global market shock.
Rosengren said that securities-trading units should face higher capital requirements whether they are in a bank-holding company or not.
“Given the very different risks of runs posed by broker-dealers and their less stable liability structure, an argument can be made for higher capital requirements for broker-dealers as well as organizations, such as bank holding companies, with significant broker-dealer operations,” he said.
Rosengren, 55, became president of the Boston Fed in July 2007, and previously served in the economic and supervision departments of the bank.Associated Program: -
In the Media | April 2013
By Joshua Zumbrun and Craig Torres
Bloomberg, April 17, 2013. All Rights Reserved.
Boston Federal Reserve President Eric Rosengren said banks should hold more capital if they own a broker-dealer unit because such businesses pose greater risks during periods of financial stress.
“Bank holding companies with large broker-dealer affiliates should hold more capital to reflect the reduced stability of their liabilities during times of stress,” Rosengren said in prepared remarks for a speech today in New York.
Rosengren made his call as members of Congress and regulators try to reduce the risk that a large bank failure might result in a taxpayer-funded bailout. Senate Republicans and Democrats are discussing legislation that would boost capital standards. Fed officials are considering ways to curb balance-sheet expansion at the largest banks and toughen capital requirements for the largest firms.
“Despite the central role that broker-dealers played in exacerbating the crisis, too little has changed to avoid a repeat of the problem,” Rosengren said at the 22nd Annual Hyman P. Minsky Conference in New York. “I firmly believe that a reexamination of the solvency risks of large broker-dealers is warranted.”
The Fed-assisted emergency sale of Bear Stearns Cos. To JPMorgan Chase & Co. (JPM) in March 2008 was the first time since the Great Depression that the U.S. central bank had come to the assistance of a securities firm, as opposed to a bank.Associated Program: -
In the Media | April 2013
By Greg Robb
MarketWatch, April 17, 2013. All Rights Reserved.
WASHINGTON (MarketWatch) — The financial health of large U.S. broker-dealers remains a significant financial stability risk five years after the financial crisis, and regulators should consider making them increase their capital buffers, said Eric Rosengren, the president of the Boston Fed Bank, on Wednesday.
“Despite the central role that broker-dealers played in exacerbating the crisis, too little has changed to avoid a repeat of the problem, I am sorry to say,” Rosengren said in a speech to a conference in New York sponsored by the Levy Economics Institute of Bard College.
“The status quo represents an ongoing and significant financial stability risk,” he said. “Broker-dealers remain vulnerable to losing the confidence of funders and counterparties should the world economy again experience a significant financial crisis.”
Some broker-dealers, like Goldman Sachs and Morgan Stanley, became bank holding companies during the crisis. Rosengren said bank holding companies with large broker-dealer affiliates might have to hold more capital than other banks to reflect the reduced stability of their liabilities during times of stress.
It is rare for Fed officials to comment on the financial health of broker-dealers.
Regulation of these firms primarily falls under the purview of the Securities and Exchange Commission.
Rosengren said he was concerned that broker-dealers represent a moral hazard, similar to “too big to fail” banks.
If there were another crisis, the Fed might have to consider relaunching emergency credit facilities that were used by broker-dealers in 2008 and 2009.
“If broker-dealers assume that they will once again have access to such government support should markets be disrupted, they will have little incentive to take the steps necessary to shield themselves from financing problems during a crisis and thus minimize their need for a government backstop,” Rosengren said.
The Fed set up two emergency facilities during the crisis. The first, the Primary Dealer Credit Facility, provided overnight loans to primary dealers in return for collateral. At its peak, lending in the program was $156 billion.
A second plan, the Term Securities Lending Facility, allowed primary dealers to lend less-liquid securities to the Fed for one month in exchange for Treasurys. The peak balance of that program was $246 billion.Associated Program: -
In the Media | April 2013MNI | Deutsche Börse Group, April 17, 2013. All Rights Reserved.
NEW YORK (MNI) - St. Louis Federal Reserve Bank President James Bullard Wednesday argued that monetary policy may not be the ideal tool to tackle the nation's jobs crisis, and that more direct policies are needed, while the Fed would be better served focusing more on its price stability mandate.
In remarks prepared for delivery at the Hyman Minsky Conference hosted by the Levy Institute in New York, Bullard said that "the essential problem is that monetary policy is not a good tool to address labor market inefficiency."
He noted that the current high level of unemployment is causing some to suggest the policy-setting Federal Open Market Committee should "put more weight" on unemployment in its decision-making process.
Bullard holds a voting position on the FOMC this year, and he countered that "frontline research suggests that 'price stability' remains the policy advice even in the face of serious labor market inefficiencies."
Bullard said the FOMC should focus on keeping inflation close to its target, citing recent research that suggests deviating from this policy can lead to "substantially worse" outcomes for households.
"The idea that the Fed should 'put more weight' on unemployment does not fare well in this analysis," he said. "Such an approach may be highly counter-productive."
"Monetary policy alone cannot effectively address multiple labor market inefficiencies, and so one must turn to more direct labor market policies to address those problems," he added.
Bullard noted that the unemployment rate has declined about 0.7 percentage points each year since its post-recession peak, and that at this pace unemployment should be "in the low 7% range" by the end of 2013.Associated Program: -
In the Media | April 2013
By Michael S. Derby
The Wall Street Journal, April 17, 2013. All Rights Reserved.
NEW YORK--The most recent overhauls of the financial regulatory system have left Wall Street's broker-dealers largely untouched and a continued threat to the financial stability, a Federal Reserve official said Wednesday.
"Despite this history of failure and substantial government support, little has changed in the solvency requirements of broker-dealers," Federal Reserve Bank of Boston President Eric Rosengren said. "The status quo represents an ongoing and significant financial stability risk."
"Consideration should be given to whether broker-dealers should be required to hold significantly more capital than depository institutions" to help mitigate the threat these institutions might pose in a period of renewed financial stress, the central banker said.
Mr. Rosengren is a voting member of the monetary-policy setting Federal Open Market Committee. His comments came from the text of a speech delivered before a gathering held by the Levy Economics Institute of Bard College, in New York.
Mr. Rosengren didn't address monetary policy or the economic outlook in his formal remarks. The official has, in a number of speeches, shown a great interest in financial stability and unresolved matters that exist in the wake of the passage of the Dodd-Frank overhaul legislation. In past speeches, Mr. Rosengren has shown a considerable amount of alarm about money-market funds, which he sees as subject to destabilizing runs.
In his speech, the official highlighted the role broker-dealers like Bear Stearns and Lehman Brothers played in the financial crisis. In the current environment, many of these types of operations have been subsumed into bank-holding companies with levels of access to the traditional safety net, but he sees still insufficient levels of capital compared with the risks these firms may be exposed to.
"Being housed within a bank-holding company should not obviate the need for the broker-dealer subsidiary to hold more capital," Mr. Rosengren said. "Broker-dealers remain vulnerable to losing the confidence of funders and counterparties should the world economy again experience a significant financial crisis."
The official worried under the status quo, new trouble could force a return of Fed emergency-lending facilities tailored to support broker-dealer operations. That would be a bad outcome, Mr. Rosengren said.
In comments to the audience, Mr. Rosengren said he believes Fed stimulus policies were helping the economy, and he remains concerned credit standards for the mortgage market have become tighter than they should be. He said there are signs of life now appearing in the housing and car markets.
Mr. Rosengren also said he is strongly supportive of the current stance of monetary policy.Associated Program: -
In the Media | April 2013
By Steve Matthews and Joshua Zumbrun
Bloomberg, April 17, 2013. All Rights Reserved.
James Bullard, president of the Federal Reserve Bank of St. Louis, said monetary policy should be guided by the central bank’s price-stability goal even with historically high unemployment.
“The idea that the Fed should ‘put more weight’ on unemployment does not fare well,” Bullard said in a speech in New York. “Such an approach may be highly counterproductive.”
Bullard supported the Federal Open Market Committee decision in March to continue to buy $85 billion in bonds every month until the labor market outlook improves “substantially.” It also pledged to keep interest rates near zero as long as unemployment is above 6.5 percent and inflation doesn’t exceed 2.5 percent. The unemployment rate stood at 7.6 percent in March.
Bullard, in his presentation on the current economy, said the U.S. unemployment rate has been declining at about 0.7 percentage point per year since peaking after the last recession ended.
“At this pace, the unemployment rate will be in the low 7 percent range by the end of 2013,” he said to the Hyman Minsky Conference on the State of the U.S. and World Economies.
While that rate is “high by historical standards,” Bullard cited academic work by economists Federico Ravenna and Carl Walsh as suggesting the Fed should use its inflation goal, which is 2 percent, as the main guide to policy.
Serious Inefficiencies “Frontline research suggests that ‘price stability’ remains the policy advice even in the face of serious labor market inefficiencies,” Bullard said. “Attempts to address the various labor market inefficiencies solely with monetary policy do not work very well because improvements on one dimension are simultaneously detriments on other dimensions.”
“The essential finding is that monetary policy alone cannot effectively address multiple labor market inefficiencies, and so one must turn to more direct labor market policies to address those problems,” Bullard said.
Federal Reserve Vice Chairman Janet Yellen yesterday said she favors holding the benchmark interest rate “lower for longer,” while New York Fed President William C. Dudley said a slowdown in the pace of employment growth in March highlights the need to maintain the pace of bond purchases.
Bullard joined the St. Louis Fed’s research department in 1990 and became president of the regional bank in 2008. His district includes all of Arkansas and parts of Illinois, Indiana, Kentucky, Mississippi, Missouri and Tennessee.Associated Program: -
In the Media | April 2013
By Robert Hultqvist
di.se, April 17, 2013. All Rights Reserved.
Federal Reserve bör fokusera på sitt traditionella mandat i form av prisstabilitet och det finns begränsningar i vad centralbanken kan göra för arbetsmarknaden. "Penningpolitik isolerat kan inte effektivt åtgärda multipla ineffektiviteter på arbetsmarknaden... Man måste rikta sig mot mer direkta arbetsmarknadsåtgärder för att åtgärda de problemen", säger James Bullard, ordförande för Federal Reserve Bank i St Louis, enligt en presentation inför ett tal han kommer att hålla vid the Levy Economics Institute of Bard College, enligt Dow Jones Newswires. I talet uppger Fed-ledamoten att centralbanken har gjort ett bra jobb med att hålla inflationen i närheten av tvåprocentsmålet. Arbetslösheten är fortsatt hög och kommer sannolik att sjunka till ett lågt sjuprocentspann vid slutet av året, bedömer han vidare.Associated Program: -
In the Media | April 2013Reuters, April 17, 2013. All Rights Reserved.
(Reuters) - The Federal Reserve should remain focused on inflation and resist putting more weight on its employment mandate, a top U.S. central bank official said on Wednesday.
St. Louis Fed President James Bullard, in a speech, cited research by Federico Ravenna and Carl Walsh that suggests "price stability remains the policy advice even in the face of serious labor market inefficiencies."
Unlike most central banks in the developed world, the Fed is tasked with maintaining price stability and achieving full employment. Since the deep recession, it has eased policy to unprecedented levels to lower the unemployment rate, which last month was 7.6 percent.
"The idea that the Fed should put more weight on unemployment ... may be highly counter-productive," Bullard, an inflation hawk and a voting member of the Fed's policy committee this year, said according to prepared remarks.
"The essential finding (of the research) is that monetary policy alone cannot effectively address multiple labor market inefficiencies, and so one must turn to more direct labor market policies to address those problems," he was to tell the annual Hyman P. Minsky Conference in New York.
Bullard expects unemployment to drop to the low 7 percent range by year end.Associated Program: -
In the Media | April 2013Televisa, April 17, 2013. All Rights Reserved.
Daña la credibilidad hablar de inflación subyacente pues crea una desconexión entre los precios minoristas y las políticas del gobierno
NUEVA YORK, EU, abr. 17, 2013.- La actual tasa baja de inflación en Estados Unidos deja a la Reserva Federal con "espacio para maniobrar" mientras intenta apuntalar la economía estadounidense a través de sus políticas monetarias extraordinarias, dijo un alto representante de la Fed.
Sin embargo, el presidente de la Fed en St. Louis James Bullard dijo que estaba preocupado sobre el ambiente de baja inflación.
Bullard dijo que daña la credibilidad del banco central hablar de "inflación subyacente", que es la que descarta rubros volátiles como los precios del los alimentos y la gasolina, creando una desconexión entre los precios minoristas y las políticas del gobierno.
Bullard estaba respondiendo preguntas del público tras un discurso en la conferencia anual Hyman P. Minsky en Nueva York.Associated Program: -
In the Media | April 2013
By Michael S. Derby
The Wall Street Journal, April 17, 2013. All Rights Reserved.
St. Louis Fed leader James Bullard appeared to take issue with the central bank’s latest move to provide increased monetary policy guidance, saying in a speech Wednesday the Fed is limited in what it can do to affect labor market conditions.
The best and most effective thing the Federal Reserve can do is focus on its traditional mandate of inflation control, the official said. “Frontline research suggests that price stability remains the policy advice even in the face of serious labor market inefficiencies,” Mr. Bullard said. “This research should provide the benchmark for contemporary monetary policy,” he explained.
At the same time, “the current high level of unemployment is causing some to suggest that the [Federal Open Market Committee] should put more weight on unemployment in its decision-making process,” he said. That would be a mistake, as research shows “monetary policy alone cannot effectively address multiple labor market inefficiencies…. One must turn to more direct labor market policies to address those problems,” the official said.
Mr. Bullard is a voting member of the monetary policy setting FOMC. His comments came from slides that were associated with a talk he was to give at a conference held by the Levy Economics Institute of Bard College, in New York.
Mr. Bullard has long argued that monetary policy faces limits in what it can do to aid the labor market, and he has said if the Fed were to target achieving a given unemployment rate, it could lead policy to go seriously wrong. But he also gave his qualified support to the Fed’s decision last December to job and inflation thresholds.
The Fed said then that it would keep short term interest rates near zero percent so long as the unemployment rate is above 6.5% and expected inflation is below 2.5%. Officials have been careful to note these levels aren’t targets and don’t promise immediate action if breached. Some have said the Fed could easily keep rates unchanged with a sub-6/5% unemployment rate if inflation remained under the threshold.
Mr. Bullard’s comments Wednesday appeared to reflect an ongoing discomfort with this new policy regime, one that is unlikely to bring a rate hike for several more years if the Fed is right about how the labor market will perform.
In his prepared remarks, Mr. Bullard said the Fed has over recent years done a good job of keeping inflation near the central bank’s official target of 2%. He said the unemployment rate “remains high” and compared to its current 7.6% level, it will likely be in the “low 7% range” by year’s end.Associated Program: -
In the Media | April 2013PRWeb, April 17, 2013. All Rights Reserved.
Federal Reserve Bank of St. Louis President James Bullard gave remarks Wednesday on "Some Unpleasant Implications for Unemployment Targeters" at the 22nd Annual Hyman P. Minsky Conference.
Federal Reserve Bank of St. Louis President James Bullard gave remarks Wednesday on “Some Unpleasant Implications for Unemployment Targeters” at the 22nd Annual Hyman P. Minsky Conference.
During his presentation, Bullard noted that the U.S. unemployment rate remains high by historical standards and that it has declined about 0.7 percentage points per year from its post-recession peak level. “At this pace, the unemployment rate will be in the low 7 percent range by the end of 2013,” he said.
Given this current high level of unemployment, some have suggested that the Federal Open Market Committee (FOMC) should “put more weight” on unemployment in its decision-making process, Bullard said. “However, frontline research suggests that ‘price stability’ remains the policy advice even in the face of serious labor market inefficiencies.” In Bullard’s view, the results from this recent research, by economists Federico Ravenna and Carl Walsh, should be considered as an important benchmark for contemporary monetary policy.
Price Stability
Bullard noted that the New Keynesian macroeconomics literature has been extraordinarily influential in monetary policy. The standard policy advice from this literature is “price stability,” he said, explaining that “practically speaking, this means ‘focus on keeping inflation close to target.’”
Technically, Bullard said, the policy advice is to maintain a price level path that is consistent with the inflation target. The FOMC has maintained such a price level path since 1995, which he has discussed previously. (See, for example, Bullard’s speech on Sept. 20, 2012, “A Singular Achievement of Recent Monetary Policy.”)
Thus, actual FOMC monetary policy during the past 18 years seems to have mimicked the policy advice from the New Keynesian literature. However, Bullard noted that the standard model does not include unemployment. In light of today’s high level of unemployment, he said that the main question is whether the FOMC should adopt a policy rule that “puts more weight” on this variable.
Unemployment To determine how the policy advice changes when unemployment is included in the model, Bullard examined recent research by Ravenna and Walsh. In a 2011 paper(1), they found that “the optimal policy is still very close to price stability, even with unemployment explicitly in the model,” Bullard said. That is, the policymaker should still “keep inflation as close to target as is practicable,” he explained. “Expressed as a Taylor-type rule, it would mean putting almost all the weight on the inflation term.”
Furthermore, the authors suggest that deviating from this policy can lead to substantially worse outcomes for households, Bullard said. “The idea that the Fed should ‘put more weight’ on unemployment does not fare well in this analysis. Such an approach may be highly counter-productive,” he stated.
In a 2012 paper(2), Ravenna and Walsh asked why price stability remains close to optimal. “Attempts to address the various labor market inefficiencies solely with monetary policy do not work very well because improvements on one dimension are simultaneously detriments on other dimensions,” Bullard said, which means that other policy tools are needed.
“The essential finding is that monetary policy alone cannot effectively address multiple labor market inefficiencies, and so one must turn to more direct labor market policies to address those problems,” Bullard said.
1. Ravenna, Federico, and Walsh, Carl E. “Welfare-Based Optimal Monetary Policy with Unemployment and Sticky Prices: A Linear-Quadratic Framework.” American Economic Journal: Macroeconomics, April 2011, 3(2), pp. 130–62.
2. Ravenna, Federico, and Walsh, Carl E. “Monetary Policy and Labor Market Frictions: A Tax Interpretation.” Journal of Monetary Economics, March 2012, 59(2), pp. 180–95.Associated Program: -
In the Media | April 2013Reuters, April 17, 2013. All Rights Reserved.
A top Federal Reserve official said Wednesday that If inflation continues to fall he would be willing to increase the pace of the central bank's bond-buying to defend its 2 percent inflation target.
St. Louis Fed President James Bullard cautioned that further accommodation in monetary policy is not needed yet, however, and said he does not currently fear deflation.
"If inflation continues to go down, I would be willing to increase the pace of purchases," Bullard told reporters after a speech at the annual Hyman P. Minsky Conference in New York.
The Fed has an official 2 percent inflation target and has said that, as long as inflation expectations do not breach 2.5 percent, it will keep benchmark interest rates near zero until unemployment falls to 6.5 percent.
(Watch More: Fed's Bullard Discounts Weak Job Report)
"I'm very willing to defend the inflation target from the low side," Bullard said. "If we say 2 percent, we should hit 2 percent."
The comments from Bullard, a pragmatic centrist and a voter on Fed policy this year, provide an interesting twist to a policy debate that has recently been focused on what level of improvement in the labor market would prompt the central bank to dial down the purchases.
The Fed's preferred measure of inflation, the Personal Consumption Expenditures rate, is around 1.3 percent and is not expected to rise much over the next two years, in large part because of the millions of unemployed workers.
The Fed is buying $85 billion a month in Treasurys and mortgage-backed securities through the latest round of quantitative easing, known as QE3, as it tries to bolster the economic recovery.
An inflation hawk, Bullard said he would prefer to ramp up if needed by buying Treasurys rather than MBS.
The central bank has said it will keep buying bonds until the labor market outlook improves substantially; financial markets have began turning their attention to how long purchases might go on.
In his speech, Bullard said the Fed should remain focused on inflation and resist putting more weight on the employment part of its dual mandate.
Unlike most central banks in the developed world, the Fed is responsible for both maintaining price stability and achieving full employment. Since the Great Recession, it has eased monetary policy to unprecedented levels to lower the unemployment rate, which stood at 7.6 percent last month.
"People have been focusing on employment a lot but have maybe gotten a little bit blinded about the inflation numbers that have come in very low," Bullard told reporters.Associated Program: -
In the Media | April 2013Reuters, April 17, 2013. All Rights Reserved.
(Reuters) – The current low inflation rate leaves the Federal Reserve with "room to maneuver" as it tries to boost the U.S. economy through its extraordinary monetary policies, a top Fed official said on Wednesday.
Still, St. Louis Fed President James Bullard said he was concerned about the low inflation environment. Bullard said it hurts the central bank's credibility to talk about so-called core inflation, which strips out volatile items such as food and gasoline prices, by creating a disconnect between Main Street and policymakers.
Bullard was fielding questions from the audience following a speech at the annual Hyman P. Minsky Conference in New York.Associated Program: -
In the Media | April 2013
By Michael S. Derby
The Wall Street Journal, April 17, 2013. All Rights Reserved.
NEW YORK--Federal Reserve Bank of St. Louis President James Bullard on Wednesday said he is concerned inflationary pressures may be growing too weakly and the central bank may have to do something about it.
"Inflation is running very low" as measured by the personal consumption expenditures price index, the Fed's favored inflation gauge, the policymaker said. "I'm getting concerned about that," he said, adding that the low rate of price pressure "gives the [Federal Open Market Committee] some room to maneuver" on the monetary-policy front.
The central banker didn't suggest that any move toward a more-stimulative monetary policy was imminent. The Fed is currently pursuing a policy of buying bonds to drive up growth and lower the unemployment rate. While most expect the bond-buying program to continue for some months to come, improving economic conditions have driven some central bankers to say the pace of buying could be reduced at some point.
The Fed wants inflation at 2% and it considers under-target inflation to be undesirable. Central bankers consider a deflationary environment as damaging to the economy.
In his speech, Mr. Bullard also appeared to take issue with the central bank's latest move to provide increased monetary-policy guidance, saying the Fed is limited in what it can do to affect labor-market conditions.
The best and most-effective action the Fed can take is to focus on its traditional mandate of inflation control, the official said. "Frontline research suggests that price stability remains the policy advice even in the face of serious labor-market inefficiencies," Mr. Bullard said. "This research should provide the benchmark for contemporary monetary policy," he explained.
At the same time, "the current high level of unemployment is causing some to suggest that the [FOMC] should put more weight on unemployment in its decision-making process," he said. That would be a mistake, he said, as research shows "monetary policy alone cannot effectively address multiple labor-market inefficiencies...One must turn to more-direct labor-market policies to address those problems."
Monetary policy by itself is "too blunt" to help lower high unemployment levels, the policymaker said. When it comes to aiding the labor market, "it's not that you can't do something about it, it's just that maybe you shouldn't lean on the monetary-policy maker" to do it.
Mr. Bullard is a voting member of the monetary-policy-setting FOMC. His comments came from a speech given before a conference held by the Levy Economics Institute of Bard College, in New York. Much of his talk referenced work by economists Federico Ravenna and Carl Walsh.
Mr. Bullard has long argued that monetary policy faces limits in what it can do to aid the labor market, and he has said that, if the Fed were to target achieving a given unemployment rate, it could lead policy to go seriously wrong. But he also gave his qualified support to the Fed's decision last December to job and inflation thresholds.
At that time, the Fed said it would keep short-term interest rates near 0% so long as the unemployment rate is above 6.5% and expected inflation is below 2.5%. Officials have been careful to note that these levels aren't targets and that they don't promise immediate action if breached. Some have said the Fed could easily keep rates unchanged with a sub-6/5% unemployment rate if inflation remained under the threshold.
The Fed's new policy guidance reflects in large part its congressionally given mandate to keep prices stable and to promote maximum sustainable job growth. The Fed is unique among major central banks in having this goal, with other major central banks charged with pursuing stable inflation alone.
Mr. Bullard's comments Wednesday appeared to reflect an ongoing discomfort with this new policy regime, one that is unlikely to bring a rate increase for several more years if the Fed is right about how the labor market will perform.
In his prepared remarks, Mr. Bullard said the Fed over recent years has done a good job of keeping inflation near the central bank's official target of 2%. He said the unemployment rate "remains high" and, compared to its current 7.6% level, it will likely be in the "low-7% range" by year's end.Associated Program: -
In the Media | April 2013
By Michael S. Derby
Dow Jones Business News, April 17, 2013. All Rights Reserved.
NEW YORK—St. Louis Fed leader James Bullard appeared to take issue with the central bank's latest move to provide increased monetary policy guidance, saying in a speech Wednesday the Fed is limited in what it can do to affect labor market conditions.
The best and most effective thing the Fed can do is focus on its traditional mandate of inflation control, the official said. "Frontline research suggests that price stability remains the policy advice even in the face of serious labor market inefficiencies," Mr. Bullard said. "This research should provide the benchmark for contemporary monetary policy," he explained.
At the same time, "the current high level of unemployment is causing some to suggest that the [Federal Open Market Committee] should put more weight on unemployment in its decision-making process," he said. That would be a mistake, as research shows "monetary policy alone cannot effectively address multiple labor market inefficiencies... One must turn to more direct labor market policies to address those problems," the official said.
Mr. Bullard is a voting member of the monetary policy setting FOMC. His comments came from slides that were associated with a talk he was to give at a conference held by the Levy Economics Institute of Bard College, in New York.
Mr. Bullard has long argued that monetary policy faces limits in what it can do to aid the labor market, and he has said if the Fed were to target achieving a given unemployment rate, it could lead policy to go seriously wrong. But he also gave his qualified support to the Fed's decision last December to job and inflation thresholds.
The Fed said then that it would keep short-term interest rates near zero% so long as the unemployment rate is above 6.5% and expected inflation is below 2.5%. Officials have been careful to note these levels aren't targets and don't promise immediate action if breached. Some have said the Fed could easily keep rates unchanged with a sub-6/5% unemployment rate if inflation remained under the threshold.
Mr. Bullard's comments Wednesday appeared to reflect an ongoing discomfort with this new policy regime, one that is unlikely to bring a rate hike for several more years if the Fed is right about how the labor market will perform.
In his prepared remarks, Mr. Bullard said the Fed has over recent years done a good job of keeping inflation near the central bank's official target of 2%. He said the unemployment rate "remains high" and compared to its current 7.6% level, it will likely be in the "low 7% range" by year's end.
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Book Series | April 2013
By Hyman P. Minsky | Preface by Dimitri B. Papadimitriou | Introduction by L. Randall Wray
Although Hyman P. Minsky is best known for his ideas about financial instability, he was equally concerned with the question of how to create a stable economy that puts an end to poverty for all who are willing and able to work. This collection of Minsky’s writing spans almost three decades of his published and previously unpublished work on the necessity of combating poverty through full employment policies—through job creation, not welfare.
Minsky was an American economist who studied under Joseph Schumpeter and Wassily Leontief. He taught economics at Washington University, the University of California–Berkeley, Brown University, and Harvard University. Minsky joined the Levy Economics Institute of Bard College as a distinguished scholar in 1990, where he continued his research and writing until a few months before his death in October 1996. His two seminal books were Stabilizing an Unstable Economy and John Maynard Keynes, both of which were reissued by the Levy Institute in 2008.
Minsky held a B.S. in mathematics from the University of Chicago (1941) and an M.P.A. (1947) and a Ph.D. in economics (1954) from Harvard. He was a recipient in 1996 of the Veblen-Commons Award, given by the Association for Evolutionary Economics in recognition of his exemplary standards of scholarship, teaching, public service, and research in the field of evolutionary institutional economics.
This book was made possible in part through the generous support of the Ford Foundation and Andrew Sheng of the Fung Global Institute.
Published By: Levy Economics Institute of Bard College
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Research Project Reports | April 2013This monograph is part of the Levy Institute’s Research and Policy Dialogue Project on Improving Governance of the Government Safety Net in Financial Crisis, a two-year project funded by the Ford Foundation.
“Never waste a crisis.” Those words were often invoked by reformers who wanted to tighten regulations and financial supervision in the aftermath of the global financial crisis that began in late 2007. Many of them have been disappointed, since the relatively weak reforms adopted (for example, in Dodd-Frank) appear to have fallen far short of what is needed. But the same words can be invoked in reference to the policy response to the crisis—that is, to the rescue of the financial system. To date, the crisis was wasted in that area, too. If anything, the crisis response largely restored the deeply flawed system that existed on the eve of the crisis. But it may not be too late to use the crisis, and the crisis response, to formulate a different approach to dealing with the next financial crisis—and another crisis is inevitable—by learning from the policy mistakes made in reaction to the last crisis, and by looking to successful policy responses around the globe.Download:Associated Program:Author(s): -
In the Media | April 2013On April 5, Senior Scholar Jan Kregel was featured on the panel "China in the World: Growth, Adjustment, and Integration" at the INET (Institute for New Economic Thinking) conference "Changing of the Guard?" in Hong Kong. The conference, cosponsored by the Fung Global Institute and the Centre for International Governance Innovation, focused on some of today's most pressing global concerns, including economic inequality and financial instability, set against the backdrop of Asia's rising share of the world economy. Click here for the panel video (Kregel’s remarks begin at 28:00).
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Working Paper No. 761 | March 2013
The Case of China
The recent declines in China’s financial account balance ended the “twin surplus” era and led to a modest decline in the stock of official reserves, which reflects a reversal in expectations for the Chinese currency. Negative balances, which have been visible in China’s financial balances since the last quarter of 2011, have heightened fears/anxiety in markets. These deficits stand in sharp contrast to the typical financial account surplus that existed until 2010. The announcement in September 2011 by Chinese monetary authorities of a “two-way floating” RMB in the foreign exchange market has unsettled market expectations and has led to a sharp fall in the financial balance. The latter brought a change in the expectations regarding the RMB-USD exchange rate. This change was reflected in the drop in foreign exchange assets, which was caused by a jump in short-term trade credits to prepay (for imports) in dollars, a rise in dollar advances from banks, and a withdrawal of dollar deposits. These changes have, of late, been a cause of concern relating to the future of China’s economic relations vis-à-vis trading and financial partners, which include the United States.
The experience of China, in a changing world beset with deregulation and with speculation affecting her external balance in recent years, provides further confirmation of John Maynard Keynes’s observation, in 1937, regarding uncertainty in markets: “About these matters there is no scientific basis on which to form any calculable probability whatever. We simply do not know.”
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Working Paper No. 759 | March 2013
A Post-Keynesian View
Several explanations of the “great inflation moderation” (1982–2006) have been put forth, the most popular being that inflation was tamed due to good monetary policy, good luck (exogenous shocks such as oil prices), or structural changes such as inventory management techniques. Drawing from Post-Keynesian and structuralist theories of inflation, this paper uses a vector autoregression with a Post-Keynesian identification strategy to show that the decline in the inflation rate and inflation volatility was due primarily to (1) wage declines and (2) falling import prices caused by international competition and exchange rate effects. The paper uses a graphical analysis, impulse response functions, and variance decompositions to support the argument that the decline in inflation has in fact been a “wage and import price moderation,” brought about by declining union membership and international competition. Exchange rate effects have lowered inflation through cheaper import and oil prices, and have indirectly affected wages through strong dollar policy, which has lowered manufacturing wages due to increased competition. A “Taylor rule” differential variable was also used to test the “good policy” hypothesis. The results show that the Taylor rule differential has a smaller effect on inflation, controlling for other factors.
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Conference Proceedings | March 2013
Debt, Deficits, and Unstable Markets
Organized by the Levy Economics Institute and ECLA of Bard with support from the Ford Foundation, The German Marshall Fund of the United States, and Deutsche Bank AG
Deutsche Bank AG
Berlin, Germany
November 26–27, 2012
The purpose of this conference was to gain a better understanding of the causes of financial instability and its implications for the global economy. Key topics included the challenge to global growth affected by the eurozone debt crisis; the impact of the credit crunch on economic and financial markets; the larger implications of government deficits and the debt crisis for US, European, and Asian economic policy; and central bank independence and financial reform.Download:Associated Program: -
Working Paper No. 758 | March 2013
The Low and Extended Lending Rates that Revived the Big Banks
Walter Bagehot’s putative principles of lending in liquidity crises—to lend freely to solvent banks with good collateral but at penalty rates—have served as a theoretical basis for thinking about the lender of last resort for close to 100 years, while simultaneously providing justification for central bank real-world intervention. If we presume Bagehot’s principles to be both sound and adhered to by central bankers, we would expect to find the lending by the Fed during the global financial crisis in line with such policies. Taking Bagehot’s principles at face value, this paper aims to examine one of these principles—central bank lending at penalty rates—and to determine whether it did in fact conform to this standard. A comprehensive analysis of these rates has revealed that the Fed did not, in actuality, follow Bagehot’s classical doctrine. Consequently, the intervention not only generated moral hazard but also set the stage for another crisis. This working paper is part of the Ford Foundation project “A Research and Policy Dialogue Project on Improving Governance of the Government Safety Net in Financial Crisis” and continues the investigation of the Fed’s bailout of the financial system—the most comprehensive study of the raw data to date.
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Press Releases | February 2013
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Working Paper No. 753 | February 2013
This paper addresses the critique of the aggregational problem attached to the financial instability hypothesis of Hyman Minsky. The core of this critique is based on the Kaleckian analytical framework and, in very broad terms, states that the expenditure of firms for investment is at the same time a source of income for the firms producing capital goods. Hence, even if investments are debt financed, as in Minsky’s analysis, the overall level of indebtedness of the firm sector remains unchanged, since the debts of investing firms are balanced by the income of capital goods–producing firms. According to the critics, Minsky incurs a fallacy of composition when he does not take this dynamic into account when applying his micro analysis of investment at the macro level. The aim of this paper is to clarify the consequences of debt-financed investments over the financial structure of an aggregate economy. Starting from the works of Michał Kalecki and Josef Steindl, we developed a stock-flow consistent analysis of a highly simplified economy under four different financial regimes: (1) debt-financed with no distributed profits, (2) debt-financed with distributed profits, (3) internally financed with no distributed profits, and (4) internally financed with distributed profits. The results of our investigation show that debt-financed investments do not lead to a worsening of the financial position of the firm sector only if specific assumptions are taken into account.
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Working Paper No. 752 | February 2013
One might expect that rising US income inequality would reduce demand growth and create a drag on the economy because higher-income groups spend a smaller share of income. But during a quarter century of rising inequality, US growth and employment were reasonably strong, by historical standards, until the Great Recession. This paper analyzes this paradox by disaggregating household spending, income, saving, and debt between the bottom 95 percent and top 5 percent of the income distribution. We find that the top 5 percent did indeed spend a smaller share of income, but demand drag did not occur because the spending share of the bottom 95 percent rose, accompanied by a historic increase in borrowing. The unsustainable rise in household leverage concentrated in the bottom 95 percent ultimately spawned the Great Recession. The demand drag of rising inequality could be one explanation for the stagnant recovery in the recession’s aftermath.
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Working Paper No. 751 | February 2013
The Fed versus the Classicals
Nineteenth-century British economists Henry Thornton and Walter Bagehot established the classical rules of behavior for a central bank, acting as lender of last resort, seeking to avert panics and crises: Lend freely (to temporarily illiquid but solvent borrowers only) against the security of sound collateral and at above-market, penalty interest rates. Deny aid to unsound, insolvent borrowers. Preannounce your commitment to lend freely in all future panics. Also lend for short periods only, and have a clear, simple, certain exit strategy. The purpose is to prevent bank runs and money-stock collapses—collapses that, by reducing spending and prices, will, in the face of downward inflexibility of nominal wages, produce falls in output and employment.
In the financial crisis of 2008–09 the Federal Reserve adhered to some of the classical rules—albeit using a credit-easing rather than a money stock–protection rationale—while deviating from others. Consistent with the classicals, the Fed filled the market with liquidity while lending to a wide variety of borrowers on an extended array of assets. But it departed from the classical prescription in charging subsidy rather than penalty rates, in lending against tarnished collateral and/or purchasing assets of questionable value, in bailing out insolvent borrowers, in extending its lending deadlines beyond intervals approved by classicals, and in failing both to precommit to avert all future crises and to articulate an unambiguous exit strategy. Given that classicals demonstrated that satiating panic-induced demands for cash are sufficient to end crises, the Fed might think of abandoning its costly and arguably inessential deviations from the classical model and, instead, return to it.
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Working Paper No. 750 | January 2013
The relevant economic literature frequently focuses on the impact of credit shocks on housing prices. The doctrine of the “New Consensus Macroeconomics” completely ignores bank credit. The “Great Recession,” however, has highlighted the significance of bank credit. The purpose of this contribution is to revisit this important macroeconomic variable. We propose to endogenize the volume of bank credit by paying special attention to those variables that are related to the real estate market, which can be considered key to the evolution of bank credit. Our theoretical hypothesis is tested by means of a sample of 15 Organisation for Economic Co-operation and Development (OECD) economies from 1970 to 2011. We apply the cointegration technique for the latter purpose, which permits the modeling of the long-run equilibrium relationship and the dynamics of the short run, along with an error-correction term.
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One-Pager No. 37 | January 2013
The global financial crisis has generated renewed interest in the 1951 Treasury – Federal Reserve Accord and its lessons for central bank independence. A broader interpretation of the Accord and of Marriner S. Eccles’s role at the Federal Reserve should teach central bankers that independence can be crucial for fighting inflation, but also encourage them to be more supportive of government efforts to fight deflation and mass unemployment.
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In the Media | January 2013
Background Briefing: Ian Masters Interviews Dimitri B. Papadimitriou
January 30, 2013. Copyright © 2013 KPFK. All Rights Reserved.
Pacific Radio host Ian Masters interviews President Dimitri B. Papadimitriou about the unexpected contraction in GDP in the last quarter of 2012 and what it means for a slowing recovery—unwelcome news that might give Republican deficit hawks pause as they insist on more budget cuts. Full audio of the interview is available here. -
In the Media | January 2013
By Jon Kelly
BBC News Magazine, January 9, 2013. All Rights Reserved.
Campaigners want to prevent the US’s rising debt from bringing government spending to a halt by minting the world’s most expensive coin. Could this bizarre scheme become reality?
It sounds like the plot of some whimsical comedy‑the 1954 Gregory Peck film The Million Dollar Note springs to mind—but a drive to create super-valuable loose change is being taken seriously in the corridors of Washington DC.
A petition urging the creation of platinum coin worth $1tn (£624bn) has attracted nearly 7,000 signatures and the support of some heavyweight economists.
Experts say the plan would be lawful and should allow the government to keep spending if President Barack Obama fails to convince lawmakers to raise the “debt ceiling”—a cap, set by Congress, on the US government’s borrowing ability.
But most believe the coin is more likely to be used as a threat than ever actually come into being.
“When people first hear about it they think, ‘Oh, it’s a gimmick,’“ says L Randall Wray, professor of economics at the University of Missouri–Kansas City.
“But it makes you think harder about the way the government spends.”
The coin owes its widely discussed, though still hypothetical existence to the looming deadline over the debt ceiling—which, as things stand, will prevent the US government issuing new bonds and paying bills, in about two months.
Republicans, who control the US House of Representatives, have pledged to seek spending cuts before consenting to any increase in this limit.
But opponents fear this brinksmanship could threaten the US’s credit rating if the country’s debt reaches or breaks through this ceiling.
These mostly centre-left critics, including Democratic Congressman Jerrold Nadler, have pointed to a loophole in US law that allows the Treasury Secretary to allocate any value he or she likes to a coin.They say the Treasury could order the coin to be minted and then deposit it at the Federal Reserve, the US’s central bank.
Effectively, the coin is an accounting trick, says Cullen Roche, who blogs about finance and economics at Pragmatic Capitalism.
Its real purpose, however, would be political—to neutralise the threat by Republicans in Congress that federal employees would not be paid, he adds.
“It’s a loophole to replace something that’s totally insane with something that’s slightly less insane,” he says.
The campaign has been taken seriously by such eminent people as Nobel prize-winning economist and New York Times columnist Paul Krugman, and Philip Diehl, the former director of the United States mint. It has also inspired the Twitter hashtag, #MintTheCoin.
But it has attracted opposition, too. Republican Congressman Greg Walden has promised to introduce a bill to ban the government from creating high-value coins to pay its debts.
Walden said he feared the practice would be “very inflationary.”
Wray disagrees. “These trillion-dollar coins are held only by the Fed,” he says. “There’s no increase in the money supply out there.”
Supporters of the scheme also say the Federal Reserve could sell bonds, which would withdraw money from circulation.
As yet, however, no such coins exist anywhere. And even those who believe the plan is perfectly feasible concede that it is likely to remain a bargaining chip in the debt-ceiling talks, rather than becoming a reality.
“I think the president will be reluctant to do it because it undermines everyone’s credibility,” says Roche.
Coin collectors might be advised not to hold their breath about this new denomination turning up on eBay any time soon.Associated Program: -
In the Media | January 2013
Pacifica Radio, January 4, 2013. All Rights Reserved.
Senior Scholar L. Randall Wray talks to KPFK’s Suzi Weissman about the economic prospects waiting on the far side of the fiscal cliff. Full audio of the interview is available here.
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Working Paper No. 747 | January 2013
Lessons for Central Bank Independence
The 1951 Treasury – Federal Reserve Accord is an important milestone in central bank history. It led to a lasting separation between monetary policy and the Treasury’s debt-management powers, and established an independent central bank focused on price stability and macroeconomic stability. This paper revisits the history of the Accord and elaborates on the role played by Marriner Eccles in the events that led up to its signing. As chairman of the Fed Board of Governors since 1934, Eccles was also instrumental in drafting key banking legislation that enabled the Federal Reserve System to take on a more independent role after the Accord. The global financial crisis has generated renewed interest in the Accord and its lessons for central bank independence. The paper shows that Eccles’s support for the Accord—and central bank independence—was clearly linked to the strong inflationary pressures in the US economy at the time, but that he was as supportive of deficit financing in the 1930s. This broader interpretation of the Accord holds the key to a more balanced view of Eccles’s role at the Federal Reserve, where his contributions from the mid-1930s up to the Accord are seen as equally important. For this reason, the Accord should not be seen as the eternal beacon for central bank independence but rather as an enlightened vision for a more symmetric policy role for central banks, with equal weight on fighting inflation and preventing depressions.
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One-Pager No. 36 | January 2013
Several years before the onset of the recent financial crisis, ex – Federal Reserve Board Member Lawrence Meyer wrote that the Fed “is often called the most powerful institution in America,” its key decisions made by 19 people whose names are known by few, meeting regularly behind closed doors. Bernard Shull examines the origin and nature of Fed authority and independence, and reviews the impact of Dodd-Frank on our central bank. His conclusion? The new constraints placed on the Fed are modest at best, and its continued expansion inexorably raises questions of governance.
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Working Paper No. 746 | January 2013
A Kaleckian Perspective
This paper examines a major channel through which financialization or finance-dominated capitalism affects macroeconomic performance: the distribution channel. Empirical data for the following dimensions of redistribution in the period of finance-dominated capitalism since the early 1980s is provided for 15 advanced capitalist economies: functional distribution, personal/household distribution, and the share and composition of top incomes. Based on the Kaleckian approach to the determination of income shares, the effects of financialization on functional income distribution are studied in more detail. Some stylized facts of financialization are integrated into the Kaleckian approach, and by means of reviewing empirical and econometric literature it is found that financialization and neoliberalism have contributed to the falling labor income share since the early 1980s through three main Kaleckian channels: (1) a shift in the sectoral composition of the economy; (2) an increase in management salaries and rising profit claims of the rentiers, and thus in overheads; and (3) weakened trade union bargaining power.
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Working Paper No. 743 | December 2012
This paper provides a theoretical explanation of the accumulation process, which accounts for the developments in the financial markets over the recent past. Specifically, our approach is focused on the presence of correlations between physical and financial investment, and how the latter could affect the former. In order to achieve this objective, two assets are considered: equities and bonds. This choice permits us to account for two extreme alternative possibilities: taking risk in the short run with unknown profits, or undertaking a commitment to the long run with known yields. This proposal also accounts for the influence of the cost of external finance and the impact of financial uncertainty, as proxied by the interest rate in the former case and the exchange rate in the latter case; thereby utilizing the Keynesian notion of conventions in the determination of investment. The model thus formulated is subsequently estimated by applying the difference GMM and the system GMM in a panel of 14 OECD countries from 1970 to 2010.
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In the Media | November 2012
Interview with James K. Galbraith
The Real News Network, November 30, 2012. All Rights Reserved.
The first in a planned series of six interviews with Senior Scholar James K. Galbraith on the validity of the "fiscal cliff." Full audio and a transcript of the interview are available here.
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In the Media | November 2012
By Brian Blackstone and Harriet Torry
The Wall Street Journal, November 27, 2012. Copyright ©2012 Dow Jones & Company, Inc. All Rights Reserved.
A temporary fix to the “horrific” US federal budget deficit that fails to give businesses any clarity on tax and regulatory policy could have destructive effects on the US economy, a Federal Reserve official warned Tuesday.
US businesses are in a “defensive crouch,” Dallas Fed President Richard Fisher said in a speech to a conference sponsored by the Levy Institute. If US leaders provide only a temporary solution to the looming deadline of combined tax hikes and spending cuts, known as the fiscal cliff, “that fix may well have an effect” on the economy, Mr. Fisher said.
US tax and regulatory policies are “stuck in a pre-globalization time warp” and must be “completely rebooted,” Mr. Fisher said.
The Fed’s policy rate is near zero and in recent years officials have introduced a series of asset-purchase measures to keep long-term interest rates low, pushing the central bank’s balance sheet past $3 trillion. Mr. Fisher said inflation remains under control in the US, with underemployment and unemployment remaining a top economic concern.
“I do not believe that inflation will be the inevitable consequence” of the rapid rise of the Fed’s balance sheet, Mr. Fisher said.
Still, “we’re going to need to soon decide and signal to the markets when…the punchbowl (of ultra-accomodative monetary policy) first will be ended and then when it will be withdrawn,” he said.
The US economy has seen an uneven recovery since exiting recession in 2009 with unemployment near 8%, far above the rates associated with vibrant activity. “I’m worried about an underemployed workforce, a dispirited workforce,” Mr. Fisher said.
He noted, however, that business balance sheets are in their best shape in many years. “American businesses are ready to roll, and we want them to roll,” he said.
Mr. Fisher outlined two ways that US bond yields may rise. If inflation expectations rise, yields would increase, Mr. Fisher said, adding the Fed is guarding “ferociously” against this scenario.
The “happy” outcome, he said, is if the economy recovers and the money currently parked at the Fed is put to work in the economy. This is the scenario the Fed hopes for, he said, even if it means a loss on its holdings of debt securities.Associated Program: -
Working Paper No. 736 | November 2012
This paper argues that the usual framing of discussions of money, monetary policy, and fiscal policy plays into the hands of conservatives.That framing is also largely consistent with the conventional view of the economy and of society more generally. To put it the way that economists usually do, money “lubricates” the market mechanism—a good thing, because the conventional view of the market itself is overwhelmingly positive. Acknowledging the work of George Lakoff, this paper takes the position that we need an alternative meme, one that provides a frame that is consistent with a progressive social view if we are to be more successful in policy debates. In most cases, the progressives adopt the conservative framing and so have no chance. The paper advances an alternative framing for money and shows how it can be used to reshape discussion. The paper shows that the Modern Money Theory approach is particularly useful as a starting point for framing that emphasizes use of the monetary system as a tool to accomplish the public purpose.
It is not so much the accuracy of the conventional view of money that we need to question, but rather the framing. We need a new meme for money, one that would emphasize the social, not the individual. It would focus on the positive role played by the state, not only in the creation and evolution of money, but also in ensuring social control over money. It would explain how money helps to promote a positive relation between citizens and the state, simultaneously promoting shared values such as liberty, democracy, and responsibility. It would explain why social control over money can promote nurturing activities over the destructive impulses of our “undertakers” (Smith’s evocative term for capitalists).
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Working Paper No. 735 | November 2012
The Federal Reserve has been criticized for not preventing the risky behavior of large financial companies prior to the financial crisis of 2008–09, for approving mergers that aggravated the “too big to fail” problem, and for its substantial contribution to bailouts when their risk management failed. The Dodd-Frank Act of 2010, in attempting to diminish financial instability and eliminate too-big-to-fail policies, has established a new regulatory framework and laid out new responsibilities for the Federal Reserve. In doing so, it appears to address criticisms of the central bank by constricting its autonomy. The law, however, has also extended the Federal Reserve’s supervisory authority and expanded its capacity to exercise regulatory control over its extended domain. This new authority is in addition to the augmentation of its monetary powers over the past several years.
This paper reviews and evaluates both constraints imposed on the Federal Reserve by the Dodd-Frank Act and the expansion of Federal Reserve authority. It finds that the constraints are unlikely to have much impact, but the expansion of authority constitutes a significant increase in power and influence. The paper concludes that the expansion of Federal Reserve authority invites questions about the organizational design and governance of the central bank, and its traditional autonomy.
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Public Policy Brief No. 127 | November 2012The United States must make a fundamental choice in its economic policy in the next few months, a choice that will shape the US economy for years to come. Pundits and policymakers are divided over how to address what is widely referred to as the “fiscal cliff,” a combination of tax increases and spending cuts that will further weaken the domestic economy. Will the United States continue its current, misguided, policy of implementing European-style austerity measures, and the economic contraction that is the inevitable consequence of such policies? Or will it turn aside from the fiscal cliff, using a combination of its sovereign currency system and Keynesian fiscal policy to strengthen aggregate demand?
Our analysis presents a model of what we call the “fiscal trap”—a self-imposed spiral of economic contraction resulting from a fundamental misunderstanding of the role and function of fiscal policy in times of economic weakness. Within this framework, we begin our analysis with the disastrous results of austerity policies in the European Union (EU) and the UK. Our account of these policies and their results is meant as a cautionary tale for the United States, not as a model.
Download:Associated Program:Author(s):Related Topic(s):Budget Control Act Budget sequester Central bank policy Chartalism European Central Bank (ECB) Eurozone Eurozone debt crisis Financial fragility Fiscal austerity Fiscal cliff Fiscal trap Macroeconomic policy Metallism Tax policy US economic policyRegion(s):United States -
Press Releases | October 2012
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In the Media | October 2012
By James Rainey
Los Angeles Times, October 29, 2012. All Rights Reserved.
The idea of expansive government and greater spending to prop up a still flagging economy has gotten little support this election year.
But two economists issued a warning Monday of a renewed recession if the government continues to restrict spending — particularly with the sharp tax increases and spending cuts scheduled for early next year.
“American austerity is precisely the wrong policy at precisely the wrong time,” Dimitri B. Papadimitriou and Greg Hannsgen wrote in their paper comparing American economic strategies with those in Europe. “Austerity policies can only make a recession worse, as government layoffs and wage cuts undermine already-weak consumer demand, investment and tax revenues.”
Papadimitriou is president of the Levy Economics Institute at Bard College in New York. Hannsgen is a research scholar at the institute.
Their paper deals with conservative U.S. economic policy, in general, but specifically warns against the precipitous $500 billion in tax increases and budget cuts schedule to take effect Jan. 2. Congress and President Obama approved the actions as part of an earlier deal to raise the debt ceiling.
Both political parties in the U.S. agreed to the austerity measures. And Republican presidential nominee Mitt Romney warns against expansive spending that he says will put American on “the road to Greece.”
The two academics disagree, saying that Greece and other European nations have exacerbated their fiscal problems by clamping down on spending when their economies had already stalled. They called those actions a “fiscal trap.”
They described the trap as a "cycle that moves from a decline in demand to falling tax revenues, which in turn engender spending cuts and tax increases. Spending cuts and tax increases undercut the economy further, and the cycle continues.”
President Obama has said he is confident that he and Congress will work out a deal after next week’s election — and before the new Congress is sworn in later in January — to stave off the tax increases and cuts. But the president and congressional Republicans have disagreed on how to proceed, with Obama insisting on tax increases for the wealthiest Americans and Republicans demanding only budget cuts.
Papadimitriou and Hannsgen called for repealing the so-called budget “sequester,” without finding equivalent offsets in the federal budget. They also recommended maintaining a holiday on payroll taxes and increasing government spending “appropriately and responsibly when the economy contracts.”
Associated Program: -
In the Media | October 2012
By Brad Plumer
The Washington Post, October 22, 2012. All Rights Reserved.
Let’s assume that the United States jumps right off the fiscal cliff next year. That means all of the Bush tax cuts expire. Those big defense and domestic spending cuts from the sequester kick in. The deficit shrivels by more than $500 billion in 2013. How much damage would that inflict on the U.S. economy?
Back in August, the Congressional Budget Office predicted that the nation would endure some short-lived, relatively mild pain. The U.S. economy would go into a shallow recession in the first half of 2013 — shrinking about 0.5 percent over the year — before roaring back. According to CBO, the economy would then grow at a healthy clip of 4.3 percent per year between 2014 and 2017. And, as a bonus, America’s short-term deficit problem would mostly vanish.
That doesn’t sound too apocalyptic. But is this forecast correct? After all, over in Europe, heavy austerity appears to have crippled growth in countries like Spain and Greece. What’s more, the International Monetary Fund recently released a report conceding that tax hikes and spending cuts can inflict far more damage on weak economies than previously thought. Is it possible that CBO might be understating the damage from the fiscal cliff?
At least one group thinks so. A report (Back to Business as Usual? Or a Fiscal Boost?) earlier this year from the Levy Economics Institute called into question the CBO’s forecasts that the U.S. economy can get back to full potential by 2018 even if we go over the fiscal cliff. The authors, Dimitri Papadimitriou, Greg Hannsgen and Gennaro Zezza argue that it’s hard to make the numbers work unless you assume that U.S. households are about to go on an unprecedented borrowing binge.
The key graph from the report is below. Households, the Levy folks note, would have to carry more debt than they did at the height of the housing bubble in order for these rapid growth casts to pan out. (That’s because budget-cutting would act as a drag on the economy and exports aren’t likely to expand enough to make up the difference.)
As Walter Kurtz of Sober Look (who pointed out the Levy report) notes, this is an awfully unlikely scenario. All indications are that U.S. households are rushing to pay down their debts right now. There’s little indication that Americans are preparing to go on another massive borrowing binge. That suggests the CBO might be too sanguine about economic growth in a post-fiscal-cliff world.
So what’s the alternative? The authors of the report model three scenarios for the future course of the economy:
In Scenario 1, there’s a surge in household borrowing and spending. This is fairly unlikely. In Scenario 2, the Bush tax cuts are extended and households increase their borrowing and consumption at a slower, more realistic rate. Unemployment stays high for years to come. In Scenario 3, Congress extends the tax cuts and adds an extra bit of fiscal stimulus. Unemployment goes down a bit further, but still stays high for years to come.
According to the Levy Institute’s modeling, unemployment will likely stay elevated for a long time under any realistic scenario, fiscal cliff or no. (Though it’s worth noting that this report came out before the Federal Reserve’s latest quantitative easing program, so it’s unclear how that would factor in.) “Based on our results,” the authors write, “we surmise that it would take a much more substantial increase in fiscal stimulus to reduce unemployment to a level that most policymakers would regard as acceptable.”
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One-Pager No. 35 | October 2012Should we allow the fiscal cliff, with its across-the-board spending cuts and big tax increases that will affect almost every American, to take effect? Economists have been weighing in on such fiscal policy questions in what seems to be the most intense election-year debate in many years. To help our readers keep track of this debate, we offer a list of some of the specious arguments against fiscal stimulus and for austerity, together with our responses.Download:Associated Program:Related Topic(s):
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Conference Proceedings | September 2012
Debt, Deficits, and Financial Instability
A conference organized by the Levy Economics Institute of Bard College with support from the Ford Foundation
The 2012 Minsky conference addressed the ongoing and far-reaching effects of the global financial crisis, including the challenge to global growth represented by the eurozone debt crisis, the impact of the credit crunch on the economic and financial markets outlook, the sustainability of the US economic recovery in the absence of support from monetary and fiscal policy, reregulation of the financial system and the design of a new financial architecture, and the larger implications of the debt crisis for US economic policy—and for the international financial and monetary system as a whole.
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In the Media | September 2012
By James K. Galbraith
The Guardian (London), September 21, 2012. All Rights Reserved.
What should we make of the latest moves to kickstart the US economy, and to save the euro? As the late, great Harvard chaplain Peter Gomes said to my graduating class many years ago, about our degrees: "There is less there than meets the eye."
Quantitative easing, the third tranche of which was announced in the US last week (QE3), is just a fancy phrase for buying bonds, notably mortgage-backed-securities, in which operation the Federal Reserve takes assets from the banks and gives them cash. This tends to boost stock prices—very nice for people who own stock—and it can spur mortgage refinancing, improving the cashflow of solvent homeowners.
And the effect on the economy? Mostly indirect and quite small. People don't generally spend capital gains as windfalls. People who are already underwater on their mortgages can't refinance anyway, and are not affected.
Meanwhile, the European Central Bank is buying the dregs of the European bond market, propping up their price. The operation is similar to QE but the help for the economy is even less. Mario Draghi, the bank chief, aims to save the euro, not the eurozone; his conditions actually prevent beneficiaries from using the money they save; in fact, to get the aid they must spend less. So long as this goes on, unemployment, budget deficits and debt will get worse. It's no surprise that sensible countries refuse the deal for as long as they can.
Some people in high places—Tim Geithner, the US treasury secretary, for example—profess that restarting bank lending is the key to economic recovery, and increasing bank reserves will spur them to lend. (What else are banks really good for?) But if anyone believes that reserves are key to lending, they deeply misunderstand what banks do.
As Hyman Minsky used to say: banks are not moneylenders! Banks don't lend reserves, and they don't need reserves in order to lend. Banks create money by lending. They need a client willing to borrow, a project worth lending to, and collateral to protect against risk. If these are lacking, no amount of reserves will turn the trick. And especially not when the government is willing to pay interest on their reserves: the truest form of welfare, income for doing nothing.
Among the deluded in this matter are Republican members of Congress who rushed to attack QE3 for overstimulating, and urge laws constraining the Federal Reserve to a single price stability objective, in the manner of the European Central Bank. Obviously if the policy won't work—and it won't—they have nothing to fear on inflation. But a "price stability only" mandate for the Fed would destroy the honest accountability of the central bank to Congress.
The Fed today operates under a "dual mandate"—full employment and price stability. The law, originally known as the Humphrey-Hawkins Act of 1978, is one for which I drafted the monetary sections. It states a range of economic objectives and was deliberately kept general; the purpose was not to dictate economic theory but to foster an honest dialogue between the Fed and Congress over what monetary policy is and does.
Changing to a price-stability objective would oblige Ben Bernanke, the Fed chairman, to claim, as ECB officials do, that he is motivated solely by his charter, even if obviously doing something else. And Congress, having imposed the price-stability straitjacket, would not be able to complain about unemployment, foreclosures or anything else. The Fed-Congress dialogue would be reduced to a tissue of ritual incantation and lies.
What we need is a candid review of what central banks cannot do. Yes, they can usually forestall panic. Yes, they can keep zombie banks alive. No, they cannot bring on economic recovery or solve any of our deeper economic problems, from unemployment and foreclosures in America to unemployment and economic collapse in Greece. The sooner we stop thinking of central bankers as wizards and magicians, the better.
James K. Galbraith teaches at the University of Texas at Austin. His new book is Inequality and Instability, a Study of the World Economy Just Before the Great Crisis.
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Press Releases | September 2012
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In the Media | September 2012
By Rosalyn Retkwa
Institutional Investor, September 5, 2012. © 2012 Institutional Investor, Inc. All material subject to strictly enforced copyright laws.
To Federal Reserve watchers, “Jackson Hole”—shorthand for the annual summit of central bankers hosted by the Kansas City Fed in Jackson Hole, Wyoming, in late August—is widely anticipated for the speaker who kicks off the proceedings, Federal Reserve chairman Ben Bernanke.
This year, Bernanke’s speech didn’t contain any market-moving surprises.
But another paper, delivered by Michael Woodford, a professor of political economy at Columbia University, caused a stir. In a 97-page study, Woodford maintained that with interest rates near zero, the time had come for the Fed to take a fresh approach in its efforts to stimulate the economy and reduce unemployment by targeting growth in nominal gross domestic product (GDP) as its key indicator of when it should reverse course and start raising interest rates. The Fed has already promised to keep rates low through 2014, but if it were to switch gears, it would instead promise to keep rates low indefinitely, until nominal GDP, or GDP adjusted for inflation, was showing clear signs of a recovery.
“The thing that the central bank should wish to signal is not a commitment to keep interest rates low for a fixed calendar period, but rather a commitment to maintain policy accommodation until the nominal GDP target path is reached,” Woodford said.
It’s not a new concept. Last October Goldman Sachs published a paper titled: “The Case for a Nominal GDP Level Target,” and right before Jackson Hole, Goldman said that moving to that target would be one of the ways in which the Fed could “open the door to ‘unconventional unconventional’ easing . . . until the economy has regained a bigger share of the lost output and/or employment.” (The Fed’s balance sheet/asset purchase policies are already considered unconventional.) But the fact that a paper of that heft from a monetary policy expert like Woodford was delivered in a forum like Jackson Hole may indicate that the concept is starting to gain ground.
It’s not without its problems, notes Roberto Perli, managing director and partner, policy research, at the International Strategy and Investment Group (ISI) of Washington, D.C.
Perli, who worked on monetary policy in different capacities for the Fed for eight years before joining ISI in 2010, says that targeting nominal GDP “is an attractive idea from an academic perspective,” but in practice, has a few issues. “For example,” he says, “targeting a nominal GDP level would essentially mean creating inflation if real output growth remained stubbornly low as it is today. In that case, can policymakers be sure that inflation expectations would remain as stable as they remain in academic models?”
There’s another set of obvious questions, he says. “What exactly is an appropriate nominal GDP target—4 percent, 5 percent, 6 percent? How would the Fed pick one? How much inflation would a central bank be willing to tolerate to achieve that? Nobody knows,” he says, but he notes that inflation “is already close to the Fed’s 2 percent target,” the level it sees as being “compatible with the dual mandate of maximum employment and price stability.”
Perli believes the Fed could move in that direction “without actually going there,” by promising “not to tighten policy even after the economy has begun its recovery.” He believes the Fed has already done that “in a sort of timid fashion.” In the minutes of the last Federal Open Market Committee (FOMC) meeting, the Fed said its guidance about it not raising rates until late 2014 “could be extended,” and that, combined with other language in the minutes to the effect that “a highly accommodative stance” was “likely to be maintained even as the recovery progressed,” suggests that the Fed “is likely to move somewhat in the direction suggested by Woodford at Jackson Hole, but in a cautious way that would leave many outs should inflation become a concern,” Perli says.
Dimitri Papadimitriou, the president of the Levy Economics Institute of Bard College in Annandale-on-Hudson, New York, is also wondering how the Fed would put a strategy of targeting nominal GDP into practice. “How do you do this?” he asks. “There is no reliable transmission channel from monetary policy to GDP. The evidence is clear about that,” he says. Still, Papadimitriou says, “Woodford’s long paper is interesting, and he is right about the ineffectiveness of monetary policy at zero-bound interest rates.”
Tearing apart the Fed’s current policies is a big part of Woodford’s 97 pages, but it looks to be a sure thing that the Fed is going to go for more quantitative easing, either at its next FOMC meeting in September, and if not then, by its last meeting of the year, in December.
“Nothing in chairman Bernanke’s published remarks at Jackson Hole altered our view that the FOMC is poised to announce a new balance-sheet program on September 13,” says Lou Crandall, the chief economist at Wrightson ICAP in Jersey City, New Jersey, adding that “we don’t think this is a particularly close call,” though there’s still a chance that stronger-than-expected economic indicators “could delay the announcement,” he said.
“The FOMC policy statement on August 1 indicated that the decision on further easing was being fast-tracked, and the minutes of that meeting two weeks later warned that additional action would be called for unless incoming information pointed to ‘a substantial and sustainable strengthening’ in economic activity,” he said, in his post-Jackson Hole report.
But Crandall also believes “the Fed’s next bond-buying program will be its last.” Noting that the Fed has itself acknowledged the “risk of diminishing returns” from each additional round of buying long-dated bonds to bring down interest rates, known as LSAP, or Large-Scale Asset Purchases, Crandall says: “There will be no ‘QE4,’” or fourth round of quantitative easing. “A skeptical public will increasingly ask whether the Fed is throwing good money after bad,” he said.
He does believe, though, that “the Fed may embrace the idea of switching to an open-ended format for its asset purchases,” and “is likely to alter the format of its forward policy guidance to lessen the reliance on specific calendar references.”
In his speech at Jackson Hole, towards the end of his remarks, Bernanke said: “The stagnation of the labor market in particular is a grave concern not only because of the enormous suffering and waste of human talent it entails, but also because persistently high levels of unemployment will wreak structural damage on our economy that could last for many years.”
Given Bernanke’s “grave concern” about unemployment, all of the economists seem to be sure Bernanke will press forward with more easing, even if some members of the FOMC are opposed.
“He will, I think, proceed with another bond-purchasing program, if there is no improvement in GDP growth and decrease in unemployment,” says Papadimitriou, noting that monetary policy won’t solve the unemployment problem. “It is only fiscal policy that is potent to improve economic conditions,” he says. But Bernanke, “being a student of the Great Depression,” doesn’t want to be blamed for not doing everything he could possibly do to lower unemployment, he says.
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Working Paper No. 730 | August 2012
Market economies and command economies have long been differentiated by the presence of alternative choice in the form of diversity. Yet most mainstream economic theory is premised on the existence of uniformity. This paper develops the implications of this contradiction for the theory of prices, income creation, and the analysis of the recent financial crisis, and provides a critique of traditional theory from an institutionalist perspective developed by J. Fagg Foster.
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In the Media | August 2012
Interview with Jan Kregel
Money Radio, August 27, 2012. © 2012 CRC Broadcasting Company. All Rights Reserved.
Senior Scholar Jan Kregel talks about the LIBOR scandal and the impracticality of regulating banks that are “too big to fail” in this radio interview. Full audio is available here.
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In the Media | August 2012
By Chris Gay
U.S. News and World Report, August 27, 2012. Copyright © 2012 U.S. News & World Report LP. All rights reserved.
Until about 25 years ago, when elders spoke in solemn tones about “the Great Crash,” there was never any doubt about which crash they meant. For nearly six decades, there was only one Great Crash worthy of the name, and its memory forever blemishes 1929, not to mention a certain Mr. Hoover.
Then came Black Monday, 1987. Suddenly, if you were of certain age, ahem, you took pains to distinguish which crash you were talking about.
Things got even more complicated with the Asian contagion of 1997, and the Long-Term Capital Management scare of 1998, and the dot-com plunge of 2000, and the near-death experience of 2008. And how can we forget the Flash Crash of 2010? Wasn’t that some ride?
But wait. This sort of blood-curdling free-fall is supposed to be a once-in-a-lifetime event, like the transit of Venus or a federal budget surplus. How is it that someone who was in high school when Justin Bieber was in Pampers has already experienced half a dozen of them? Either we need to redefine “crash” or someone owes you some lifetimes.
If you’re starting to suspect that something’s amiss, Hyman Minsky is way ahead of you. Alas, he’s also dead, but while alive (1919–96) and teaching economics at Washington University in St. Louis, among other venues, he developed a theory about how financial panics happen. His Financial Instability Hypothesis describes a process by which the normal, profit-maximizing behavior of borrowers and lenders leads inevitably to crisis. (If you’re interested, the New Yorker’s John Cassidy does a wonderful job of explaining Minsky on his blog and in his superb book, How Markets Fail.)
The panic is usually preceded by what has come to be known as a “Minsky moment”—the point when a critical mass of investors realizes that the overleveraged party is about to end, so they flee for the door—ensuring, of course, that the party ends. Market outcomes are often self-fulfilling.
But what’s really interesting—and most important—is how the party gets going in the first place. Minsky held that what appear to be periods of stability are actually just lulls between storms. All the while stock prices are rising at some modest, sustainable-looking pace, and interest rates are hovering around some reasonable long-term average, the Masters of the Universe are back in the kitchen cooking up the next crisis.
Not because they are evil, but because they are rational, in an Adam Smith sort of way. In a period of modest returns, investors look for higher yield, which they’re more likely to get the more they can leverage (i.e., borrow). Creditors, happily obliging, scramble to outcompete each other by lowering lending standards or inventing exotic new realms of financial risk (think “synthetic CDOs”). That fuels more buying, turning a normal economy into a bubble economy through a self-reinforcing dynamic that leads inevitably to the Minsky Moment.
“The first theorem of the financial instability hypothesis is that the economy has financing regimes under which it is stable, and financing regimes in which it is unstable,” wrote Minsky in a 1992 paper. “The second theorem of the financial instability hypothesis is that over periods of prolonged prosperity, the economy transits from financial relations that make for a stable system to financial relations that make for an unstable system.”
In short, says Minsky, financial systems do not tend, like some immutable law of physics, toward equilibrium. They tend toward instability. If so, expecting financial markets to self-moderate without the occasional meltdown is a bit like handing your 16-year-old a six-pack and the keys to the car. He might come home just fine, but it’s not a prudent expectation.
To be sure, Minsky has his detractors. While many economists have discovered or grown more interested in Minsky following the subprime disaster, others dismiss him. “You have to understand that to really take Minsky’s ideas on board, you have to be willing to surrender some of the precepts of equilibrium economics, which is the sine qua non of most mainstream approaches,” says Gary Dymski, a professor of economics at the University of California–Riverside. “And this, most economists still are not prepared to do. Minsky is still a bridge too far for most.”
A critical difference between Minsky and other scholars of market extremes is that Minsky is not primarily concerned with market manias. “In Minsky, everything that’s being done can be completely rational,” says L. Randall Wray, a University of Missouri–Kansas City professor who studied under Minsky in the 1980s. “Everyone is profit-maximizing, innovating, working to get around regulations and supervision.”
What’s more, Minsky contended, extremes in financial markets are not just occasional and incidental; they are inevitable. “That’s what economics has persistently and consistently gotten wrong,” says Wray. “Their belief is that market forces are stabilizing, and Minsky’s argument is that market forces are destabilizing because normal profit-seeking behavior is what leads to this fragile position.”
That financial markets are inherently destabilizing is worrying enough. Mix in a political culture that says the best regulation is no regulation, and the 16-year-old doesn’t even need a license. In the United States, many argue, the abdication of regulatory authority and the “financialization” of the economy in recent decades explains the frequency of market extremes in the past generation.
One telling metric: The financial industry accounted for about 3 percent of GDP in 1960, but about 8 percent in 2008. For the lurid details of getting to 8 percent from 3 percent, Cooper Union professor Jeff Madrick’s Age of Greed is a good place to start.
Meantime, unless Congress decides to reign in the financial industry like it did in the 1930s, there’s no reason not to expect more portfolio chills and thrills during your investing lifetime than your grandparents expected in theirs.
To put it another way: You, Dodd-Frank, are no Glass-Steagall.
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Public Policy Brief No. 125 | August 2012
No Solution for Financial Reform
Before the law has even been fully implemented, the inadequacies of the regulatory approach underlying the Dodd-Frank Act are becoming more and more apparent. Financial scandal by financial scandal, the realization is hardening that there is a pressing need to search for more robust regulatory alternatives.
The real challenge for financial reform is to develop a vision for a financial structure that would simplify the system and the activities of financial institutions so that they can be regulated and supervised effectively. Some paths to such simplification, however, are not worth treading. Against the backdrop of renewed present-day interest in the Depression-era “Chicago Plan,” featuring 100 percent reserve backing for deposits, Senior Scholar Jan Kregel turns to Hyman Minsky’s consideration of a similar “narrow banking” proposal in the mid-1990s. For reasons that eventually led Minsky himself to abandon the proposal, as well as reasons developed here by Kregel that have even more pressing relevance in today’s political climate, plans for a narrow banking system are found wanting.Download:Associated Program:Author(s):Jan KregelRelated Topic(s): -
In the Media | August 2012
By Jonathan Camhi
Bank Systems Technology, August 23, 2012. Copyright © 2012 UBM TechWeb. All Rights Reserved.
The LIBOR scandal clearly indicates that banks have grown too large to effectively regulate, a new study by Bard College’s Levy Economics Institute claims. The report emphasizes the need for structural changes to the banks and rejects the idea that a failure by Bank of England officials and regulators to respond to alerts of LIBOR’s manipulation are at fault for the scandal, a statement from the institute said.
The Levy Institute’s Senior Scholar Jan Kregel, who authored the report, titled “The LIBOR Scandal: The Fix Is In—The Bank of England Did It,” compared the scandal with JPMorgan’s trading losses fiasco earlier this year. Kregel said that in both cases the response has been to point the finger at individuals involved instead of looking at any institutional changes that need to be made to the big banks. “The rotten apples have been removed without anyone noticing that it is the barrel that is the cause of the problem,” Kregel wrote.
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Policy Note 2012/9 | August 2012
The Fix Is In—the Bank of England Did It!
As the results of the various official investigations spread, it becomes more and more apparent that a large majority of financial institutions engaged in fraudulent manipulation of the benchmark London Interbank Offered Rate (LIBOR) to their own advantage, and that bank management and regulators were unable to effectively monitor the activity of institutions because they were too big to manage and too big to regulate. However, instead of drawing the obvious conclusion—that structural changes are needed to reduce banks to a size that can be effectively regulated, as proposed on numerous occasions by the Levy Economics Institute—discussion in the media and political circles has turned to whether the problem was the result of the failure of central bank officials and government regulators to respond to repeated suggestions of manipulation, and to stop the fraudulent behavior.
Just as the “hedging” losses at JPMorgan Chase have been characterized as the result of misbehavior on the part of some misguided individual traders, leaving top bank management without culpability, politicians and the media are now questioning whether government officials condoned, or even encouraged, manipulation of the LIBOR rate, virtually ignoring the banks’ blatant abuse of principles of good banking practice. Just as in the case of JPMorgan, the only response has been to remove the responsible individuals, rather than questioning the structure and size of the financial institutions that made managing and policing this activity so difficult. Again, the rotten apples have been removed without anyone noticing that it is the barrel that is the cause of the problem. But in the current scandal, the ad hominem culpability has been extended to central bank officials in the UK and the United States.
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In the Media | July 2012
By Dimitri B. Papadimitriou
Huffington Post Business, July 22, 2012. © 2012 TheHuffingtonPost.com, Inc. "The Huffington Post” is a registered trademark of TheHuffingtonPost.com, Inc. All rights reserved.
There's a sad truth about the fate of financial regulation: It's almost certain to be outmoded by the time it's introduced. This was as true of Glass-Steagall in 1933 as it is of Dodd-Frank today.
This month we begin the third year since the Dodd-Frank Wall Street reform act passed, with the struggle over its shape ongoing. It's a still-unmolded toddler, and already on the fast track to fossilization. Does the most ambitious finance legislation in decades carry the DNA to successfully cope with the next crisis? In a word, no.
The take-away from this challenge doesn't have to be cynicism, inaction, or laissez-faire tirades. To be ready for the next shock rather than the last one, though, we need to reset our thinking.
Dodd-Frank is based on the idea that financial markets are normally stable, with the exception of the occasional alarming "event." The New Deal's Glass-Steagall Act and the Clinton-era Gramm-Leach-Bliley "Modernization" shared those assumptions. All of these efforts were conceived as system-wide overhauls. In reality, though, they were designed only to remedy random, ad hoc crises; shocks like the 2008 meltdown, sometimes called "Minsky Moments."
Ironically, the late economist Hyman Minsky actually believed that these "moments" were anything but. At the Levy Institute, we share his view that instability is central to the genome of modern finance.
In other words, it's normal for the boat to keep rocking. The increasingly risky practices that fuel danger and instability are still being rewarded, and the absence of penalties for losses continues. The shocks will keep coming.
And each new threat to stability is destined to be different than the last. Dodd-Frank aims to identify the most vulnerable institutions and practices. That approach is too brittle to contain the disastrous effects of risks that are always morphing. Even constructive aspects of the Act could have perverse consequences, unless the rules are subject to sophisticated re-examination as the finance world develops.
Banks carry an urge -- maybe it's a genetic imperative? -- to evolve in a way that maximizes revenue. We're always witnessing how quickly markets create newer, riskier, and more profitable instruments. Credit default swaps aren't the only example, of course; look at the whole range of off-balance-sheet special purpose vehicles. It's the very nature of modern finance to transform its structure in response to the prevailing regulation, and to evade it successfully.
Under Dodd-Frank, banks will function more-or-less as they did in the past.
Their enormous size and multi-function operations -- the business model that underlies the latest crisis -- will be subject only to a series of cosmetic changes. The act's most significant measure, the Volcker Rule, continues to be diluted, and many of its other regulations are tied up in delays.
Instead of fundamental changes that would cushion our fragile system from shocks, Dodd-Frank's centerpiece is a limit on the use of public funds to rescue failing banks. By enabling rapid dissolutions, it aims to avoid a repeat of 2008, when the Lehman Brothers bankruptcy virtually froze capital markets. It's also an understandable response to TARP, which recapitalized insolvent financial institutions at a great cost, while allowing failing households to fall into foreclosure.
But limiting taxpayer exposure to the next bank breakdown is not the same as preventing a system-wide collapse. Tweaks to Dodd-Frank aren't a solution. Glass-Steagall contained features worth preserving, but reviving the law -- outdated then; infeasible now -- won't help. Neither will blaming Gramm-Leach-Bliley which, profound as it was, merely reflected the new status quo of its day. It institutionalized the changes that had already emerged in the markets.
We need banks that can earn competitive rates of return while they focus not on big risks, but on financing capital development. Reforms that promote enterprise and industry over speculation will have to be as innovative, flexible, opportunistic and plastic as the markets they aim to improve.
Regulators could begin by breaking banks down into smaller units. A bank holding company structure with numerous types of subsidiaries, each one subject to strict limitations on the type of permitted activities, would be a valuable deterrent to risky behavior. Restrictions on size and function would allow a reasonable shot at understanding esoteric subsidiaries, and a chance to react quickly to mutations.
As Dodd-Frank reaches its second anniversary, it faces both the limitations of its scope and the disheartening obstacles to its implementation. Will we really wait for the next, inevitable crisis before we start to develop adaptable reforms? In a word, probably.
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In the Media | June 2012
In audio clips from a forthcoming interview, Senior Scholar Jan Kregel argues that, to address the current crisis, there is a need for regulations that place limits on the activities of financial institutions. The market does not adjust by itself, says Kregel—it needs rules to function efficiently. Radio Audizioni Italiane. Clip 1. Clip 2.
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Policy Note 2012/6 | June 2012
What a Hedge Gone Awry at JPMorgan Chase Tells Us about What's Wrong with Dodd-Frank
What can we learn from JPMorgan Chase’s recent self-proclaimed “stupidity” in attempting to hedge the bank’s global risk position? Clearly, the description of the bank’s trading as “sloppy” and reflecting ”bad judgment” was designed to prevent the press reports of large losses from being used to justify the introduction of more stringent regulation of large, multifunction financial institutions. But the lessons to be drawn are not to be found in the specifics of the hedges that were put on to protect the bank from an anticipated decline in the value of its corporate bond holdings, or in any of its other global portfolio hedging activities. The first lesson is this: despite their acumen in avoiding the worst excesses of the subprime crisis, the bank’s top managers did not have a good idea of its exposure, which serves as evidence that the bank was “too big to manage.” And if it was too big to manage, it was clearly too big to regulate effectively.
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Press Releases | May 2012
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Working Paper No. 724 | May 2012
This paper surveys the context and contours of contemporary Post-Keynesian Institutionalism (PKI). It begins by reviewing recent criticism of conventional economics by prominent economists as well as examining, within the current context, important research that paved the way for PKI. It then sketches essential elements of PKI—drawing heavily on the contributions of Hyman Minsky—and identifies directions for future research. Although there is much room for further development, PKI offers a promising starting point for economics after the Great Recession.
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Working Paper No. 720 | May 2012
A FAVAR Model for Greece and Ireland
This paper examines the underlying dynamics of selected euro-area sovereign bonds by employing a factor-augmenting vector autoregressive (FAVAR) model for the first time in the literature. This methodology allows for identifying the underlying transmission mechanisms of several factors; in particular, market liquidity and credit risk. Departing from the classical structural vector autoregressive (VAR) models, it allows us to relax limitations regarding the choice of variables that could drive spreads and credit default swaps (CDSs) of euro-area sovereign debts. The results show that liquidity, credit risk, and flight to quality drive both spreads and CDSs of five years’ maturity over swaps for Greece and Ireland in recent years. Greece, in particular, is facing an elastic demand for its sovereign bonds that further stretches liquidity. Moreover, in current illiquid market conditions spreads will continue to follow a steep upward trend, with certain adverse financial stability implications. In addition, we observe a negative feedback effect from counterparty credit risk.
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One-Pager No. 30 | May 2012
Hyman Minsky had particular views about how the regulatory system and financial architecture should be reformulated, and one of the many lessons we can learn from his work is that there is an intimate connection between how we think about the prospect of financial market instability and how we approach financial regulation. Regulation cannot be effective if it is simply based on “piecemeal” measures produced in response to the current “moment,” Minsky wrote. It needs to reformulate the structure of the financial system itself.
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Working Paper No. 717 | May 2012
This paper integrates the various strands of an alternative, heterodox view on the origins of money and the development of the modern financial system in a manner that is consistent with the findings of historians and anthropologists. As is well known, the orthodox story of money’s origins and evolution begins with the creation of a medium of exchange to reduce the costs of barter. To be sure, the history of money is “lost in the mists of time,” as money’s invention probably predates writing. Further, the history of money is contentious. And, finally, even orthodox economists would reject the Robinson Crusoe story and the evolution from a commodity money through to modern fiat money as historically accurate. Rather, the story told about the origins and evolution of money is designed to shed light on the “nature” of money. The orthodox story draws attention to money as a transactions-cost-minimizing medium of exchange.
Heterodox economists reject the formalist methodology adopted by orthodox economists in favor of a substantivist methodology. In the formalist methodology, the economist begins with the “rational” economic agent facing scarce resources and unlimited wants. Since the formalist methodology abstracts from historical and institutional detail, it must be applicable to all human societies. Heterodoxy argues that economics has to do with a study of the institutionalized interactions among humans and between humans and nature. The economy is a component of culture; or, more specifically, of the material life process of society. As such, substantivist economics cannot abstract from the institutions that help to shape economic processes; and the substantivistproblem is not the formal one of choice, but a problem concerning production and distribution.
A powerful critique of the orthodox story regarding money can be developed using the findings of comparative anthropology, comparative history, and comparative economics. Given the embedded nature of economic phenomenon in prior societies, an understanding of what money is and what it does in capitalist societies is essential to this approach. This can then be contrasted with the functioning of precapitalist societies in order to allow identification of which types of precapitalist societies would use money and what money would be used for in these societies. This understanding is essential for informed speculation on the origins of money. The comparative approach used by heterodox economists begins with an understanding of the role money plays in capitalist economies, which shares essential features with analyses developed by a wide range of Institutionalist, Keynesian, Post Keynesian, and Marxist macroeconomists. This paper uses the understanding developed by comparative anthropology and comparative history of precapitalist societies in order to logically reconstruct the origins of money.
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Working Paper No. 716 | April 2012
A Minskyan Approach
This paper presents a method to capture the growth of financial fragility within a country and across countries. This is done by focusing on housing finance in the United States, the United Kingdom, and France. Following the theoretical framework developed by Hyman P. Minsky, the paper focuses on the risk of amplification of shock via a debt deflation instead of the risk of a shock per se. Thus, instead of focusing on credit risk, for example, financial fragility is defined in relation to the means used to service debts, given credit risk and all other sources of shocks. The greater the expected reliance on capital gains and debt refinancing to meet debt commitments, the greater the financial fragility, and so the higher the risk of debt deflation induced by a shock if no government intervention occurs. In the context of housing finance, this implies that the growth of subprime lending was not by itself a source of financial fragility; instead, it was the change in the underwriting methods in all sectors of the mortgage markets that created a financial situation favorable to the emergence of a debt deflation. Stated alternatively, when nonprime and prime mortgage lending moved to asset-based lending instead of income-based lending, the financial fragility of the economy grew rapidly.
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Working Paper No. 714 | April 2012
China and India
The narrative as well as the analysis of global imbalances in the existing literature are incomplete without the part of the story that relates to the surge in capital flows experienced by the emerging economies. Such analysis disregards the implications of capital flows on their domestic economies, especially in terms of the “impossibility” of following a monetary policy that benefits domestic growth. It also fails to recognize the significance of uncertainty and changes in expectation as factors in the (precautionary) buildup of large official reserves. The consequences are many, and affect the fabric of growth and distribution in these economies. The recent experiences of China and India, with their deregulated financial sectors, bear this out.
Financial integration and free capital mobility, which are supposed to generate growth with stability (according to the “efficient markets” hypothesis), have not only failed to achieve their promises (especially in the advanced economies) but also forced the high-growth developing economies like India and China into a state of compliance, where domestic goals of stability and development are sacrificed in order to attain the globally sanctioned norm of free capital flows.
With the global financial crisis and the specter of recession haunting most advanced economies, the high-growth economies in Asia have drawn much less attention than they deserve. This oversight leaves the analysis incomplete, not only by missing an important link in the prevailing network of global trade and finance, but also by ignoring the structural changes in these developing economies—many of which are related to the pattern of financialization and turbulence in the advanced economies.
Download:Associated Program(s):Author(s):Related Topic(s):Capital mobility Current account imbalances Efficient markets Impossible trinity Monetary policy National autonomy Official reservesRegion(s):Asia -
In the Media | April 2012
By Michael Hudson
Naked Capitalism, April 22, 2012. Copyright © 2006, 2007, 2008, 2009, 2010, 2011 Aurora Advisors Incorporated. All Rights Reserved.
Research Associate Michael Hudson looks at the disconnect between the enormous productivity gains in the postwar era and the failed promise of a leisure economy. The full post is available here.
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Book Series | April 2012This eBook traces the roots of the 2008 financial meltdown to the structural and regulatory changes leading from the 1933 Glass-Steagall Act to the 1999 Financial Services Modernization Act, and on through to the subprime-triggered crash. It evaluates the regulatory reactions to the global financial crisis—most notably, the 2010 Dodd-Frank Act—and, with the help of Minsky’s work, sketches a way forward in terms of stabilizing the financial system and providing for the capital development of the economy.
The book explains how money manager capitalism set the stage for the outbreak of the systemic crisis and debt deflation through which we are still living. And it explains that, despite calls for a return to Glass-Steagall, we cannot turn back the clock. Minsky’s blueprint for a more stable structure is smaller banks and the restoration of relationship banking. Modifying and extending his idea for creating a bank holding company would preserve some of the features of Glass-Steagall.Download:Associated Program:Related Topic(s):Bank resolution Commercial banking Credit default swaps Dodd-Frank Financial fragility Financial Modernization Act Financial Stability Oversight Council (FSOC) Glass-Steagall Act Hyman Minsky Investment banking Minsky moment Monetary production Money manager capitalism Mortgage banking Regulatory reform Relationship banking Securitization Shadow banking Volcker rule -
Research Project Reports | April 2012This monograph is part of the Institute’s research program on Financial Instability and the Reregulation of Financial Institutions and Markets, funded by the Ford Foundation. Its purpose is to investigate the causes and development of the recent financial crisis from the point of view of the late financial economist and Levy Distinguished Scholar Hyman Minsky, and to propose “a thorough, integrated approach to our economic problems.”
The monograph draws on Minsky’s work on financial regulation to assess the efficacy of the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010, enacted in response to the 2008 subprime crisis and subsequent deep recession. Some two years after its adoption, the implementation of Dodd-Frank is still far from complete. And despite the fact that a principal objective of this legislation was to remove the threat of taxpayer bailouts for banks deemed “too big to fail,” the financial system is now more concentrated than ever and the largest banks even larger. As economic recovery seems somewhat more assured and most financial institutions have regrouped sufficiently to repay the governmental support they received, the specific rules and regulations required to make Dodd-Frank operational are facing increasing resistance from both the financial services industry and from within the US judicial system.
This suggests that the Dodd-Frank legislation may be too extensive, too complicated, and too concerned with eliminating past abuses to ever be fully implemented, much less met with compliance. Indeed, it has been called a veritable paradise for regulatory arbitrage. The result has been a call for a more fundamental review of the extant financial legislation, with some suggesting a return to a regulatory framework closer to Glass-Steagall’s separation of institutions by function—a cornerstone of Minsky’s extensive work on regulation in the 1990s. For Minsky, the goal of any systemic reform was to ensure that the basic objectives of the financial system—to support the capital development of the economy and to provide a safe and secure payments system—were met. Whether the Dodd-Frank Act can fulfill this aspect of its brief remains an open question.
Download:Associated Program:Related Topic(s):Commercial banking Dodd-Frank Financial crisis Financial fragility Financial instability Financial regulation Financial regulatory reform Glass-Steagall Act Global financial crisis Hyman Minsky Investment banking Liquidity Monetary policy Money manager capitalism Regulatory reform Securitization Shadow banking Subprime mortgage crisis Too big to fail (TBTF) -
Research Project Reports | April 2012This monograph is part of the Levy Institute’s Research and Policy Dialogue Project on Improving Governance of the Government Safety Net in Financial Crisis, a two-year project funded by the Ford Foundation.
In the current financial crisis, the United States has relied on two primary methods of extending the government safety net: a stimulus package approved and budgeted by Congress, and a massive and unprecedented response by the Federal Reserve in the fulfillment of its lender-of-last-resort function. This monograph examines the benefits and drawbacks of each method, focusing on questions of accountability, democratic governance and transparency, and mission consistency. The aim is to explore the possibility of reform that would place more responsibility for provision of a safety net on Congress, with a smaller role to be played by the Fed, not only enhancing accountability but also allowing the Fed to focus more closely on its proper mission.
Download:Associated Program:Author(s):Related Topic(s):Commercial banking Deregulation Dodd-Frank Federal Reserve Financial governance Financial instability Financial Stability Oversight Council (FSOC) Glass-Steagall Act Global financial crisis Hyman Minsky Investment banking Lender of last resort (LOLR) Monetary policy Securitization Self-supervision Social safety net Subprime mortgage crisis Too big to fail (TBTF) -
Public Policy Brief No. 123 | April 2012
The extraordinary scope and magnitude of the financial crisis of 2007–09 required an extraordinary response by the Federal Reserve in the fulfillment of its lender-of-last-resort (LOLR) function. In an attempt to stabilize financial markets during the worst financial crisis since the Great Crash of 1929, the Fed engaged in loans, guarantees, and outright purchases of financial assets that were not only unprecedented, but cumulatively amounted to over twice current US GDP as well. the purpose of this brief is to provide a descriptive account of the Fed's response to the recent crisis—to delineate the essential characteristics and logistical specifics of the veritable "alphabet soup" of LOLR machinery rolled out to save the world financial system. It represents the most comprehensive investigation of the raw data to date, one that draws on three discrete measures: the peak outstanding commitment at a given point in time; the total peak flow of commitments (loans plus asset purchases), which helps identify periods of maximum financial system distress; and, finally, the total amouunt of loans and asset purchases made between January 2007 and March 2012. This third number, which is a cumulative measure, reveals that the total Fed response exceeded $29 trillion. Providing this account from such varying angles is a necessary first step in any attempt to fully understand the actions of the central bank in this critical period—and a prerequisite for thinking about how to shape policy for future crises.
Download:Associated Program:Author(s):James Andrew FelkersonRelated Topic(s):Central bank policy Federal Reserve Financial governance Global financial crisis Lender of last resort (LOLR)Region(s):United States -
Working Paper No. 713 | April 2012
A Reinterpretation of Henry Simons’s “Rules versus Authorities in Monetary Policy"
Henry Simons’s 1936 article “Rules versus Authorities in Monetary Policy” is a classical reference in the literature on central bank independence and rule-based policy. A closer reading of the article reveals a more nuanced policy prescription, with significant emphasis on the need to control short-term borrowing; bank credit is seen as highly unstable, and price level controls, in Simons’s view, are not be possible without limiting banks’ ability to create money by extending loans. These elements of Simons’s theory of money form the basis for Hyman P. Minsky’s financial instability hypothesis. This should not come as a surprise, as Simons was Minsky’s teacher at the University of Chicago in the late 1930s. I review the similarities between their theories of financial instability and the relevance of their work for the current discussion of macroprudential tools and the conduct of monetary policy. According to Minsky and Simons, control of finance is a prerequisite for successful monetary policy and economic stabilization.
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In the Media | April 2012
James K. Galbraith
The Real News Network, April 5, 2012. All original content copyright © The Real News Network.
In an interview with TRNN’s Paul Jay, Senior Scholar James K. Galbraith offers a solution to boosting demand: raise the minimum wage. Full video and a transcript of the interview are available here.
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Working Paper No. 712 | April 2012
How to Achieve a Better Balance between Global and Official Liquidity
Global liquidity provision is highly procyclical. The recent financial crisis has resulted in a flight to safety, with severe strains in key funding markets leading central banks to employ highly unconventional policies to avoid a systemic meltdown. Bagehot’s advice to “lend freely at high rates against good collateral” has been stretched to the limit in order to meet the liquidity needs of dysfunctional financial markets. As the eligibility criteria for central bank borrowing have been tweaked, it is legitimate to ask, How elastic should the supply of central bank currency be?
Even when the central bank has the ability to create abundant official liquidity, there should be some limits to its support for the financial sector. Traditionally, the misuse of the fiat money privilege has been limited by self-imposed rules that central bank loans must be fully backed by gold or collateralized in some other way. But since the onset of the crisis, we have seen how this constraint has been relaxed to accommodate the demand for market support. My suggestion is that there has to be some upper limit, and that we should work hard to find guidelines and policies that can limit the need for central bank liquidity support in future crises.
In this paper, I review the recent expansion of central bank liquidity support during the crisis, before discussing the collateral polices related to central banks’ lender-of-last-resort and market-maker-of-last-resort policies and their rationale. I then examine the relationship between the central bank and the treasury, and the potential threat to central bank independence if they venture into too much risky balance sheet expansion. A discussion about the exceptional growth of the shadow banking system follows. I introduce the concept of “liquidity illusion” to describe the fragility upon which much of the sector is based, and note that market growth has been based largely on a “fair-weather” view that central banks will support the market on rainy days. I argue that we need a better theoretical framework to understand the growth in the shadow banking system and the role of central banks in providing liquidity in a crisis.
Recently, the concept of “endogenous finance” has been used to explain the strong procyclical tendencies of the global financial system. I show that this concept was central to Hyman P. Minsky’s theory of financial instability, and suggest that his insights should be integrated into the ongoing search for a better theoretical framework for understanding the growth of the shadow banking system and how we can limit official liquidity support for this system. I end the paper with a summary and a discussion of some of the policy issues. I note that the Basel III “package” will hopefully reduce the need for central bank liquidity support in the future, but suggest that further structural reforms of the financial sector are needed to ease the tension between freewheeling private credit expansion and the limited ability or willingness of central banks to provide unlimited official liquidity support in a future crisis.
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Working Paper No. 711 | March 2012
A Minskyan Interpretation of the Causes, the Fed’s Bailout, and the Future
This paper provides a quick review of the causes of the Global Financial Crisis that began in 2007. There were many contributing factors, but among the most important were rising inequality and stagnant incomes for most American workers, growing private sector debt in the United States and many other countries, financialization of the global economy (itself a very complex process), deregulation and desupervision of financial institutions, and overly tight fiscal policy in many nations. The analysis adopts the “stages” approach developed by Hyman P. Minsky, according to which a gradual transformation of the economy over the postwar period has in many ways reproduced the conditions that led to the Great Depression. The paper then moves on to an examination of the US government’s bailout of the global financial system. While other governments played a role, the US Treasury and the Federal Reserve assumed much of the responsibility for the bailout. A detailed examination of the Fed’s response shows how unprecedented—and possibly illegal—was its extension of the government’s “safety net” to the biggest financial institutions. The paper closes with an assessment of the problems the bailout itself poses for the future.
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Working Paper No. 710 | March 2012
A Historic Monetary Policy Pivot Point and Moment of (Relative) Clarity
Not since the Great Depression have monetary policy matters and institutions weighed so heavily in commercial, financial, and political arenas. Apart from the eurozone crisis and global monetary policy issues, for nearly two years all else has counted for little more than noise on a relative risk basis.
In major developed economies, a hypermature secular decline in interest rates is pancaking against a hard, roughly zero lower-rate bound (i.e., barring imposition of rather extreme policies such as a tax on cash holdings, which could conceivably drive rates deeply negative). Relentlessly mounting aggregate debt loads are rendering monetary- and fiscal policy–impaired governments and segments of society insolvent and struggling to escape liquidity quicksands and stubbornly low or negative growth and employment trends.
At the center of the current crisis is the European Monetary Union (EMU)—a monetary union lacking fiscal and political integration. Such partial integration limits policy alternatives relative to either full federal integration of member-states or no integration at all. As we have witnessed since spring 2008, this operationally constrained middle ground progressively magnifies economic divergence and political and social discord across member-states.
Given the scale and scope of the eurozone crisis, policy and actions taken (or not taken) by the European Central Bank (ECB) meaningfully impact markets large and small, and ripple with force through every major monetary policy domain. History, for the moment, has rendered the ECB the world’s most important monetary policy pivot point.
Since November 2011, the ECB has taken on an arguably activist liquidity-provider role relative to private banks (and, in some important measure, indirectly to sovereigns) while maintaining its long-held post as rhetorical promoter of staunch fiscal discipline relative to sovereignty-encased “peripheral” states lacking full monetary and fiscal integration. In December 2011, the ECB made clear its intention to inject massive liquidity when faced with crises of scale in future. Already demonstratively disposed toward easing due to conditions on their respective domestic fronts, other major central banks have mobilized since the third quarter of 2011. The collective global central banking policy posture has thus become more homogenized, synchronized, and directionally clear than at any time since early 2009.
Download:Associated Program(s):Author(s):Robert DuboisRelated Topic(s):Basel III Credit default swaps Debt monetization Deleveraging Economic and Monetary Union (EMU) European Central Bank (ECB) Eurozone debt crisis Fiscal policy Liquidity Long-term refinancing operations (LTRO) Monetary policyRegion(s):Europe -
In the Media | March 2012
By Michael Hudson
Naked Capitalism, February 28, 2012. Copyright © 2006, 2007, 2008, 2009, 2010, 2011 Aurora Advisors Incorporated. All Rights Reserved.
I have just returned from Rimini, Italy, where I experienced one of the most amazing spectacles of my academic life. Four of us associated with the University of Missouri at Kansas City (UMKC) were invited to lecture for three days on Modern Monetary Theory (MMT) and explain why Europe is in such monetary trouble today—and to show that there is an alternative, that the enforced austerity for the 99% and vast wealth grab by the 1% is not a force of nature.
Stephanie Kelton (incoming UMKC Economics Dept. chair and editor of its economic blog, New Economic Perspectives), criminologist and law professor Bill Black, investment banker Marshall Auerback and me (along with a French economist, Alain Parquez) stepped into the basketball auditorium on Friday night. We walked down, and down, and further down the central aisle, past a packed audience reported as over 2,100. It was like entering the Oscars as People called out our first names. Some told us they had read all of our economics blogs. Stephanie joked that now she knew how The Beatles felt. There was prolonged applause—all for an intellectual rather than a physical sporting event.
With one difference, of course: Our adversaries were not there. There was much press, but the prevailing Euro-technocrats (the bank lobbyists who determine European economic policy) hoped that the less discussion of possible alternatives to austerity, the easier it would be to force their brutal financial grab through.
All the audience members had contributed to raise the funds to fly us over from the United States (and from France for Alain), and treat us to Federico Fellini’s Grand Hotel on the Rimini beach. The conference was organized by reporter Paolo Barnard, who had studied MMT with Randall Wray and realized that there was plenty of demand in Italian mass culture for a discussion of what actually was determining the living conditions of Europe—and the emerging financial elite that hopes to use this crisis as an opportunity to become the new financial lords carving out fiefdoms by privatizing the public domain being sold off by governments that have no central bank to finance their deficits, and are tragically beholden to bondholders and to Eurocrats drawn from the neoliberal camp.
Paolo and his enormous support staff of translators and interns provided an opportunity to hear an approach to monetary and tax theory and policy that until recently was almost unheard of in the United States. Just one week earlier the Washington Post published a review of MMT, followed by a long discussion in the Financial Times. But the theory remains grounded primarily at the UMKC’s economics department and the Levy Institute at Bard College, with which most of us are associated.
The basic thrust of our argument is that just as commercial banks create credit electronically on their computer keyboards (creating a bank account credit for borrowers in exchange for their signing an IOU at interest), governments can create money. There is no need to borrow from banks, as computer keyboards provide nearly free credit creation to finance spending.
The difference, of course, is that governments spend money (at least in principle) to promote long-term growth and employment, to invest in public infrastructure, research and development, provide health care and other basic economic functions. Banks have a more short-term time frame. They lend credit against collateral in place. Some 80% of bank loans are mortgages against real estate. Other loans are made to finance leveraged buyouts and corporate takeovers. But most new fixed capital investment by corporations is financed out of retained earnings.
Unfortunately, the flow of earnings is now being diverted increasingly to the financial sector—not only to pay interest and penalties to banks, but for stock buybacks intended to support stock prices and hence the value of stock options that managers of today’s financialized companies give themselves. As for the stock market—which textbook diagrams still depict as raising money for new capital investment—it has been turned into a vehicle to buy out companies on credit (e.g., with high interest junk bonds) and replace equity with debt. Inasmuch as interest payments are tax-deductible, as if they were a necessary cost of doing business, corporate income-tax payments lowered. And what the tax collector relinquishes is available to be paid out to the bankers and bondholders who get rich by loading the economy down with debt.
Welcome to the post-industrial economy, financialized style. Industrial capitalism has passed into a series of stages of finance capitalism, from the Bubble Economy to the Negative Equity stage, foreclosure time, debt deflation, austerity—and what looks like debt peonage in Europe, above all for the PIIGS: Portugal, Ireland, Italy, Greece and Spain. (The Baltic countries of Latvia, Estonia and Lithuania already have been plunged so deeply into debt that their populations are emigrating to find work and flee debt-burdened real estate. The same has plagued Iceland since its bank rip-offs collapsed in 2008.)
Why aren’t economists describing this phenomenon? The answer is a combination of political ideology and analytic blinders. As soon as the Rimini conference ended on Sunday evening, for instance, Paul Krugman’s Monday, February 27 New York Times column, “What Ails Europe?” blamed the euro’s problems simply on the inability of countries to devalue their currencies. He rightly criticized the Republican party line that blames European welfare spending for the Eurozone’s problems, and also criticizing putting the blame on budget deficits.
But he left out of account the straitjacket of the European Central Bank (ECB) unable to monetize the deficits, as a result of junk economics written into the EU constitution.
If the peripheral nations still had their own currencies, they could and would use devaluation to quickly restore competitiveness. But they don’t, which means that they are in for a long period of mass unemployment and slow, grinding deflation. Their debt crises are mainly a byproduct of this sad prospect, because depressed economies lead to budget deficits and deflation magnifies the burden of debt.
Depreciation would lower the price of labor while raising the price of imports. The burden of debts denominated in foreign currencies would increase in keeping with the devaluation, thereby creating problems unless the government passed a law re-denominating all debts in domestic currency. This would satisfy the Prime Directive of international financing: always denominated debts in your own currency, as the United States does.
In 1933, Franklin Roosevelt nullified the Gold Clause in U.S. loan contracts, enabling banks and other creditors to be paid in the equivalent gold value. But in his usual neoclassical fashion, Mr. Krugman ignores the debt issue:
The afflicted nations, in particular, have nothing but bad choices: either they suffer the pains of deflation or they take the drastic step of leaving the euro, which won’t be politically feasible until or unless all else fails (a point Greece seems to be approaching). Germany could help by reversing its own austerity policies and accepting higher inflation, but it won’t.
But leaving the euro is not sufficient to avert austerity, foreclosure and debt deflation if the nation that withdraws retains the neoliberal policy that plagues the euro. Suppose the post-euro economy has a central bank that still refuses to finance public budget deficits, forcing the government to borrow from commercial banks and bondholders? Suppose the government believes that it should balance the budget rather than provide the economy with spending power to increase its growth?
Suppose the government slashes public welfare spending, or bails out banks for their losses, or takes losing bank gambles onto the public balance sheet, as Ireland has done? Or for that matter, what if the governments do not write down real estate mortgages and other debts to the debtors’ ability to pay, as Iceland has failed to do? The result will still be debt deflation, forfeiture of property, unemployment—and a rising tide of emigration as the domestic economy and employment opportunities shrink.
So what then is the key? It is to have a central bank that does what central banks were founded to do: monetize government budget deficits so as to spend money into the economy, in a way best intended to promote economic growth and full employment.
This was the MMT message that the five of us were invited to explain to the audience in Rimini. Some attendees came up and explained that they had come all the way from Spain, others from France and cities across Italy. And although we did many press, radio and TV interviews, we were told that the major media were directed to ignore us as not politically correct.
Such is the censorial spirit of neoliberal monetary austerity. Its motto is TINA: There Is No Alternative, and it wants to keep matters this way. As long as it can suppress discussion of how many better alternatives there are, the hope is that the public will remain acquiescent as their living standards shrink and wealth is sucked up to the top of the economic pyramid to the 1%.
The audience requested above all more theory from Stephanie Kelton, who gave the clearest lecture on economics I had ever heard—a Euclidean presentation of MMT logic. For a visual of the magnitude, see http://www.youtube.com/watch?v=XP60tpwu5cs. At the end, we felt like concert performers.
The size of the audience filling the sports stadium to hear our economic explanation of how a real central bank should operate to avoid austerity and promote rather than discourage employment showed that the government’s attempt to brainwash the population was not working. It was not working any better than Harvard’s Economics 101 class, from which students walked out in protest against the unrealistic parallel universe thinking whose only appeal is to Aspergers Syndrome sufferers who are selected as useful idiots to train to draw pictures of the economy that exclude analysis of the debt overhead, rentier free lunches and financial parasitism. -
Working Paper No. 709 | February 2012
Motives, Countermeasures, and the Dodd-Frank Response
Government forbearance, support, and bailouts of banks and other financial institutions deemed “too big to fail” (TBTF) are widely recognized as encouraging large companies to take excessive risk, placing smaller ones at a competitive disadvantage and influencing banks in general to grow inefficiently to a “protected” size and complexity. During periods of financial stress, with bailouts under way, government officials have promised “never again.” During periods of financial stability and economic growth, they have sanctioned large-bank growth by merger and ignored the ongoing competitive imbalance.
Repeated efforts to do away with TBTF practices over the last several decades have been unsuccessful. Congress has typically found the underlying problem to be inadequate regulation and/or supervision that has permitted important financial companies to undertake excessive risk. It has responded by strengthening regulation and supervision. Others have located the underlying problem in inadequate regulators, suggesting the need for modifying the incentives that motivate their behavior. A third explanation is that TBTF practices reflect the government’s perception that large financial firms serve a public interest—they constitute a “national resource” to be preserved. In this case, a structural solution would be necessary. Breakups of the largest financial firms would distribute the “public interest” among a larger group than the handful that currently hold a disproportionate concentration of financial resources.
The Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 constitutes the most recent effort to eliminate TBTF practices. Its principal focus is on the extension and augmentation of regulation and supervision, which it envisions as preventing excessive risk taking by large financial companies; Congress has again found the cause for TBTF practices in the inadequacy of regulation and supervision. There is no indication that Congress has given any credence to the contention that regulatory motivations have been at fault. Finally, Dodd-Frank eschews a structural solution, leaving the largest financial companies intact and bank regulatory agencies still with extensive discretion in passing on large bank mergers. As a result, the elimination of TBTF will remain problematic for years to come.
Download:Associated Program:Author(s):Bernard ShullRelated Topic(s): -
In the Media | February 2012
By Dylan Matthews
The Washington Post, February 19, 2012. © 1996–2012 The Washington Post
About 11 years ago, James K. “Jamie” Galbraith recalls, hundreds of his fellow economists laughed at him. To his face. In the White House.
A discounted poster presenting US dollars bills in circulation is seen in the visitor center of the Bureau of Engraving and Printing in Washington on August 09, 2011. It was April 2000, and Galbraith had been invited by President Bill Clinton to speak on a panel about the budget surplus. Galbraith was a logical choice. A public policy professor at the University of Texas and former head economist for the Joint Economic Committee, he wrote frequently for the press and testified before Congress.
What’s more, his father, John Kenneth Galbraith, was the most famous economist of his generation: a Harvard professor, best-selling author and confidante of the Kennedy family. Jamie has embraced a role as protector and promoter of the elder’s legacy.
But if Galbraith stood out on the panel, it was because of his offbeat message. Most viewed the budget surplus as opportune: a chance to pay down the national debt, cut taxes, shore up entitlements or pursue new spending programs.
He viewed it as a danger: If the government is running a surplus, money is accruing in government coffers rather than in the hands of ordinary people and companies, where it might be spent and help the economy.
“I said economists used to understand that the running of a surplus was fiscal (economic) drag,” he said, “and with 250 economists, they giggled.”
Galbraith says the 2001 recession—which followed a few years of surpluses—proves he was right.
A decade later, as the soaring federal budget deficit has sharpened political and economic differences in Washington, Galbraith is mostly concerned about the dangers of keeping it too small. He’s a key figure in a core debate among economists about whether deficits are important and in what way. The issue has divided the nation’s best-known economists and inspired pockets of passion in academic circles. Any embrace by policymakers of one view or the other could affect everything from employment to the price of goods to the tax code.
In contrast to “deficit hawks” who want spending cuts and revenue increases now in order to temper the deficit, and “deficit doves” who want to hold off on austerity measures until the economy has recovered, Galbraith is a deficit owl. Owls certainly don’t think we need to balance the budget soon. Indeed, they don’t concede we need to balance it at all. Owls see government spending that leads to deficits as integral to economic growth, even in good times.
The term isn’t Galbraith’s. It was coined by Stephanie Kelton, a professor at the University of Missouri at Kansas City, who with Galbraith is part of a small group of economists who have concluded that everyone—members of Congress, think tank denizens, the entire mainstream of the economics profession—has misunderstood how the government interacts with the economy. If their theory—dubbed “Modern Monetary Theory” or MMT—is right, then everything we thought we knew about the budget, taxes and the Federal Reserve is wrong.
Keynesian roots
“Modern Monetary Theory” was coined by Bill Mitchell, an Australian economist and prominent proponent, but its roots are much older. The term is a reference to John Maynard Keynes, the founder of modern macroeconomics. In “A Treatise on Money,” Keynes asserted that “all modern States” have had the ability to decide what is money and what is not for at least 4,000 years.
This claim, that money is a “creature of the state,” is central to the theory. In a “fiat money” system like the one in place in the United States, all money is ultimately created by the government, which prints it and puts it into circulation. Consequently, the thinking goes, the government can never run out of money. It can always make more.
This doesn’t mean that taxes are unnecessary. Taxes, in fact, are key to making the whole system work. The need to pay taxes compels people to use the currency printed by the government. Taxes are also sometimes necessary to prevent the economy from overheating. If consumer demand outpaces the supply of available goods, prices will jump, resulting in inflation (where prices rise even as buying power falls). In this case, taxes can tamp down spending and keep prices low.
But if the theory is correct, there is no reason the amount of money the government takes in needs to match up with the amount it spends. Indeed, its followers call for massive tax cuts and deficit spending during recessions.
Warren Mosler, a hedge fund manager who lives in Saint Croix in the U.S. Virgin Islands—in part because of the tax benefits—is one proponent. He’s perhaps better know for his sports car company and his frequent gadfly political campaigns (he earned a little less than one percent of the vote as an independent in Connecticut’s 2010 Senate race). He supports suspending the payroll tax that finances the Social Security trust fund and providing an $8 an hour government job to anyone who wants one to combat the current downturn.
The theory’s followers come mainly from a couple of institutions: the University of Missouri-Kansas City’s economics department and the Levy Economics Institute of Bard College, both of which have received money from Mosler. But the movement is gaining followers quickly, largely through an explosion of economics blogs. Naked Capitalism, an irreverent and passionately written blog on finance and economics with nearly a million monthly readers, features proponents such as Kelton, fellow Missouri professor L. Randall Wray and Wartberg College professor Scott Fullwiler. So does New Deal 2.0, a wonky economics blog based at the liberal Roosevelt Institute think tank.
Their followers have taken to the theory with great enthusiasm and pile into the comment sections of mainstream economics bloggers when they take on the theory. Wray’s work has been picked up by Firedoglake, a major liberal blog, and the New York Times op-ed page. “The crisis helped, but the thing that did it was the blogosphere,” Wray says. “Because, for one thing, we could get it published. It’s very hard to publish anything that sounds outside the mainstream in the journals.”
Most notably, Galbraith has spread the message everywhere from the Daily Beast to Congress. He advised lawmakers including then-House Speaker Nancy Pelosi (D-Calif.) when the financial crisis hit in 2008. Last summer he consulted with a group of House members on the debt ceiling negotiations. He was one of the handful of economists consulted by the Obama administration as it was designing the stimulus package. “I think Jamie has the most to lose by taking this position,” Kelton says. “It was, I think, a really brave thing to do, because he has such a big name, and he’s so well-respected.”
Wray and others say they, too, have consulted with policymakers, and there is a definite sense among the group that the theory’s time is now. “Our Web presence, every few months or so it goes up another notch,” Fullwiler says.
A divisive theory
The idea that deficit spending can help to bring an economy out of recession is an old one. It was a key point in Keynes’s “The General Theory of Employment, Interest and Money.” It was the chief rationale for the 2009 stimulus package, and many self-identified Keynesians, such as former White House adviser Christina Romer and economist Paul Krugman, have argued that more is in order. There are, of course, detractors.
A key split among Keynesians dates to the 1930s. One set of economists, including the Nobel laureates John Hicks and Paul Samuelson, sought to incorporate Keynes’s insights into classical economics. Hicks built a mathematical model summarizing Keynes’s theory, and Samuelson sought to wed Keynesian macroeconomics (which studies the behavior of the economy as a whole) to conventional microeconomics (which looks at how people and businesses allocate resources). This set the stage for most macroeconomic theory since. Even today, “New Keynesians,” such as Greg Mankiw, a Harvard economist who served as chief economic adviser to George W. Bush, and Romer’s husband, David, are seeking ways to ground Keynesian macroeconomic theory in the micro-level behavior of businesses and consumers.
Modern Monetary theorists hold fast to the tradition established by “post-Keynesians” such as Joan Robinson, Nicholas Kaldor and Hyman Minsky, who insisted Samuelson’s theory failed because its models acted as if, in Galbraith’s words, “the banking sector doesn’t exist.”
The connections are personal as well. Wray’s doctoral dissertation was advised by Minsky, and Galbraith studied with Robinson and Kaldor at the University of Cambridge. He argues that the theory is part of an “alternative tradition, which runs through Keynes and my father and Minsky.”
And while Modern Monetary Theory’s proponents take Keynes as their starting point and advocate aggressive deficit spending during recessions, they’re not that type of Keynesians. Even mainstream economists who argue for more deficit spending are reluctant to accept the central tenets of Modern Monetary Theory. Take Krugman, who regularly engages economists across the spectrum in spirited debate. He has argued that pursuing large budget deficits during boom times can lead to hyperinflation. Mankiw concedes the theory’s point that the government can never run out of money but doesn’t think this means what its proponents think it does.
Technically it’s true, he says, that the government could print streams of money and never default. The risk is that it could trigger a very high rate of inflation. This would “bankrupt much of the banking system,” he says. “Default, painful as it would be, might be a better option.”
Mankiw’s critique goes to the heart of the debate about Modern Monetary Theory—and about how, when and even whether to eliminate our current deficits.
When the government deficit spends, it issues bonds to be bought on the open market. If its debt load grows too large, mainstream economists say, bond purchasers will demand higher interest rates, and the government will have to pay more in interest payments, which in turn adds to the debt load.
To get out of this cycle, the Fed—which manages the nation’s money supply and credit and sits at the center of its financial system—could buy the bonds at lower rates, bypassing the private market. The Fed is prohibited from buying bonds directly from the Treasury—a legal rather than economic constraint. But the Fed would buy the bonds with money it prints, which means the money supply would increase. With it, inflation would rise, and so would the prospects of hyperinflation.
“You can’t just fund any level of government that you want from spending money, because you’ll get runaway inflation and eventually the rate of inflation will increase faster than the rate that you’re extracting resources from the economy,” says Karl Smith, an economist at the University of North Carolina. “This is the classic hyperinflation problem that happened in Zimbabwe and the Weimar Republic.”
The risk of inflation keeps most mainstream economists and policymakers on the same page about deficits: In the medium term—all else being equal—it’s critical to keep them small.
Economists in the Modern Monetary camp concede that deficits can sometimes lead to inflation. But they argue that this can only happen when the economy is at full employment—when all who are able and willing to work are employed and no resources (labor, capital, etc.) are idle. No modern example of this problem comes to mind, Galbraith says.
“The last time we had what could be plausibly called a demand-driven, serious inflation problem was probably World War I,” Galbraith says. “It’s been a long time since this hypothetical possibility has actually been observed, and it was observed only under conditions that will never be repeated.”
Critics’ rebuttals
According to Galbraith and the others, monetary policy as currently conducted by the Fed does not work. The Fed generally uses one of two levers to increase growth and employment. It can lower short-term interest rates by buying up short-term government bonds on the open market. If short-term rates are near-zero, as they are now, the Fed can try “quantitative easing,” or large-scale purchases of assets (such as bonds) from the private sector including longer-term Treasuries using money the Fed creates. This is what the Fed did in 2008 and 2010, in an emergency effort to boost the economy.
According to Modern Monetary Theory, the Fed buying up Treasuries is just, in Galbraith’s words, a “bookkeeping operation” that does not add income to American households and thus cannot be inflationary.
“It seemed clear to me that . . . flooding the economy with money by buying up government bonds . . . is not going to change anybody’s behavior,” Galbraith says. “They would just end up with cash reserves which would sit idle in the banking system, and that is exactly what in fact happened.”
The theorists just “have no idea how quantitative easing works,” says Joe Gagnon, an economist at the Peterson Institute who managed the Fed’s first round of quantitative easing in 2008. Even if the money the Fed uses to buy bonds stays in bank reserves—or money that’s held in reserve—increasing those reserves should still lead to increased borrowing and ripple throughout the system.
Mainstreamers are equally baffled by another claim of the theory: that budget surpluses in and of themselves are bad for the economy. According to Modern Monetary Theory, when the government runs a surplus, it is a net saver, which means that the private sector is a net debtor. The government is, in effect, “taking money from private pockets and forcing them to make that up by going deeper into debt,” Galbraith says, reiterating his White House comments.
The mainstream crowd finds this argument as funny now as they did when Galbraith presented it to Clinton. “I have two words to answer that: Australia and Canada,” Gagnon says. “If Jamie Galbraith would look them up, he would see immediate proof he’s wrong. Australia has had a long-running budget surplus now, they actually have no national debt whatsoever, they’re the fastest-growing, healthiest economy in the world.” Canada, similarly, has run consistent surpluses while achieving high growth.
To even care about such questions, Galbraith says, marked him as “a considerable eccentric” when he arrived from Cambridge to get a PhD at Yale, which had a more conventionally Keynesian economics department. Galbraith credits Samuelson and his allies’ success to a “mass-marketing of economic doctrine, of which Samuelson was the great master . . . which is something the Cambridge school could never have done.”
The mainstream economists are loath to give up any ground, even in cases such as the so-called “Cambridge capital controversy” of the 1960s. Samuelson debated post-Keynesians and, by his own admission, lost. Such matters have been, in Galbraith’s words, “airbrushed, like Trotsky” from the history of economics.
But MMT’s own relationship to real-world cases can be a little hit-or-miss. Mosler, the hedge fund manager, credits his role in the movement to an epiphany in the early 1990s, when markets grew concerned that Italy was about to default. Mosler figured that Italy, which at that time still issued its own currency, the lira, could not default as long as it had the ability to print more liras. He bet accordingly, and when Italy did not default, he made a tidy sum. “There was an enormous amount of money to be made if you could bring yourself around to the idea that they couldn’t default,” he says.
Later that decade, he learned there was also a lot of money to be lost. When similar fears surfaced about Russia, he again bet against default. Despite having its own currency, Russia defaulted, forcing Mosler to liquidate one of his funds and wiping out much of his $850 million in investments in the country. Mosler credits this to Russia’s fixed exchange rate policy of the time and insists that if it had only acted like a country with its own currency, default could have been avoided.
But the case could also prove what critics insist: Default, while technically always avoidable, is sometimes the best available option.Associated Program: -
Working Paper No. 704 | January 2012
A Dissenting View
It is commonplace to link neoclassical economics to 18th- or 19th-century physics and its notion of equilibrium, of a pendulum once disturbed eventually coming to rest. Likewise, an economy subjected to an exogenous shock seeks equilibrium through the stabilizing market forces unleashed by the invisible hand. The metaphor can be applied to virtually every sphere of economics: from micro markets for fish that are traded spot, to macro markets for something called labor, and on to complex financial markets in synthetic collateralized debt obligations—CDOs. Guided by invisible hands, supplies balance demands and markets clear. Armed with metaphors from physics, the economist has no problem at all extending the analysis across international borders to traded commodities, to what are euphemistically called capital flows, and on to currencies themselves. Certainly there is a price, somewhere, somehow, that will balance supply and demand. The orthodox economist is sure that if we just get the government out of the way, the market will do the dirty work. The heterodox economist? Well, she is less sure. The market might not work. It needs a bit of coaxing. Imbalances can persist. Market forces can be rather impotent. The visible hand of government can hasten the move toward balance.
Orthodox economists as well as most heterodox economists see the Global Financial Crisis as a consequence of domestic and global imbalances. The most common story blames the US Federal Reserve for excessive monetary ease that spurred borrowing, and the US fiscal and trade imbalances for a surplus of liquidity sloshing around global financial markets. Looking to the specific problems in Euroland, the imbalances are attributed to profligate Mediterraneans. The solution is to restore global balance, which requires some combination of higher exchange rates for the Chinese, reduction of US trade deficits, and Teutonic fiscal discipline in the United States, the UK, and Japan, as well as on the periphery of Europe.
This paper takes an alternative view, following the sectoral balances approach of Wynne Godley, combined with the modern money theory (MMT) approach derived from the work of Innes, Knapp, Keynes, Lerner, and Minsky. The problem is not one of financial imbalance, but rather one of an imbalance of power. There is too much power in the hands of the financial sector, money managers, the predator state, and Europe’s center. There is too much privatization and pursuit of the private purpose, and too little use of government to serve the public interest. In short, there is too much neoliberalism and too little democracy, transparency, and accountability of government.
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Working Paper No. 700 | December 2011
This paper takes off from Jan Kregel’s paper “Shylock and Hamlet, or Are There Bulls and Bears in the Circuit?” (1986), which aimed to remedy shortcomings in most expositions of the “circuit approach.” While some “circuitistes” have rejected John Maynard Keynes’s liquidity preference theory, Kregel argued that such rejection leaves the relation between money and capital asset prices, and thus investment theory, hanging. This paper extends Kregel’s analysis to an examination of the role that banks play in the circuit, and argues that banks should be modeled as active rather than passive players. This also requires an extension of the circuit theory of money, along the lines of the credit and state money approaches of modern Chartalists who follow A. Mitchell Innes. Further, we need to take Charles Goodhart’s argument about default seriously: agents in the circuit are heterogeneous credit risks. The paper concludes with links to the work of French circuitist Alain Parguez.
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One-Pager No. 23 | December 2011
The extraordinary scope and magnitude of the financial crisis of 2007–09 induced an extraordinary response by the Federal Reserve in the fulfillment of its lender-of-last-resort function. Estimates of the total amount of bailout funding provided by the Fed have ranged from its own lowball claim of $1.2 trillion to Bloomberg’s estimate of $7.7 trillion (just for the biggest banks) to the GAO tally of $16 trillion. But new research conducted as part of a Ford Foundation project directed by Senior Scholar L. Randall Wray finds that the Fed’s commitments—in the form of loans and asset purchases to prop up the global financial system—far exceeded even the highest estimates.
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Working Paper No. 698 | December 2011
There have been a number of estimates of the total amount of funding provided by the Federal Reserve to bail out the financial system. For example, Bloomberg recently claimed that the cumulative commitment by the Fed (this includes asset purchases plus lending) was $7.77 trillion. As part of the Ford Foundation project “A Research and Policy Dialogue Project on Improving Governance of the Government Safety Net in Financial Crisis,” Nicola Matthews and James Felkerson have undertaken an examination of the data on the Fed’s bailout of the financial system—the most comprehensive investigation of the raw data to date. This working paper is the first in a series that will report the results of this investigation.
The purpose of this paper is to provide a descriptive account of the Fed’s extraordinary response to the recent financial crisis. It begins with a brief summary of the methodology, then outlines the unconventional facilities and programs aimed at stabilizing the existing financial structure. The paper concludes with a summary of the scope and magnitude of the Fed’s crisis response. The bottom line: a Federal Reserve bailout commitment in excess of $29 trillion.
Download:Associated Program:Author(s):James Andrew FelkersonRelated Topic(s):Agency Mortgage-backed Securities (MBS) Purchase Program AIG Revolving Credit Facility AIG Securities Borrowing Facility Asset-backed Commercial Paper Money Market Mutual Fund Liquidity Facility (AMLF) Bailouts Central bank liquidity swaps Commercial Paper Funding Facility (CPFF) Global financial crisis Lender of last resort (LOLR) Maiden Lane Primary Dealer Credit Facility (PDCF) Single-tranche open market operations Term Asset-backed Securities Loan Facility (TALF) Term Auction Facility (TAF) Term Securities Lending Facility (TSLF) Term Securities Lending Facility Options Program (TOP) -
Policy Note 2011/6 | November 2011Although it didn't originate with an economist, the malaprop “It’s déjà vu all over again” is invariably what springs to mind in the aftermath of virtually any euro summit of the past few years, all of which seem to end with the requisite promise of a so-called “final solution” to the problems posed by the increasingly problematic currency union. But it’s hard to get excited about any of the “solutions” on offer, since they steadfastly refuse to acknowledge that the eurozone’s problem is fundamentally one of flawed financial architecture. Today’s crisis has arisen because the creation of the euro has robbed nations of their sovereign ability to engage in a fiscal counterresponse against sudden external demand shocks of the kind we experienced in 2008. And it is being exacerbated by the ongoing reluctance of the European Union, European Central Bank, and International Monetary Fund—the “troika”—to abandon fiscal austerity as a quid pro quo for backstopping these nations’ bonds.
Download:Associated Program(s):Author(s):Related Topic(s):Bond buy-back Central bank policy Euro European Central Bank (ECB) Eurozone Eurozone debt crisis Fiscal austerity TroikaRegion(s):Europe -
Conference Proceedings | November 2011
Financial Reform and the Real Economy
A conference organized by the Levy Economics Institute of Bard College with support from the
.
This year’s Minsky conference marks the Levy Institute’s 25 anniversary, and the third year of the Ford–Levy joint initiative on reforming global financial governance. This initiative aims to examine financial instability and reregulation within the theoretical framework of Minsky’s work on financial crises. Minsky was convinced that a program of financial reform must be based on a critique of the existing system that identifies not only what went wrong, but also why it happened. Speakers addressed the ongoing effects of the global financial crisis on the real economy, and examined proposed as well as recently enacted policy responses. Should ending too-big-to-fail be the cornerstone of reform? Do the markets’ pursuit of self-interest generate real societal benefits? Is financial sector growth actually good for the real economy? Will the recently passed US financial reform bill make the entire financial system, not only the banks, safer?Download:Associated Program(s):Region(s):United States -
Working Paper No. 695 | November 2011
Explosion in the 1990s versus Implosion in the 2000s
Orthodox and heterodox theories of financial crises are hereby compared from a theoretical viewpoint, with emphasis on their genesis. The former view (represented by the fourth-generation models of Paul Krugman) reflects the neoclassical vision whereby turbulence is an exception; the latter insight (represented by the theories of Hyman P. Minsky) validates and extends John Maynard Keynes’s vision, since it is related to a modern financial world. The result of this theoretical exercise is that Minsky’s vision represents a superior explanation of financial crises and current events in financial systems because it considers the causes of financial crises as endogenous to the system. Crucial facts in relevant financial crises are mentioned in section 1, as an introduction; the orthodox models of financial crises are described in section 2; the heterodox models of financial crises are outlined in section 3; the main similarities and differences between orthodox and heterodox models of financial crises are identified in section 4; and conclusions based on the information provided by the previous section are outlined in section 5. References are listed at the end of the paper.
Download:Associated Program(s):Author(s):Jesús MuñozRelated Topic(s):Asset bubbles Financial crisis Financial fragility Hyman Minsky John Maynard Keynes Paul Krugman Speculative financeRegion(s):United States -
One-Pager No. 16 | October 2011
The American Jobs Act now before Congress relies largely on a policy of aggregate demand management, or “pump priming”: injecting demand into a frail economy in hopes of boosting growth and lowering unemployment. But this strategy, while beneficial in setting a floor beneath economic collapse, fails to produce and maintain full employment, while doing little to address income inequality. The alternative? Fiscal policy that directly targets unemployment by providing paid work to all those willing to do their part.
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Public Policy Brief No. 120 | October 2011
The Minskyan Lessons We Failed to Learn
Senior Scholar L. Randall Wray lays out the numerous and critical ways in which we have failed to learn from the latest global financial crisis, and identifies the underlying trends and structural vulnerabilities that make it likely a new crisis is right around the corner. Wray also suggests some policy changes that would shore up the financial system while reinvigorating the real economy, including the clear separation of commercial and investment banking, and a universal job guarantee.
Download:Associated Program:Author(s):Related Topic(s):Commercial banking Control fraud Employer of Last Resort (ELR) policy Employment guarantee Financial instability Financialization Full employment policy Global financial crisis Hyman Minsky Investment banking Monetary policy Money manager capitalism Securitization Shadow banking Subprime mortgage crisis -
Working Paper No. 685 | September 2011
The main purpose of this study is to explore the potential expansionary effect stemming from the monetization of debt. We develop a simple macroeconomic model with Keynesian features and four sectors: creditor households, debtor households, businesses, and the public sector. We show that such expansionary effect stems mainly from a reduction in the financial cost of servicing the public debt. The efficacy of the channel that allegedly operates through the compression of the risk/term premium on securities is found to be ambiguous. Finally, we show that a country that issues its own currency can avoid becoming stuck in a structural “liquidity trap,” provided its central bank is willing to monetize the debt created by a strong enough fiscal expansion.
Download:Associated Program:Author(s):Alfonso Palacio-VeraRelated Topic(s): -
Working Paper No. 684 | September 2011
This paper reviews the key insights of Hyman P. Minsky in arguing why finance cannot be left to free markets, drawing on the East Asian development experience. The paper suggests that Minsky’s more complete stock-flow consistent analytical framework, by putting finance at the center of analysis of economic and financial system stability, is much more pragmatic and realistic compared to the prevailing neoclassical analysis. Drawing upon the East Asian experience, the paper finds that Minsky’s analysis has a system-wide slant and correctly identifies Big Government and investment as driving employment and profits, respectively. Specifically, his two-price system can aid policymakers in correcting the systemic vulnerability posed by asset bubbles. By concentrating on cash-flow analysis and funding behaviors, Minsky’s analysis provides the link between cash flows and changes in balance sheets, and therefore can help identify unsustainable Ponzi processes. Overall, his multidimensional analytical framework is found to be more relevant than ever in understanding the Asian crisis, the 2008 global financial crisis, and policymaking in the postcrisis world.
Download:Associated Program:Author(s):Andrew ShengRelated Topic(s): -
Working Paper No. 683 | September 2011
Currency market intervention–cum–reserve accumulation has emerged as the favored “self-insurance” strategy in recipient countries of excessive private capital inflows. This paper argues that capital account management represents a less costly alternative line of defense deserving renewed consideration, especially in the absence of fundamental reform of the global monetary and financial order. Mainstream arguments in favor of financial globalization are found unconvincing; any indirect benefits allegedly obtainable through hot money inflows are equally obtainable without actually tolerating such inflows. The paper investigates the experiences of Brazil, Russia, India, and China (the BRICs) in the global crisis and subsequent recovery, focusing on their respective policies regarding capital flows.
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Working Paper No. 682 | August 2011
Final Working Paper Version
This paper adumbrates a theory of what might be going wrong in the monetary SVAR literature and provides supporting empirical evidence. The theory is that macroeconomists may be attempting to identify structural forms that do not exist, given the true distribution of the innovations in the reduced-form VAR. The paper shows that this problem occurs whenever (1) some innovation in the VAR has an infinite-variance distribution and (2) the matrix of coefficients on the contemporaneous terms in the VAR’s structural form is nonsingular. Since (2) is almost always required for SVAR analysis, it is germane to test hypothesis (1). Hence, in this paper, we fit α-stable distributions to VAR residuals and, using a parametric-bootstrap method, test the hypotheses that each of the error terms has finite variance.
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Press Releases | August 2011
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In the Media | August 2011
New Economic Perspectives, August 13, 2011. Copyright © 2010 KPFK. All Rights Reserved.
Senior Scholar Wray joins Masters for a macroeconomic analysis of adverse economic trends at home and abroad amid dire predictions of a double-dip recession in the United States and defaults in Europe, connecting the dots to see if we are indeed at a Smoot-Hawley moment where the Congress, instead of reversing economic decline, has accelerated it. Full audio of the interview is available here.
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Working Paper No. 681 | August 2011
This paper begins by recounting the causes and consequences of the global financial crisis (GFC). The triggering event, of course, was the unfolding of the subprime crisis; however, the paper argues that the financial system was already so fragile that just about anything could have caused the collapse. It then moves on to an assessment of the lessons we should have learned. Briefly, these include: (a) the GFC was not a liquidity crisis, (b) underwriting matters, (c) unregulated and unsupervised financial institutions naturally evolve into control frauds, and (d) the worst part is the cover-up of the crimes. The paper argues that we cannot resolve the crisis until we begin going after the fraud, and concludes by outlining an agenda for reform, along the lines suggested by the work of Hyman P. Minsky.
Download:Associated Program(s):Author(s):Related Topic(s):Control fraud Deregulation Financial regulatory reform Global financial crisis Hyman Minsky Modern Money Theory (MMT) Subprime mortgage crisis UnderwritingRegion(s):United States -
Working Paper No. 674 | July 2011
A Proposal in Terms of “Institutional Fragility”
The relevancy of Minsky’s Financial Instability Hypothesis (FIH) in the current (and still unfolding) crisis has been clearly acknowledged by both economists and regulators. While most papers focus on discussing to what extent the FIH or Minsky’s Big Bank/Big Government interpretation is appropriate to explain and sort out the crisis, some authors have also emphasized the need to consider the institutional foundations of Minsky’s work (Whalen 2007, Wray 2008, Dimsky 2010). The importance of institutions within the FIH was strongly emphasized by Minsky himself, who assigned them the function of constraining the development of financial fragility. Yet only limited literature has focused on the institutional aspects on Minsky’s FIH. The reason for this may be that they were mainly dealt with by Minsky in his latest papers, and they have remained, to some extent, incomplete, unclear, and even ambiguous. In our view, a synthesis of Minsky’s proposals, along with a clarification and theoretical justification, remains to be done. Our objective in this paper is to contribute to this theoretical project. It leads us to propose that the notion of “institutional fragility” can constitute a useful perspective to complement and justify the endogenous development of financial fragility within the FIH. Eventually, this view may contribute to the debate about international financial governance.
Download:Associated Program:Author(s):Christine SinapiRelated Topic(s): -
Working Paper No. 669 | May 2011
A Mesoanalysis
Economists’ principal explanations of the subprime crisis differ from those developed by noneconomists in that the latter see it as rooted in the US legacy of racial/ethnic inequality, and especially in racial residential segregation, whereas the former ignore race. This paper traces this disjuncture to two sources. What is missing in the social science view is any attention to the market mechanisms involved in subprime lending; and economists, on their side, have drawn too tight a boundary for “the economic,” focusing on market mechanisms per se,to the exclusion of the households and community whose resources and outcomes these mechanisms affect. Economists’ extensive empirical studies of racial redlining and discrimination in credit markets have, ironically, had the effect of making race analytically invisible. Because of these explanatory lacunae, two defining aspects of the subprime crisis have not been well explained. First, why were borrowers that had previously been excluded from equal access to mortgage credit instead super included in subprime lending? Second, why didn’t the flood of mortgage brokers that accompanied the 2000s housing boom reduce the proportion of minority borrowers who were burdened with costly and ultimately unpayable mortgages? This paper develops a mesoanalysis to answer the first of these questions. This analysis traces the coevolution of banking strategies and client communities, shaped by and reinforcing patterns of racial/ethnic inequality. The second question is answered by showing how unequal power relations impacted patterns of subprime lending. Consequences for gender inequality in credit markets are also briefly discussed.
Download:Associated Program:Author(s):Gary A. Dymski Jesus Hernandez Lisa MohantyRelated Topic(s): -
Policy Note 2011/4 | May 2011
At the end of 1930, as the 1929 US stock market crash was starting to have an impact on the real economy in the form of falling commodity prices, falling output, and rising unemployment, John Maynard Keynes, in the concluding chapters of his Treatise on Money, launched a challenge to monetary authorities to take “deliberate and vigorous action” to reduce interest rates and reverse the crisis. He argues that until “extraordinary,” “unorthodox” monetary policy action “has been taken along such lines as these and has failed, need we, in the light of the argument of this treatise, admit that the banking system can not, on this occasion, control the rate of investment, and, therefore, the level of prices.”
The “unorthodox” policies that Keynes recommends are a near-perfect description of the Japanese central bank’s experiment with a zero interest rate policy (ZIRP) in the 1990s and the Federal Reserve’s experiment with ZIRP, accompanied by quantitative easing (QE1 and QE2), during the recent crisis. These experiments may be considered a response to Keynes’s challenge, and to provide a clear test of his belief in the power of monetary policy to counter financial crisis. That response would appear to be an unequivocal No.
Download:Associated Program:Author(s):Jan KregelRelated Topic(s): -
Working Paper No. 666 | April 2011
The Dollar versus the Euro in a Cartalist Perspective
This paper suggests that the dollar is not threatened as the hegemonic international currency, and that most analysts are incapable of understanding the resilience of the dollar, not only because they ignore the theories of monetary hegemonic stability or what, more recently, has been termed the geography of money; but also as a result of an incomplete understanding of what a monetary hegemon does. The hegemon is not required to maintain credible macroeconomic policies (i.e., fiscally contractionary policies to maintain the value of the currency), but rather to provide an asset free of the risk of default. It is argued that the current crisis in Europe illustrates why the euro is not a real contender for hegemony in the near future.
Download:Associated Program:Author(s):David Fields Matías VernengoRelated Topic(s): -
Research Project Reports | April 2011
Will Dodd-Frank Prevent "It" from Happening Again? `
This monograph is part of the Institute's ongoing research program on Financial Instability and the Reregulation of Financial Institutions and Markets, funded by the Ford Foundation. This program's purpose is to investigate the causes and development of the recent financial crisis from the point of view of the late financial economist and Levy Distinguished Scholar Hyman P. Minsky. The monograph draws on Minsky's extensive work on regulation in order to review and analyze the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010, enacted in response to the crisis in the US subprime mortgage market, and to assess whether this new regulatory structure will prevent "It"—a debt deflation on the order of the Great Depression—from happening again. It seeks to assess the extent to which the Act will be capable of identifying and responding to the endogenous generation of financial fragility that Minsky believed to be the root cause of financial instability, building on the views expressed in his published work, his official testimony, and his unfinished draft manuscript on the subject. Whether the Dodd-Frank Act will fulfill its brief—in part, "to promote the financial stability in the United States by improving accountability and transparency in the financial system, to end 'too big to fail,' to protect the American taxpayer by ending bailouts, [and] to protect consumers from abusive financial services practices"—is an open question. As Minsky wrote in his landmark 1986 book Stabilizing an Unstable Economy, "A new era of reform cannot be simply a series of piecemeal changes. Rather, a thorough, integrated approach to our economic problems must be developed." This has been one of the organizing principles of our project.Download:Associated Program:Related Topic(s):Dodd-Frank Financial crisis Financial fragility Financial instability Financial regulation Financial regulatory reform Financial Stability Oversight Council (FSOC) Hyman Minsky Shadow banking Subprime mortgage crisis Too big to fail (TBTF)Region(s):United States -
Public Policy Brief No. 117 | April 2011
Scott Fullwiler and Senior Scholar L. Randall Wray review the roles of the Federal Reserve and the Treasury in the context of quantitative easing, and find that the financial crisis has highlighted the limited oversight of Congress and the limited transparency of the Fed. And since a Fed promise is ultimately a Treasury promise that carries the full faith and credit of the US government, the question is whether the Fed should be able to commit the public purse in times of national crisis.
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Working Paper No. 665 | April 2011
Don’t Forget Finance
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.
Download:Associated Program(s):Author(s):Dirk BezemerRelated Topic(s):Agent-based models Complex systems Credit crisis Dynamic stochastic general equilibrium (DSGE) Finance Financial instability Stock-flow consistent (SFC) modelingRegion(s):United States -
Working Paper No. 664 | March 2011
The creation of the Economic and Monetary Union (EMU) has not brought significant gains to the Portuguese economy in terms of real convergence with wealthier eurozone countries. We analyze the causes of the underperformance of the Portuguese economy in the last decade, discuss its growth prospects within the EMU, and make two proposals for urgent institutional reform of the EMU. We argue that, under the prevailing institutional framework, Portugal faces a long period of stagnation, high unemployment, and painful structural reform, and conclude that, in the absence of institutional reform of the EMU, getting out of the eurozone represents a serious political option for Portugal.
Download:Associated Program(s):Author(s):Pedro Leao Alfonso Palacio-VeraRelated Topic(s):Region(s):Europe -
Working Paper No. 662 | March 2011
This paper examines the causes and consequences of the current global financial crisis. It largely relies on the work of Hyman Minsky, although analyses by John Kenneth Galbraith and Thorstein Veblen of the causes of the 1930s collapse are used to show similarities between the two crises. K.W. Kapp’s “social costs” theory is contrasted with the recently dominant “efficient markets” hypothesis to provide the context for analyzing the functioning of financial institutions. The paper argues that, rather than operating “efficiently,” the financial sector has been imposing huge costs on the economy—costs that no one can deny in the aftermath of the economy’s collapse. While orthodox approaches lead to the conclusion that money and finance should not matter much, the alternative tradition—from Veblen and Keynes to Galbraith and Minsky—provides the basis for developing an approach that puts money and finance front and center. Including the theory of social costs also generates policy recommendations more appropriate to an economy in which finance matters.
Download:Associated Program:Author(s):Related Topic(s):Casino capitalism Coase theorem Deregulation Efficient markets Finance Hyman Minsky Innovation and finance Karl William Kapp Money Securitization Self-supervision Shadow banking Social efficiency Social provisioning Theory of social costs Thorstein VeblenRegion(s):United States -
Working Paper No. 661 | March 2011
The world’s worst economic crisis since the 1930s is now well into its third year. All sorts of explanations have been proffered for the causes of the crisis, from lax regulation and oversight to excessive global liquidity. Unfortunately, these narratives do not take into account the systemic nature of the global crisis. This is why so many observers are misled into pronouncing that recovery is on the way—or even under way already. I believe they are incorrect. We are, perhaps, in round three of a nine-round bout. It is still conceivable that Minsky’s “it”—a full-fledged debt deflation with failure of most of the largest financial institutions—could happen again.
Indeed, Minsky’s work has enjoyed unprecedented interest, with many calling this a “Minsky moment” or “Minsky crisis.” However, most of those who channel Minsky locate the beginnings of the crisis in the 2000s. I argue that we should not view this as a “moment” that can be traced to recent developments. Rather, as Minsky argued for nearly 50 years, we have seen a slow realignment of the global financial system toward “money manager capitalism.” Minsky’s analysis correctly links postwar developments with the prewar “finance capitalism” analyzed by Rudolf Hilferding, Thorstein Veblen, and John Maynard Keynes—and later by John Kenneth Galbraith. In an important sense, over the past quarter century we created conditions similar to those that existed in the run-up to the Great Depression, with a similar outcome. Getting out of this mess will require radical policy changes no less significant than those adopted in the New Deal.
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Working Paper No. 660 | March 2011
This paper provides a brief exposition of financial markets in Post Keynesian economics. Inspired by John Maynard Keynes’s path-breaking insights into the role of liquidity and finance in “monetary production economies,” Post Keynesian economics offers a refreshing alternative to mainstream (mis)conceptions in this area. We highlight the importance of liquidity—as provided by the financial system—to the proper functioning of real world economies under fundamental uncertainty, contrasting starkly with the fictitious modeling world of neo-Walrasian exchange economies. The mainstream vision of well-behaved financial markets, channeling saving flows from savers to investors while anchored by fundamentals, complements a notion of money as an arbitrary numéraire and mere convenience, facilitating exchange but otherwise “neutral.” From a Post Keynesian perspective, money and finance are nonneutral but condition and shape real economic performance. It takes public policy to anchor asset prices and secure financial stability, with the central bank as the key public policy tool.
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Working Paper No. 659 | March 2011
Stability is destabilizing. These three words concisely capture the insight that underlies Hyman Minsky’s analysis of the economy’s transformation over the entire postwar period. The basic thesis is that the dynamic forces of a capitalist economy are explosive and must be contained by institutional ceilings and floors. However, to the extent that these constraints achieve some semblance of stability, they will change behavior in such a way that the ceiling will be breached in an unsustainable speculative boom. If the inevitable crash is “cushioned” by the institutional floors, the risky behavior that caused the boom will be rewarded. Another boom will build, and the crash that follows will again test the safety net. Over time, the crises become increasingly frequent and severe, until finally “it” (a great depression with a debt deflation) becomes possible.
Policy must adapt as the economy is transformed. The problem with the stabilizing institutions that were put in place in the early postwar period is that they no longer served the economy well by the 1980s. Further, they had been purposely degraded and even in some cases dismantled, often in the erroneous belief that “free” markets are self-regulating. Hence, the economy evolved over the postwar period in a manner that made it much more fragile. Minsky continually formulated and advocated policy to deal with these new developments. Unfortunately, his warnings were largely ignored by the profession and by policymakers—until it was too late.
Download:Associated Program:Author(s):Related Topic(s):Financial instability hypothesis (FIH) Global financial crisis Hyman Minsky Money manager capitalism Self-regulating marketsRegion(s):United States -
Working Paper No. 658 | March 2011
Rethinking Money as a Public Monopoly
In this paper I first provide an overview of alternative approaches to money, contrasting the orthodox approach, in which money is neutral, at least in the long run; and the Marx-Veblen-Keynes approach, or the monetary theory of production. I then focus in more detail on two main categories: the orthodox approach that views money as an efficiency-enhancing innovation of markets, and the Chartalist approach that defines money as a creature of the state. As the state’s “creature,” money should be seen as a public monopoly. I then move on to the implications of viewing money as a public monopoly and link that view back to Keynes, arguing that extending Keynes along these lines would bring his theory up to date.
Download:Associated Program:Author(s):Related Topic(s):Chartalism Georg Friedrich Knapp John Maynard Keynes Karl Marx Money Public monopoly Thorstein VeblenRegion(s):United States -
Working Paper No. 656 | March 2011
This paper begins by defining, and distinguishing between, money and finance, and addresses alternative ways of financing spending. We next examine the role played by financial institutions (e.g., banks) in the provision of finance. The role of government as both regulator of private institutions and provider of finance is also discussed, and related topics such as liquidity and saving are explored. We conclude with a look at some of the new innovations in finance, and at the global financial crisis, which could be blamed on excessive financialization of the economy.
Download:Associated Program:Author(s):Related Topic(s):Chartalism Finance Financial Institutions Financial Instruments Financialization Hyman Minsky Innovation and finance Liquidity Money Robert Clower Saving Securitization Shadow bankingRegion(s):United States -
Working Paper No. 655 | March 2011
In the aftermath of the global financial collapse that began in 2007, governments around the world have responded with reform. The outlines of Basel III have been announced, although some have already dismissed its reform agenda as being too little (and too late!). Like the proposed reforms in the United States, it is argued, Basel III would not have prevented the financial crisis even if it had been in place. The problem is that the architects of reform are working around the edges, taking current bank activities as somehow appropriate and trying to eliminate only the worst excesses of the 2000s.
Hyman Minsky would not be impressed.
Before we can reform the financial system, we need to understand what the financial system does—or, better, what it should do. To put it as simply as possible, Minsky always insisted that the proper role of the financial system is to promote the “capital development” of the economy. By this he did not simply mean that banks should finance investment in physical capital. Rather, he was concerned with creating a financial structure that would be conducive to economic development to improve living standards, broadly defined.
In this paper, we first examine Minsky’s general proposals for reform of the economy—how to restore stable growth that promotes job creation and rising living standards. We then turn to his proposals for financial reform. We will focus on his writing in the early 1990s, when he was engaged in a project at the Levy Economics Institute on reconstituting the financial system (Minsky 1992a, 1992b, 1993, 1996). As part of that project, he offered his insights on the fundamental functions of a financial system. These thoughts lead quite naturally to a critique of the financial practices that precipitated the global financial crisis, and offer a path toward thorough-going reform.
Download:Associated Program:Author(s):Related Topic(s):Banking Basel III Capital development Financial regulatory reform Global financial crisis Hyman MinskyRegion(s):United States -
Working Paper No. 654 | March 2011
Financial Fragility Indexes
With the Great Recession and the regulatory reform that followed, the search for reliable means to capture systemic risk and to detect macrofinancial problems has become a central concern. In the United States, this concern has been institutionalized through the Financial Stability Oversight Council, which has been put in charge of detecting threats to the financial stability of the nation. Based on Hyman Minsky’s financial instability hypothesis, the paper develops macroeconomic indexes for three major economic sectors. The index provides a means to detect the speed with which financial fragility accrues, and its duration; and serves as a complement to the microprudential policies of regulators and supervisors. The paper notably shows, notably, that periods of economic stability during which default rates are low, profitability is high, and net worth is accumulating are fertile grounds for the growth of financial fragility.
Download:Associated Program:Author(s):Related Topic(s):Debt deflation Financial crisis Financial fragility Financial regulation Macroprudential risk Ponzi financeRegion(s):United States -
Working Paper No. 653 | March 2011
In this paper I will follow Hyman Minsky in arguing that the postwar period has seen a slow transformation of the economy from a structure that could be characterized as “robust” to one that is “fragile.” While many economists and policymakers have argued that “no one saw it coming,” Minsky and his followers certainly did! While some of the details might have surprised Minsky, certainly the general contours of this crisis were foreseen by him a half century ago. I will focus on two main points: first, the past four decades have seen the return of “finance capitalism”; and second, the collapse that began two years ago is a classic “Fisher-Minsky” debt deflation. The appropriate way to analyze this transformation and collapse is from the perspective of what Minsky called “financial Keynesianism”—a label he preferred over Post Keynesian because it emphasized the financial nature of the capitalist economy he analyzed.
Download:Associated Program:Author(s):Related Topic(s):Finance capitalism Fisher debt deflation Hyman Minsky John Maynard Keynes Keynesianism Money manager capitalism Rudolf HilferdingRegion(s):United States -
One-Pager No. 8 | February 2011
The economic crisis that has gripped the US economy since 2007 has highlighted Congress’s limited oversight of the Federal Reserve, and the limited transparency of the Fed’s actions. And since a Fed promise is ultimately a Treasury promise that carries the full faith and credit of the US government, the question is, Should the Fed be able to commit the public purse in times of national crisis?
Download:Associated Program:Author(s):Scott Fullwiler L. Randall WrayRelated Topic(s):Federal Reserve Financial crisis Fiscal stimulus Interest rates Monetary policy Quantitative easing (QE) TreasuryRegion(s):United States -
Working Paper No. 651 | February 2011
The Competitiveness Debate Again
Current discussions about the need to reduce unit labor costs (especially through a significant reduction in nominal wages) in some countries of the eurozone (in particular, Greece, Ireland, Italy, Portugal, and Spain) to exit the crisis may not be a panacea. First, historically, there is no relationship between the growth of unit labor costs and the growth of output. This is a well-established empirical result, known in the literature as Kaldor’s paradox. Second, construction of unit labor costs using aggregate data (standard practice) is potentially misleading. Unit labor costs calculated with aggregate data are not just a weighted average of the firms’ unit labor costs. Third, aggregate unit labor costs reflect the distribution of income between wages and profits. This has implications for aggregate demand that have been neglected. Of the 12 countries studied, the labor share increased in one (Greece), declined in nine, and remained constant in two. We speculate that this is the result of the nontradable sectors gaining share in the overall economy. Also, we construct a measure of competitiveness called unit capital costs as the ratio of the nominal profit rate to capital productivity. This has increased in all 12 countries. We conclude that a large reduction in nominal wages will not solve the problem that some countries of the eurozone face. If this is done, firms should also acknowledge that unit capital costs have increased significantly and thus also share the adjustment cost. Barring solutions such as an exit from the euro, the solution is to allow fiscal policy to play a larger role in the eurozone, and to make efforts to upgrade the export basket to improve competitiveness with more advanced countries. This is a long-term solution that will not be painless, but one that does not require a reduction in nominal wages.
Download:Associated Program(s):Author(s):Jesus Felipe Utsav KumarRelated Topic(s):Region(s):Europe -
Policy Note 2011/1 | February 2011
Like marriage, membership in the eurozone is supposed to be a lifetime commitment, “for better or for worse.” But as we know, divorce does occur, even if the marriage was entered into with the best of intentions. And the recent turmoil in Europe has given rise to the idea that the euro itself might also be reversible, and that one or more countries might revert to a national currency. The prevailing thought has been that one of the weak periphery countries would be the first to call it a day. It may not, however, work out that way: suddenly, the biggest euro-skeptics in Europe are not the perfidious English but the Germans themselves.
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Working Paper No. 650 | January 2011
This paper argues for a fundamental reorientation of fiscal policy, from the current aggregate demand management model to a model that explicitly and directly targets the unemployed. Even though aggregate demand management has several important benefits in stabilizing an unstable economy, it also has a number of serious drawbacks that merit its reconsideration. The paper identifies the shortcomings that can be observed during both recessions and economic recoveries, and builds the case for a targeted demand-management approach that can deliver economic stabilization through full employment and better income distribution. This approach is consistent with Keynes’s original policy recommendations, largely neglected or forgotten by economists across the theoretical spectrum, and offers a reinterpretation of his proposal for the modern context that draws on the work of Hyman Minsky.
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Working Paper No. 649 | January 2011
This paper reconsiders fiscal policy effectiveness in light of the recent economic crisis. It examines the fiscal policy approach advocated by the economics profession today and the specific policy actions undertaken by the Bush and Obama administrations. An examination of the labor market renders the contemporary aggregate demand–management approach wholly inadequate for achieving certain macroeconomic objectives, such as the stabilization of investment and investor expectations, the generation and maintenance of full employment, and the equitable distribution of incomes. The paper reconsiders the policy effectiveness of alternative fiscal policy approaches, and argues that a policy that directly targets the labor demand gap (as opposed to the output gap) is far more effective in stabilizing employment, incomes, investment, and balance sheets.
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Working Paper No. 647 | December 2010
This paper advances three fundamental propositions regarding money:
(1) As R. W. Clower (1965) famously put it, money buys goods and goods buy money, but goods do not buy goods.
(2) Money is always debt; it cannot be a commodity from the first proposition because, if it were, that would mean that a particular good is buying goods.
(3) Default on debt is possible.
These three propositions are used to build a theory of money that is linked to common themes in the heterodox literature on money. The approach taken here is integrated with Hyman Minsky’s (1986) work (which relies heavily on the work of his dissertation adviser, Joseph Schumpeter [1934]); the endogenous money approach of Basil Moore; the French-Italian circuit approach; Paul Davidson’s (1978) interpretation of John Maynard Keynes, which relies on uncertainty; Wynne Godley’s approach, which relies on accounting identities; the “K” distribution theory of Keynes, Michal Kalecki, Nicholas Kaldor, and Kenneth Boulding; the sociological approach of Ingham; and the chartalist, or state money, approach (A. M. Innes, G. F. Knapp, and Charles Goodhart). Hence, this paper takes a somewhat different route to develop the more typical heterodox conclusions about money.
Download:Associated Program:Author(s):Related Topic(s):Circuit approach Credit Debt Default Endogenous money Georg Friedrich Knapp Heterodox macroeconomics Hyman Minsky Joseph A. Schumpeter Money Uncertainty Wynne GodleyRegion(s):United States -
Working Paper No. 645 | December 2010
Beyond its original mission to “furnish an elastic currency” as lender of last resort and manager of the payments system, the Federal Reserve has always been responsible (along with the Treasury) for regulating and supervising member banks. After World War II, Congress directed the Fed to pursue a dual mandate, long interpreted to mean full employment with reasonable price stability. The Fed has been left to decide how to achieve these objectives, and it has over time come to view price stability as the more important of the two. In our view, the Fed’s focus on inflation fighting diverted its attention from its responsibility to regulate and supervise the financial sector, and its mandate to keep unemployment low. Its shift of priorities contributed to creation of the conditions that led to this crisis. Now in its third phase of responding to the crisis and the accompanying deep recession—so-called “quantitative easing 2,” or “QE2”—the Fed is currently in the process of purchasing $600 billion in Treasuries. Like its predecessor, QE1, QE2 is unlikely to seriously impact either of the Fed’s dual objectives, however, for the following reasons: (1) additional bank reserves do not enable greater bank lending; (2) the interest rate effects are likely to be small at best given the Fed’s tactical approach to QE2, while the private sector is attempting to deleverage at any rate, not borrow more; (3) purchases of Treasuries are simply an asset swap that reduce the maturity and liquidity of private sector assets but do not raise incomes of the private sector; and (4) given the reduced maturity of private sector Treasury portfolios, reduced net interest income could actually be mildly deflationary.
The most fundamental shortcoming of QE—or, in fact, of using monetary policy in general to combat the recession—is that it only “works” if it somehow induces the private sector to spend more out of current income. A much more direct approach, particularly given much-needed deleveraging by the private sector, is to target growth in after tax incomes and job creation through appropriate and sufficiently large fiscal actions. Unfortunately, stimulus efforts to date have not met these criteria, and so have mostly kept the recession from being far worse rather than enabling a significant economic recovery. Finally, while there is identical risk to the federal government whether a bailout, a loan, or an asset purchase is undertaken by the Fed or the Treasury, there have been enormous, fundamental differences in democratic accountability for the two institutions when such actions have been taken since the crisis began. Public debates surrounding the wisdom of bailouts for the auto industry, or even continuing to provide benefits to the unemployed, never took place when it came to the Fed committing trillions of dollars to the financial system—even though, again, the federal government is “on the hook” in every instance.
Download:Associated Program:Author(s):Scott Fullwiler L. Randall WrayRelated Topic(s):Region(s):United States -
Working Paper No. 640 | December 2010
Remedies for High Unemployment and Fears of Fiscal Crisis
In recent years, the US public debt has grown rapidly, with last fiscal year’s deficit reaching nearly $1.3 trillion. Meanwhile, many of the euro nations with large amounts of public debt have come close to bankruptcy and loss of capital market access. The same may soon be true of many US states and localities, with the governor of California, for example, publicly regretting that he has been forced to cut bone, and not just fat, from the state’s budget. Chartalist economists have long attributed the seemingly limitless borrowing ability of the US government to a particular kind of monetary system, one in which money is a “creature of the state” and the government can create as much currency and bank reserves as it needs to pay its bills (this is not to say that it lacks the power to impose taxes). In this paper, we examine this situation in light of recent discussions of possible limits to the federal government’s use of debt and the Federal Reserve’s “printing press.” We examine and compare the fiscal situations in the United States and the eurozone, and suggest that the US system works well, but that some changes must be made to macro policy if the United States and the world as a whole are to avoid another deep recession.
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Press Releases | November 2010
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Working Paper No. 639 | November 2010
The Federal Reserve’s quantitative easing is presented as injecting $600 billion into “the economy.” But instead of getting banks lending to Americans again—households and firms—the money is going abroad, through arbitrage interest-rate speculation, currency speculation, and capital flight. No wonder foreign economies are protesting, as their currencies are being pushed up.
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One-Pager No. 6 | November 2010
Before we can reform the financial system, we need to understand what banks do—or, better yet, what banks should do. Senior Scholar L. Randall Wray examines Hyman Minsky’s views on banking and the proper role of the financial system—not simply to finance investment in physical capital but to promote the “capital development” of the economy as a whole and the improvement of living standards, broadly defined.
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Working Paper No. 637 | November 2010
Some Postrecession Regulatory Implications
Over the past 40 years, regulatory reforms have been undertaken on the assumption that markets are efficient and self-corrective, crises are random events that are unpreventable, the purpose of an economic system is to grow, and economic growth necessarily improves well-being. This narrow framework of discussion has important implications for what is expected from financial regulation, and for its implementation. Indeed, the goal becomes developing a regulatory structure that minimizes the impact on economic growth while also providing high-enough buffers against shocks. In addition, given the overarching importance of economic growth, economic variables like profits, net worth, and low default rates have been core indicators of the financial health of banking institutions.
This paper argues that the framework within which financial reforms have been discussed is not appropriate to promoting financial stability. Improving capital and liquidity buffers will not advance economic stability, and measures of profitability and delinquency are of limited use to detect problems early. The paper lays out an alternative regulatory framework and proposes a fundamental shift in the way financial regulation is performed, similar to what occurred after the Great Depression. It is argued that crises are not random, and that their magnitude can be greatly limited by specific pro-active policies. These policies would focus on understanding what Ponzi finance is, making a difference between collateral-based and income-based Ponzi finance, detecting Ponzi finance, managing financial innovations, decreasing competitions in the banking industry, ending too-big-to-fail, and deemphasizing economic growth as the overarching goal of an economic system. This fundamental change in regulatory and supervisory practices would lead to very different ways in which to check the health of our financial institutions while promoting a more sustainable economic system from both a financial and a socio-ecological point of view.
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Working Paper No. 636 | November 2010
This paper examines Federal Reserve Chairman Ben Bernanke’s recipe for deflation fighting and the specific policy actions he took in the aftermath of the 2008 financial crisis. Both in his academic and in his policy work, Bernanke has made the case that monetary policy is able to stem deflationary forces largely because of its “fiscal components,” and that governments like those in the United States or Japan face no constraints in financing these fiscal components. On the other hand, he has recently expressed strong concerns about the size of the federal budget deficit, calling for its reversal in the name of financial sustainability. The paper argues that these positions are fundamentally at odds with each other, and resolves the paradox by arguing on theoretical and technical grounds that there are no fundamental differences in financing conventional government spending programs and what Bernanke considers to be the fiscal components of monetary policy.
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Policy Note 2010/4 | November 2010
A common refrain heard from those trying to justify the results of the recent midterm elections is that the government’s fiscal stimulus to save the US economy from depression undermined growth, and that fiscal restraint is the key to economic expansion. Research Associate Marshall Auerback maintains that this refrain stems from a failure to understand a fundamental reality of bookkeeping—that when the government runs a surplus (deficit), the nongovernment sector runs a deficit (surplus). If the new GOP Congress led by Republicans and their Tea Party allies cuts government spending now, deficits will go higher, as growth slows, automatic stabilizers kick in, and tax revenues fall farther. And if extending the Bush tax cuts faces congressional gridlock, taxes will rise in 2011, further draining aggregate demand. Moreover, there are potential solvency issues for the United States if the debt ceiling is reached and Congress does not raise it. This chain of events potentially creates a new financial crisis and effectively forces the US government to default on its debt. The question is whether or not President Obama (and his economic advisers) will be enlightened enough to embrace this “teachable moment” about US main sector balances. Recent remarks to the press about deficit reduction suggest otherwise.
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Working Paper No. 634 | November 2010
The post-1945 mode of global integration has outlived its early promise. It has become exploitative rather than supportive of capital investment, public infrastructure, and living standards.
In the sphere of trade, countries need to rebuild their self-sufficiency in food grains and other basic needs. In the financial sphere, the ability of banks to create credit (loans) at almost no cost, with only a few strokes on their computer keyboards, has led North America and Europe to become debt ridden—a contagion that now threatens to move into Brazil and other BRIC countries as banks seek to finance buyouts and lend against these countries' natural resources, real estate, basic infrastructure, and industry. Speculators, arbitrageurs, and financial institutions using "free money" see these economies as easy pickings. But by obliging countries to defend themselves financially, they and their predatory credit creation are helping to bring the era of free capital movements to an end.
Does Brazil really need inflows of foreign credit for domestic spending when it can create this at home? Foreign lending ends up in its central bank, which invests its reserves in US Treasury and euro bonds that yield low returns, and whose international value is likely to decline against the BRIC currencies. Accepting credit and buyout "capital inflows" from the North thus provides a "free lunch" for key-currency issuers of dollars and euros, but it does not significantly help local economies.
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Working Paper No. 632 | November 2010
A Structural VAR Analysis
This paper investigates private net saving in the US economy—divided into its principal components, households and (nonfinancial) corporate financial balances—and its impact on the GDP cycle from the 1980s to the present. Furthermore, we investigate whether the financial markets (stock prices, BAA spread, and long-term interest rates) have a role in explaining the cyclical pattern of the two private financial balances. We analyze all these aspects estimating a VAR—between household and (nonfinancial) corporate financial balances (also known as the corporate financing gap), financial markets, and the economic cycle—and imposing restrictions on the matrix A to identify the structural shocks. We find that households and corporate balances react to financial markets as theoretically expected, and that the economic cycle reacts positively to corporate balance, in accordance with the Minskyan view of the operation of the economy that we have embraced.
Download:Associated Program(s):Author(s):Paolo Casadio Antonio ParadisoRelated Topic(s):Business cycles Financial markets Financing gap Household financial balance Structural vector autoregression (SVAR)Region(s):United States -
Working Paper No. 630 | October 2010
The Case of India
India has been experiencing rising inflows of overseas capital since the deregulation of its financial sector. Often looked upon as a success story among other emerging economies, the country has been subject to pitfalls and trilemmas that deserve attention. It has been officially recognized by the Governors of RBI that the financial crisis in India reflects the “dirty face” of what is described in the literature as the impossible trinity, along with the volatility in the markets that was caused by speculative capital in search of profits. However, Joseph Stiglitz observed that India’s policymakers, “particularly the Reserve Bank of India, are already doing a great job. I wish the US Federal Reserve displayed the same understanding of the role of regulation that the RBI has done, at least so far.” Recently, the United States made a path-breaking move with the launching of the recent bill on the regulation of Wall Street, which was passed by a majority of the Senate on May 20, 2010. We urge the implementation of similar laws in India and other emerging economies, especially in view of the fact that the recent moves for financial deregulation in these countries have, rather, been in the opposite direction.
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Policy Note 2010/3 | October 2010The global financial breakdown is part of the price to be paid for the refusal of the Federal Reserve and Treasury to accept a prime axiom of banking: debts that cannot be paid, won’t be. These agencies tried to “save” the banking system from debt writedowns by keeping the debt overhead in place, while reinflating asset prices. In the face of the repayment burden that is shrinking the US economy, the Fed’s way of helping the banks “earn their way out of negative equity” actually provided opportunities for predatory finance, which led to excessive financial speculation. It is understandable that countries whose economies have been targeted by global speculators are seeking alternative arrangements. But it appears that these arrangements cannot be achieved via the International Monetary Fund or any other international forum in ways that US financial strategists will accept willingly.
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Working Paper No. 625 | October 2010
A Dubious Success Story in Monetary Economics
This paper critically assesses the rise of central bank independence (CBI) as an apparent success story in modern monetary economics. As to the observed rise in CBI since the late 1980s, we single out the role of peculiar German traditions in spreading CBI across continental Europe, while its global spread may be largely attributable to the rise of neoliberalism. As to the empirical evidence alleged to support CBI, we are struck by the nonexistence of any compelling evidence for such a case. The theoretical support for CBI ostensibly provided by modeling exercises on the so-called time-inconsistency problem in monetary policy is found equally wanting. Ironically, New Classical modelers promoting the idea of maximum CBI unwittingly reinstalled a (New Classical) “benevolent dictator” fiction in disguise. Post Keynesian critiques of CBI focus on the money neutrality postulate as well as potential conflicts between CBI and fundamental democratic values. John Maynard Keynes’s own contributions on the issue of CBI are found worth revisiting.
Download:Associated Program:Author(s):Related Topic(s):Central bank independence Central banking Democratic accountability Monetary policy Time inconsistencyRegion(s):United States -
Working Paper No. 623 | September 2010
A Keynes-Minsky Episode?
The enormity and pervasiveness of the global economic crisis that began in 2008 makes it relevant to analyze the circumstances that can explain this catastrophe. This will also provide clues to the appropriate remedial measures needed to prevent future occurrences of similar developments.
The paper begins with some theoretical concerns relating to factors that could trigger a similar crisis. The first of these concerns relates to the deregulated financial institutions and the growing uncertainty that can be witnessed in these liberalized financial markets. The secondrelates to financial engineering with innovations in these markets, simultaneously providing cushions against risks while generating flows of liquidity that remain beyond the conventional sources of bank credit.
Interpreting the role of uncertainty, one can observe the connections between investment and finance, both of which are subject to changes in the state of expectations. The initial formulation can be traced back to John Maynard Keynes’s General Theory (1936), where liquidity preference is linked to asset prices and new investments. The Keynesian analysis of the impact of uncertainty related expectations was reformulated in 1986 by Hyman P. Minsky, who introduced the possibility of sourcing external finance through debt, which further adds to the impact of uncertainty. Minsky’s characterization of deregulated financial markets considers the newfangled sources of nonbank credit, especially with the involvement of banks in the securities market under the universal banking model.
As for the institutional arrangements that provide for profits on transactions, financial assets bought and sold in the primary market as initial public offerings of stocks are usually transacted later, in the secondary market, where these are no longer backed by physical assets.In the upswing, finance creates a myriad of financial claims and liabilities, and thus becomes increasingly remote from the real economy, while innovations to hedge and insulate assets continue to proliferate in the financial market, especially in the presence of uncertainty.
The paper dwells on an account of the pattern of the financial crisis and its spread in the United States. This is appended by a stylized account of the turn of events in terms of a theoretical model that highlights the role of uncertainty in the process.
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Working Paper No. 622 | September 2010
This paper discusses recent UK monetary policies as instances of John Kenneth Galbraith’s “innocent fraud,” including the idea that money is a thing rather than a relationship, the fallacy of composition (i.e., that what is possible for one bank is possible for all banks), and the belief that the money supply can be controlled by reserves management. The origins of the idea of quantitative easing (QE), and its defense when it was applied in Britain, are analyzed through this lens. An empirical analysis of the effect of reserves on lending is conducted; we do not find evidence that QE “worked,” either by a direct effect on money spending, or through an equity market effect. These findings are placed in a historical context in a comparison with earlier money control experiments in the UK.
Download:Associated Program:Author(s):Dirk Bezemer Geoffrey GardinerRelated Topic(s):Region(s):United States -
Book Series | September 2010
Edited by Dimitri B. Papadimitriou and L. Randall Wray
Hyman Minsky’s analysis, in the early 1990s, of the capitalist economy’s transformation in the postwar period accurately predicted the global financial meltdown that began in late 2007. With the republication in 2008 of his seminal books John Maynard Keynes (1975) and Stabilizing an Unstable Economy (1986), his ideas have seen an unprecedented resurgence, and the essays collected in this companion volume demonstrate why both economists and policymakers have turned to Minsky’s works for guidance in understanding and addressing the current crisis. The volume brings together the world’s foremost Minsky scholars to provide a comprehensive overview of his approach, and includes chapters that extend his analysis to the present. Beginning with Minsky’s ideas on money, banking, and finance—including his influential financial instability hypothesis—subjects range from the psychology of financial markets to financial innovation and disequilibrium, to the role of Big Government in constraining endogenous instability, to a Minskyan approach to international relations theory.
Published By: Edward Elgar
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Public Policy Brief No. 115 | September 2010
A Minskyan Analysis
In this new brief, Senior Scholar L. Randall Wray examines the later works of Hyman P. Minsky, with a focus on Minsky’s general approach to financial institutions and policy.
The New Deal reforms of the 1930s strengthened the financial system by separating investment banks from commercial banks and putting in place government guarantees such as deposit insurance. But the system’s relative stability, and relatively high rate of economic growth, encouraged innovations that subverted those constraints over time. Financial wealth (and private debt) grew on trend, producing immense sums of money under professional management: we had entered what Minsky, in the early 1990s, labeled the “money manager” phase of capitalism. With help from the government, power was consolidated in a handful of huge firms that provided the four main financial services: commercial banking, payments services, investment banking, and mortgages. Brokers didn’t have a fiduciary responsibility to act in their clients’ best interests, while financial institutions bet against households, firms, and governments. By the early 2000s, says Wray, banking had strayed far from the (Minskyan) notion that it should promote the capital development of the economy.
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Public Policy Brief Highlights No. 113A | September 2010
Without Major Restructuring, the Eurozone is Doomed
Critics argue that the current crisis has exposed the profligacy of the Greek government and its citizens, who are stubbornly fighting proposed social spending cuts and refusing to live within their means. Yet Greece has one of the lowest per capita incomes in the European Union (EU), and its social safety net is modest compared to the rest of Europe. Since implementing its austerity program in January, it has reduced its budget deficit by 40 percent, largely through spending cuts. But slower growth is causing revenues to come in below targets, and fuel-tax increases have contributed to growing inflation. As the larger troubled economies like Spain and Italy also adopt austerity measures, the entire continent could find government revenues collapsing.
No rescue plan can address the central problem: that countries with very different economies are yoked to the same currency. Lacking a sovereign currency and unable to devalue their way out of trouble, they are left with few viable options—and voters in Germany and France will soon tire of paying the bill. A more far-reaching solution is needed.
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Working Paper No. 614 | August 2010
With the global crisis, the policy stance around the world has been shaken by massive government and central bank efforts to prevent the meltdown of markets, banks, and the economy. Fiscal packages, in varied sizes, have been adopted throughout the world after years of proclaimed fiscal containment. This change in policy regime, though dubbed the “Keynesian moment,” is a “short-run fix” that reflects temporary acceptance of fiscal deficits at a time of political emergency, and contrasts with John Maynard Keynes’s long-run policy propositions. More important, it is doomed to be ineffective if the degree of tolerance of fiscal deficits is too low for full employment.
Keynes’s view that outside the gold standard fiscal policies face real, not financial, constraints is illustrated by means of a simple flow-of-funds model. This shows that government deficits do not take financial resources from the private sector, and that demand for net financial savings by the private sector can be met by a rising trade surplus at the cost of reduced consumption, or by a rising government deficit financed by the monopoly supply of central bank credit. Fiscal deficits can thus be considered functional to the objective of supplying the private sector with a provision of financial wealth sufficient to restore demand. By contrast, tax hikes and/or spending cuts aimed at reducing the public deficit lower the available savings of the private sector, and, if adopted too soon, will force the adjustment by way of a reduction of demand and standard of living.
This notion, however, is not applicable to the euro area, where constraints have been deliberately created that limit public deficits and the supply of central bank credit, thus introducing national solvency risks. This is a crucial flaw in the institutional structure of Euroland, where monetary sovereignty has been removed from all existing fiscal authorities. Absent a reassessment of its design, the euro area is facing a deflationary tendency that may further erode the economic welfare of the region.
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Working Paper No. 612 | August 2010
Before we can reform the financial system, we need to understand what banks do; or, better, what banks should do. This paper will examine the later work of Hyman Minsky at the Levy Institute, on his project titled “Reconstituting the United States’ Financial Structure.” This led to a number of Levy working papers and also to a draft book manuscript that was left uncompleted at his death in 1996. In this paper I focus on Minsky’s papers and manuscripts from 1992 to 1996 and his last major contribution (his Veblen-Commons Award–winning paper).
Much of this work was devoted to his thoughts on the role that banks do and should play in the economy. To put it as succinctly as possible, Minsky always insisted that the proper role of the financial system was to promote the “capital development” of the economy. By this he did not simply mean that banks should finance investment in physical capital. Rather, he was concerned with creating a financial structure that would be conducive to economic development to improve living standards, broadly defined. Central to his argument is the understanding of banking that he developed over his career. Just as the financial system changed (and with it, the capitalist economy), Minsky’s views evolved. I will conclude with general recommendations for reform along Minskyan lines.
Download:Associated Program:Author(s):Related Topic(s):Debt deflation Finance capitalism Financial instability hypothesis (FIH) Global financial crisis Hyman Minsky Money manager capitalism Shadow bankingRegion(s):United States -
Public Policy Brief Highlights No. 112A | August 2010
The global abatement of the inflationary climate of the past three decades, combined with continuing financial instability, helped to promote the worldwide holding of US dollar reserves as a cushion against financial instability outside the United States, with the result that, for the United States itself, this was a period of remarkable price stability and reasonably stable economic expansion.
For the most part, the economics profession viewed these events as a story of central bank credibility, fiscal probity, and accelerating technological change coupled with changing demands on the labor market, creating a model of self-stabilizing free markets and hands-off policy makers motivated by doing the right thing—what Senior Scholar James K. Galbraith calls “the grand illusion of the Great Moderation.” A dissenting line of criticism focused on the stagnation of real wages, the growth of deficits in trade and the current account, and the search for new markets. This view implied that a crisis would occur, but that it would result from a rejection of US financial hegemony and a crash of the dollar, with the euro and the European Union (EU) the ostensible beneficiaries.
A third line of argument was articulated by two figures with substantially different perspectives on the Keynesian tradition: Wynne Godley and Hyman P. Minsky. Galbraith discusses the approaches of these Levy distinguished scholars, including Godley’s correlation of government surpluses and private debt accumulation and Minsky’s financial stability hypothesis, as well as their influence on the responses of the larger economic community.
Galbraith himself argues the fundamental illusion of viewing the US economy through the free-market prism of deregulation, privatization, and a benevolent government operating mainly through monetary stabilization. The real sources of American economic power, he says, lie with those who manage and control the public-private sectors—especially the public institutions in those sectors—and who often have a political agenda in hand. Galbraith calls this the predator state: a state that is not intent upon restructuring the rules in any idealistic way but upon using the existing institutions as a device for political patronage on a grand scale. And it is closely aligned with deregulation.
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Working Paper No. 606 | August 2010
The subprime financial crisis has forced several North American and European central banks to take extraordinary measures and to modify some of their operational procedures. These changes have made even clearer the deficiencies and lack of realism in mainstream monetary theory, as can be found in both undergraduate textbooks and most macroeconomic models. They have also forced monetary authorities to reject publicly some of the assumptions and key features of mainstream monetary theory, fearing that, on that mistaken basis, actors in the financial markets would misrepresent and misjudge the consequences of the actions taken by the monetary authorities. These changes in operational procedures also have some implications for heterodox monetary theory; in particular, for post-Keynesian theory.
The objective of this paper is to analyze the implications of these changes in operational procedures for our understanding of monetary theory. The evolution of the operating procedures of the Federal Reserve since August 2007 is taken as an exemplar. The American case is particularly interesting, both because it was at the center of the financial crisis and because the US monetary system and its federal funds rate market are the main sources of theorizing in monetary economics.
Download:Associated Program:Author(s):Marc LavoieRelated Topic(s):Central bank policy Corridor system Federal funds rate Monetary economics Money multiplier Subprime mortgage crisisRegion(s):United States -
Press Releases | July 2010
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Policy Note 2010/2 | July 2010
Facts on the Ground
The developed world faces a cyclical deficiency of aggregate demand, the product of a liquidity trap and the paradox of thrift, in the context of headwinds born of ongoing structural realignments. According to Paul McCulley, PIMCO, front-loaded fiscal austerity would only add to that deflationary cocktail. This is why the market vigilantes are fleeing risk assets, which depend on growth for valuation support, rather than the sovereign debt of fiat-currency countries. McCulley bases his outlook on the financial balances approach (double-entry bookkeeping) pioneered by the late Wynne Godley, who was a distinguished scholar at the Levy Institute. Godley’s analytical framework, says McCulley, should be the workhorse of discussions on global rebalancing.Download:Associated Program(s):Author(s):Paul McCulleyRegion(s):United States -
Public Policy Brief No. 113 | July 2010
Without Major Restructuring, the Eurozone Is Doomed
Critics argue that the current crisis has exposed the profligacy of the Greek government and its citizens, who are stubbornly fighting proposed social spending cuts and refusing to live within their means. Yet Greece has one of the lowest per capita incomes in the European Union (EU), and its social safety net is modest compared to the rest of Europe. Since implementing its austerity program in January, it has reduced its budget deficit by 40 percent, largely through spending cuts. But slower growth is causing revenues to come in below targets, and fuel-tax increases have contributed to growing inflation. As the larger troubled economies like Spain and Italy also adopt austerity measures, the entire continent could find government revenues collapsing.
No rescue plan can address the central problem: that countries with very different economies are yoked to the same currency. Lacking a sovereign currency and unable to devalue their way out of trouble, they are left with few viable options—and voters in Germany and France will soon tire of paying the bill. A more far-reaching solution is needed.
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Conference Proceedings | July 2010
After the Crisis: Planning a New Financial Structure
A conference organized by the Levy Economics Institute of Bard College with support from the.
On April 14–16, more than 200 policymakers, economists, and analysts from government, industry, and academia gathered at the NYC headquarters of the Ford Foundation for the Levy Institute’s annual Minsky conference on the state of the US and world economies. This year’s conference drew upon many Minskyan themes, including reconstituting the financial structure; the reregulation and supervision of financial institutions; the relevance of the Glass-Steagall Act; the roles of the Federal Reserve, FDIC, and the Treasury; the moral hazard of the “too big to fail” doctrine; debt deflation; and the economics of the “big bank” and “big government.” Speakers compared the European and Latin American responses to the global financial crisis and proposals for reforming the international financial architecture. Moreover, central bank exit strategies, both national and international, were considered.Download:Associated Program(s):Region(s):United States -
Press Releases | July 2010
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Working Paper No. 605 | June 2010
An Evolutionary Approach to the Measure of Financial Fragility
Different frameworks of analysis lead to different conceptions of financial instability and financial fragility. On one side, the static approach conceptualizes financial instability as an unfortunate byproduct of capitalism that results from unpredictable random forces that no one can do anything about except prepare for through adequate loss reserves, capital, and liquidation buffers. On the other side, the evolutionary approach conceptualizes financial instability as something that the current economic system invariably brings upon itself through internal market and nonmarket forces, and that requires change in financial practices rather than merely good financial buffers. This paper compares the two approaches in order to lay the foundation for the empirical analysis developed within the evolutionary approach. The paper shows that, with the use of macroeconomic data, it is possible to detect financial fragility, especially Ponzi finance. The methodology is applied to residential housing in the US household sector and is able to capture some of the trends that are known to be sources of economic difficulties. Notably, the paper finds that Ponzi finance was going on in the housing sector from at least 2004 to 2007, which concurs with other works based on more detailed data.Download:Associated Program:Author(s):Related Topic(s):Region(s):United States -
Public Policy Brief No. 112 | June 2010Senior Scholar James K. Galbraith argues the fundamental illusion of viewing the US economy through the free-market prism of deregulation, privatization, and a benevolent government operating mainly through monetary stabilization—the prevailing view among economists over the past three decades. The real sources of American economic power, he says, lie with those who manage and control the public‑private sectors—especially the public institutions in those sectors—and who often have a political agenda in hand. Galbraith calls this the predator state: a government that is intent, not upon restructuring the rules in any idealistic way, but upon using the existing institutions as a device for political patronage on a grand scale. And it is closely aligned with financial deregulation.Download:Associated Program(s):Author(s):Region(s):United States
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Working Paper No. 604 | June 2010
The Financial Trilemma and the Wall Street Complex
This would seem an opportune moment to reshape banking systems in the Americas. But any effort to rethink and improve banking must acknowledge three major barriers. The first is a crisis of vision: there has been too little consideration of what kind of banking system would work best for national economies in the Americas. The other two constraints are structural. Banking systems in Mexico and the rest of Latin America face a financial regulation trilemma, the logic and implications of which are similar to those of smaller nations’ macroeconomic policy trilemma. The ability of these nations to impose rules that would pull banking systems in the direction of being more socially productive and economically functional is constrained both by regional economic compacts (in the case of Mexico, NAFTA) and by having a large share of the domestic banking market operated by multinational banks.
For the United States, the structural problem involves the huge divide between Wall Street megabanks and the remainder of the US banking system. The ambitions, modes of operation, and economic effects of these two different elements of US banking are quite different. The success, if not survival, of one element depends on the creation of a regulatory atmosphere and set of enabling federal government subsidies or supports that is inconsistent with the success, or survival, of the other element.
Download:Associated Program:Author(s):Gary A. DymskiRelated Topic(s):Banking Financial crisis Financial regulation Impossible trinity Megabanks Mexico North American Free Trade Agreement (NAFTA) Regional compacts United States Wall StreetRegion(s):United States -
Working Paper No. 602 | June 2010The use of government fiscal stimulus to support the economy in the recent economic crisis has brought increases in government deficits and increased government debt. This has produced an interest in sustainable government debt and the role of deficits in the economy. This paper argues in favor of a concept of "responsible" government policy, referring to positions held by Franklin and Marshall Professor Will Lyons. The idea is that government should be responsible to the needs and desires of its citizens, but that this should go beyond physical security and education, to economic security. Building on the fallacy of composition and misplaced concreteness, it suggests that in an integrated macro system an increased desire to save on the part of the private sector will be self-defeating unless the government acts in a responsible manner to support those desires. This can only be done by government dissaving via an expenditure deficit. The outstanding government debt simply represents the desires of the public to hold safe financial assets, and can only be unsustainable if the public’s desires change. The government should always be responsive to these desires, and adjust its expenditure policy.Download:Associated Program:Author(s):Jan KregelRelated Topic(s):Region(s):United States
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Working Paper No. 601 | June 2010
Motives, Countermeasures, and Prospects
Regulatory forbearance and government financial support for the largest US financial companies during the crisis of 2007–09 highlighted a "too big to fail" problem that has existed for decades. As in the past, effects on competition and moral hazard were seen as outweighed by the threat of failures that would undermine the financial system and the economy. As in the past, current legislative reforms promise to prevent a reoccurrence.
This paper proceeds on the view that a better understanding of why too-big-to-fail policies have persisted will provide a stronger basis for developing effective reforms. After a review of experience in the United States over the last 40 years, it considers a number of possible motives. The explicit rationale of regulatory authorities has been to stem a systemic threat to the financial system and the economy resulting from interconnections and contagion, and/or to assure the continuation of financial services in particular localities or regions. It has been contended, however, that such threats have been exaggerated, and that forbearance and bailouts have been motivated by the "career interests" of regulators. Finally, it has been suggested that existing large financial firms are preserved because they serve a public interest independent of the systemic threat of failure they pose—they constitute a "national resource."
Each of these motives indicates a different type of reform necessary to contain too-big-to-fail policies. They are not, however, mutually exclusive, and may all be operative simultaneously. Concerns about the stability of the financial system dominate current legislative proposals; these would strengthen supervision and regulation. Other kinds of reform, including limits on regulatory discretion, would be needed to contain "career interest" motivations. If, however, existing financial companies are viewed as serving a unique public purpose, then improved supervision and regulation would not effectively preclude bailouts should a large financial company be on the brink of failure. Nor would limits on discretion be binding.
To address this motivation, a structural solution is necessary. Breakups through divestiture, perhaps encompassing specific lines of activity, would distribute the "public interest" among a larger group of companies than the handful that currently hold a disproportionate and growing concentration of financial resources. The result would be that no one company, or even a few, would appear to be irreplaceable. Neither economies of scale nor scope appear to offset the advantages of size reduction for the largest financial companies. At a minimum, bank merger policy that has, over the last several decades, facilitated their growth should be reformed so as to contain their continued absolute and relative growth. An appendix to the paper provides a review of bank merger policy and proposals for revision.Download:Associated Program:Author(s):Bernard ShullRelated Topic(s):Region(s):United States -
One-Pager No. 3 | May 2010
A year and a half after the collapse in the financial markets, the debate about necessary “reforms” is still in its early stages, and none of the debaters seriously claims that his solution will in fact prevent a new crisis. The problem is that the proposed remedies deal with superficial matters of industrial organization and regulatory procedure, while the real problems—outsized, ungovernable financial firms and rampant securitization—lie on a more profound level.
Download:Associated Program:Author(s):Martin MayerRelated Topic(s):Region(s):United States -
One-Pager No. 2 | May 2010
What We Can Do Today to Straighten Out Financial Markets
Congress is currently debating new regulations for financial institutions in an effort to avoid a repeat of the recent crisis that brought the banking system to the brink. Some of those proposed changes would be valuable. But what nobody seems to have noticed is that the government already has the power to address some of the most important factors that contributed to the crisis. Today, right now, Washington could change a few key rules and prevent a repeat of the rampant speculation, and possible fraud, that led to so much trouble this last time around.
Download:Associated Program:Author(s):Jan KregelRelated Topic(s):Region(s):United States -
Public Policy Brief No. 111 | May 2010
Why We Should Stop Worrying About U.S. Government Deficits
This brief by Yeva Nersisyan and Senior Scholar L. Randall Wray argues that deficits do not burden future generations with debt, nor do they crowd out private spending. The authors base their conclusions on the premise that a sovereign nation with its own currency cannot become insolvent, and that government financing is unlike that of a household or firm. Moreover, they observe that automatic stabilizers, not government bailouts and the stimulus package, have prevented the US economic contraction from devolving into another Great Depression. The authors dispense with unsubstantiated concerns about deficits and debts, noting that they mask the real issue: the unwillingness of deficit hawks to allow government to work for the good of the people.Download:Associated Program(s):Author(s):Region(s):United States -
Working Paper No. 597 | May 2010This paper sets out to investigate the forces and conditions that led to the emergence of global imbalances preceding the worldwide crisis of 2007–09, and both the likelihood and the potential sustainability of reemerging global imbalances as the world economy recovers from that crisis. The “Bretton Woods 2” hypothesis of sustainable global imbalances featuring a quasi-permanent US current account deficit overlooked that the domestic counterpart to the United States’ external deficit—soaring household indebtedness—was based not on safe debts but rather toxic ones. We critique the “global saving glut” hypothesis, and propose the “global dollar glut” hypothesis in its stead. With the US private sector in retrenchment mode, the question arises whether fiscal expansion might not only succeed in filling the gap in US domestic demand but also restart global arrangements along BW2 lines, albeit this time based on public debt—call it “Bretton Woods 3.” This paper explores the chances of a BW3 regime, highlighting the role of “dollar leveraging” in sustaining US trade deficits. Longer-term prospects for a postdollar standard are discussed in the light of John Maynard Keynes’s “bancor” plan.Download:Associated Program(s):Author(s):Related Topic(s):Bancor proposal Bretton Woods Global financial crisis Global imbalances Global monetary order Reserve currencyRegion(s):United States
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In the Media | May 2010
Wynne Godley and Marc Lavoie
The work of Wynne Godley and Marc Lavoie offers a novel approach, based on a consistent accounting methodology relating stocks and flows, and making use of Post-Keynesian behavioural assumptions that tie the analysis to a monetary economics perspective. The authors’ objective is to provide an analytical framework that could provide an alternative to the standard approach, by taking into account comprehensively the interrelations between real and financial variables.Download:Associated Program:Author(s):Célia FirminRegion(s):United States -
Working Paper No. 596 | May 2010The process of constructing impulse-response functions (IRFs) and forecast-error variance decompositions (FEVDs) for a structural vector autoregression (SVAR) usually involves a factorization of an estimate of the error-term variance-covariance matrix V. Examining residuals from a monetary VAR, this paper finds evidence suggesting that all of the variances in V are infinite. Specifically, this study estimates alpha-stable distributions for the reduced-form error terms. The ML estimates of the residuals’ characteristic exponents α range from 1.5504 to 1.7734, with the Gaussian case lying outside 95 percent asymptotic confidence intervals for all six equations of the VAR. Variance-stabilized P-P plots show that the estimated distributions fit the residuals well. Results for subsamples are varied, while GARCH(1,1) filtering yields standardized shocks that are also all likely to be non-Gaussian alpha stable. When one or more error terms have infinite variance, V cannot be factored. Moreover, by Proposition 1, the reduced-form DGP cannot be transformed, using the required nonsingular matrix, into an appropriate system of structural equations with orthogonal, or even finite-variance, shocks. This result holds with arbitrary sets of identifying restrictions, including even the null set. Hence, with one or more infinite-variance error terms, structural interpretation of the reduced-form VAR within the standard SVAR model is impossible.Download:Associated Program(s):Monetary Policy and Financial Structure Economic Policy for the 21st Century Explorations in Theory and Empirical AnalysisRelated Topic(s):
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Working Paper No. 595 | May 2010The recycling problem is general, and is not confined to a multicurrency setting: whenever there are surplus and deficit units—that is, everywhere—adjustment in real terms can be either upward or downward. The question is, Which? An attempt is made to formulate the problem in terms of the European Monetary Union. While the problem seems clear, the resolution is not. It is proposed to engage the issue through a detour consistent with the Maastricht rules. Inadequate as this is, it highlights the limits of technical arrangements when governments are confronted with political economy—namely, the inability to set the rules of the larger game from within a set of axiomatically predetermined rules dependent on the fact and practice of sovereignty. Even so, an attempt at persuasion through clarification of the issues—in particular, by highlighting the distinction between recycling and transfers—may be a useful preliminary. Some of the paper’s evocations, notably on oligopoly, may be taken as merely heuristic.Download:Associated Program(s):Author(s):G. E. KrimpasRelated Topic(s):Banking principle Competitiveness Currency union Full employment policy History of economic thought International payments John Maynard Keynes Surplus recyclingRegion(s):Europe
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Working Paper No. 593 | May 2010The paper examines three aspects of a financial crisis of domestic origin. The first section studies the evolution of a debt-financed consumption boom supported by rising asset prices, leading to a credit crunch and fluctuations in the real economy, and, ultimately, to debt deflation. The next section extends the analysis to trace gradual evolution toward Ponzi finance and its consequences. The final section explains the link between the financial and the real sector of the economy, pointing to an inherent liquidity problem. The paper concludes with comments on the interactions between the three aspects.Download:Associated Program:Author(s):Amit BhaduriRelated Topic(s):Capital gains Consumer debt Debt-driven fluctuations Effective demand Financial fragility Liquidity preferenceRegion(s):United States
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Working Paper No. 592 | May 2010The 2008 global financial crisis was the consequence of the process (1) of financialization, or the creation of massive fictitious financial wealth, that began in the 1980s,; and (2) the hegemony of a reactionary ideology—namely, neoliberalism—based on self-regulated and efficient markets. Although laissez-faire capitalism is intrinsically unstable, the lessons of the 1929 stock market crash of 1929 and the Great Depression of the 1930s were transformed into theories and institutions or regulations that led to the “30 glorious years of capitalism” (1948–77) and that could have helped avoid a financial crisis as profound as the present one. But it did not, because a coalition of rentiers and “financists” achieved hegemony and, while deregulating the existing financial operations, refused to regulate the financial innovations that made these markets even riskier. Neoclassical economics played the role of a meta-ideology as it legitimized, mathematically and “scientifically,” neoliberal ideology and deregulation. From this crisis a new democratic capitalist system will emerge, though its character is difficult to predict. It will not be financialized, but the glory years’ tendencies toward a global and knowledge-based capitalism in which professionals have more say than rentier capitalists, as well as the tendency to improve democracy by making it more social and participative, will be resumed.Download:Associated Program:Author(s):Luiz Carlos Bresser-PereiraRelated Topic(s):Region(s):United States
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Public Policy Brief Highlights No. 109A | April 2010
Toward an Alternative Public Policy to Support Retirement
Pension funds have taken a big hit during the current financial crisis, with losses in the trillions of dollars. In addition, both private and public pensions are experiencing significant funding shortfalls, as is the government-run Pension Benefit Guaranty Corporation, which insures the defined-benefit pension plans of private American companies. Yeva Nersisyan and Senior Scholar L. Randall Wray argue that the employment-based pension system is highly problematic, since the strategy for managing pension funds leads to excessive cost and risk in an effort to achieve above-average returns. The average fund manager, however, will only achieve the risk-free return. The authors therefore advocate expanding Social Security and encouraging private and public pensions to invest only in safe (risk-free) Treasury bonds—which, on average, will beat the net returns on risky assets.
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Public Policy Brief Highlights No. 107A | April 2010
The purpose of the 1933 Banking Act—aka Glass-Steagall—was to prevent the exposure of commercial banks to the risks of investment banking and to ensure stability of the financial system. A proposed solution to the current financial crisis is to return to the basic tenets of this New Deal legislation.
Senior Scholar Jan Kregel provides an in-depth account of the Act, including the premises leading up to its adoption, its influence on the design of the financial system, and the subsequent collapse of the Act’s restrictions on securities trading (deregulation). He concludes that a return to the Act’s simple structure and strict segregation between (regulated) commercial and (unregulated) investment banking is unwarranted in light of ongoing questions about the commercial banks’ ability to compete with other financial institutions. Moreover, fundamental reform—the conflicting relationship between state and national charters and regulation—was bypassed by the Act.
Download:Associated Program:Author(s):Jan KregelRegion(s):United States -
Working Paper No. 591 | March 2010
This paper investigates the spread of what started as a crisis at the core of the global financial system to emerging economies. While emerging economies had exhibited some resilience through the early stages of the financial turmoil that began in the summer of 2007, they have been hit hard since mid-2008. Their deteriorating fortunes are only partly attributable to the collapse in world trade and sharp drop in commodity prices. Things were made worse by emerging markets’ exposure to the turmoil in global finance itself. As “innocent bystanders,” even countries that had taken out “self-insurance” proved vulnerable to the global “sudden stop” in capital flows. We critique loanable funds theoretical interpretations of global imbalances and offer an alternative explanation that emphasizes the special status of the US dollar. Instead of taking out even more self-insurance, developing countries should pursue capital account management to enlarge their policy space and reduce external vulnerabilities.
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Public Policy Brief No. 109 | March 2010
Toward an Alternative Public Policy to Support Retirement
Pension funds have taken a big hit during the current financial crisis, with losses in the trillions of dollars. In addition, both private and public pensions are experiencing significant funding shortfalls, as is the government-run Pension Benefit Guaranty Corporation, which insures the defined-benefit pension plans of private American companies. Yeva Nersisyan and Senior Scholar L. Randall Wray argue that the employment-based pension system is highly problematic, since the strategy for managing pension funds leads to excessive cost and risk in an effort to achieve above-average returns. The average fund manager, however, will only achieve the risk-free return. The authors therefore advocate expanding Social Security and encouraging private and public pensions to invest only in safe (risk-free) Treasury bonds—which, on average, will beat the net returns on risky assets.
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Working Paper No. 587 | February 2010
While most economists agree that the world is facing the worst economic crisis since the Great Depression, there is little agreement as to what caused it. Some have argued that the financial instability we are witnessing is due to irrational exuberance of market participants, fraud, greed, too much regulation, et cetera. However, some Post Keynesian economists following Hyman P. Minsky have argued that this is a systemic problem, a result of internal market processes that allowed fragility to build over time. In this paper we focus on the shift to the “shadow banking system” and the creation of what Minsky called the money manager phase of capitalism. In this system, rapid growth of leverage and financial layering allowed the financial sector to claim an ever-rising proportion of national income—what is sometimes called “financialization”—as the financial system evolved from hedge to speculative and, finally, to a Ponzi scheme.
The policy response to the financial crisis in the United States and elsewhere has largely been an attempt to rescue money manager capitalism. Moreover, in the case of the United States. the bailout policy has contributed to further concentration of the financial sector, increasing dangers. We believe that the policies directed at saving the system are doomed to fail—and that alternative policies should be adopted. The effective solution should come in the way of downsizing the financial sector by two-thirds or more, and effecting fundamental modifications.
Download:Associated Program:Author(s):Related Topic(s):Financial concentration Financial crisis Financialization Institutional investors Money manager capitalism Securitization Shadow banking Subprime mortgagesRegion(s):United States -
In the Media | February 2010
Friday, February 19, 2010 02:00. Copyright The Financial Times Limited 2010.
From Mr Dimitri B. Papadimitriou
Sir, Martin Feldstein (February 17) argues in favour of Greece taking a holiday from the eurozone. While his very thoughtful comment makes sense on the face of it, if implemented I believe it will bankrupt Greece absolutely.
Under his plan, once the new drachma is devalued there would be a very strong demand for wages and prices to rise in tandem with the devaluation, so that parity is maintained with the euro. The result would be high inflation rates and even bigger budget deficits. The country’s holiday from the eurozone would likely become permanent, and prime minister George Papandreou’s valiant efforts to change the culture of a country’s expanding and wasteful public sector, rife with tax avoidance and evasion, will be forever lost.
The plethora of articles in your pages and others, some arguing in favour and others against a bail-out, contribute to market confusion and drive the country’s financing costs to record levels. It is not yet clear that a bail-out is even needed, but this market confusion is rendering the government’s ability to achieve its deficit goals ever more difficult.
Since the architects of economic and monetary union are neither about to change the system, nor to provide a sympathetic ear and a helping hand, what Greece really needs now is a holiday from further market confusion being created by contradictory, alarmist public commentary.
Dimitri B. Papadimitriou
President
Levy Economics Institute
Annandale, NY, US -
Working Paper No. 586 | February 2010
The current financial crisis has been characterized as a “Minsky” moment, and as such provides the conditions required for a reregulation of the financial system similar to that of the New Deal banking reforms of the 1930s. However, Minsky’s theory was not one that dealt in moments but rather in systemic, structural changes in the operations of financial institutions. Therefore, the framework for reregulation must start with an understanding of the longer-term systemic changes that took place between the New Deal reforms and their formal repeal under the 1999 Financial Services Modernization Act. This paper attempts to identify some of those changes and their sources. In particular, it notes that the New Deal reforms were eroded by an internal process in which commercial banks that were given a monopoly position in deposit taking sought to remove those protections because unregulated banks were able to provide substitute instruments that were more efficient and unregulated but unavailable to regulated banks, since they involved securities market activities that would eventually be recognized as securitization. Regulators and the courts contributed to this process by progressively ruling that these activities were related to the regulated activities of the commercial banks, allowing them to reclaim securities market activities that had been precluded in the New Deal legislation. The 1999 Act simply made official the de facto repeal of the 1930s protections. Any attempt to provide reregulation of the system will thus require safeguards to ensure that this internal process of deregulation is not repeated.
Download:Associated Program:Author(s):Jan KregelRelated Topic(s):Region(s):United States -
Working Paper No. 585 | February 2010
The extension of the subprime mortgage crisis to a global financial meltdown led to calls for fundamental reregulation of the United States financial system. However, that reregulation has been slow in implementation and the proposals under discussion are far from fundamental. One explanation for this delay is the fact that many of the difficulties stemmed not from lack of regulation but from a failure to fully implement existing regulations. At the same time, the crisis evolved in stages, interspersed by what appeared to be the system’s return to normalcy. This evolution can be defined in terms of three stages (regulation and supervision, securitization, and a run on investment banks), each stage associated with a particular failure of regulatory supervision. It thus became possible to argue at each stage that all that was necessary was the appropriate application of existing regulations, and that nothing more needed to be done. This scenario progressed until the collapse of Lehman Brothers brought about a full-scale recession and attention turned to support of the real economy and employment, leaving the need for fundamental financial regulation in the background.
Download:Associated Program:Author(s):Jan KregelRelated Topic(s):Region(s):United States -
Working Paper No. 584 | February 2010
This paper investigates the United States dollar’s role as the international currency of choice as a key contributing factor in critical global developments that led to the crisis of 2007–09, and considers the future role of the dollar as the global economy emerges from that crisis. It is argued that the dollar is likely to retain its hegemonic status for a few more decades, but that United States spending powered by public rather than private debt would provide a more sustainable motor for global growth. In the process, the “Bretton Woods II” regime depicted by Dooley, Folkerts-Landau, and Garber (2003) as sustainable despite featuring persistent US current account deficits may turn into a “Bretton Woods III” regime that sees US fiscal policy and public debt as “minding the store” in maintaining US and global growth.
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Public Policy Brief No. 107 | January 2010
The purpose of the 1933 Banking Act—aka Glass-Steagall—was to prevent the exposure of commercial banks to the risks of investment banking and to ensure stability of the financial system. A proposed solution to the current financial crisis is to return to the basic tenets of this New Deal legislation.
Senior Scholar Jan Kregel provides an in-depth account of the Act, including the premises leading up to its adoption, its influence on the design of the financial system, and the subsequent collapse of the Act’s restrictions on securities trading (deregulation). He concludes that a return to the Act’s simple structure and strict segregation between (regulated) commercial and (unregulated) investment banking is unwarranted in light of ongoing questions about the commercial banks’ ability to compete with other financial institutions. Moreover, fundamental reform—the conflicting relationship between state and national charters and regulation—was bypassed by the Act.
Download:Associated Program:Author(s):Jan KregelRegion(s):United States -
Press Releases | January 2010
Download:Associated Program:Author(s):Mark Primoff -
Policy Note 2009/11 | December 2009
Past experience suggests that multifunctional banking is the leading source of financial crisis, while large bank size contributes to contagion and systemic risk. This indicates that resolving large banks will not solve the problems associated with multifunctional banking—a conclusion reached after every financial crisis, and one that should apply to the present crisis as well. Senior Scholar Jan Kregel observes that it is important to recognize that past solutions may not be appropriate for present conditions. The approach to the current financial crisis has been to resolve small- and medium-size banks through the FDIC, while banks considered “too big to fail” are given direct and indirect government support. Many of these large government-supported banks have been allowed to absorb smaller banks through FDIC resolution, creating even larger banks. As these institutions repay their direct government support, the problem of “too big to fail” is simply aggravated. Thus, the current thrust of government regulatory reform—increased capital and liquidity requirements, and further legislation—is unlikely to lessen the systemic risks these institutions pose.
Download:Associated Program:Author(s):Jan KregelRegion(s):United States -
Public Policy Brief Highlights No. 106A | December 2009
Social unrest across Europe is growing as Euroland’s economy collapses faster than the United States’, the result of falling exports and a weaker fiscal response. The controversial title of this brief is based on a belief that the nature of the euro itself limits Euroland’s fiscal policy space. The nations that have adopted the euro face “market-imposed” fiscal constraints on borrowing because they are not sovereign countries. Research Associate Stephanie A. Kelton and Senior Scholar L. Randall Wray foresee a real danger that these nations will be unable to prevent an accelerating slide toward depression that will threaten the existence of the European Union.
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Public Policy Brief No. 106 | November 2009
Social unrest across Europe is growing as Euroland’s economy collapses faster than the United States’, the result of falling exports and a weaker fiscal response. The controversial title of this brief is based on a belief that the nature of the euro itself limits Euroland’s fiscal policy space. The nations that have adopted the euro face “market-imposed” fiscal constraints on borrowing because they are not sovereign countries. Research Associate Stephanie A. Kelton and Senior Scholar L. Randall Wray foresee a real danger that these nations will be unable to prevent an accelerating slide toward depression that will threaten the existence of the European Union.
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Working Paper No. 583 | November 2009
The Fiction and Reality of the 10th Anniversary Blast
This paper investigates why Europe fared particularly poorly in the global economic crisis that began in August 2007. It questions the self-portrait of Europe as the victim of external shocks, pushed off track by reckless policies pursued elsewhere. It argues instead that Europe had not only contributed handsomely to the buildup of global imbalances since the 1990s and experienced their implosive unwinding as an internal crisis from the beginning, but that it had also nourished its own homemade intra-Euroland and intra-EU imbalances, the simultaneous implosion of which has further aggravated Europe's predicament. To keep its own house in order in the future, Euroland must shun the outdated “stability oriented” policy wisdom inherited from Germany’s mercantilist past and Bundesbank mythology. Steps toward a fiscal union to back the euro are also warranted.
Download:Associated Program:Author(s):Related Topic(s):Competitiveness imbalances Economic and Monetary Union (EMU) Euro European Central Bank (ECB) Financial supervision Global financial crisis Global imbalances Intra-area imbalances Mercantilism Policy coordination Tax-push inflationRegion(s):United States -
Working Paper No. 582 | November 2009
The Methodological Puzzles of the Financial Instability Analysis
The recent revival of Hyman P. Minsky’s ideas among policymakers, economists, bankers, financial institutions, and the mass media, synchronized with the increasing gravity of the subprime financial crisis, demands a reappraisal of the meaning and scope of the “financial instability hypothesis” (FIH). We argue that we need a broader approach than that conventionally pursued, in order to understand not only financial crises but also the periods of financial calm between them and the transition from stability to instability. In this paper we aim to contribute to this challenging task by restating the strictly financial part of the FIH on the basis of a generalization of Minsky’s taxonomy of economic units. In light of this restatement, we discuss a few methodological issues that have to be clarified in order to develop the FIH in the most promising direction.
Download:Associated Program:Author(s):Alessandro VercelliRelated Topic(s):Business cycles Financial fragility Financial instability Hedge finance Minsky moment Ponzi finance Speculative finance Subprime mortgage crisisRegion(s):United States -
Public Policy Brief No. 105 | October 2009
The Obama administration has implemented several policies to “jump-start” the American economy—efforts that have largely focused on preserving the financial interests of major banks. The authors of this new policy brief believe that maintaining the status quo is not the solution, since it overlooks the debt problems of households and nonfinancial businesses—and re-creating the financial conditions that led to disaster will simply set the stage for a recurrence of the Great Depression or a Japanese-style “lost decade.” They recommend a more radical policy agenda, such as federal spending programs that directly provide jobs and sustain employment, thereby helping to restore the creditworthiness of borrowers, the profitability of firms, and the fiscal position of state and federal budgets.
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Working Paper No. 580 | October 2009
This paper contrasts the orthodox approach with an alternative view on finance, saving, deficits, and liquidity. The conventional view on the cause of the current global financial crisis points first to excessive United States trade deficits that are supposed to have “soaked up” global savings. Worse, this policy was ultimately unsustainable because it was inevitable that lenders would stop the flow of dollars. Problems were compounded by the Federal Reserve’s pursuit of a low-interest-rate policy, which involved pumping liquidity into the markets and thereby fueling a real estate boom. Finally, with the world awash in dollars, a run on the dollar caused it to collapse. The Fed (and then the Treasury) had to come to the rescue of US banks, firms, and households. When asset prices plummeted, the financial crisis spread to much of the rest of the world. According to the conventional view, China, as the residual supplier of dollars, now holds the fate of the United States, and possibly the entire world, in its hands. Thus, it’s necessary for the United States to begin living within its means, by balancing its current account and (eventually) eliminating its budget deficit.
I challenge every aspect of this interpretation. Our nation operates with a sovereign currency, one that is issued by a sovereign government that operates with a flexible exchange rate. As such, the government does not really borrow, nor can foreigners be the source of dollars. Rather, it is the US current account deficit that supplies the net dollar saving to the rest of the world, and the federal government budget deficit that supplies the net dollar saving to the nongovernment sector. Further, saving is never a source of finance; rather, private lending creates bank deposits to finance spending that generates income. Some of this income can be saved, so the second part of the saving decision concerns the form in which savings might be held—as liquid or illiquid assets. US current account deficits and federal budget deficits are sustainable, so the United States does not need to adopt austerity, nor does it need to look to the rest of the world for salvation. Rather, it needs to look to domestic fiscal stimulus strategies to resolve the crisis, and to a larger future role for government in helping to stabilize the economy.
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Working Paper No. 579 | October 2009
The Core of the Financial Instability Hypothesis in Light of the Subprime Crisis
This paper aims to help bridge the gap between theory and fact regarding the so-called “Minsky moments” by revisiting the “financial instability hypothesis” (FIH). We limit the analysis to the core of FIH—that is, to its strictly financial part. Our contribution builds on a reexamination of Minsky’s contributions in light of the subprime financial crisis. We start from a constructive criticism of the well-known Minskyan taxonomy o f financial units (hedge, speculative, and Ponzi) and suggest a different approach that allows a continuous measure of the unit’s financial conditions. We use this alternative approach to account for the cyclical fluctuations of financial conditions that endogenously generate instability and fragility. We may thus suggest a precise definition of the “Minsky moment” as the starting point of a Minskyan process—the phase of a financial cycle when many financial units suffer from both liquidity and solvency problems. Although the outlined approach is very simple and has to be further developed in many directions, we may draw from it a few policy insights on ways of stabilizing the financial cycle.
Download:Associated Program:Author(s):Alessandro VercelliRelated Topic(s):Financial fragility Financial instability Hedge finance Minsky moment Ponzi finance Speculative finance Subprime mortgage crisisRegion(s):United States -
Policy Note 2009/9 | October 2009
Oblivious to any lessons that might have been learned from the global financial mess it has created, Wall Street is looking for the next asset bubble. Perhaps in the market for death it has found a replacement for the collapsed markets in subprime mortgage–backed securities and credit default swaps (CDSs). Instead of making bets on the “death” of securities, this new product will allow investors to gamble on the death of human beings by purchasing “life settlements”—life insurance policies that the ill and elderly sell for cash. These policies will then be packaged together as bonds—securitized—and resold to investors, who will receive payouts when the people with the insurance die. In effect, just as the sale of a CDS creates a vested interest in financial calamity, here the act of securitizing life insurance policies creates huge financial incentives in favor of personal calamity. The authors of this Policy Note argue that this is a subversion—or an inversion—of insurance, and it raises important public policy issues: Should we allow the marketing of an instrument in which holders have a financial stake in death? More generally, should we allow the “innovation” of products that condone speculation under the guise of providing insurance?
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Public Policy Brief Highlights No. 105A | October 2009<p>The Obama administration has implemented several policies to “jump-start” the American economy—efforts that have largely focused on preserving the financial interests of major banks. The authors of this new policy brief believe that maintaining the status quo is not the solution, since it overlooks the debt problems of households and nonfinancial businesses—and re-creating the financial conditions that led to disaster will simply set the stage for a recurrence of the Great Depression or a Japanese-style “lost decade.” They recommend a more radical policy agenda, such as federal spending programs that directly provide jobs and sustain employment, thereby helping to restore the creditworthiness of borrowers, the profitability of firms, and the fiscal position of state and federal budgets.</p>
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Working Paper No. 578 | September 2009
This paper applies Hyman Minsky’s approach to provide an analysis of the causes of the global financial crisis. Rather than finding the origins in recent developments, this paper links the crisis to the long-term transformation of the economy from a robust financial structure in the 1950s to the fragile one that existed at the beginning of this crisis in 2007. As Minsky said, “Stability is destabilizing”: the relative stability of the economy in the early postwar period encouraged this transformation of the economy. Today’s crisis is rooted in what he called “money manager capitalism,” the current stage of capitalism dominated by highly leveraged funds seeking maximum returns in an environment that systematically under-prices risk. With little regulation or supervision of financial institutions, money managers have concocted increasingly esoteric instruments that quickly spread around the world. Those playing along are rewarded with high returns because highly leveraged funding drives up prices for the underlying assets. Since each subsequent bust wipes out only a portion of the managed money, a new boom inevitably rises. Perhaps this will prove to be the end of this stage of capitalism–the money manager phase. Of course, it is too early even to speculate on the form capitalism will take. I will only briefly outline some policy implications.
Download:Associated Program:Author(s):Related Topic(s):Asset-backed securities Commodity markets Financial crisis Financial instability hypothesis (FIH) Hyman Minsky Money manager capitalismRegion(s):United States -
Press Releases | September 2009
Download:Associated Program:Author(s):Mark Primoff -
Press Releases | September 2009
Download:Associated Program:Author(s):Mark Primoff -
Public Policy Brief Highlights No. 103A | September 2009
A group of experts associated with Economists for Peace and Security and the Initiative for Rethinking the Economy met recently in Paris to discuss financial and monetary issues; their viewpoints, summarized here by Senior Scholar James K. Galbraith, are largely at odds with the global political and economic establishment.
Despite noting some success in averting a catastrophic collapse of liquidity and a decline in output, the Paris group was pessimistic that there would be sustained economic recovery and a return of high employment. There was general consensus that the precrisis financial system should not be restored, that reviving the financial sector first was not the way to revive the economy, and that governments should not pursue exit strategies that permit a return to the status quo. Rather, the crisis exposes the need for profound reform to meet a range of physical and social objectives.
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Working Paper No. 576 | September 2009
This paper investigates the relationship between asset markets and business cycles with regard to the US economy. We consider the Goldman Sachs approach (2003) developed to study the dynamics of financial balances.
By means of a small econometric model we find that asset market dynamics are fundamental to determining the long-run financial sector balance dynamics. The gap between long-run equilibrium values and the actual values of the financial balances help to explain the cyclical path of the economy. Among all financial sectors balances, the financing gap in the corporate sector shows a leading effect on business cycles, in a Minskyan spirit. The last results appear innovative with respect to Goldman Sachs’s findings. Furthermore, our econometric results are robust and quite stable.
Download:Associated Program:Author(s):Paolo Casadio Antonio ParadisoRelated Topic(s):Region(s):United States -
Public Policy Brief Highlights No. 102A | September 2009
Is the B Really Justified?
The term BRIC was first coined by Goldman Sachs and refers to the fast-growing developing economies of Brazil, Russia, India, and China–a class of middle-income emerging market economies of relatively large size that are capable of self-sustained expansion. Their combined economies could exceed the combined economies of today’s richest countries by 2050. However, there are concerns about how the current financial crisis will affect the BRICs, and Goldman has questioned whether Brazil should remain within this group.
Senior Scholar Jan Kregel reviews the implications of the global crisis for developing countries, based on the factors driving global trade. He concludes that there is unlikely to be a return to the extremely positive conditions underlying the recent sharp increase in growth and external accounts. The key for developing countries is to transform from export-led to domestic demand-led growth, says Kregel. From this viewpoint, Brazil seems much better placed than the other BRIC countries.
Download:Associated Program:Author(s):Jan KregelRegion(s):United States -
Public Policy Brief No. 103 | August 2009
A group of experts associated with the Economists for Peace and Security and the Initiative for Rethinking the Economy met recently in Paris to discuss financial and monetary issues; their viewpoints, summarized here by Senior Scholar James K. Galbraith, are largely at odds with the global political and economic establishment.
Despite noting some success in averting a catastrophic collapse of liquidity and a decline in output, the Paris group was pessimistic that there would be sustained economic recovery and a return of high employment. There was general consensus that the precrisis financial system should not be restored, that reviving the financial sector first was not the way to revive the economy, and that governments should not pursue exit strategies that permit a return to the status quo. Rather, the crisis exposes the need for profound reform to meet a range of physical and social objectives.Download:Associated Program:Author(s):Region(s):United States -
Public Policy Brief No. 102 | August 2009
Is the B Really Justified?
The term BRIC was first coined by Goldman Sachs and refers to the fast-growing developing economies of Brazil, Russia, India, and China–a class of middle-income emerging market economies of relatively large size that are capable of self-sustained expansion. Their combined economies could exceed the combined economies of today’s richest countries by 2050. However, there are concerns about how the current financial crisis will affect the BRICs, and Goldman has questioned whether Brazil should remain within this group.
Senior Scholar Jan Kregel reviews the implications of the global crisis for developing countries, based on the factors driving global trade. He concludes that there is unlikely to be a return to the extremely positive conditions underlying the recent sharp increase in growth and external accounts. The key for developing countries is to transform from export-led to domestic demand-led growth, says Kregel. From this viewpoint, Brazil seems much better placed than the other BRIC countries.
Download:Associated Program:Author(s):Jan KregelRelated Topic(s):BRICS Demand-led growth Developing economies Global financial crisis Trade and development Trade imbalancesRegion(s):United States -
Working Paper No. 574.4 | August 2009
Summary Tables
This four-part study is a critical analysis of several reports dealing with the reform of the financial system in the United States. The study uses Minsky’s framework of analysis and focuses on the implications of Ponzi finance for regulatory and supervisory policies. The main conclusion of the study is that, while all reports make some valuable suggestions, they fail to deal with the socioeconomic dynamics that emerge during long periods of economic stability. As a consequence, it is highly doubtful that the principal suggestions contained in the reports will provide any applicable means to limit the worsening of financial fragility over periods of economic stability. The study also concludes that any meaningful systemic and prudential regulatory changes should focus on the analysis of expected and actual cash flows (sources and stability) rather than capital equity, and on preventing the emergence of Ponzi processes. The latter tend to emerge over long periods of economic stability and are not necessarily engineered by crooks. On the contrary, the pursuit of economic growth may involve the extensive use of Ponzi financial processes in legal economic activities. The study argues that some Ponzi processes—more precisely, pyramid Ponzi processes—should not be allowed to proceed, no matter how severe the immediate impact on economic growth, standards of living, or competitiveness. This is so because pyramid Ponzi processes always collapse, regardless how efficient financial markets are, how well informed and well behaved individuals are, or whether there is a “bubble” or not. The longer the process is allowed to proceed, the more destructive it becomes. Pyramid Ponzi processes cannot be risk-managed or buffered against; if economic growth is to be based on a solid financial foundation, these processes cannot be allowed to continue. Finally, a supervisory and regulatory process focused on detecting Ponzi processes would be much more flexible and adaptive, since it would not be preoccupied with either functional or product limits, or with arbitrary ratios of “prudence.” Rather, it would oversee all financial institutions and all products, no matter how new or marginal they might be.
See also, Working Paper Nos. 574.1, 574.2, and 574.3.
Download:Associated Program:Author(s):Related Topic(s):Region(s):United States -
Working Paper No. 574.3 | August 2009
G30, OECD, GAO, ICMBS Reports
This four-part study is a critical analysis of several reports dealing with the reform of the financial system in the United States. The study uses Minsky’s framework of analysis and focuses on the implications of Ponzi finance for regulatory and supervisory policies. The main conclusion of the study is that, while all reports make some valuable suggestions, they fail to deal with the socioeconomic dynamics that emerge during long periods of economic stability. As a consequence, it is highly doubtful that the principal suggestions contained in the reports will provide any applicable means to limit the worsening of financial fragility over periods of economic stability. The study also concludes that any meaningful systemic and prudential regulatory changes should focus on the analysis of expected and actual cash flows (sources and stability) rather than capital equity, and on preventing the emergence of Ponzi processes. The latter tend to emerge over long periods of economic stability and are not necessarily engineered by crooks. On the contrary, the pursuit of economic growth may involve the extensive use of Ponzi financial processes in legal economic activities. The study argues that some Ponzi processes—more precisely, pyramid Ponzi processes—should not be allowed to proceed, no matter how severe the immediate impact on economic growth, standards of living, or competitiveness. This is so because pyramid Ponzi processes always collapse, regardless how efficient financial markets are, how well informed and well behaved individuals are, or whether there is a “bubble” or not. The longer the process is allowed to proceed, the more destructive it becomes. Pyramid Ponzi processes cannot be risk-managed or buffered against; if economic growth is to be based on a solid financial foundation, these processes cannot be allowed to continue. Finally, a supervisory and regulatory process focused on detecting Ponzi processes would be much more flexible and adaptive, since it would not be preoccupied with either functional or product limits, or with arbitrary ratios of “prudence.” Rather, it would oversee all financial institutions and all products, no matter how new or marginal they might be.
See also, Working Paper Nos. 574.1, 574.2, and 574.4.
Download:Associated Program:Author(s):Related Topic(s):Region(s):United States -
Working Paper No. 574.2 | August 2009
Treasury, CRMPG Reports, Financial Stability Forum
This four-part study is a critical analysis of several reports dealing with the reform of the financial system in the United States. The study uses Minsky’s framework of analysis and focuses on the implications of Ponzi finance for regulatory and supervisory policies. The main conclusion of the study is that, while all reports make some valuable suggestions, they fail to deal with the socioeconomic dynamics that emerge during long periods of economic stability. As a consequence, it is highly doubtful that the principal suggestions contained in the reports will provide any applicable means to limit the worsening of financial fragility over periods of economic stability. The study also concludes that any meaningful systemic and prudential regulatory changes should focus on the analysis of expected and actual cash flows (sources and stability) rather than capital equity, and on preventing the emergence of Ponzi processes. The latter tend to emerge over long periods of economic stability and are not necessarily engineered by crooks. On the contrary, the pursuit of economic growth may involve the extensive use of Ponzi financial processes in legal economic activities. The study argues that some Ponzi processes—more precisely, pyramid Ponzi processes—should not be allowed to proceed, no matter how severe the immediate impact on economic growth, standards of living, or competitiveness. This is so because pyramid Ponzi processes always collapse, regardless how efficient financial markets are, how well informed and well behaved individuals are, or whether there is a “bubble” or not. The longer the process is allowed to proceed, the more destructive it becomes. Pyramid Ponzi processes cannot be risk-managed or buffered against; if economic growth is to be based on a solid financial foundation, these processes cannot be allowed to continue. Finally, a supervisory and regulatory process focused on detecting Ponzi processes would be much more flexible and adaptive, since it would not be preoccupied with either functional or product limits, or with arbitrary ratios of “prudence.” Rather, it would oversee all financial institutions and all products, no matter how new or marginal they might be.
See also, Working Paper Nos. 574.1, 574.3, and 574.4.
Download:Associated Program:Author(s):Related Topic(s):Region(s):United States -
Working Paper No. 574.1 | August 2009
Key Concepts and Main Points
This four-part study is a critical analysis of several reports dealing with the reform of the financial system in the United States. The study uses Minsky’s framework of analysis and focuses on the implications of Ponzi finance for regulatory and supervisory policies. The main conclusion of the study is that, while all reports make some valuable suggestions, they fail to deal with the socioeconomic dynamics that emerge during long periods of economic stability. As a consequence, it is highly doubtful that the principal suggestions contained in the reports will provide any applicable means to limit the worsening of financial fragility over periods of economic stability. The study also concludes that any meaningful systemic and prudential regulatory changes should focus on the analysis of expected and actual cash flows (sources and stability) rather than capital equity, and on preventing the emergence of Ponzi processes. The latter tend to emerge over long periods of economic stability and are not necessarily engineered by crooks. On the contrary, the pursuit of economic growth may involve the extensive use of Ponzi financial processes in legal economic activities. The study argues that some Ponzi processes—more precisely, pyramid Ponzi processes—should not be allowed to proceed, no matter how severe the immediate impact on economic growth, standards of living, or competitiveness. This is so because pyramid Ponzi processes always collapse, regardless how efficient financial markets are, how well informed and well behaved individuals are, or whether there is a “bubble” or not. The longer the process is allowed to proceed, the more destructive it becomes. Pyramid Ponzi processes cannot be risk-managed or buffered against; if economic growth is to be based on a solid financial foundation, these processes cannot be allowed to continue. Finally, a supervisory and regulatory process focused on detecting Ponzi processes would be much more flexible and adaptive, since it would not be preoccupied with either functional or product limits, or with arbitrary ratios of “prudence.” Rather, it would oversee all financial institutions and all products, no matter how new or marginal they might be.
See also, Working Paper Nos. 574.2, 574.3, and 574.4.
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Working Paper No. 573.2 | August 2009
Deregulation, the Financial Crisis, and Policy Implications
This study analyzes the trends in the financial sector over the past 30 years, and argues that unsupervised financial innovations and lenient government regulation are at the root of the current financial crisis and recession. Combined with a long period of economic expansion during which default rates were stable and low, deregulation and unsupervised financial innovations generated incentives to make risky financial decisions. Those decisions were taken because it was the only way for financial institutions to maintain market share and profitability. Thus, rather than putting the blame on individuals, this paper places it on an economic setup that requires the growing use of Ponzi processes during enduring economic expansion, and on a regulatory system that is unwilling to recognize (on the contrary, it contributes to) the intrinsic instability of market mechanisms. Subprime lending, greed, and speculation are merely aspects of the larger mechanisms at work.
It is argued that we need to change the way we approach the regulation of financial institutions and look at what has been done in other sectors of the economy, where regulation and supervision are proactive and carefully implemented in order to guarantee the safety of society. The criterion for regulation and supervision should be neither Wall Street’s nor Main Street’s interests but rather the interests of the socioeconomic system. The latter requires financial stability if it’s to raise, durably, the standard of living of both Wall Street and Main Street. Systemic stability, not profits or homeownership, should be the paramount criterion for financial regulation, since systemic stability is required to maintain the profitability—and ultimately, the existence—of any capitalist economic entity. The role of the government is to continually counter the Ponzi tendencies of market mechanisms, even if they are (temporarily) improving standards of living, and to encourage economic agents to develop safe and reliable financial practices.
See also, Working Paper No. 573.1, “Securitization, Deregulation, Economic Stability, and Financial Crisis, Part I: The Evolution of Securitization.”
Download:Associated Program:Author(s):Related Topic(s):Bubble economy Financial crisis Financial regulation Financial supervision Hyman Minsky SecuritizationRegion(s):United States -
Working Paper No. 573.1 | August 2009
The Evolution of Securitization
This study analyzes the trends in the financial sector over the past 30 years, and argues that unsupervised financial innovations and lenient government regulation are at the root of the current financial crisis and recession. Combined with a long period of economic expansion during which default rates were stable and low, deregulation and unsupervised financial innovations generated incentives to make risky financial decisions. Those decisions were taken because it was the only way for financial institutions to maintain market share and profitability. Thus, rather than putting the blame on individuals, this paper places it on an economic setup that requires the growing use of Ponzi processes during enduring economic expansion, and on a regulatory system that is unwilling to recognize (on the contrary, it contributes to) the intrinsic instability of market mechanisms. Subprime lending, greed, and speculation are merely aspects of the larger mechanisms at work.
It is argued that we need to change the way we approach the regulation of financial institutions and look at what has been done in other sectors of the economy, where regulation and supervision are proactive and carefully implemented in order to guarantee the safety of society. The criterion for regulation and supervision should be neither Wall Street’s nor Main Street’s interests but rather the interests of the socioeconomic system. The latter requires financial stability if it’s to raise, durably, the standard of living of both Wall Street and Main Street. Systemic stability, not profits or homeownership, should be the paramount criterion for financial regulation, since systemic stability is required to maintain the profitability—and ultimately, the existence—of any capitalist economic entity. The role of the government is to continually counter the Ponzi tendencies of market mechanisms, even if they are (temporarily) improving standards of living, and to encourage economic agents to develop safe and reliable financial practices.
See also, Working Paper No. 573.2, “Securitization, Deregulation, Economic Stability, and Financial Crisis, Part II: Deregulation, the Financial Crisis, and Policy Implications.”
Download:Associated Program:Author(s):Related Topic(s):Bubble economy Financial crisis Financial regulation Financial supervision Hyman Minsky SecuritizationRegion(s):United States -
Testimony | July 2009
On July 9, 2009, Senior Scholar James K. Galbraith testified before the House Financial Services Committee regarding the functions of the Federal Reserve under the Obama administration’s proposals for financial regulation reform—specifically, the extent to which the newly proposed role of systemic risk regulator might conflict with the Fed’s traditional role as the independent authority on monetary policy. He also addressed questions of whether the Fed should relinquish its role in consumer protection, and whether the shadow banking system should be restored.
Galbraith pointed out that the Board’s primary mission is macroeconomic: “Rigorous enforcement of safety and soundness regulation is never going to be the first priority of the agency in the run-up to a financial crisis.” Systemic risk regulation needs to be deeply integrated into ongoing examination and supervision—a function best taken on by an agency “with no record of regulatory capture or institutional identification with the interests of the regulated sector.” That agency, said Galbraith, is the FDIC. If systemic risk is to be subject to consolidated prudential regulation, why not place that responsibility in the hands of an agency for which it is the first priority? Further, if large banks and other financial holding companies pose systemic risks, why not require them to divest and otherwise reduce the concentration of power that presently exists in the financial sector? In Galbraith’s view it would, over time, “bring the scale of financial activity into line with the capacity of supervisory authorities to regulate it, and the result would be a somewhat safer system.”
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Policy Note 2009/8 | June 2009
The demand for reform of the financial system has focused on the dollar’s loss of international purchasing power (the Triffin dilemma) and its substitution by an international reserve currency that is not a national currency. The problem, however, is not the particular asset that serves as the international currency but rather the operation of the adjustment mechanism for dealing with global imbalances.
In a preliminary report issued in May, the Commission of Experts of the President of the United Nations General Assembly on Reforms of the International Monetary and Financial System made clear that the international system suffers from an inherent tendency toward deficient aggregate demand, a reflection of the asymmetry in the international adjustment mechanism. Even the simple creation of a notional currency to be used in a clearing union (proposed by Keynes) cannot do this without some commitment to coordinated symmetric adjustment by both surplus and deficit countries. Thus, the first steps in the reform process must be (1) to offset the balance sheet losses caused by the collapse of asset values and (2) to provide an alternative source of demand to replace the US consumer and an alternative source of finance to offset the deleveraging of financial institutions. This can be done through the coordinated introduction of traditional, countercyclical deficit expenditure policies, on a global scale.
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Policy Note 2009/7 | May 2009
The capital adequacy requirements for banks, enshrined in international banking regulations, are based on a fallacy of composition—namely, the notion that an individual firm can choose the structure of its financial liabilities without affecting the financial liabilities of other firms. In practice, says author Jan Toporowski, capital adequacy regulations for banks are a way of forcing nonfinancial companies into debt. “Enforced indebtedness” then reduces the quality of credit in the economy. In an international context, the present system of capital adequacy regulation reinforces this indebtedness. Proposals for “dynamic provisioning” to increase capital requirements during an economic boom would simply accelerate the boom’s collapse. Contingent commitments to lend to governments in the event of private-sector lending withdrawals, alongside lending to foreign private-sector borrowers, are a much more viable alternative.
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Working Paper No. 564 | May 2009
This paper is concerned with the New Consensus Macroeconomics (NCM) in the case of an open economy. It outlines and explains briefly the main elements of and way of thinking about the macroeconomy from the standpoint of both its theoretical and its policy dimensions. There are a few problems with this particular theoretical framework. We focus here on two important aspects closely related to NCM: the absence of banks and monetary aggregates from this theoretical framework, and the way the notion of the “equilibrium real rate of interest” is utilized by the same framework. The analysis is critical of NCM from a Keynesian perspective.
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Working Paper No. 563 | May 2009
The Role of Government and Fiscal Policy in Modern Macroeconomics
In the face of the dramatic economic events of recent months and the inability of academics and policymakers to prevent them, the New Consensus Macroeconomics (NCM) model has been the subject of several criticisms. This paper considers one of the main criticisms lodged against the NCM model, namely, the absence of any essential role for the government and fiscal policy. Given the size of the public sector and the increasing role of fiscal policy in modern economies, this simplifying assumption of the NCM model is difficult to defend. This paper maintains that conventional arguments used to support this controversial assumption—including historical reasons, theoretical propositions, and practical issues—do not have solid foundations. There is, in fact, nothing inherently monetary in the stabilization policies found in the model. Thus, fiscal policy could play a role at least as important as monetary policy in the NCM model.
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Policy Note 2009/6 | May 2009
A simple consideration of history tells us that each new piece of legislation contains loopholes that benefit a new class of entrepreneurs; some of these loopholes are small, but others are such that one could drive a bullion-laden truck through them. In this new Policy Note, Martin Shubik suggests creating a “war gaming group” to stress-test all major new legislation, with a first prize of $1 million to be awarded to the competing lawyer or team of lawyers who finds the most egregious loophole—a small amount relative to the potential savings.
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Public Policy Brief Highlights No. 100A | April 2009
The Federal Reserve’s response to the current financial crisis has been praised because it introduced a zero interest rate policy more rapidly than the Bank of Japan (during the Japanese crisis of the 1990s) and embraced massive “quantitative easing.” However, despite vast capital injections, the banking system is not lending in support of the private sector.
Senior Scholar Jan Kregel compares the current situation with the Great Depression, and finds an absence of New Deal measures and institutions in the current rescue packages. The lessons of the Great Depression suggest that any successful policy requires fundamental structural reform, an understanding of how the financial system failed, and the introduction of a new financial structure (in a short space of time) that is designed to correct these failures. The current crisis could have been avoided if increased household consumption had been financed through wage increases, says Kregel, and if financial institutions had used their earnings to augment bank capital rather than bonuses.
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Conference Proceedings | April 2009
Meeting the Challenges of Financial Crisis
A conference organized by The Levy Economics Institute of Bard College with support from the Ford Foundation.
On April 16 and 17, more than 150 policymakers, economists, and analysts from government, industry, and academia gathered at the NYC headquarters of the Ford Foundation for the Levy Institute’s annual Minsky conference on the state of the US and world economies. This year’s conference focused on the extraordinary challenges posed by the current global financial crisis. Topics included current conditions and forecasts, macro policy proposals by the Obama administration and others, the rehabilitation of mortgage financing and the banks, financial market reregulation, proposals to limit foreclosures and modify servicing agreements, regulation of alternative financial products (derivatives and credit default swaps), the institutional shape of the future financial system, and international responses to the crisis.
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Public Policy Brief No. 100 | April 2009
The Federal Reserve’s response to the current financial crisis has been praised because it introduced a zero interest rate policy more rapidly than the Bank of Japan (during the Japanese crisis of the 1990s) and embraced massive “quantitative easing.” However, despite vast capital injections, the banking system is not lending in support of the private sector.
Senior Scholar Jan Kregel compares the current situation with the Great Depression, and finds an absence of New Deal measures and institutions in the current rescue packages. The lessons of the Great Depression suggest that any successful policy requires fundamental structural reform, an understanding of how the financial system failed, and the introduction of a new financial structure (in a short space of time) that is designed to correct these failures. The current crisis could have been avoided if increased household consumption had been financed through wage increases, says Kregel, and if financial institutions had used their earnings to augment bank capital rather than bonuses.
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Policy Note 2009/4 | April 2009
The ad hoc emergency approach to the current economic crisis has a great chance of wasting billions of dollars by mismatching skills and needs. According to Martin Shubik of Yale University, the current deepening recession needs a “quick fix” solution now, but a longer-fix solution must be put into place along with it.
There is already considerable talk about the possible need for a large public works program to follow the massive infusion of funds into the financial and automobile sectors. But who is going to manage it? For us to weather this great economic storm we need to line up and coordinate (at least) four sets of highly different talents—political, bureaucratic, financial, and industrial. Without their coordination, economic recommendations, no matter how good they may appear to be in theory, will fail in execution.
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Press Releases | April 2009
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Working Paper No. 560 | April 2009
Unemployment was singled out by John Maynard Keynes as one of the principle faults of capitalism; the other is excessive inequality. Obviously, there is some link between these two faults: since most people living in capitalist economies must work for wages as a major source of their incomes, the inability to obtain a job means a lower income. If jobs can be provided to the unemployed, inequality and poverty will be reduced—although such policy will not directly address the problem of excessive income at the top of the distribution. Most importantly, Keynes wanted to put unemployed labor to work—not digging holes, but in socially productive ways. This would help to ensure that the additional effective demand created by government spending would not be exhausted in higher prices as it ran up against bottlenecks or other supply constraints. Further, it would help maintain public support for the government’s programs by providing useful output. And it would generate respect for, and feelings of self-worth in, the workers employed in these projects (no worker would want to spend her days digging holes that serve no useful purpose). President Roosevelt’s New Deal jobs programs (such as the Works Progress Administration and the Civilian Conservation Corps) are good examples of such targeted job-creating programs. These provided income and employment for workers, actually helped increase the nation’s productivity, and left us with public buildings, dams, trails, and even music that we still enjoy today. As our nation (and the world) collapses into deep recession, or even depression, it is worthwhile to examine Hyman P. Minsky’s comprehensive approach to resolving the unemployment problem.
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Public Policy Brief Highlights No. 99A | April 2009
Policy Advice for President Obama
In the current global financial crisis, economists and policymakers have reembraced Big Government as a means of preventing the reoccurrence of a debt-deflation depression. The danger, however, is that policy may not downsize finance and replace money manager capitalism. According to Senior Scholar L. Randall Wray, we need a permanently larger fiscal presence, with more public services. His advice to President Obama is to discard all of former Treasury Secretary Paulson’s actions. Wray believes that we can afford any necessary spending and bailouts, and that these actions will not burden our grandchildren.
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Strategic Analysis | April 2009
In 1930, John Maynard Keynes wrote: “The world has been slow to realise that we are living this year in the shadow of one of the greatest economic catastrophes of modern history.” The same holds true today: we are in the shadow of a global catastrophe, and we need to come to grips with the crisis—fast. According to Senior Scholar James K. Galbraith, two ingrained habits are leading to our failure to do so. The first is the assumption that economies will eventually return to normal on their own—an overly hopeful view that doesn’t take into account the massive pay-down of household debt resulting from the collapse of the banks. The second bad habit is the belief that recovery runs through the banks rather than around them. But credit cannot flow when there are no creditworthy borrowers or profitable projects; banks have failed, and the failure to recognize this is a recipe for wild speculation and control fraud, compounding taxpayer losses.
Galbraith outlines a number of measures that are needed now, including realistic economic forecasts, more honest bank auditing, effective financial regulation, measures to forestall evictions and keep people in their homes, and increased public retirement benefits. We are not in a temporary economic lull, an ordinary recession, from which we will emerge to return to business as usual, says Galbraith. Rather, we are at the beginning of a long, painful, profound, and irreversible process of change—we need to start thinking and acting accordingly.
Download:Associated Program(s):Author(s):Related Topic(s):Bank auditing Control fraud Financial crisis Financial regulation Housing crisis Private sector debt Public retirement benefitsRegion(s):United States -
Working Paper No. 558 | April 2009
International financial flows are the propagation mechanism for transmitting financial instability across borders; they are also the source of unsustainable external debt. Managing volatility thus requires institutions that promote domestic financial stability, ensure that domestic instability is contained, and guarantee that international institutions and rules of the game are not themselves a cause of volatility. This paper analyzes proposals to increase stability in domestic markets, in international markets, and in the structure of the international financial system from the point of view of Hyman P. Minsky’s financial instability hypothesis, and outlines how each of these three channels can produce financial fragility that lays the system open to financial instability and financial crisis.
Download:Associated Program:Author(s):Jan KregelRelated Topic(s):Bretton Woods Capital flows Financial crisis Global financial system Hedge finance Hyman Minsky Risk reduction Speculative financeRegion(s):United States -
Policy Note 2009/3 | March 2009
All of the various schemes that have been put forward to resolve the current credit crisis follow either the “business as usual” or the “good bank” model. The “business as usual” model takes different forms—insurance or guarantee of the assets or liabilities of the financial institutions, creation of a “bad bank” to buy toxic assets, temporary nationalization—and is the one favored by banks and pursued by government. It amounts to a bailout of the financial system using taxpayer money. Its drawback is that the cost may exceed by trillions the original estimate of $700 billion, and despite the mounting cost, it may not even prevent the bankruptcy of financial institutions. Moreover, it runs the risk of government insolvency, and turning an already severe recession into a depression worse than that in the 1930s.
The “good bank” solution consists of creating a new banking system from the ashes of the old one by removing the healthy assets and liabilities from the balance sheet of the old banks. It has a relatively small cost and the major advantage that credit flows will resume. Its drawback is that it lets the old banks sink or swim. But if they sink, with huge losses, these might spill over into the personal sector, and the ultimate cost may be the same as in the business-as-usual model: a catastrophic depression.
In this new Policy Note, author Elias Karakitsos of Guildhall Asset Management and the Centre for Economic and Public Policy, University of Cambridge, outlines a modified “good bank” approach, with the government either guaranteeing a large proportion of the personal sector’s assets or assuming the first loss in case the old banks fail. It has the same advantages as the original good-bank model, but it makes sure that, in the eventuality that the old banks become insolvent, the economy is shielded from falling into depression, and recovery is ultimately ensured.
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Policy Note 2009/2 | March 2009
Central banks have an aversion to bailing out speculators when asset bubbles burst, but ultimately, as custodians of the financial system, they have to do exactly that. Their actions are justified by the goal of protecting the economy from the bursting of bubbles; while their intention may be different, the result is the same: speculators, careless investors, and banks are bailed out.
The authors of this new Policy Note say that a far better approach is for central banks to widen their scope and target the net wealth of the personal sector. Using interest rates in both the upswing and the downswing of a (business) cycle would avoid moral hazard. A net wealth target would not impede the free functioning of the financial system, as it deals with the economic consequences of the rise and fall of asset prices rather than with asset prices (equities or houses) per se. It would also help to control liquidity and avoid future crises. The current crisis has its roots in the excessive liquidity that, beginning in the mid 1990s, financed a series of asset bubbles. This liquidity was the outcome of “bad” financial engineering that spilled over to other banks and to the personal sector through securitization, in conjunction with overly accommodating monetary policy. Hence, targeting net wealth would also help control liquidity, the authors say, without interfering with the financial engineering of banks.
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Press Releases | March 2009
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Working Paper No. 557 | March 2009
Third Time a Charm? Or Strike Three?
United States financial regulation has traditionally made functional and institutional regulation roughly equivalent. However, the gradual shift away from Glass-Steagall and the introduction of the Financial Modernization Act (FMA) generated a disorderly mix of functions and products across institutions, creating regulatory gaps that contributed to the recent crisis. An analysis of this history suggests that a return to regulation by function or product would strengthen regulation. The FMA also made a choice in favor of financial holding companies over universal banks, but without recognizing that both types of structure require specific regulatory regimes. The paper reviews the specific regime that has been used by Germany in regulating its universal banks and suggests that a similar regime adapted to holding companies should be developed.
Download:Associated Program:Author(s):Jan KregelRelated Topic(s):Financial Modernization Act Financial regulation Germany Glass-Steagall Act Macroprudential regulation Universal banking systemRegion(s):United States -
Public Policy Brief No. 99 | March 2009
In the current global financial crisis, economists and policymakers have reembraced Big Government as a means of preventing the reoccurrence of a debt-deflation depression. The danger, however, is that policy may not downsize finance and replace money manager capitalism. According to Senior Scholar L. Randall Wray, we need a permanently larger fiscal presence, with more public services. His advice to President Obama is to discard all of former Treasury Secretary Paulson’s actions. Wray believes that we can afford any necessary spending and bailouts, and that these actions will not burden our grandchildren.
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Public Policy Brief Highlights No. 98A | February 2009
The Accounting Campaign Against Social Security and Medicare
The Federal Accounting Standards Advisory Board (FASAB) has proposed subjecting the entire federal budget to “intergenerational accounting”—which purports to calculate the debt burden our generation will leave for future generations—and is soliciting comments on the recommendations of its two “exposure drafts.” The authors of this brief find that intergenerational accounting is a deeply flawed and unsound concept that should play no role in federal government budgeting, and that arguments based on this concept do not support a case for cutting Social Security or Medicare.
The FASAB exposure drafts have not made a persuasive argument about basic matters of accounting, say the authors. Federal budget accounting should not follow the same procedures adopted by households or business firms because the government operates in the public interest, with the power to tax and issue money. There is no evidence, nor any economic theory, behind the proposition that government spending needs to match receipts. Social Security and Medicare spending need not be politically constrained by tax receipts—there cannot be any “underfunding.” What matters is the overall fiscal stance of the government, not the stance attributed to one part of the budget.
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Press Releases | February 2009Download:Associated Program:Author(s):Mark Primoff
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Public Policy Brief No. 98 | February 2009
The Federal Accounting Standards Advisory Board (FASAB) has proposed subjecting the entire federal budget to “intergenerational accounting”—which purports to calculate the debt burden our generation will leave for future generations—and is soliciting comments on the recommendations of its two “exposure drafts.” The authors of this brief find that intergenerational accounting is a deeply flawed and unsound concept that should play no role in federal government budgeting, and that arguments based on this concept do not support a case for cutting Social Security or Medicare.
The FASAB exposure drafts have not made a persuasive argument about basic matters of accounting, say the authors. Federal budget accounting should not follow the same procedures adopted by households or business firms because the government operates in the public interest, with the power to tax and issue money. There is no evidence, nor any economic theory, behind the proposition that government spending needs to match receipts. Social Security and Medicare spending need not be politically constrained by tax receipts—there cannot be any “underfunding.” What matters is the overall fiscal stance of the government, not the stance attributed to one part of the budget.
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Public Policy Brief No. 97 | January 2009
The Outlook for Macroeconomics and Macroeconomic Policy
“Change” was the buzzword of the Obama campaign, in response to a political agenda precipitated by financial turmoil and a global economic crisis. According to Research Associate Thomas Palley, the neoliberal economic policy paradigm underlying that agenda must itself change if there is to be a successful policy response to the crisis. Mainstream economic theory remains unreformed, says Palley, and he warns of a return to failed policies if a deep crisis is averted. Since Post Keynesians accurately predicted that the US economy would implode from within, there is an opportunity for Post Keynesian economics to replace neoliberalism with a more successful approach.
Palley notes that there is significant disagreement among economic paradigms about how to ensure full employment and shared prosperity. A salient feature of the neoliberal economy is the disconnect between wages and productivity growth. Workers are boxed in on all sides by globalization, labor market flexibility, inflation concerns, and a belief in “small government” that has eroded economic rights and government services. Financialization, the economic foundation of neoliberalism, serves the interests of financial markets and top management. Thus, reversing the neoliberal paradigm will require a policy agenda that addresses financialization and ensures that financial markets and firms are more closely aligned with the greater public interest.
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Working Paper No. 555 | January 2009
This paper explores the significance of Islamic banking in Malaysia for stability in the country’s economy as a whole. Neither conventional theory nor Islamic economics puts forward a systematic explanation of financial intermediation; consequently, neither is capable of identifying destabilizing elements in the system. Instead, a flow-of-funds approach similar to Minsky’s own is applied to the (post-) modern (consumption-led) business cycle and financial (and asset) market.
Malaysia’s structural current account surplus contributes to the overcapitalization of domestic firms. This in turn finances a financial (as opposed to an industrial), consumption-led (instead of investment-led) business cycle, where banking favors destabilizing asset price inflation. Islamic banks operating interdependently with conventional ones contribute to economic destabilization, channelling surplus funds from the corporate to the household sector.
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Working Paper No. 554 | January 2009
Macroeconomic Imbalances in the United States and Their Impact on the International Financial System
The argument put forward in this paper is twofold. First, the financial crisis of 2007–08 was made global by the current account deficit in the United States; and second, there is global dependence on the United States trade deficit as a means of maintaining liquidity in financial markets. The outflow of dollars from the United States was invested in US capital markets, causing inflation in asset markets and leading to a bubble and bust in the subprime mortgage sector. Since the US dollar is the international reserve currency, international debt is mostly denominated in dollars. Because there is a high degree of global financial integration, any reduction in the US balance of trade will have negative effects on many countries throughout the world—for example, those countries dependent on exporting to the United States in order to finance their debt.
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Public Policy Brief Highlights No. 97A | January 2009
The Outlook for Macroeconomics and Macroeconomic Policy
“Change” was the buzzword of the Obama campaign, in response to a political agenda precipitated by financial turmoil and a global economic crisis. According to Research Associate Thomas Palley, the neoliberal economic policy paradigm underlying that agenda must itself change if there is to be a successful policy response to the crisis. Mainstream economic theory remains unreformed, says Palley, and he warns of a return to failed policies if a deep crisis is averted. Since Post Keynesians accurately predicted that the US economy would implode from within, there is an opportunity for Post Keynesian economics to replace neoliberalism with a more successful approach.
Palley notes that there is significant disagreement among economic paradigms about how to ensure full employment and shared prosperity. A salient feature of the neoliberal economy is the disconnect between wages and productivity growth. Workers are boxed in on all sides by globalization, labor market flexibility, inflation concerns, and a belief in “small government” that has eroded economic rights and government services. Financialization, the economic foundation of neoliberalism, serves the interests of financial markets and top management. Thus, reversing the neoliberal paradigm will require a policy agenda that addresses financialization and ensures that financial markets and firms are more closely aligned with the greater public interest.
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Working Paper No. 553 | December 2008
Is It Worth the Premium? What Are the Alternatives?
Following an analysis of the forces behind the “global capital flows paradox” observed in the era of advancing financial globalization, this paper sets out to investigate the opportunity costs of self-insurance through precautionary reserve holdings. We reject the idea of reserves as low-cost protection against the vagaries of global finance. We also deny that arrangements giving rise to their rapid accumulation might be sustainable in the first place. Alternative policy options open to developing countries are explored, designed to limit both the risks of financial globalization and the costs of insurance-type responses. We propose comprehensive capital account management as an alternative to full capital account liberalization. The aims of a permanent regulatory regime of capital controls, with respect to both the aggregate size and the composition of capital flows, are twofold: first, to maintain sufficient macro policy space; second, to assure a good micro fit of external expertise incorporated in foreign direct investment as part of a country’s development strategy.
Download:Associated Program:Author(s):Related Topic(s):Capital controls Capital flows Financial crisis Globalization International monetary order International reservesRegion(s):United States -
Working Paper No. 549 | November 2008
These notes present a new approach to corporate finance, one in which financing is not determined by prospective income streams but by financing opportunities, liquidity considerations, and prospective capital gains. This approach substantially modifies the traditional view of high interest rates as a discouragement to speculation; the Keynesian and Post-Keynesian theory of liquidity preference as the opportunity cost of investment; and the notion of the liquidity premium as a factor in determining the rate of interest on longer-term maturities.
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Policy Note 2008/6 | November 2008
While serving as chairman of the Federal Reserve Board, Alan Greenspan advocated unsupervised securitization, subprime lending, option ARMs, credit-default swaps, and all manner of financial alchemy in the belief that markets “work” to reduce and spread risk, and to allocate it to those best able to assess and bear it—in his view, markets would stabilize in the absence of nasty government intervention. But as Greenspan now admits, he could never have imagined the outcome: a financial and economic crisis of biblical proportions.
The problem is, market forces are not stabilizing. Left to their own devices, Wall Street wizards gleefully ran right off the cliff, and took the rest of us with them for good measure. The natural instability of market processes was recognized long ago by John Maynard Keynes, and convincingly updated by Hyman P. Minsky throughout his career. Minsky’s theory explained the transformation of the economy over the postwar period from robust to fragile. He pointed his finger at managed money—huge pools of pension funds, hedge funds, sovereign wealth funds, university endowments, money market funds—that are outside traditional banking and therefore largely underregulated and undersupervised. With a large appetite for risk, managed money sought high returns promised by Wall Street’s financial engineers, who innovated highly complex instruments that few people understood.
In this new Policy Note, President Dimitri B. Papadimitriou and Research Scholar L. Randall Wray take a look back at Wall Street’s path to Armageddon, and propose some alternatives to the Bush-Paulson plan to “bail out” both the Street and the American homeowner. Under the existing plan, Treasury would become an owner of troubled financial institutions in exchange for a capital injection—but without exercising any ownership rights, such as replacing the management that created the mess. The bailout would be used as an opportunity to consolidate control of the nation’s financial system in the hands of a few large (Wall Street) banks, with government funds subsidizing purchases of troubled banks by “healthy” ones.
But it is highly unlikely that relieving banks of some of their bad assets, or injecting some equity into them, will increase their willingness to lend. Resolving the liquidity crisis is the best strategy, the authors say, and keeping small-to-medium-size banks open is the best way to ensure access to credit once the economy recovers. A temporary suspension of the collection of payroll taxes would put more income into the hands of households while lowering the employment costs for firms, fueling spending and employment. The government should assume a more active role in helping homeowners saddled with mortgage debt they cannot afford, providing low-cost 30-year loans directly to all comers; in the meantime, a moratorium on foreclosures is necessary. And federal grants to support local spending on needed projects would go a long way toward rectifying our $1.6 trillion public infrastructure deficit.
Can the Treasury afford all these measures? The answer, the authors say, is yes—and it is a bargain if one considers the cost of not doing it. It is obvious that there exist unused resources today, as unemployment rises and factories are idled due to lack of demand. Markets are also voting with their dollars for more Treasury debt. This does not mean the Treasury should spend without restraint—whatever rescue plan is adopted should be well planned and targeted, and of the proper size. The point is that setting arbitrary budget constraints is neither necessary nor desired—especially in the worst financial and economic crisis since the Great Depression.
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Working Paper No. 548 | November 2008
A Minskyan Analysis of the Subprime Crisis
The paper uses Minsky’s financial instability hypothesis as an analytical framework for understanding the subprime mortgage crisis and for introducing adequate reforms to restore economic stability. We argue that the subprime crisis has structural origins that extend far beyond the housing and financial markets. We further argue that rising inequality since the 1980s formed the breeding ground for the current financial markets meltdown. What we observe today is only the manifestation of the ingenuity of the market in taking advantage of moneymaking opportunities, regardless of the consequences. The so-called “democratization of homeownership ” rapidly turned into record-high delinquencies and foreclosures. The sudden turn in market expectations led investors and banks to reevaluate their portfolios, which brought about a credit crunch and widespread economic instability. The Federal Reserve Bank’s intervention came too late and failed to usher in adequate regulation. Finally, the paper argues that a true democratization of homeownership is only possible through job creation and income-generation programs, rather than through exotic mortgage schemes.
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Policy Note 2008/5 | October 2008
As the House Committee on Financial Services meets to hear the expert testimony of witnesses concerning the regulation of the financial system, the measures that have been introduced to support the system are laying the groundwork for a new domestic financial architecture. Hyman Minsky suggests that the basic principle behind any reformulation of the regulatory system should limit the size and activities of financial institutions, and should be dictated by the ability of supervisors, examiners, and regulators to understand the institutions’ operations. Following Minsky’s preference for bank holding company structures, Senior Scholar Jan Kregel proposes the creation of numerous types of subsidiaries within the holding company. The aim would be to limit each type of holding company to a range of activities that were sufficiently linked to their core function and to ensure that each company was small enough to be effectively managed and supervised.
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Working Paper No. 547 | October 2008
“Keynesianism” All Over Again?
Recently, national newspapers all over the world have suggested that we should reread John Maynard Keynes, and that Hyman P. Minsky provides a valuable framework for understanding the world in which we live. While rereading Keynes and discovering Minsky are noble goals, one should also remember the mistakes that were made in the past. The mainstream interpretation and implementation of Keynes’s ideas have been very different from what Keynes proposed, and they have been reduced to simple “fiscal activism.” This led to the 1950s and 1960s “Keynesian” era, during which fine-tuning was supposed to be a straightforward way to fix economic problems. We know today that this is not the case: just playing around with taxes and government expenditures will not do. On the contrary, problems may worsen. If one wants to get serious about Keynes and Minsky, one should understand that the theoretical and policy implications are far-reaching. This paper compares and contrasts Minsky’s views of the capitalist system to the tenets of the New Consensus, and argues that there never has been any true Keynesian revolution. This is illustrated by studying the Roosevelt and Kennedy/Johnson eras, as well as Keynes’s reaction to the former and Minsky’s critique of the latter. Overall, it is argued that the theoretical framework and policy prescriptions of Irving Fisher, not Keynes, have been much more consistent with past and current government policies.
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Working Paper No. 546 | October 2008
Since Christopher Sims’s “Macroeconomics and Reality” (1980), macroeconomists have used structural VARs, or vector autoregressions, for policy analysis. Constructing the impulse-response functions and variance decompositions that are central to this literature requires factoring the variance-covariance matrix of innovations from the VAR. This paper presents evidence consistent with the hypothesis that at least some elements of this matrix are infinite for one monetary VAR, as the innovations have stable, non-Gaussian distributions, with characteristic exponents ranging from 1.5504 to 1.7734 according to ML estimates. Hence, Cholesky and other factorizations that would normally be used to identify structural residuals from the VAR are impossible.
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Policy Note 2008/4 | October 2008
The impaired risk assessment caused by the collapse of mortgage-backed securities is the major problem threatening the stability of the American financial system, yet it is not clear that removing these assets from institutional balance sheets, as the government has proposed, will make it easier to assess counterparty risk in short-term credit markets. Resolving the disruption of counterparty risk should be the first objective of policy, argues Senior Scholar Jan Kregel, since these markets provide basic liquidity support for institutions operating in the broader financial markets.
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Public Policy Brief No. 96 | October 2008
Money Manager Capitalism and the Financialization of Commodities
Money manager capitalism—characterized by highly leveraged funds seeking maximum returns in an environment that systematically underprices risk—has resulted in a series of boom-and-bust cycles in equities, real estate, and commodities. Because subsequent cycles have been increasingly damaging to the broader economy, we are now at the point where we are experiencing the most severe financial crisis since the Great Depression. Hasty interventions (bailouts) by Congress, the Treasury, and the Federal Reserve are attempting to keep the financial industry solvent, in the belief that government inaction would result in a prolonged recession.
In this new public policy brief, Senior Scholar L. Randall Wray shows how money manager capitalism (financialization) has destabilized one asset class after another. He concludes that policymakers must fundamentally change the structure of our economic system, break the cycle of booms and busts, and reduce the influence of managed money—as well as prevent the next speculative boom in yet another asset class.
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Working Paper No. 544 | September 2008
The monetary policy regime of inflation targeting (IT) has been adopted by a significant number of emerging economies. While the focus of this paper is on Brazil, which began inflation targeting in 1999, the authors also examine the experience of other countries, both for comparative purposes and for evidence of the extent of this “new” economic policy’s success. In addition, they compare the experience of Brazil with that of non-IT countries, and ask the question of whether adopting IT makes a difference in the fight against inflation.
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Press Releases | September 2008
New Policy Paper Says Fiscal Stimulus and Regulation Are Needed to Support Economy and That There’s Not Much More Monetary Policy Can Do
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Working Paper No. 543 | September 2008
The Financial Theory of Investment
Expanding on an approach developed by financial economist Hyman Minsky, the authors present an alternative to the standard “efficient markets hypothesis”—the relevance of which Minsky vehemently denied. Minsky recognized that, in a modern capitalist economy with complex, expensive, and long-lived assets, the method used to finance asset positions is of critical importance, both for theory and for real-world outcomes—one reason his alternate approach has been embraced by Post Keynesian economists and Wall Street practitioners alike.
Coauthors L. Randall Wray and �ric Tymoigne argue that the current financial crisis, which began with the collapse of the US subprime mortgage market in 2007, provides a compelling reason to show how Minsky’s approach offers us a solid grounding in the workings of financial capitalism. They examine Minsky’s extension to Keynes’s investment theory of the business cycle, which allowed Minsky to analyze the evolution, over time, of the modern capitalist economy toward fragility—what is well known as his financial instability hypothesis. They then update Minsky’s approach to finance with a more detailed examination of asset pricing and the evolution of the banking sector, and conclude with a brief review of the insights that such an approach can provide for analysis of the current global financial crisis.
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Public Policy Brief No. 95 | August 2008
A bursting asset bubble inevitably requires central bank action, usually when it is already too late and with adverse spillover effects. In this sense, the Federal Reserve and other central banks already target asset prices; yet, by taking aim at them only on the way down—as in the current housing and credit crisis—the "Big Banks" create a self-perpetuating cycle of perverse incentives and moral hazard that often gives rise to yet another round of bubbles.
The US central bank's current premise is that policymakers cannot and should not target asset bubbles. However, the housing story has rendered untenable the prevailing belief that bubbles are impossible to spot ahead of time. The warning signals were ubiquitous—for example, price charts showing home values rising impossibly into the stratosphere, and Wall Street's increasing reliance on housing-backed bonds for its record-setting profits. It has become abundantly clear that there was plenty the Fed could have done to discourage speculative behavior and put a stop to predatory lending.
Recent US experience has bolstered the view that asset prices must come under the central bank's purview in order for the economy to retain some semblance of stability. Former Fed Chairman Paul Volcker recently called for a broader regulatory role for the central bank in light of the housing-centered credit crisis. Indeed, Treasury Secretary Henry Paulson's latest plan for tackling the crisis involves giving the Fed vast new authority to regulate investment banks, not just depository institutions. However, news analyst Pedro Nicolaci da Costa argues that attitude changes among regulators will be even more important than shifts in mandate in ensuring that regulators like the Fed do their jobs properly.
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Policy Note 2008/3 | August 2008
Policy Response to the Current Crisis
As homeowner equity continues to disappear, there is a growing consensus that losses on all mortgages will exceed $1 trillion, with financial losses spreading far beyond real estate. Mortgage rates are spiking and, more generally, interest rate spreads remain wide, as financial players shun private debt in the rush to safe Treasury securities. Labor markets continue to weaken as firms shed jobs, and state tax revenues have plummeted. In March, the dollar fell to new record lows against the euro and other currencies. Commodities prices have boomed, fueling inflation and adding to consumer distress.
What's a central bank to do? So far, the Federal Reserve has met or exceeded the market’s anticipations for rate cuts. It has allowed banks to offer securitized mortgages as collateral against borrowed reserves, and opened its discount window to a broad range of financial institutions to guard against future liquidity problems (remember Bear Stearns?). It helped to formulate a rescue plan for Freddie Mac and Fannie Mae, and Chairman Ben Bernanke even supported the fiscal stimulus package that will increase the federal budget deficit—something that is normally anathema to central bankers. Most importantly, Fed officials have consistently argued that, while they are carefully monitoring inflation pressures, they will not reverse monetary easing until the fallout from the subprime crisis is past.
Unfortunately, the policy isn’t working—the economy continues to weaken, the financial crisis is spreading, and inflation is accelerating. The problem is that policymakers do not recognize the underlying forces driving the crisis, in part because they operate with an incorrect model of how our economy works. This Policy Note summarizes that model, offers an alternative view based on Hyman Minsky’s approach, and outlines an alternative framework for policy formation.
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Public Policy Brief Highlights No. 95A | August 2008
Policy Lessons from America’s Historic Housing Crash
Treasury Secretary Henry Paulson’s latest plan for tackling the housing-centered credit crisis involves giving the Federal Reserve vast new authority to regulate investment banks, not just depository institutions. However, news analyst Pedro Nicolaci da Costa argues that attitude changes among regulators will be even more important than shifts in mandate in ensuring that regulators like the Fed do their jobs properly.
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Policy Note 2008/2 | June 2008
“At the annual banking structure and competition conference of the Federal Reserve Bank of Chicago in May 1987, the buzzword heard in the corridors and used by many of the speakers was ‘that which can be securitized, will be securitized.’” So notes Hyman Minsky in a prescient memo on the nature, and the implications, of securitization, written 20 years before an explosion in the securitization of home mortgages helped create the current financial crisis. This memo, which served as the basis for a lecture in Minsky’s monetary theory class at Washington University, has not been widely circulated. It is published here in its entirety, with a preface and an afterword by Senior Scholar L. Randall Wray that places Minsky’s work in context.
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Policy Note 2008/1 | May 2008
What in monetarism, and what in the "new monetary consensus," led to a correct or even remotely relevant anticipation of the extraordinary financial crisis that broke over the housing sector, the banking system, and the world economy in August 2007 and that has continued to preoccupy central bankers ever since? Absolutely nothing, says Senior Scholar James K. Galbraith.
In this new Policy Note, Galbraith reevaluates monetary policy in light of the collateral damages inflicted by the subprime mortgage crisis. He provides a critique of monetarism—what Milton Friedman famously defined as the proposition that "inflation is everywhere and always a monetary phenomenon"—and of the "new monetary consensus" on which Federal Reserve Chairman Ben Bernanke's ostensible doctrine of inflation targeting rests. Given the current economic crisis, Galbraith says, the Fed would do well to embrace the intellectual victory of John Maynard Keynes, John Kenneth Galbraith, and Hyman P. Minsky—and act accordingly.
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Book Series | May 2008
Hyman P. Minsky. Introduction by Dimitri B. Papadimitriou and L. Randall Wray
The late American economist and Distinguished Scholar Hyman P. Minsky first wrote about the inherent instability of financial markets in the late 1950s, and accurately predicted a transformation of the economy that would not become apparent for nearly a generation. In 2007, interest in his work suddenly exploded as the financial press recognized the relevance of his analysis to the meltdown of the mortgage-backed securities market. Indeed, in this book, first published in 1986, Minsky examined a number of financial crises in detail, several of which involved similar financial instruments, such as commercial paper, municipal bonds, and real estate and investment trusts. More important, he explained why the economy tends to evolve in such a way that these crises become more likely.
Minsky insisted that there is an inherent and fundamental instability in our sort of economy that tends toward a speculative boom. Unlike other critical analyses of capitalist processes, which emphasize the crash, Minsky was more concerned with the behavior of agents during the euphoric periods. And unlike other analyses that blame "shocks," "irrational exuberance," or "foolish" policy, he argued that the processes that generate financial fragility are "natural," or endogenous to the system.
Stabilizing an Unstable Economy is Minsky's seminal work, and it has been reissued so that it may be broadly available to a new generation of economists, analysts, and investors. The book covers, among other topics, the effect of speculative finance on investment and asset prices; booms and busts as unavoidable results of high-risk lending practices; government's role in bolstering consumption during times of high unemployment; and the need to increase Federal Reserve oversight of banks.
Published By: McGraw-Hill
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Book Series | May 2008
Hyman P. Minsky. Introduction by Dimitri B. Papadimitriou and L. Randall Wray
This reissue of Hyman P. Minsky's classic book offers a timely reconsideration of the work of economics icon John Maynard Keynes. In it, Minsky argues that what most economists consider Keynesian economics is at odds with the major points of Keynes's The General Theory of Employment, Interest, and Money. Both Keynes and Minsky refuse to ignore pervasive uncertainty. Once uncertainty is given center stage, they observe, recurring financial crises are all but inescapable. For Minsky, economic calm on Main Street engenders financial system fragility that, in turn, ensures a perpetuation of boom-and-bust cycles.
As President Dimitri B. Papadimitriou and Senior Scholar L. Randall Wray write in their Introduction, this new edition of John Maynard Keynes has been published "in the hope that it will contribute to the reformation of economic theory so that it can address the world in which we actually live—the world that was always the topic of Minsky's analysis."
Hyman P. Minsky was an American economist who studied under Joseph Schumpeter and Wassily Leontief. He later taught economics at The University of California–Berkeley and at Washington, Brown, and Harvard Universities. In 1990, Minsky joined The Levy Economics Institute as a distinguished scholar, where he continued his research and writing until a few months before his death in October 1996.
Published By: McGraw-Hill
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Working Paper No. 533 | April 2008
Over the last two centuries in Latin America a Washington Consensus development strategy based on integration in the global trading system has dominated both domestic demand management and industrialization "from within." This paper assesses the performance of each from the point of view of the impact of external conditions, and the validity of its underlying theory. It concludes by noting that replacing the Consensus will require not only reform of the international financial architecture but also a return to the integrated policy framework represented in the Havana Charter.
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Working Paper No. 532 | April 2008
This paper seeks to explain the causes and consequences of the United States subprime mortgage crisis, and how this crisis has led to a generalized credit crunch in other financial sectors that ultimately affects the real economy. It postulates that, despite the recent financial innovations, the financial strategies—leveraging and financial risk mismatching—that led to the present crisis are similar to those found in the United States savings-and-loan debacle of the late 1980s and in the Asian financial crisis of the late 1990s. However, these strategies are based on market innovations that have heightened, not reduced, systemic risks and financial instability. They are as the title implies: old wine in a new bottle. Going beyond these financial practices, the underlying structural causes of the crisis are located in the loose monetary policies of central banks, deregulation, and excess liquidity in financial markets that is a consequence of the kind of economic growth that produces various imbalances—trade imbalances, financial sector imbalances, and wealth and income inequality. The consequences of excessive risk, moral hazards, and rolling bubbles are discussed.
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Working Paper No. 531 | April 2008
This paper sets out to investigate the forces behind the so-called “global capital flows paradox” and related “dollar glut” observed in the era of advancing financial globalization. The supposed paradox is that the developing world has increasingly come to pursue policies that result in current account surpluses and thus net capital exports—destined primarily for the capital-rich United States. The hypothesis put forward here is that systemic deficiencies in the international monetary and financial order have been the root cause behind today’s situation. Furthermore, it is argued that the United States’ position as issuer of the world’s premiere reserve currency and supremacy in global finance explain the related conundrum of a positive investment income balance despite a negative international investment position. The assessment is carried out in light of John Maynard Keynes’s views on a sound international monetary and financial order.
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Working Paper No. 530 | April 2008
This paper traces the evolution of housing finance in the United States from the deregulation of the financial system in the 1970s to the breakdown of the savings and loan industry and the development of GSE (government-sponsored enterprise) securitization and the private financial system. The paper provides a background to the forces that have produced the present system of residential housing finance, the reasons for the current crisis in mortgage financing, and the impact of the crisis on the overall financial system.
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Public Policy Brief Highlights No. 94A | April 2008
According to Senior Scholar L. Randall Wray, the current crisis in financial markets can be traced back to securitization (the “originate and distribute” model), leverage, the demise of relationship-based banking, and a dizzying array of extremely complex instruments that—quite literally—only a handful understand.
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Public Policy Brief No. 94 | April 2008
What Can We Learn from Minsky?
In this new Public Policy Brief, Senior Scholar L. Randall Wray explains today’s complex and fragile financial system, and how the seeds of crisis were sown by lax oversight, deregulation, and risky innovations such as securitization. He estimates that the combined losses throughout the entire financial sector could amount to several trillion dollars, and that the United States will feel the effects of the crisis for some time—perhaps a decade or more.
Wray recommends enhanced oversight of financial institutions, much larger stimulus packages, and creation of a new institution in line with President Franklin D. Roosevelt’s Home Owners’ Loan Corporation.
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Working Paper No. 528 | February 2008
The Role of Catching Up by Late-industrializing Developing Countries
While the traditional approach to the adjustment of international imbalances assumes industrialized countries at a similar level of development and with similar production structures, such imbalances have historically been the result of a process of catching up by late-industrializing developing countries. This may call for an alternative approach that assesses how these imbalances can be managed in order to support developing countries’ efforts to achieve successful industrialization and integration into the global trade and financial system. In this light, the paper presents an alternative explanation of the existence and persistence of the currently high levels of imbalances and suggests reasons why they may persist in the medium term.
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Public Policy Brief Highlights No. 93A | January 2008
In this brief, Senior Scholar Jan Kregel reviews Hyman P. Minsky’s concept of financial fragility—in short, that the structure of a capitalist economy becomes more fragile over a period of prosperity—and concludes that the current crisis is in fact the result of insufficient margins of safety based on how creditworthiness is assessed in the new “originate and distribute” financial system.
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Public Policy Brief No. 93 | January 2008
Systemic Risk and the Crisis in the U.S. Subprime Mortgage Market
In this brief, Senior Scholar Jan Kregel reviews Hyman P. Minsky’s concept of financial fragility—in short, that the structure of a capitalist economy becomes more fragile over a period of prosperity—and concludes that the current crisis is in fact the result of insufficient margins of safety based on how creditworthiness is assessed in the new “originate and distribute” financial system.
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Working Paper No. 525 | December 2007
What It Is and Why It Matters
Financialization is a process whereby financial markets, financial institutions, and financial elites gain greater influence over economic policy and economic outcomes. Financialization transforms the functioning of economic systems at both the macro and micro levels.
Its principal impacts are to (1) elevate the significance of the financial sector relative to the real sector, (2) transfer income from the real sector to the financial sector, and (3) increase income inequality and contribute to wage stagnation. Additionally, there are reasons to believe that financialization may put the economy at risk of debt deflation and prolonged recession.
Financialization operates through three different conduits: changes in the structure and operation of financial markets, changes in the behavior of nonfinancial corporations, and changes in economic policy.
Countering financialization calls for a multifaceted agenda that (1) restores policy control over financial markets, (2) challenges the neoliberal economic policy paradigm encouraged by financialization, (3) makes corporations responsive to interests of stakeholders other than just financial markets, and (4) reforms the political process so as to diminish the influence of corporations and wealthy elites.
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Working Paper No. 523 | December 2007
This paper contrasts the economic incentives implicit in the Keynes-Minsky approach to inherent financial market instability with the incentives behind the traditional equilibrium approach leading to market stability to provide a framework for analyzing the stability induced by the recent changes in bank regulation to modernize financial services and the evolution of financial engineering innovations in the US financial system. It suggests that the changes that have occurred in the profit incentives for bank holding companies have modified the provision of liquidity to the financial system by banks, and the way credit assessment has moved from banks to other actors in the system. It takes the current experience in financial instability created by the expansion, through securitization, of the mortgage market as an example of these changes.
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Working Paper No. 522 | December 2007
This paper uses Hyman P. Minsky’s approach to analyze the current international financial crisis, which was initiated by problems in the American real estate market. In a 1987 manuscript, Minsky had already recognized the importance of the trend toward securitization of home mortgages. This paper identifies the causes and consequences of the financial innovations that created the real estate boom and bust. It examines the role played by each of the key players—including brokers, appraisers, borrowers, securitizers, insurers, and regulators—in creating the crisis. Finally, it proposes short-run solutions to the current crisis, as well as longer-run policy to prevent “it” (a debt deflation) from happening again.
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Working Paper No. 520 | November 2007
Ragnar Nurkse was one the pioneers in development economics. This paper celebrates the hundredth anniversary of his birth with a critical retrospective of his overall contribution to the field, in particular his views on the importance of employment policy in mobilizing domestic resources and the difficulties surrounding the use of external resources to finance development. It also demonstrates the affinity between Nurkse’s theory of mobilizing domestic resources and employer-of-last-resort proposals.
Download:Associated Program(s):Explorations in Theory and Empirical Analysis Employment Policy and Labor Markets Monetary Policy and Financial StructureAuthor(s):Jan Kregel -
Public Policy Brief No. 92 | October 2007
A Minsky Moment
It is now clear that most economists underestimated the widening economic impact of the credit crunch that has shaken American financial markets since at least mid-July. A credit crunch is an economic condition in which loans and investment capital are difficult to obtain; in such a period, banks and other lenders become wary of issuing loans, so the price of borrowing rises, often to the point where deals simply do not get done. Financial economist Hyman P. Minsky (1919–1996) was the foremost expert on such crunches, and his ideas remain relevant to understanding the current situation.
This brief by Charles J. Whalen demonstrates that the US credit crunch of 2007 can aptly be described as a “Minsky moment.” It begins by taking a look at aspects of this crunch, then examines the notion of a Minsky moment, along with the main ideas informing Minsky’s perspective on economic instability. At the heart of that viewpoint is what Minsky called the “financial instability hypothesis,” which derives from an interpretation of John Maynard Keynes’s work and underscores the value of an evolutionary and institutionally grounded alternative to conventional economics. The brief then returns to the 2007 credit crunch and identifies some of the key elements relevant to fleshing out a Minsky-oriented account of that event.
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Working Paper No. 512 | September 2007
Structuralist and Horizontalist
While the mainstream long argued that the central bank could use quantitative constraints as a means to controlling the private creation of money, most economists now recognize that the central bank can only set the overnight interest rate—which has only an indirect impact on the quantity of reserves and the quantity of privately created money. Indeed, in order to hit the overnight rate target, the central bank must accommodate the demand for reserves, draining the excess or supplying reserves when the system is short. Thus, the supply of reserves is best characterized as horizontal, at the central bank’s target rate. Because reserves pay relatively low rates, or even zero rates (as in the United States), banks try to minimize their holdings. Over time, they continually innovate, as they seek to minimize costs and increase profits. This includes innovations that reduce the quantity of reserves they need to hold (either to satisfy legal requirements, or to meet the needs of check cashing and clearing), and also innovations that allow them to increase the rate of return on equity within regulatory constraints, such as those associated with Basle agreements. Such behavior has been a central concern of the structuralist approach—which argued that it is too simplistic to hypothesize simple horizontal loan-and-deposit supply curves.
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In the Media | September 2007
By Wolfgang Münchau
FT.com, September 3, 2007. Copyright 2007 The Financial Times Limited. “FT” and “Financial Times” are trademarks of the Financial Times
“Financial operations do not lend themselves to innovation. What is recurrently so described and celebrated is, without exception, a small variation on an established design. . . . The world of finance hails the invention of the wheel over and over again, often in a slightly more unstable version.” —John Kenneth Galbraith, A Short History of Financial Euphoria
The late John Kenneth Galbraith would have enjoyed this summer. He was no expert on modern credit markets but his analysis of historic bubbles fits our most recent boom and bust episode with uncanny precision.
All historic bubbles were accompanied by a sharp rise in leverage. A salient feature of modern bubbles is the emergence of innovative financial products. No matter whether we are talking about junk bonds or modern collateralised debt obligations (CDOs), as Galbraith has pointed out, such products boil down to variants of debt secured on a real asset.
By historic standards, our credit bubble is probably one of the largest ever, given the sheer size of the market itself and the degree of euphoria that was characteristic in the final stages of the boom. While the fallout was initially concentrated in the financial sector itself, it would be surprising if the ongoing problems did not trickle down into the real economy. The availability of credit affects house prices and numerous studies have demonstrated the interlinkages between US house prices and US economic growth.
So what should central banks do? I suspect that central banks are not going to be the main actors in any rescue operation, but rather governments. Central banks' room for manoeuvre to cut interest rates is more constrained this time than during the most recent recession. But more important, this is not the kind of crisis that can easily be stopped by a few hasty rate cuts or bank bail-outs. If your subprime mortgage exceeds the value of your house by 10 per cent, and if the monthly payments exceed your income, no positive interest rate could bail you out. Your only hope is some serious debt relief.
The economists Dimitri Papadimitriou, Greg Hannsgen and Gennaro Zezza last week published a study* in which they demonstrated the danger to US economic growth posed by the present real estate crisis. Their policy recommendations go significantly beyond the usual bail-out calls. They argue that it is almost impossible for policymakers to stop the decline in real estate prices, but “if the Fed and Congress can work to stop any incipient recession, they will prevent job losses, which are one of the main contributors to foreclosures. An effective job-creation method could be some form of employer-of-last-resort programme that offers government jobs to all workers who ask for them”.
We should remember that the subprime market is not the only unstable subsection of the credit market. Once US consumption slows, we should prepare for a crisis in credit card and car finance CDOs. And once corporate bankruptcies start to rise again as the cycle turns down, both in the US and in Europe, we will probably hear about problems with collateralised loan obligations. The credit market is very deep and offers significant potential for contagion.
In this sense, the debate about whether this is a liquidity or a solvency crisis is beside the point. Banks may look at their CDO investments as a source of temporary illiquidity, but may sooner or later realise that they are sitting on a pile of junk. The fiscal and monetary authorities should therefore assume that they are confronted with a solvency crisis. Bailing out the odd bank, as the Germans did last month, is not going to be sufficient and perhaps not even necessary.
Instead, the monetary and fiscal authorities should stand ready to support the economy if and when needed. Lower interest rates will probably be part of any such deal, but a large part of the help will invariably come from fiscal policy. The US Federal Reserve will probably cut interest rates soon and the European Central Bank will almost certainly postpone the rate rise it unwisely preannounced only a few weeks ago. I am convinced the next interest rate movement both in the US and the eurozone will be downwards.
One of the problems the monetary authorities have to deal with is moral hazard. This is not a theoretical issue, as some suggest, but a far more immediate concern. Moral hazard is the result of asymmetric expectations, as markets expect the central bank to bail out the financial sector during a time of crisis. The problem of moral hazard is to some extent related to the monetary policy strategy of central banks, with their mechanistic focus on a single consumer price index. Such strategies often have no space for asset prices, but markets know fully well that central banks must invariably take account of asset prices during sharp downturns. One way out of this asymmetry is for central banks to include asset prices into their policy frameworks in some form or other.
This said, a bail-out of the financial system will probably become unavoidable, but it should be accompanied with structural policy changes. Tighter financial regulation is probable. The role of the ratings agencies is bound to change too. And central banks should reconsider their monetary policy frameworks. They are part of the problem.
*Cracks in the Foundations of Growth, Levy Institute, www.levyinstitute.org/pubs/ppb_90.pdf
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In the Media | August 2007
Mr. Minsky long argued markets were crisis prone; his “moment” has arrived
By Justin Lahart. The Wall Street Journal, August 18, 2007, Page A1
Copyright 2007 Dow Jones & Company, Inc.The recent market turmoil is rocking investors around the globe. But it is raising the stock of one person: a little-known economist whose views have suddenly become very popular.
Hyman Minsky, who died more than a decade ago, spent much of his career advancing the idea that financial systems are inherently susceptible to bouts of speculation that, if they last long enough, end in crises. At a time when many economists were coming to believe in the efficiency of markets, Mr. Minsky was considered somewhat of a radical for his stress on their tendency toward excess and upheaval.
Today, his views are reverberating from New York to Hong Kong as economists and traders try to understand what’s happening in the markets. The Levy Economics Institute of Bard College, where Mr. Minsky worked for the last six years of his life, is planning to reprint two books by the economist—one on John Maynard Keynes, the other on unstable economies. The latter book was being offered on the Internet for thousands of dollars.
Christopher Wood, a widely read Hong Kong-based analyst for CLSA Group, told his clients that recent cash injections by central banks designed “to prevent, or at least delay, a ’Minsky moment,’ is evidence of market failure.”
Indeed, the Minsky moment has become a fashionable catch phrase on Wall Street. It refers to the time when over-indebted investors are forced to sell even their solid investments to make good on their loans, sparking sharp declines in financial markets and demand for cash that can force central bankers to lend a hand.
Mr. Minsky, who died in 1996 at the age of 77, was a tall man with unruly hair who wore unpressed suits. He approached the world as “one big research tank,” says Diana Minsky, his daughter, an art history professor at Bard. “Economics was an integrated part of his life. It wasn’t isolated. There wasn’t a sense that work was something he did at the office.”
She recalls how, on a trip to a village in Italy to meet friends, Mr. Minsky ended up interviewing workers at a glove maker to understand how small-scale capitalism worked in the local economy.
Although he was born in Chicago, Mr. Minsky didn’t have many fans in the “Chicago School” of economists, who believed that markets were efficient. A follower of the economist John Maynard Keynes, he died just before a decade of financial crises in Asia, Russia, tech stocks, corporate credit and now mortgage debt, began to lend credence to his ideas.
Following those periods of tumult, more investors turned to the investment classic “Manias, Panics, and Crashes: A History of Financial Crises,” by Charles Kindleberger, a professor at the Massachusetts Institute of Technology who leaned heavily on Mr. Minsky’s work.
Mr. Kindleberger showed that financial crises unfolded the way that Mr. Minsky said they would. Though a loyal follower, Mr. Kindleberger described Mr. Minsky as “a man with a reputation among monetary theorists for being particularly pessimistic, even lugubrious, in his emphasis on the fragility of the monetary system and its propensity to disaster.”
At its core, the Minsky view was straightforward: When times are good, investors take on risk; the longer times stay good, the more risk they take on, until they’ve taken on too much. Eventually, they reach a point where the cash generated by their assets no longer is sufficient to pay off the mountains of debt they took on to acquire them. Losses on such speculative assets prompt lenders to call in their loans. “This is likely to lead to a collapse of asset values,” Mr. Minsky wrote.
When investors are forced to sell even their less-speculative positions to make good on their loans, markets spiral lower and create a severe demand for cash. At that point, the Minsky moment has arrived.
“We are in the midst of a Minsky moment, bordering on a Minsky meltdown,” says Paul McCulley, an economist and fund manager at Pacific Investment Management Co., the world’s largest bond-fund manager, in an email exchange.
The housing market is a case in point, says Investment Technology Group Inc. economist Robert Barbera, who first met Mr. Minsky in the late 1980s. When home buyers were expected to have a down payment of 10% or 20% to qualify for a mortgage, and to provide income documentation that showed they’d be able to make payments, there was minimal risk. But as home prices rose, and speculators entered the market, lenders relaxed their guard and began offering loans with no money down and little or no documentation.
Once home prices stalled and, in many of the more-speculative markets, fell, there was a big problem.
“If you’re lending to home buyers with 20% down and house prices fall by 2%, so what?” Mr. Barbera says. If most of a lender’s portfolio is tied up in loans to buyers who “don’t put anything down and house prices fall by 2%, you’re bankrupt,” he says.
Several money managers are laying claim to spotting the Minsky moment first. “I featured him about 18 months ago,” says Jeremy Grantham, chairman of GMO LLC, which manages $150 billion in assets. He pointed to a note in early 2006 when he wrote that investors had become too comfortable that financial markets were safe, and consequently were taking on too much risk, just as Mr. Minsky predicted. “Guinea pigs of the world unite. We have nothing to lose but our shirts,” he concluded.
It was Mr. McCulley at Pacific Investment, though, who coined the phrase “Minsky moment” during the Russian debt crisis in 1998.
Laurence Meyer, who served on the faculty with Mr. Minsky at Washington University in St. Louis, was a Federal Reserve Governor during those turbulent times. Mr. Meyer says that when he was an academic, Mr. Minsky’s work didn’t interest him very much, but that changed when he went into the real world. He says he grew to appreciate it even more when he was at the Fed watching financial crises unfold.
“Had Minsky been there, he probably would have been calling me and alerting me along the ride. And that would have been a good thing,” Mr. Meyer says. “Every year that goes by, I appreciate him more. I hear myself sometimes and I think, oh my gosh, I sound like Hy Minsky.“
Steven Fazzari, an economics professor at Washington University, says that Mr. Minsky would have supported the Federal Reserve’s recent move to provide cash and cut the rate it charges banks on loans from its discount window to try to avert a financial crisis that could spill over to the economy. But he would probably be worried, too, that the moves might be bailing out investors who would all too soon be speculating again.
Having seen recent events unfold in the way his friend and former colleague predicted, Mr. Fazzari says, “I hope he’s someplace saying, ‘Aha, I told you so!’”
—Jon E. Hilsenrath contributed to this article.
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Working Paper No. 511 | August 2007
Monetary Policy, Inflation, Unemployment, Inequality—and Presidential Politics
Using a VAR model of the American economy from 1984 to 2003, we find that, contrary to official claims, the Federal Reserve does not target inflation or react to “inflation signals.” Rather, the Fed reacts to the very “real” signal sent by unemployment, in a way that suggests that a baseless fear of full employment is a principal force behind monetary policy. Tests of variations in the workings of a Taylor Rule, using dummy variable regressions, on data going back to 1969 suggest that after 1983 the Federal Reserve largely ceased reacting to inflation or high unemployment, but continued to react when unemployment fell “too low.” Further, we find that monetary policy (measured by the yield curve) has significant causal impact on pay inequality—a domain where the Fed refuses responsibility. Finally, we test whether Federal Reserve policy has exhibited a pattern of partisan bias in presidential election years, with results that suggest the presence of such bias, after controlling for the effects of inflation and unemployment.
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Working Paper No. 510 | August 2007
This paper addresses three issues surrounding monetary policy formation: policy independence, choice of operating targets, and rules versus discretion. According to the New Monetary Consensus, the central bank needs policy independence to build credibility; the operating target is the overnight interbank lending rate, and the ultimate goal is price stability. This paper provides an alternative view, arguing that an effective central bank cannot be independent as conventionally defined, where effectiveness is indicated by ability to hit an overnight nominal interest rate target. Discretionary policy is rejected, as are conventional views of the central bank’s ability to achieve traditional goals such as robust growth, low inflation, and high employment. Thus, the paper returns to Keynes’s call for low interest rates and euthanasia of the rentier.
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Public Policy Brief No. 90 | July 2007
What Will the Housing Debacle Mean for the U.S. Economy?
With economic growth having cooled to less than 1 percent in the first quarter of 2007, the economy can ill afford a slump in consumption by the American household. But it now appears that the household sector could finally give in to the pressures of rising gasoline prices, a weakening home market, and a large debt burden. The signals are still mixed; for example, while April’s retail sales numbers caused concern, May’s were much improved, and so was the ISM manufacturing index for June. Consumption growth indicates a slowdown. This Public Policy Brief examines the American household and its economic fortunes, concentrating on how falling home prices might hamper economic growth, generate social dislocations, and possibly lead to a full-blown financial crisis.
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Public Policy Brief Highlights No. 90A | July 2007
What Will the Housing Debacle Mean for the U.S. Economy?
With economic growth having cooled to less than 1 percent in the first quarter of 2007, the economy can ill afford a slump in consumption by the American household. But it now appears that the household sector could finally give in to the pressures of rising gasoline prices, a weakening home market, and a large debt burden.Download:Associated Program(s):Author(s):Region(s):United States -
Working Paper No. 489 | January 2007
This paper provides an analysis of Keynes's original "Bancor" proposal as well as more recent proposals for fixed exchange rates. We argue that these schemes fail to pay due attention to the importance of capital movements in today's economy, and that they implicitly adopt an unsatisfactory notion of money as a mere medium of exchange. We develop an alternative approach to money based on the notion of currency sovereignty. As currency sovereignty implies the ability of a country to implement monetary and fiscal policies independently, we argue that it is necessarily contingent on a country's adoption of floating exchange rates. As illustrations of the problems created for domestic policy by the adoption of fixed exchange rates, we briefly look at the recent Argentinean and European experiences. We take these as telling examples of the high costs of giving up sovereignty (Argentina and the European countries of the EMU) and the benefits of regaining it (Argentina). A regime of more flexible exchange rates would have likely produced a more viable and dynamic European economic system, one in which each individual country could have adopted and implemented a mix of fiscal and monetary policies more suitable to its specific economic, social, and political context. Alternatively, the euro area will have to create a fiscal authority on par with that of the US Treasury, which means surrendering national authority to a central government—an unlikely possibility in today's political climate. We conclude by pointing out some of the advantages of floating exchange rates, but also stress that such a regime should not be regarded as a sort of panacea. It is a necessary condition if a country is to retain its sovereignty and the power to implement autonomous economic policies, but it is not a sufficient condition for guaranteeing that such policies actually be aimed at providing higher levels of employment and welfare.
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Public Policy Brief No. 89 | January 2007
How Should Policy Respond?
According to Research Associate Thomas I. Palley, global outsourcing represents a new economic challenge that calls for a new set of institutions. In this brief, he expands upon the problems of offshore outsourcing as outlined in Public Policy Brief no. 86 and focuses on the microeconomic foundations. He argues that outsourcing is a central element of globalization that is best understood as a new form of competition. Palley urges policymakers to understand the economic basis of outsourcing in order to develop effective policies, and suggests that they focus on enhancing national competitiveness and establishing new rules that govern the nature of global competition.
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Public Policy Brief Highlights No. 89A | January 2007
How Should Policy Respond?
According to Research Associate Thomas I. Palley, global outsourcing represents a new economic challenge that calls for a new set of institutions. Palley expands upon the problems of offshore outsourcing as outlined in Public Policy Brief No. 86 and focuses on the microeconomic foundations. He argues that outsourcing is a central element of globalization that is best understood as a new form of competition. Palley urges policymakers to understand the economic basis of outsourcing in order to develop effective policies, and suggests that they focus on enhancing national competitiveness and establishing new rules that govern the nature of global competition.Download:Associated Program:Author(s):Thomas I. Palley -
Working Paper No. 485 | December 2006
This paper contrasts the conventional balance sheet approach to the analysis of economic disturbances in emerging markets with the alternative balance sheet approach that applies and extends Minsky’s Financial Instability Hypothesis to (open) emerging market economies. Earlier balance sheet studies are found to be flawed because of a failure to disaggregate firms’ balance sheets. Examination of such balance sheets in Thailand, Malaysia, Indonesia, Singapore, and Hong Kong suggests that firms in the three crisis countries did share common causes of financial fragility, but that the level of financial development and the particular domestic economic and political situation also affected their situation.
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Working Paper No. 484 | December 2006
The Greek Experience under the Euro
Apart from its widely accepted direct advantages, the introduction of the euro has been accompanied by a surge of inflation in most of the EU member states. At the same time, wages–in part, wages of the unskilled–are relatively losing ground, while the purchasing power of the average European seems also to have weakened since the introduction of the single currency. In this paper we deal with five relevant central issues to interpret "expensiveness" in Greece. First, we examine to what extent recent inflation trends are attributable to the constraints imposed by the monetary union–namely negative demand disturbances in certain Greek regions. Second, we investigate to what extent these patterns are also due to the adoption of the euro–including conversion period effects–over product market and other domestic rigidities. Third, we investigate the impact of seasonal effects on inflation, in the context of the Greek so-called traditional "petit-bourgeois capitalism." Fourth, we explore the extent to which unemployment is another factor that drives wages and purchasing power down. Fifth, we apply the Balassa-Samuelson effect to see whether it constitutes the culprit for price hikes in nontradable products in particular. We find that all the aforementioned factors contribute to the Greek expensiveness.
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Working Paper No. 483 | November 2006
A Critique
By providing five different criticisms of the notion of real rate, the paper argues that this concept, as Fisher defined it or as a definition, is not relevant to economic analysis. Following Keynes and other post-Keynesians, the article shows that the notion of real rate is microeconomically and macroeconomically unfounded. Adjusting interest rates for inflation does not protect the purchasing power of wealth, and it is impossible to do so at the macroeconomic level. In addition, an empirical interpretation of the break in the correlation between interest rates and inflation since 1953 is provided.
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Working Paper No. 481 | November 2006
An Alternative to the Functional Approach
The paper argues that the functional approach of money does not provide a good method to study monetary history and monetary mechanisms. An alternative approach is developed and illustrated by analyzing the role of tobacco and cowry shells in past monetary systems. It is shown that any monetary system has specific properties that most students of money do not take into account when theorizing about money or analyzing its history. This leads them to miss some important points, and to see monetary systems where none exist. Hence, one can doubt some of the past research on the subject, at least until further investigation is conducted that is based, not on what we think "money" is, but on what its essential properties are. By comprehending what the main characteristics of a monetary system are, one is able to improve regulation of the system and get some insights into the financial mechanisms of sovereign governments.
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Working Paper No. 478 | November 2006
A Framework for the Analysis of Monetary Policy in the "Age" of Central Banks
We present a simple theoretical framework that integrates the notion of the natural or neutral interest rate, liquidity preference theory, and the monetary policy practice by modern central banks. We claim that this theory explains the conditions under which an economy will experience an aggregate demand deficiency problem within a modern institutional setting. Contrary to the predictions of the "new consensus" view in macroeconomics, the model suggests that "structural" factors such as a high saving rate and, especially, a low "natural" rate of growth increase the chances that an economy experiences an aggregate demand deficiency. Contrary to conventional wisdom, the model predicts that a fall in the NAIRU may lead to a rise in the natural interest rate, and vice versa.Download:Associated Program:Author(s):Alfonso Palacio-Vera -
Working Paper No. 476 | October 2006
A New Wicksellian Connection?
One of the greatest achievements of the modern “new consensus” view in macroeconomics is the assertion of a nonquantity theoretic approach to monetary policy. Leading theorists and practitioners of this view have indeed rejected the quantity theory of money, and defended a return to the old Wicksellian idea of eliminating high levels of inflation by adjusting nominal interest rates to changes in the price level. This paper evaluates these recent developments in the theory and practice of monetary policy in terms of two basic questions: 1) What is the monetary policy instrument controlled by the central bank? and 2) Which macroeconomic variables are affected in the short and long run by monetary policy?
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Working Paper No. 460 | July 2006
This paper investigates the phenomenon of persistent macroeconomic divergence that has occurred across the eurozone in recent years. Optimal currency area theory would point toward asymmetric shocks and structural factors as the foremost candidate causes. The alternative hypothesis pursued here focuses on the working of the Maastricht regime itself, making it clear that the regime features powerful built-in destabilizers that foster divergence as well as fragility. Supposed adjustment mechanisms actually have turned out to undermine the operation of the currency union by making it less "optimal," that is, less subject to a "one-size-fits-all" monetary policy and common nominal exchange rate, in view of the resulting business cycle desynchronization and related build-up of financial imbalances. The threats of fragility and divergence reinforce each other. Without regime reform these developments could potentially spiral out of control, threatening the long-term survival of EMU.
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Working Paper No. 459 | July 2006
A Socioeconomics Approach
This paper briefly summarizes the orthodox approach to banking, finance, and money, and then points the way toward an alternative based on socioeconomics. It argues that the alternative approach is better fitted to not only the historical record, but also sheds more light on the nature of money in modern economies. In orthodoxy, money is something that reduces transaction costs, simplifying "economic life" by lubricating the market mechanism. Indeed, this is the unifying theme in virtually all orthodox approaches to banking, finance, and money: banks, financial instruments, and even money itself originate to improve market efficiency. However, the orthodox story of money's origins is rejected by most serious scholars outside the field of economics as historically inaccurate. Further, the orthodox sequence of "commodity (gold) money" to credit and fiat money does not square with the historical record. Finally, historians and anthropologists have long disputed the notion that markets originated spontaneously from some primeval propensity, rather emphasizing the important role played by authorities in creating and organizing markets.
By contrast, this paper locates the origin of money in credit and debt relations, with the money of account emphasized as the numeraire in which credits and debts are measured. Importantly, the money of account is chosen by the state, and is enforced through denominating tax liabilities in the state’s own currency. What is the significance of this? It means that the state can take advantage of its role in the monetary system to mobilize resources in the public interest, without worrying about "availability of finance." The alternative view of money leads to quite different conclusions regarding monetary and fiscal policy, and it rejects even long-run neutrality of money. It also generates interesting insights on exchange rate regimes and international payments systems.
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Working Paper No. 457 | June 2006Some have argued that a significant decrease in the demand for money, due to financial innovations, could imply that central banks are unable to implement effective monetary policies. This paper argues that central banks are always able to influence the economy's interest rates, because their liability is the economy's unit of account. In this sense, central banks "rule the roost." In the 1930s, starting from Keynes's ideas and referring to money in general, Kaldor had followed a similar line of analysis. In principle, a new unit of account could displace conventional money and, hence, central banks. But this process meets relevant obstacles, which essentially derive from the externalities and network effects that characterize money. Money is a "social relation." Money and central banks are the outcome of complex social and economic processes. Their displacement will occur through equally complex processes, rather than through mere innovation.Download:Associated Program:Author(s):Claudio Sardoni
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Working Paper No. 456 | June 2006The paper reviews the current literature on the subject in both the New Consensus and Post Keynesian frameworks. It shows that both approaches give to central banks a wrong goal (inflation, distribution, curbing speculation, and so on) and a wrong instrument (interest rate rule). The paper claims that central banks should focus their attention on maintaining financial stability and leave other problems to public institutions better suited for this task. In doing so they should develop new tools of intervention and leave policy interest rates unchanged, close to or at zero percent. Central banks have been created to deal with financial matters (government finance and financial stability) and should stick to this. Central banks, then, have a large amount of improvements to make, both as reformers and as guides for the financial community. Their main instrument should be an analysis of the financial fragility of the financial system and of the different economic sectors. In this context, it is shown that the notion of "bubble" does not matter for policy purposes, and that the current regulatory system lacks an institution that is able to deal effectively with solvency crisis.Download:Associated Program:Author(s):
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Working Paper No. 455 | June 2006
System Dynamics Modeling of a Stock Flow–Consistent Minskyan Model
This is the last part of a three-part analysis of the Minskyan Framework. The paper presents a model that studies some of the features presented in Parts I and II. The model is Post-Keynesian in nature and puts a large emphasis on the role of conventions and the importance of the financial side. In doing so, it provides an innovative way to determine aggregate investment and to introduce nonlinearities in the modeling of Minsky’s framework. This nonlinearity relies on the shifting property of conventions and the behavioral and psychological assumptions that they carry. Another specific characteristic of the model is that it is stock-flow consistent and explicitly takes into account the amortization of principal and refinancing loans. All of the modeling is done by using system dynamics, a flexible but rigorous modeling tool that gives the modeler a good understanding of the dynamics of complex models.Download:Associated Program:Author(s): -
Public Policy Brief No. 85 | June 2006
Why Today’s International Financial System Is Unsustainable
The stability of the international financial system is in doubt. Analysis of the system has focused mainly on the sustainability of financing the American trade deficit and has failed to understand the microeconomics of transactions within the system. According to this brief by Thomas I. Palley, the international financial system is unsustainable for reasons of demand, not supply. He recommends a global system of managed exchange rates to replace the current system before it crashes, along with the US economy.
East Asian economies are pursuing export-led growth and running huge trade surpluses with the United States by actively pursuing policies aimed at maintaining undervalued exchange rates. Their governments continue to accumulate US financial assets in order to support and stabilize the international financial system.While East Asian policymakers are correct in their belief that they can improve economic outcomes through exchange rate intervention, the system is undermining the structure of income and aggregate demand and eroding US manufacturing capacity.
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Working Paper No. 453 | June 2006
Dynamics of the Minskyan Analysis and the Financial Fragility Hypothesis
This is the second part of a three-part analysis of the Minskyan framework. It studies in detail the dynamics at the root of the endogenous financial weakening of capitalist economic systems. This part combines the properties presented in part I with other important concepts, such as the paradox of leverage and conventional expectations, to explain the Financial Instability Hypothesis. It is demonstrated that the signs of fragility are not always visible and that financial weakening can take many different (even though well-defined) routes. This is used to draw some conclusion about the appropriate way to test for this hypothesis and the limit of data.Download:Associated Program:Author(s): -
Public Policy Brief Highlights No. 85A | June 2006
Why Today’s International Financial System Is Unsustainable
The stability of the international financial system is in doubt. Analysis of the system has focused mainly on the sustainability of financing the American trade deficit and has failed to understand the microeconomics of transactions within the system. According to this brief by Thomas I. Palley, the international financial system is unsustainable for reasons of demand, not supply. He recommends a global system of managed exchange rates to replace the current system before it crashes, along with the US economy. East Asian economies are pursuing export-led growth and running huge trade surpluses with the United States by actively pursuing policies aimed at maintaining undervalued exchange rates. Their governments continue to accumulate US financial assets in order to support and stabilize the international financial system.While East Asian policymakers are correct in their belief that they can improve economic outcomes through exchange rate intervention, the system is undermining the structure of income and aggregate demand and eroding US manufacturing capacity.Download:Associated Program:Author(s):Thomas I. Palley -
Public Policy Brief No. 84 | May 2006
A Pessimistic View
Even as the United States enjoys an economic expansion, there is an undercurrent of concern among economic analysts who follow financial markets. Some feel that the expansion of the credit derivatives markets poses the threat of a crisis similar to the Long-Term Capital Management debacle of 1998. Credit derivatives allow banks to share risks with holders of the derivatives, which are often mutual funds and other nonbank financial institutions.The Basel II Accord, now being implemented in many countries, is hailed as a good form of protection against the risk of a series of bank failures of the type that might cause problems in the derivatives markets. Basel II represents a more sophisticated and complex version of the original Basel Accord of 1992, which set minimum capital ratios for various types of bank assets.Download:Associated Program:Author(s): -
Public Policy Brief Highlights No. 84A | May 2006
A Pessimistic View
Even as the United States enjoys an economic expansion, there is an undercurrent of concern among economic analysts who follow financial markets. Some feel that the expansion of the credit derivatives markets poses the threat of a crisis similar to the Long-Term Capital Management debacle of 1998. Credit derivatives allow banks to share risks with holders of the derivatives, which are often mutual funds and other nonbank financial institutions.The Basel II Accord, now being implemented in many countries, is hailed as a good form of protection against the risk of a series of bank failures of the type that might cause problems in the derivatives markets. Basel II represents a more sophisticated and complex version of the original Basel Accord of 1992, which set minimum capital ratios for various types of bank assets.Download:Associated Program:Author(s): -
Public Policy Brief No. 83 | January 2006
The Case to Replace FDIC Protection with Self-Insurance
The Federal Deposit Insurance Corporation (FDIC) currently insures bank deposit balances up to $100,000. According to some observers, statutory protection creates moral hazard problems for insurers because it allows banks to engage in risky activities. As an example, moral hazard was a key contributor to huge losses suffered when thrift institutions failed during the 1980s.
This brief by Panos Konstas outlines a plan to reduce the risk of government losses by replacing insured deposits with uninsured deposits and eliminating some of the costs of deposit insurance. His plan proposes a self-insured (SI) depositor system that places an intermediary between the lender (saver) and borrower (bank) in the credit-flow chain. The FDIC would guarantee saver loans and allow the intermediary to borrow at the risk-free interest rate if the intermediary’s bank deposit is statutorily defined outside the realm of FDIC insurance. The risk is therefore transferred to depositors (intermediaries); thus creating incentives for depositors to earn a rate of return at least equal to the cost of borrowing plus a risk premium based on the risk profile of banks.
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Policy Note 2006/1 | January 2006
On September 15, the Federal Reserve convened 14 large credit derivatives–dealer banks to an unusual meeting. The last such meeting occurred on September 16, 1998, in secret. At that time, a major financial institution was melting down and threatening to take some large banks with it. This time, they met to discuss the same topic: the clearing of transactions in the credit derivatives market.
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Working Paper No. 431 | November 2005
In the debate on monetary policy strategies on both sides of the Atlantic, it is now almost a commonplace to contrast the Fed and the ECB by pointing out the former’s flexibility and capacity to adjust rigidity, and the latter’s extreme caution and its obsession with low inflation. In looking at the foundations of the two banks’ strategies, however, we do not find differences that can provide a simple explanation for their divergent behavior, nor for the very different economic performance in the United States and in Euroland in recent years. Not surprisingly, both central banks share the same conviction that money is neutral in the long period, and even their short-term policies are based on similar fundamental principles. The two policy approaches really differ only in terms of implementation, timing, competence, etc., but not in terms of the underlying theoretical orientation. We then draw the conclusion that monetary policy cannot represent a significant variable in the explanation of the different economic performances of Euroland and US The two economic areas’ differences must be explained by considering other factors among which the most important is fiscal policy.
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Working Paper No. 430 | November 2005
A central tenet of the so-called "new consensus" view in macroeconomics is that there is no long-run trade-off between inflation and unemployment. The main policy implication of this principle is that all monetary policy can aim for is (modest) short-run output stabilization and long-run price stability—i.e., monetary policy is neutral with respect to output and employment in the long run. However, research on the different sources of path dependency in the economy suggests that persistent but nevertheless transitory changes in aggregate demand may have a permanent effect on output and employment. If this is the case, then, the way monetary policy is run does have long-run effects on real variables. This paper provides an overview of this research and explores how monetary policy should be implemented once these long-run effects are acknowledged.
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Working Paper No. 429 | November 2005
The ECB's Record
This paper assesses the contribution of the European Central Bank (ECB) to Germany’s ongoing economic crisis, a vicious circle of decline in which the country has become stuck since the early 1990s. It is argued that the ECB continues the Bundesbank tradition of asymmetric policymaking: the bank is quick to hike, but slow to ease. It thereby acts as a brake on growth. This approach has worked for the Bundesbank in the past because other banks behaved differently. Exporting the Bundesbank “success story” to Euroland has undermined its working, however; given its sheer size, Euroland simply cannot freeload on external stimuli forever. While Euroland cannot do without proper demand management, the Maastricht regime and especially the ECB are firmly geared against it. The ECB’s monetary policies have been biased against growth and have thus proved bad for Euroland as a whole. Meanwhile, the German disease of protracted domestic demand weakness has spread across much of Euroland. Yet, by pursuing its peculiar traditions of wage restraint and procyclical public thrift, the ECB’s policies have had even worse results for Germany. Fragility and divergence undermine the euro’s long-term survival.
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Working Paper No. 428 | August 2005
Central Banking Gone Astray
This paper provides an overview of central banking arrangements in those European countries that have adopted the euro. Issues addressed include the structure of the “Eurosystem” and its central banking functions, the kind of independence granted to the system and the role of monetary policy that central bankers have adopted for themselves, the “two-pillar policy framework,” operating procedures, and actual performance since the euro’s launch in 1999. The analysis concludes that, given the current macroeconomic policy regime, trends, and practices, the euro is on track for failure.
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Working Paper No. 427 | August 2005
To Ditch or to Build on It?
This paper revisits Keynes’s liquidity preference theory as it evolved from the Treatise on Money to The General Theory and after, with a view of assessing the theory’s ongoing relevance and applicability to issues of both monetary theory and policy. Contrary to the neoclassical “special case” interpretation, Keynes considered his liquidity preference theory of interest as a replacement for flawed saving or loanable funds theories of interest emphasizing the real forces of productivity and thrift. His point was that it is money, not saving, which is the necessary prerequisite for economic activity in monetary production economies. Accordingly, turning neoclassical wisdom on its head, it is the terms of finance as determined within the financial system that “rule the roost” to which the real economy must adapt itself. The key practical matter is how deliberate monetary control can be applied to attain acceptable real performance. In this regard, it is argued that Keynes’s analysis offers insights into practical issues, such as policy credibility and expectations management, that reach well beyond both heterodox endogenous money approaches and modern Wicksellian orthodoxy, which remains trapped in the illusion of money neutrality.
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Working Paper No. 425 | July 2005
Challenging the conventional wisdom that structural problems are to blame for the euro area’s protracted domestic demand stagnation, this paper sets out to shed some fresh light on the role of the ECB in the ongoing EMU crisis. Contrary to the widely held interpretation of the ECB as an inflation targeter—and a rather soft one, too—it is argued that the key characteristic of the ECB is the pronounced asymmetry in its policy approach and mindset. Curiously, this asymmetry has not only given rise to an antigrowth bias, but to upward price pressures and distortions as well. There is a link between stagnation and inflation persistence that owes to the ECB’s failure to internalize the euro area’s fiscal regime. This raises the question as to whether inflation targeting would have led to better results, or could do so in future.
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Working Paper No. 424 | June 2005
Despite his emphasis on the speculative character of investment decisions, Minsky paid little attention to asset price speculation per se, ignoring asset price bubbles and their macroeconomic effects. That is perhaps because his views were formed during the era of financial regulation, when speculation “could do no harm as bubbles on a steady stream of enterprise.” Clearly, times have since changed. Keynes's old warning that the situation “is serious when enterprise becomes the bubble on a whirlpool of speculation” has begun to ring true again. To deepen our understanding of financial fragility under present-day conditions, the paper builds on Keynes's insights in his General Theory on the stock exchange by going back to his Treatise, where asset price expectations and speculation play an integral part in his analysis of the business cycle. More specifically, it develops the macroeconomic implications of some of his arguments that have mainly been eclipsed by his GT. These can be summarized in three related propositions:
- Asset price expectations systematically exhibit self-sustained biases in one direction or another over the business cycle;
- Once an asset price bubble emerges no automatic mechanism exists to check the deviation of prices from their true values;
- Mean reversion in asset prices over time plays itself out through a rise in inactive money balances in the banking system, which Keynes called the bear position, as more and more people begin to think that asset prices have reached levels that are unreasonable.
This early picture of how financial variables interact with output determination over the business cycle is contrasted with Keyne's better known analysis in the GT, which, it is argued, does not lend itself as readily to analyzing asset price misalignments.
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Working Paper No. 423 | May 2005
This paper explores the possibility that unregulated FDI flows are causally implicated in the decline in labor productivity growth in semi-industrialized economies. These effects are hypothesized to operate through the negative impact of firm mobility on worker bargaining power and thus affecting wages. Downward pressure on wages can reduce the pressure on firms to raise productivity in defense of profits, contributing to a low wage–low productivity trap. This paper presents empirical evidence, based on panel data fixed effects and GMM estimation for 37 semi-industrialized economies, that supports the causal link between increased firm mobility and lower wages, as well as slower productivity growth over the period 1970–2000.
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Working Paper No. 419 | March 2005
Using Insurance to Gain Market Discipline and Lower the Cost of Bank Funding
Insured depositors have no reason to care how their banks perform or how safe they are. Only uninsured depositors have that incentive. This paper offers a plan to replace some insured deposits with uninsured deposits. The plan: the FDIC would guarantee loan contracts if the loan takers deposited the proceeds exclusively in uninsured deposits and backed those deposits with equity. This would ensure that the loan takers could share the likely costs if any of their depositories failed. The loans made under FDIC guarantee would only require interest at the risk-free rate. Thus the loan takers could offer the proceeds at lower rates than the rates paid on current deposits. Accordingly, funding by banks would shift to the new deposits, and since the new "self-insured" depositors would have equity at stake, they would have no choice but to duly monitor their banks and impose rate premiums based on each bank's indigenous risk. With these reforms, some very costly imperfections of current deposit insurance would be eliminated: the FDIC would now have in place a program that would dissuade banks from moral hazard and high risk and set the foundation for better disciplined, safer, and more cost-efficient banking.
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Public Policy Brief No. 80 | December 2004
The Case for Rate Hikes, Part Two
The most charitable interpretation of the Federal Reserve’s recent interest rate hikes is that they appear to have been premature. A convincing array of data on payrolls, employment-to-population ratios, and other labor market indicators show that the current recovery has not yet attained the degree of labor market tightness that was common in previous recoveries, and therefore that the threat of inflation is minimal. Hence, the Fed, in raising rates, was unnecessarily jeopardizing the economy’s weak recovery.
In this new brief, we learn about the flaws in the Fed’s thinking that have led to its frequent policy mistakes. Author L. Randall Wray traces several strands of current central bank thinking back to their roots in the Fed’s internal discussions in the mid-1990s. Transcripts of these discussions have recently been released, a development that has yielded some disturbing and telling insights about the way in which monetary policy is formed.
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Public Policy Brief Highlights No. 80A | December 2004
The Case for Rate Hikes, Part Two
The most charitable interpretation of the Federal Reserve’s recent interest rate hikes is that they appear to have been premature. A convincing array of data on payrolls, employment-to-population ratios, and other labor market indicators show that the current recovery has not yet attained the degree of labor market tightness that was common in previous recoveries, and therefore that the threat of inflation is minimal. Hence, the Fed, in raising rates, was unnecessarily jeopardizing the economy’s weak recovery.
In this new brief, we learn about the flaws in the Fed’s thinking that have led to its frequent policy mistakes. Author L. Randall Wray traces several strands of current central bank thinking back to their roots in the Fed’s internal discussions in the mid-1990s. Transcripts of these discussions have recently been released, a development that has yielded some disturbing and telling insights about the way in which monetary policy is formed.
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Working Paper No. 415 | November 2004
A Cointegration Method
This paper derives measures of potential output and capacity utilization for a number of OECD countries, using a method based on the cointegration relation between output and the capital stock. The intuitive idea is that economic capacity (potential output) is the aspect of output that co-varies with the capital stock over the long run. We show that this notion can be derived from a simple model that allows for a changing capital-capacity ratio in response to partially exogenous, partially embodied, technical change. Our method provides a simple and general procedure for estimating capacity utilization. It also closely replicates a previously developed census-based measure of US manufacturing capacity-utilization. Of particular interest is that our measures of capacity utilization are very different from those based on aggregate production functions, such as the ones provided by the IMF.
Download:Associated Program(s):Monetary Policy and Financial Structure Explorations in Theory and Empirical Analysis The State of the US and World EconomiesAuthor(s):Anwar M. Shaikh Jamee K. MoududRegion(s):Europe -
Working Paper No. 412 | October 2004
A Critical Review
Recently, many economists have credited the late-1990s economic boom in the United States for the easy money policies of the Federal Reserve. On the other hand, observers have noted that very low interest rates have had very little positive effect on the chronically weak Japanese economy. Therefore, some theory of how money affects the economy when it is endogenous would be useful. This paper pursues several such explanations, including the effects of interest rate changes on (1) investment; (2) consumer spending; (3) the exchange rate; and (4) financial markets. The theories of such authors as Kalecki, Keynes, Minsky, and J. K. Galbraith are discussed and evaluated, with an emphasis on the role of cash flow. Some of these theories turn out to be stronger than others when subjected to tests of logic and empirical evidence.
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Public Policy Brief No. 79 | August 2004
Did the Fed Prematurely Raise Rates?
For a time, the Federal Open Market Committee (FOMC) seemed to have learned from the mistakes of the past. Instead of taking good economic performance as a sign of incipient inflation, Chairman Alan Greenspan kept interest rates relatively low in the late 1990s, even as unemployment plummeted. Many commentators worried that the FOMC’s unusually easy stance would usher in a period of runaway inflation, but inflation stayed in the 2 to 3 percent range.
Now, with scant evidence of an inflationary threat, Greenspan and his committee seem intent on raising interest rates. Greenspan argues that the current anemic expansion is “self-sustaining” and no longer needs the support of low interest rates.
In this new brief, Levy Institute Senior Scholar L. Randall Wray evaluates the Fed’s concern about a coming inflation and its decision to begin raising interest rates. He begins with an examination of key market developments that might signal inflation. Most economists worry about inflation when labor markets begin to tighten and employees gain the bargaining power necessary to demand pay raises. Wray marshals an array of evidence demonstrating that workers can only wish for such conditions. The economy has created no net new jobs since the beginning of the current presidential term. To match the 64.4 percent proportion of adults who held jobs during the Clinton era, the economy would have to generate four million new positions. It is clear that the job market will not be a source of inflation any more than it was during the Clinton boom.
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Public Policy Brief Highlights No. 79A | August 2004
Did the Fed Prematurely Raise Rates?
For a time, the Federal Open Market Committee (FOMC) seemed to have learned from the mistakes of the past. Instead of taking good economic performance as a sign of incipient inflation, Chairman Alan Greenspan kept interest rates relatively low in the late 1990s, even as unemployment plummeted. Many commentators worried that the FOMC's unusually easy stance would usher in a period of runaway inflation, but inflation stayed in the 2 to 3 percent range.
Now, with scant evidence of an inflationary threat, Greenspan and his committee seem intent on raising interest rates. Greenspan argues that the current anemic expansion is "self-sustaining" and no longer needs the support of low interest rates.
Senior Scholar L. Randall Wray evaluates the Fed's concern about a coming inflation and its decision to begin raising interest rates. He begins with an examination of key market developments that might signal inflation. Most economists worry about inflation when labor markets begin to tighten and employees gain the bargaining power necessary to demand pay raises. Wray marshals an array of evidence demonstrating that workers can only wish for such conditions. The economy has created no net new jobs since the beginning of the current presidential term. To match the 64.4 percent proportion of adults who held jobs during the Clinton era, the economy would have to generate four million new positions. It is clear that the job market will not be a source of inflation any more than it was during the Clinton boom.
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Working Paper No. 411 | July 2004
Channels of Influence
Financial development and its effects on the economic development of a country has recently been one of the most prolific areas of research in the fields of development, finance, and international economics. So far, however, very little work has been done to analyze comprehensively the relationship between financial liberalization and poverty. There is still controversy about the exact role and the effectiveness of financial liberalization on improving economic conditions in developing countries. This paper aims to contribute to this debate by critically reviewing the relevant literature and looking closely at the channels through which financial liberalization can affect poverty.
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Working Paper No. 410 | July 2004
Many empirical studies have found that interest rate increases have a positive effect on the price level. This paper pursues an obvious, but neglected explanation: interest payments are a cost of production that is at least in part passed on to customers. A model shows that the cost-push effect of inflation, long known as Gibson's paradox, intensifies destabilizing forces and can be involved in the generation of cycles. An empirical investigation finds that the positive association of interest rates with inflation or the log of the price level is present in data from the 1950s to present.
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Working Paper No. 409 | July 2004
A Structural Policy Bias Coming Home to Roost?
This paper assesses the ECB's performance, which the author finds to be seriously lacking but which is of paramount importance to understanding euroland's ongoing stagnation and fragility. A main finding is that the series of policy blunders which characterized the bank's conduct features a bias. Institutions as well as personalities appear to be behind the bank's tendency to err systematically in one direction. Curiously, this bias is adverse not only to growth, but to price stability. The author shows that viewing the ECB through inflation-targeting lenses is very misleading, since that view does not reflect the bank's perspective at all, and that standard Taylor rule exercises are superfluous. The ECB's words and deeds may be far more consistent than is widely held, without making them any less detrimental to economic performance.
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Working Paper No. 406 | May 2004
Central Banking Institutions and Traditions in West Germany after the War
This paper investigates the (re-)establishment of central banking in West Germany after 1945 and the history of the Bundesbank Act of 1957. The main focus is on the early emphasis on the "independence" of the central bank, which, together with a "stability-orientation" in monetary policy, proved a lasting German peculiarity. The paper inquires whether contemporary German economic thought may have provided a theoretical case for this peculiar tradition and scrutinizes the political calculus that motivated some key actors in the play. Contrary to a widespread presumption, Ordoliberalism--the dominant contemporary force within the German economics profession widely held to have shaped the new economic order of West Germany called "Soziale Marktwirtschaft" (social market economy)--is found to have had no such impact on the country's emerging monetary order at all. In fact, important contradictions between the postulate of central bank independence and some key ideas underlying Ordoliberalism will be identified. Nor can an alternative (more Keynesian) policy regime and and its model of central bank independence that was developed in the mid 1950s by the Economic Advisory Council of Ludwig Erhard, West Germany's famous first economics minister, claim any credit for the eventual legal status of the central bank that became enshrined in the Bundesbank Act of 1957; that policy regime subsequently remained untouched despite the (Keynesian) Stability and Growth Act of 1967. It appears that, while contemporary economic theory had no decisive influence on the outcome, the central bank's role as a political actor in its own right and in carving public opinion should not be underestimated in explaining a peculiar German tradition that was finally exported to Europe in the 1990s.
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Policy Note 2004/2 | May 2004
Deficits, Debt, Deflation, and Depreciation
Recent economic commentary has been filled with “D” words: deficits, debt, deflation, depreciation. Deficits—budget and trade—are of the greatest concern and may be on an unsustainable course, as federal and national debt grow without limit. The United States is already the world’s largest debtor nation, and unconstrained trade deficits are said to raise the specter of a “tequila crisis” if foreigners run from the dollar. Federal budget red ink is expected to imperil the nation’s ability to care for tomorrow’s retirees. While public concern with deflationary pressures has subsided, concern continues regarding America’s ability to compete in a global economy in which wages and prices are falling. In fact, the current situation is far more “sustainable” than that at the peak of the Clinton boom, which had federal budget surpluses but record-breaking private sector deficits. Nevertheless, it is time to take stock of the dangers faced by the US economy.
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Policy Note 2004/1 | April 2004
Inflation targeting has become an increasingly popular strategy for setting monetary policy during the last decade. While no countries had formal inflation targets before 1990, currently 22 countries use inflation targeting. One notable exception is the United States, where the Federal Reserve has a dual mandate to pursue both price stability and full employment. Some economists advocate inflation targeting for the United States, partly because they fear that otherwise the Fed will try to push unemployment below its “natural rate”—its lowest sustainable level—and trigger accelerating inflation. However, the natural rate theory has proven to be a poor guide for policy making over the last 10 years. Unemployment in 2000 fell two percentage points below estimates of the natural rate without spurring inflation. Since inflation targeting derives its justification largely from the theory of the natural rate, it is questionable whether the United States should switch to an inflation-targeting regime. These doubts are reinforced by the manifest success of monetary policy under the dual mandate.
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Working Paper No. 400 | January 2004
Contrasting Strategies & Lessons from International Experiences
This paper analyzes the issues of public finance sustainability and suitability of strategies aimed at fiscal consolidation. Contrasting growth-based versus thrift-based consolidation strategies, it is argued that in the light of theory only the former promises success in large economies. Empirically, this study investigates the experiences with consolidation over the 1990s in the US, Japan, and the eurozone while scrutinizing disparities in economic performance and consolidation within Europe. It is argued that experiences of individual European Union (EU) member states may not be applicable to the eurozone as a whole and that the US may provide the only relevant example for guiding policymaking in the EMU. The US example features cooperative macroeconomic policies geared at steering domestic demand growth, with sustainable public finances as a consequence of their success. By contrast, the Maastricht regime features a counterproductive mix of thrift-based consolidation and inflation-obsessed monetary policy--ultimately a recipe for disaster. Reforms should focus on securing cooperation and proper growth orientation in macroeconomic policymaking, with discipline being imposed in a more balanced way on both finance ministers and central bankers.
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Working Paper No. 399 | January 2004
We address the issue of whether financial structure influences economic growth. Three competing views of financial structure exist in the literature: the bank-based, the market-based and the financial services view. Recent empirical studies examine their relevance by utilizing panel and cross-section approaches. This paper, for the first time ever, utilizes time series data and methods, along with the Dynamic Heterogeneous Panel approach, on developing countries. We find significant cross-country heterogeneity in the dynamics of financial structure and economic growth, and conclude that it is invalid to pool data across our sample countries. We find significant effects of financial structure on real per capita output, which is in sharp contrast to some recent findings. Panel estimates, in most cases, do not correspond to country-specific estimates, and hence may proffer incorrect inferences for several countries of the panel.
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Public Policy Brief Highlights No. 75A | December 2003
New Institutions for an Inclusive Capital Market
In 2002 more than $1 trillion worth of new bonds was sold across international boundaries. The total stock of cross-border bond holdings was more than $9 trillion. Such lending, together with sales of equities, is regarded as one of the chief benefits of globalization. But financial investment does not always flow where it is needed most. While it appears that the world cannot be satiated with US securities, issues of emerging economies account for less than 6 percent of total international holdings of debt securities (D’Arista 2003). And, as Argentina discovered recently, international lenders can be fickle, selling enough foreign currency and securities to cause a currency crisis. -
Working Paper No. 397 | December 2003
This paper attempts to define financial globalization as a process whereby financial markets internationally are integrated so closely that they can be considered as a single market. The process, viewed as a by-product of financial liberalization, is only a necessary condition for financial globalization, however. The sufficient condition is the creation of world-wide single currency, managed and regulated by a single international monetary authority. The system itself needs to be managed carefully to avoid the kind of crises countries have experienced over the last 30 years or so. This sufficient condition has not yet been met.
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Public Policy Brief No. 75 | December 2003
New Institutions for an Inclusive Capital Market
In 2002 more than $1 trillion worth of new bonds was sold across international boundaries. The total stock of cross-border bond holdings was more than $9 trillion. Such lending, together with sales of equities, is regarded as one of the chief benefits of globalization. But financial investment does not always flow where it is needed most. While it appears that the world cannot be satiated with US securities, issues of emerging economies account for less than 6 percent of total international holdings of debt securities (D’Arista 2003). And, as Argentina discovered recently, international lenders can be fickle, selling enough foreign currency and securities to cause a currency crisis.
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Policy Note 2003/7 | December 2003
Has the Unthinkable Become Thinkable?
The big question is whether the dollar—the world's reserve currency—can survive a steep fall in its value without the active support of the major central banks. Can the United States broker another Plaza Accord, as it did in 1985 when the dollar lost half of its value against the yen and the mark within two years, without jeopardizing its unique international role? Is an orderly retreat for the dollar possible today?
Download:Associated Program:Author(s):Korkut A. Ertürk -
Working Paper No. 392 | October 2003
Treating the Disease, Not the Symptoms
Deflation can be defined as a falling general price level utilizing one of the common price indices.the consumer price index; the GDP deflator or other, narrower indices as the wholesale price index; or an index of manufactured goods prices. Falling indices of output prices can be the result of several mechanisms: productivity increases, quality increases and hedonic imputations of prices, competition from low-cost producers, government policy influences, or depressed aggregate demand. Falling output prices, in turn, can have strong effects, especially on the ability to service debts fixed in nominal terms; depending on the level of indebtedness of households and firms, they can set off a classic Minsky-Fisher debt deflation spiral. In this paper, we argue that deflation can and usually does generate large economic and social costs, but it is more important to understand that deflation itself is a symptom of severe and chronic economic problems. This distinction becomes important for the design and implementation of economic policy.
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Policy Note 2003/5 | September 2003
For the first time since the 1930s, many worry that the world's economy faces the prospect of deflation—accompanied by massive job losses—on a global scale. In a rather hopeful sign, policymakers from Euroland to Japan to America all seem to recognize the threat that falling prices pose to markets. Given the singleminded pursuit of deflationary policies over the past decade, this does come as something of a surprise. But policymakers—especially central bankers—in Europe and the United States seem to have little inkling of how to stave off deflation, with the result that prices are already falling in much of the world. Contrary to widespread beliefs, the worst outcome will not be avoided if the only response is to balance budgets and introduce new monetary policy gimmicks. To the contrary, policymakers should increase deficits to at least 7 percent of GDP.
Download:Associated Program(s):Federal Budget Policy Monetary Policy and Financial Structure The State of the US and World EconomiesAuthor(s):Region(s):United States -
Working Paper No. 391 | September 2003
The dominant view relating to unemployment and inflation is that inflation will be constant at a level of unemployment (the nonaccelerating inflation rate of unemployment, NAIRU) determined on the supply side of the economy (and in the labor market in particular). Further, the economy will tend to converge to (or oscillate around) that level of unemployment. Moreover, demand variables or economic policy changes are thought to have no influence whatsoever on NAIRU. An alternative perspective on inflation would indicate that there would be no automatic forces leading to a level of aggregate demand consistent with constant inflation. Inflationary pressures would arise from, inter alia, a role of conflict over income shares, and from cost elements, with the price of raw materials, especially oil, being the most important. Insofar as there are supply-side factors impinging on the inflationary process, these would arise from the level of productive capacity (relative to aggregate demand) and from conflict over income shares. This paper focuses on the arguments and the evidence that supply-side constraints should be viewed as arising from capacity constraints, rather than from the operation of the labor market.
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Working Paper No. 388 | September 2003
A Critical Appraisal
Since the early 1990s, a number of countries have adopted Inflation Targeting (IT) in an effort to reduce inflation. Most literature has praised IT as a superior framework of monetary policy. We suggest that IT is a major policy prescription closely associated with the New Consensus Macroeconomics (NCM). Focusing mainly on the IT aspects of the NCM, we address and assess the theoretical foundations of IT, and then assess the empirical work on IT, distinguishing between work that utilizes structural macroeconomic models and work based on single-equation techniques. The IT theoretical framework and the available empirical evidence do not appear to support the views of IT proponents.
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Policy Note 2003/4 | August 2003
Germany’s fiscal crisis cannot be attributed to unification per se; it arose as a consequence of ill-guided macroeconomic policies pursued in response to that event. Many structural problems that popped up along the way were mere symptoms of persistent macroeconomic mismanagement and protracted stagnation. Since Germany provided the blueprint for Europe's stability-oriented macroeconomic policy regime, the risk is that the “German disease” is spreading throughout the regime and, potentially, beyond Europe.
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Public Policy Brief Highlights No. 73A | August 2003
How Far Can Equity Prices Fall?
In an asset and debt deflation, the process of reducing debt by saving and curtailing spending takes a long time, say authors Philip Arestis and Elias Karakitsos. Current imbalances and poor prospects for spending in the private sector affect the balance sheets of the commercial banks. The downward spiral between the banks and the private sector induces a credit crunch that adversely affects the US economy, which is vulnerable to exogenous shocks and lacks the foundations for a new, long-lasting business cycle.Download:Associated Program:Author(s):Elias Karakitsos -
Public Policy Brief No. 73 | August 2003
How Far Can Equity Prices Fall?
In an asset and debt deflation, the process of reducing debt by saving and curtailing spending takes a long time, say authors Philip Arestis and Elias Karakitsos. Current imbalances and poor prospects for spending in the private sector affect the balance sheets of the commercial banks. The downward spiral between the banks and the private sector induces a credit crunch that adversely affects the US economy, which is vulnerable to exogenous shocks and lacks the foundations for a new, long-lasting business cycle.
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Working Paper No. 384 | July 2003
Using Minsky (1986), this paper attempts to answer two questions: (1) How does policy affect real and nominal variables? and (2) How should monetary policy be conducted so as to improve the performance of the economy? Minsky asserted that rising interest rates, brought about by contractionary monetary policy, compromised the balance sheets of firms that had financed long-term positions in illiquid assets with short-term borrowing. As interest rates rose, the debt service costs of a project increased relative to the present discounted value of its future revenue streams. This approach accounts for the effects of interest rate policy on the economy, answering the first question. A model based on Minsky's theory confirms the plausibility of his theory. The model also shows that anti-inflationary policy destabilizes the economy and is therefore counterproductive, providing a partial answer to the second question. A vector autoregression analysis suggests that post-War US data are consistent with Minsky's theory.
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Working Paper No. 383 | July 2003
Financial reforms, and financial liberalization in particular, have been at the root of many recent cases of financial and banking crises. In several countries financial reforms allowed real interest rates to reach levels exceeding 20 percent per annum in some cases; in other cases, banking and financial crises led to currency crises. National governments either abandoned attempts at implementing financial liberalization (some countries even reimposed controls) or were forced to intervene by nationalizing banks and guaranteeing deposits. This paper draws on this experience to show that the main cause of these crises is the application of a theoretical framework that is predicated on a number of assumptions that are problematic and based on weak empirical foundations. Consequently, it should be no surprise that the reforms were often unsuccessful and in many cases led to severe financial crises. We will also argue that the case of Egypt is particularly interesting in this regard, since although financial reforms have been enacted, the experience has been rather different: there has been no accompanying financial crisis.
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Working Paper No. 379 | May 2003
An Analysis of the Current Crisis and Recommendations for Reforming Macroeconomic Policymaking in Euroland
This paper challenges the view that external shocks caused Euroland's 2001 slowdown and subsequent stagnation. Instead, the design of Euroland's macro policymaking arrangements is found lacking in looking after sufficient domestic demand growth. In the event the ECB has failed on its stabilization role--a rather vital role given that fiscal policy is severely constrained by the Stability and Growth Pact. As a result, Europe is in a precarious situation of stagnation today, and under the current regime there is even a risk of self-reinforcing destabilization. Hence, reforming the regime is urgent. A nominal GDP target to be pursued by fiscal and monetary policies in cooperation would provide Europe with the growth anchor that is currently missing.
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Working Paper No. 377 | April 2003
Institutional and Policy Alternatives to Financial Liberalization
There are many recent worldwide examples of severe financial crises that are linked to periods of financial liberalization. Given the ubiquity of these crises, there is the legitimate question of why governments still pursue financial liberalization policies. Answers to this question range from the recent institutionalization of norms of "acceptable" financial policies and perceived potential gains of attracting private capital inflows to the implied gains arising from the economic logic embedded in the theory underlying financial liberalization. This paper will focus on the latter arguing that financial transformation along the lines proposed by McKinnon-Shaw has engendered widespread banking crises precisely because of the weak foundations of the theory. The financial liberalization theory is critically evaluated on both theoretical and empirical grounds. An alternative theoretical approach is presented that focuses on ways to effect financial and banking transformation that is more consistent with economic development that draws on an institutional-centric perspective.
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Working Paper No. 374 | March 2003
This paper considers the nature and role of monetary policy when money is envisaged as credit money endogenously created within the private sector (by the banking system). Monetary policy is now based in many countries on the setting (or targeting) of a key interest rate, such as the Central Bank discount rate. The amount of money in existence then arises from the interaction of the private sector and the banks, based on the demand to hold money and the willingness of banks to provide loans. Monetary policy has become closely linked with the targeting of the rate of inflation. In this paper we consider whether monetary policy is well-equipped to act as a counter-inflation policy and discuss the more general role of monetary policy in the context of the treatment of money as endogenous. Currently, two schools of thought view money as endogenous. One school has been labeled the "new consensus" and the other the Keynesian endogenous (bank) money approach. Significant differences exist between the two approaches; the most important of these, for the purposes of this paper, is in the way in which the endogeneity of money is viewed. Although monetary policy—essentially interest rate policy—appears to be the same in both schools of thought, it is not. In this paper we investigate the differing roles of monetary policy in these two schools.
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Working Paper No. 371 | February 2003
A Markov Regime-switching Approach
The aim of this study is to estimate the credibility of monetary policy in four accession countries (the Czech Republic, Hungary, Poland, and the Slovak Republic), based on the Markov regime-switching (MRS) framework. We utilize the theoretical proposition that in the conduct of monetary policy, there is uncertainty in terms of the type of central bank. We measure this uncertainty as a deviation of monetary policy from a target level. We utilize for the target level the differential between the interest rates of the four individual accession countries and a "synthetic" interest rate of 11 EMU member countries.
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Policy Note 2003/2 | February 2003
The SGP has been the focus of growing controversy within the eurozone. The ECB continues to argue that reforming the SGP by relaxing its rules would damage the credibility of the euro. The opposite, however, may be closer to reality. Relaxing the rules according to the measures already taken by the European Commission has been inconsequential regarding the euro's credibility. In our view, many more fiscal policy reforms are needed so that the Eurozone can realize a true economic recovery and enhance the credibility of the euro.
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Public Policy Brief No. 71 | January 2003
The Dubious Effectiveness of Interest Rate Policy
Central bankers and many economists have abandoned “activist” policies and monetarism and adopted in their place a new view of the role of monetary policy. This view draws on many of the tenets of more traditional theories of money—monetarism’s emphasis on inflation control and skepticism about the use of easy-money policies to permanently increase output, and the Keynesian view that the total stock of money is not an important driving force behind either inflation or unemployment—yet it also takes a dim view of democratic input to the policymaking process. This brief evaluates a premise subscribed to by most central bankers: that monetary policy can be effectively used to control inflation without any permanent sacrifice in the form of reduced income or job opportunities.
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Public Policy Brief Highlights No. 71A | January 2003
The Dubious Effectiveness of Interest Rate Policy
Central bankers and many economists have abandoned "activist" policies and monetarism and adopted in their place a new view of the role of monetary policy. This view draws on many of the tenets of more traditional theories of money—monetarism's emphasis on inflation control and skepticism about the use of easy-money policies to permanently increase output, and the Keynesian view that the total stock of money is not an important driving force behind either inflation or unemployment—yet it also takes a dim view of democratic input to the policymaking process. This brief evaluates a premise subscribed to by most central bankers: that monetary policy can be effectively used to control inflation without any permanent sacrifice in the form of reduced income or job opportunities.Download:Associated Program:Author(s): -
Working Paper No. 370 | January 2003
This paper examines whether, during the 1997 East Asian crisis, there was any contagion from the four largest economies in the region (Thailand, Indonesia, Korea, and Malaysia) to a number of developed countries (Japan, the United States, the United Kingdom, Germany, and France). Following Forbes and Rigobon (2002) and Rigobon (2003), we test for contagion as a positive significant shift in the degree of comovement between asset returns, taking into account heteroscedasticity and endogeneity bias. However, we improve on earlier empirical studies by taking the approach introduced by Caporale et al. (2002), and employ a full sample test of the stability of the system that relies on more plausible (over)identifying restrictions. The estimation results show that the impact of the East Asian crisis on developed financial markets was small (Japan being the only exception), while the drastic reduction in international lending to the region severely affected it.
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Working Paper No. 369 | January 2003
Within the framework of macroeconomic policy and theory over the past 20 years or so, a major shift has occurred regarding the relative importance given of monetary policy versus fiscal policy. The former has gained considerably in stature, while the latter is rarely mentioned. Further, monetary policy no longer focuses on attempts to control some monetary aggregate, as it did in the first half of the 1980s, but instead focuses on the setting of interest rates as the key policy instrument. There has also been a general shift toward the adoption of inflation targets and the use of monetary policy to target inflation. This paper considers the significance of this shift in the emphasis of monetary policy, questions its effectiveness, and explores the role of fiscal policy. We examine these subjects from the point of view of the "new consensus" in monetary economics and suggest that its analysis is rather limited. When the analysis is broadened to embrace empirical issues and evidence, the conclusion clearly emerges that monetary policy is relatively impotent. We argue that fiscal policy (under specified conditions) remains a powerful tool for macroeconomic policy, particularly under current economic conditions.
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Working Paper No. 368 | January 2003
Equity prices have been falling since March 2000. How far can they fall before they reach bottom? The current bear market differs from the mid-1970s plunge in equity prices in terms of the causes and, consequently, the factors that should be monitored to test its progress. In the 1970s, the bear market was caused by soaring inflation resulting from a surge in the price of oil. It eroded households' real disposable income and corporate profits. That was a supply-led business cycle. Now, the bear market is caused by asset and debt deflation triggered by the burst of the "new economy" bubble. This working paper argues that on current economic fundamentals, the Standard & Poor's (S&P) index is fairly valued at 871, but the fair value may fall if the economy has a double-dip recession that triggers a property market crash. We suggest that the US economy is heading for such a recession, as the poor prospects of the corporate sector are affecting the real disposable income of the personal sector. The forces that drive the economy back to recession are related to imbalances in the corporate and personal sectors that have started infecting the balance sheet of the commercial banks. The final stage of the asset-and-debt-deflation process involves a spiral between banks and the nonbank private sector (personal and corporate). Banks cut lending to the nonbank private sector, creating a credit crunch that worsens the economic health of the latter, which is reflected subsequently as a further deterioration of banks' balance sheets.
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Working Paper No. 366 | December 2002
This paper clarifies why a transaction tax of the type proposed by James Tobin can have a stabilizing influence in financial markets. It argues that such a tax is potentially stabilizing, not because it reduces the "excessive" volume of transactions, but because it can slow the speed with which market traders react to price changes. To the extent that a Tobin tax causes financial market traders to delay their decisions a few "grains of sand in the wheels of international finance" can indeed be stabilizing. Whether that is sufficient, or whether boulders-not just grains-are needed to prevent speculative attacks on currencies, is, however, a different matter.
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Working Paper No. 364 | December 2002
In this paper we seek first to set out the economic analysis that underpins the ideas of what has been termed the “third way.” The explicit mention of the “third way” is much diminished since the early days of the Blair government in the UK and the Schroeder government in Germany. We argue that the ideas associated with the “third way” continue to influence these governments and, more broadly, other governments and the European Union, and that these ideas are firmly embedded in New Keynesian economics. Our paper then focuses on some particular aspects of New Keynesian economics and its emphasis on the role of monetary policy and the downgrading of fiscal policy. There has emerged a so-called “new consensus” on macroeconomic policy (specifically, monetary policy), which we regard as an outgrowth of New Keynesian economics. We review this “new consensus” and argue that the empirical evidence on the operation of monetary policy reveals that such a policy is rather impotent. Insofar as it does have an effect, it operates to influence the level of investment, which in turn affects the future level and distribution of productive capacity. Thus, contrary to the prevailing view, monetary policy is not an effective way to control inflation, but it can have effects on the real side of the economy. The lack of attention to fiscal policy and the overemphasis on monetary policy leaves the European Union and its member countries without the means to tackle any serious recession or upsurge of inflation.
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Working Paper No. 363 | December 2002
Recent developments in macroeconomics, and in economic policy in general, have produced a "new consensus" economy-wide model. In this model, the stock of money does not play any causal role, but operates as a mere residual in the economic process. The absence of the stock of money in many current debates over monetary policy has prompted the deputy governor of the Bank of England to note the irony of the situation: as central banks became more and more concerned with price stability, less and less attention is paid to money. Indeed in several countries, the decline of interest in money appears to have coincided with low inflation. In turn, a number of contributions have attempted, wittingly or unwittingly, to "reinstate" a more substantial role for money in this "new" macroeconomics. In this paper we argue that these attempts to "reinstate" money in current macroeconomic thinking entail two important problems. First, they contradict an important theoretical property of the new "consensus" macroeconomic model, namely, that of dichotomy between the monetary and the real sector. Second, some of these attempts either fail in terms of their objective or merely reintroduce the problem rather than solve it. We conclude that if money is to be given a causal role in the "new" consensus model, more substantial research is needed.
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Public Policy Brief Highlights No. 69A | November 2002
An Evaluation of a Plan to Reduce Financial Instability
In this brief, Biagio Bossone of the International Monetary Fund evaluates narrow banking from the perspective of modern theories of financial intermediation. These theories portray the status quo banking system as a solution to otherwise intractable problems of imperfect information, risk, and even moral hazard. The system's characteristic coupling of liquid liabilities with illiquid assets—seen by some as an undesirable "mismatch"—in fact contributes greatly to the efficiency of the economy. Bossone argues that these efficiency gains outweigh the disadvantages associated with the existing legal framework.Download:Associated Program:Author(s):Biagio Bossone -
Public Policy Brief No. 69 | November 2002
An Evaluation of a Plan to Reduce Financial Instability
In this brief, Biagio Bossone of the International Monetary Fund evaluates narrow banking from the perspective of modern theories of financial intermediation. These theories portray the status quo banking system as a solution to otherwise intractable problems of imperfect information, risk, and even moral hazard. The system's characteristic coupling of liquid liabilities with illiquid assets—seen by some as an undesirable “mismatch”—in fact contributes greatly to the efficiency of the economy. Bossone argues that these efficiency gains outweigh the disadvantages associated with the existing legal framework.
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Working Paper No. 362 | November 2002
Evidence from Developed and Developing Economies
We collect data on a number of financial restraints, including restrictions on interest rates and capital flows and reserve and liquidity requirements, and capital adequacy requirements from central banks of 14 countries. We estimate the effects of these policies on the aggregate productivity of the capital stock, controlling for the effects of inputs and financial development and using modern econometric techniques. We find that financial development has positive effects on productivity, while the effects of financial policies vary considerably across countries. Our findings demonstrate that financial liberalization is a much more complex process than has been assumed by earlier literature, and its effects on macroeconomic aggregates are ambiguous.
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Working Paper No. 361 | November 2002
A Markov Regime-switching Approach
The primary objective of this paper is to use the Markov regime-switching modeling framework to study the credibility of monetary policy in five member countries of the European Monetary System (EMS) during the period 1979 to 1998. The five countries examined for this purpose are Austria, Belgium, France, Italy, and the Netherlands. The major innovation of this paper is the use of a Markov regime-switching model with time-varying transition probabilities. The output-gap variability and the inflation variability variables are incorporated into the determination of the monetary policy preferences of individual member countries of the EMS. Empirical evidence is provided to show that although all the countries in our sample followed a credible monetary policy regarding price stability, they had different preferences regarding the trade-off between the stabilization of output-gap variability and inflation variability.
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Book Series | November 2002
By Leon Levy, with Eugene Linden; foreword by Alan Abelson
As stock prices and investor confidence have collapsed in the wake of Enron, WorldCom, and the dot-com crash, people want to know how this happened and how to make sense of the uncertain times to come.
Into the breach comes one of Wall Street's legendary investors, Leon Levy, to explain why the market so often confounds us, and why those who ought to understand it tend to get chewed up and spat out. Levy, who pioneered many of the innovations and investment instruments that we now take for granted, has prospered in every market for the past fifty years, particularly in today’s bear market. In The Mind of Wall Street he recounts stories of his successes and failures to illustrate how investor psychology and willful self-deception so often play critical roles in the process. Like his peers George Soros and Warren Buffett, Levy takes a long and broad view of the rhythms of the markets and the economy. He also offers a provocative analysis of the spectacular Internet bubble, showing that the market has not yet completely recovered from its bout of “irrational exuberance.”
The Mind of Wall Street is essential reading for all of us, whether we are active traders or simply modest contributors to our 401(k) plans, as volatile and unnerving markets come to define so much of our net worth.
Published By: PublicAffairs
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Working Paper No. 360 | October 2002
Some Conceptual Problems
In recent years free movement of financial capital following financial liberalization has given the impression that financial markets are truly globalized. In this paper we argue that free movement of financial capital alone does not constitute financial globalization. To achieve true financial globalization, an important requirement is the creation of a worldwide single currency, managed by a single international monetary authority. This condition, however, is not met under current institutional arrangements.
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Working Paper No. 359 | October 2002
This paper examines two issues. First, we compare, based on the ratio of output-gap variability to inflation variability, the monetary policy performance of eleven EMU countries for the whole period of the EMS. Second, we examine whether the introduction of an implicit inflation-targeting by the EMU member countries after the Maastricht Treaty changed the trade-off between inflation variability and output-gap variability. We employ a stochastic volatility model for the whole period of the EMS and for two sub-periods (i.e., before and after the Maastricht Treaty). We find that for the whole period the trade-off ratio varies among EMU countries, especially in the case where industrial production is utilized to construct the output-gap variable. The results also vary from the point of view of how the trade-off variabilities change for each country before and after the Maastricht Treaty. The implication of these findings is that asymmetries exist in the euro area as a result of either different monetary policy preferences or different economic structures among the EMU's member countries.
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Working Paper No. 357 | October 2002
This paper explores the probable consequences for public expenditure in the United Kingdom if Britain were to join the euro. It focuses on the effects of sterling joining the euro (and the associated implications, such as monetary policy being governed by the European Central Bank). It does not consider any broader questions of the effects of membership in the European Union and the policies pursued by the EU and the European Commission. Since the fiscal stance of government influences the level of demand in the economy, there are also important implications for the level of employment more generally. While the general deflationary nature of the economic policy of the eurozone (an issue we have explored elsewhere on many occasions) should not be overlooked, the focus of this paper is on the implications for public expenditure of the eurozone and the UK's possible entry into the euro.
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Working Paper No. 355 | October 2002
Current monetary policy involves the manipulation of the central bank interest rate (the repo rate), with the specific objective of achieving the goal(s) of monetary policy. The latter is normally the inflation rate, although in a number of instances this may include the level of economic activity (the monetary policy of the United States' Federal Reserve is a good example of this category). This raises two issues. The first is the theoretical underpinnings of this mode of monetary policy. The second is the channels of monetary policy or, more concretely, the channels through which changes in the rate of interest may affect the ultimate goal(s) of policy. Both aspects are investigated in this paper. Furthermore, we suggest that it is imperative to consider the empirical estimates of the effects of monetary policy. We summarise results drawn from the eurozone, the US and the UK and suggest that these empirical results point to a relatively weak effect of interest rate changes on inflation. We also suggest, on the basis of the evidence adduced in the paper, that monetary policy can have long-run effects on real magnitudes. This particular result does not fit comfortably with the theoretical basis of current thinking on monetary policy.
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Working Paper No. 354 | October 2002
Over the past 70 years, a proposal to narrow the scope of banks has emerged more and more frequently in financial debates and research. Narrow banking would prevent deposit-issuing banks from lending to the private sector and restrict nonbank intermediaries from funding investments with demand deposits. Proponents of narrow banking defend it as a step toward greater financial stability and efficiency. This study reviews the literature on the subject, contrasts the concept of narrow banking with contemporary banking theories, and evaluates the potential effects of narrow banking on finance and the real economy. The study also delineates an empirical exercise to estimate the costs of bank narrowness and draws policy conclusions based on those estimates.
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Public Policy Brief Highlights No. 68A | August 2002
Balancing Government Regulation and Market Force
At issue in the debate over the renewal of the Community Reinvestment Act (CRA) of 1977 are the various yardsticks regulators use to judge whether individual institutions are meeting the credit and service needs of low- and moderate-income (LMI) communities. Based on careful examination of new CRA data and assessments of comments by selected stakeholders, the author concludes that if the new rules are to succeed, regulators will have to strike a careful balance between various competing interests vying to tip the balance of power in their favor. For example, to offset the effects of a possibly too-close relationship between industry and government agencies, the rules could mandate very explicit and objective measures of institutions' lending performance. To relieve the burden of compliance, the rules could be simplified and pared down to their essentials. And to prevent banks from taking advantage of vulnerable members of LMI communities, rule makers could adopt strong measures against "predatory lending."Download:Associated Program:Author(s):Kenneth H. Thomas -
Public Policy Brief No. 68 | August 2002
Balancing Government Regulation and Market Forces
At issue in the debate over the renewal of the Community Reinvestment Act (CRA) of 1977 are the various yardsticks regulators use to judge whether individual institutions are meeting the credit and service needs of low- and moderate-income (LMI) communities. Based on careful examination of new CRA data and assessments of comments by selected stakeholders, the author concludes that if the new rules are to succeed, regulators will have to strike a careful balance between various competing interests vying to tip the balance of power in their favor. For example, to offset the effects of a possibly too-close relationship between industry and government agencies, the rules could mandate very explicit and objective measures of institutions’ lending performance. To relieve the burden of compliance, the rules could be simplified and pared down to their essentials. And to prevent banks from taking advantage of vulnerable members of LMI communities, rule makers could adopt strong measures against “predatory lending.”
Download:Associated Program:Author(s):Kenneth H. Thomas -
Working Paper No. 349 | July 2002
This paper raises questions about austerity policies by investigating the effects of the state's tax and expenditure policies on the warranted growth rate. It proposes two mechanisms to raise the warranted growth rate in the event that there is long-run unemployment. First, it incorporates Pasinetti's taxation function into Harrod's growth framework to show how, with an unbalanced budget, an increase in any kind of tax rate, including the tax rate on profits, will raise the warranted path. Such a policy can be accompanied by an increase in aggregate government spending. Second, by introducing a public investment function and, following Keynes, by assuming that the government's expenditures are split into a current and a capital budget, it shows that an increase in capacity-augmenting investment by state enterprises can also raise the warranted path. In other words, judicious tax and expenditure policies provide the basis for increases in government spending, including a greater degree of capacity-augmenting public investment. The paper thus formalizes Keynes's proposals regarding the socialization of investment and shows how this can be accomplished via appropriate compositional changes in government spending and taxation policies.
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Working Paper No. 345 | May 2002
In the United Kingdom the emergence of a “New Labour” has been closely associated with the development of the notion of the “third way.” Tony Blair, for example, stated that “New Labour is neither old left nor new right. . . . Instead we offer a new way ahead, that leads from the centre but is profoundly radical in the change it promises.” In a similar vein Giddens locates the "third way" by reference to two other “ways” of classical social democracy and neoliberalism. Although some notable contributions have been made on the subject of the “third way,” rather little has been written specifically on the economic analysis underpinning it. This paper infers such an analysis by working back from the policies and policy pronouncements of governments. To do so, the paper examines the types of economic analyses being used to underpin the ideas of the “third way”; the suggestion that the ideas surrounding the economic analysis of the economic and monetary union's (EMU's) theoretical and policy framework are firmly embedded in that of “third way”; and the argument that the challenge for EMU macropolicies lies in their potential to achieve full employment and low inflation in the euro system. On the last point, the author concludes that these policies, as they currently operate, are not very promising. Alternatives are therefore suggested.
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Working Paper No. 344 | March 2002
A Dead End
When economies "dollarize," their exchange rate and monetary policy, both considered to be sources of instability, are simultaneously discarded. Often, dollarization becomes an attractive option for developing countries that have experienced successive failures of exchange rate and monetary management. This paper makes use of a theoretical model that shows, contrary to the commonly accepted view, that a dollarized economy would experience financial instability in the event of external shocks should it attempt to operate discretionary fiscal policies. Shocks not simultaneously contained by adjustments to spending would lead to ever-increasing fiscal and current account deficits because public sector borrowing requirements can only be financed by selling bonds in the open market at constantly rising rates of interest. Hence, such a path cannot be an option. Alternatively, if fiscal spending were curbed at par with the shock, external and current account balances would converge to equilibrium, but trigger a recession and increased unemployment. Since this, too, is unacceptable, dollarization turns out to be a "dead end."
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Policy Note 2002/3 | March 2002
The introduction of the euro has been a significant step in the integration of the economies of the countries that form the European Union (EU) and the 12 countries that comprise the Economic and Monetary Union (EMU). Its adoption not only means that a single currency prevails across the Eurozone, with reduced transactions costs for trade between member countries; the currency also has become embedded in a particular set of institutional and policy arrangements that tell us about the nature of economic integration in the EU. In fact, the euro is a relatively small step along the path to further economic integration at the global level, and the neoliberal agenda of globalization can be clearly seen from the ways in which the euro has been introduced.
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Policy Note 2002/2 | February 2002
The International Monetary Fund has offered Brazil a $30 billion loan, most of it reserved for next year, on condition that the country continue to run a large primary surplus in the government budget. In this way the Fund maintains a strong arm over Brazil's next government. Any significant move toward fiscal expansion would trigger revocation of the promised loan, followed by capital market chaos. Or so one is led to suppose.
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Public Policy Brief Highlights No. 67A | November 2001
The Impact of Misguided Macroeconomic Policies
Although the costs associated with moving an antiquated socialist economy toward its capitalist counterpart was anticipated to be significant, German industrial efficiency was expected to quickly overcome any challenges. Things turned out rather differently. Conventional wisdom blamed poor economic performance on unification. The government and the Bundesbank therefore put in place fiscal and monetary policies aimed at reducing borrowing and, in turn, containing the threat of inflation. The positive results (albeit in five years) supported this perception. The author of this brief, however, takes exception to the notion that these policies were effective in stabilizing the economy. His analysis shows that the country’s poor economic performance dramatically dampened economic activity and led to an extended period of sluggish growth. Blame for anemic growth and high unemployment, he believes, should be placed squarely on the country’s finance department and central bank rather than on unification.Download:Associated Program:Author(s): -
Public Policy Brief No. 67 | November 2001
The Impact of Misguided Macroeconomic Policies
Although the costs associated with moving an antiquated socialist economy toward its capitalist counterpart was anticipated to be significant, German industrial efficiency was expected to quickly overcome any challenges. Things turned out rather differently. Conventional wisdom blamed poor economic performance on unification. The government and the Bundesbank therefore put in place fiscal and monetary policies aimed at reducing borrowing and, in turn, containing the threat of inflation. The positive results (albeit in five years) supported this perception. The author of this brief, however, takes exception to the notion that these policies were effective in stabilizing the economy. His analysis shows that the country’s poor economic performance dramatically dampened economic activity and led to an extended period of sluggish growth. Blame for anemic growth and high unemployment, he believes, should be placed squarely on the country’s finance department and central bank rather than on unification.
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Working Paper No. 338 | September 2001
A Stability-oriented Assessment
The stability-oriented macroeconomic framework established in the Maastricht and Amsterdam Treaties on European Union (TEU), especially the unparalleled status of independence and peculiar mandate of the European Central Bank (ECB), were promised to virtually guarantee price stability and a "strong" euro. Actual developments have shattered these hopes in a rather drastic way. Despite the dismal monetary developments, conventional wisdom holds that neither the Maastricht regime nor the ECB might possibly be at fault. Yet, the euro's performance over 2000–01 is generally seen as a puzzle. This paper assesses the ECB's role in relation to the euro's (mal-) performance, explores the institutional setting and traditions behind the ECB's conduct, and scrutinizes the rationale that inspired its interest rate policies.
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Policy Note 2001/9 | September 2001
The tools of countercyclical monetary policy have been brought fully to bear on a potentially severe recession. This note argues, however, that such a policy is less effective in times such as these—that is, when uncertainty is especially high—and so is likely to be particularly ineffective in combating the current economic slowdown.
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Public Policy Brief Highlights No. 65A | August 2001
The Markets vs. the ECB
This brief assesses the experiences of Europe’s policy regime in the two years since the introduction of the euro in 1999, particularly the performance of the European Central Bank (ECB), the institution in charge of conducting monetary policy for the euro area. Conventional accounts of European growth, price, and labor market performance over recent years focus on labor market institutions and wage trends. By contrast, the interpretation offered here assigns a key role to demand-side factors as the driving force behind the recovery in output and employment growth. It is argued that the euro's plunge essentially resumed the trend of deutsche mark weakness that had started in 1996 and that currency depreciation amounted to a significant easing of monetary conditions.Download:Associated Program:Author(s): -
Working Paper No. 337 | August 2001
The debate about balance of payment problems is generally linked with adjustments in the fiscal sector, especially since the views of Bretton Woods institutions became predominant. For the majority of theoretical models that currently inform policy, it is becoming common thought that in a world of free trade and free movement of capital, a floating rate of exchange may clear the market for financial assets. In these models, the persistence of balance of payment problems can be attributed to rigidities either in the fiscal sector (that is, the inability of the public sector to run a balanced budget), or the labor market (that is, trade union pressures and welfare protective measures leading to uncompetitive salaries). This approach, which makes the fiscal stance the culprit of macroeconomic imbalances in countries with floating exchange rates, is, however, also applied to countries that have adopted other, more rigid forms of exchange rate policy, such as currency boards, dollarization, and common currency agreements. It seems to be overlooked that systems of common currency pose problems of an entirely different kind because two major mechanisms of macroeconomic adjustment—exchange rate flexibility and money issuing—are obviously removed. Thus, theoretical and policy-oriented propositions need to take into account this new set of restrictions.
Download:Associated Program:Author(s):Alex Izurieta -
Public Policy Brief No. 65 | August 2001
The Markets vs. the ECB
This brief assesses the experiences of Europe’s policy regime in the two years since the introduction of the euro in 1999, particularly the performance of the European Central Bank (ECB), the institution in charge of conducting monetary policy for the euro area. Conventional accounts of European growth, price, and labor market performance over recent years focus on labor market institutions and wage trends. By contrast, the interpretation offered here assigns a key role to demand-side factors as the driving force behind the recovery in output and employment growth. It is argued that the euro's plunge essentially resumed the trend of deutsche mark weakness that had started in 1996 and that currency depreciation amounted to a significant easing of monetary conditions.
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Working Paper No. 334 | July 2001
This paper challenges the time-inconsistency case for central bank independence. It argues that the time-inconsistency literature not only seriously confuses the substance of the rules versus discretion debate, but also posits an implausible view of monetary policy. Most worrisome, the inflationary bias featured prominently in the time-inconsistency literature has encouraged the development of a dangerously one-sided approach to central bank independence that entirely ignores the potential risks involved in maximizing central bankers' latitude for discretion. The analysis shows that a more balanced and symmetric approach to central bank independence is urgently warranted. The views of John Maynard Keynes and Milton Friedman are shown to shed some illuminating and disconcerting light on a fashionable free-lunch promise that is based on rather shallow theoretical foundations.
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Working Paper No. 328 | May 2001
The Economic Consequences of Messrs. Waigel and Tietmeyer
This paper investigates the causes of western Germany's remarkably poor performance since 1992. The paper challenges the view that the poor record of the nineties, particularly the marked deterioration in public finances since unification, might be largely attributable to unification. Instead, the analysis highlights the role of ill-timed and overly ambitious fiscal consolidation in conjunction with tight monetary policies of an exceptional length and degree. The issue of fiscal sustainability and Germany's fiscal and monetary policies are assessed both in the light of economic theory and in comparison to the best practices of other more successful countries. The analysis concludes that Germany's dismal record of the nineties must not be seen as a direct and apparently inevitable result of unification. Rather, the record arose as a perfectly unnecessary consequence of unsound macro demand policies conducted under the Bundesbank's dictate in response to it, policies that caused the severe and protracted de-stabilization of western Germany in the first place.
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Policy Note 2001/4 | April 2001
According to Federal Reserve Chairman Alan Greenspan, we live in a time “profoundly different from the typical postwar business cycle.” Our experiences have “defied conventional wisdom” and mark ”veritable shifts in the tectonic plates of technology.” Evidently, the law of supply and demand has been repealed. This is the theme of “Put your chips on 35”—where 35 refers to the standard industrial classification code for machinery, of which 357, computers and office equipment, is the ground zero of the technological earthquake.
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Public Policy Brief Highlights No. 63A | March 2001
Is There an Alternative to the Stability and Growth Pact?
This brief provides a detailed description of the Stability and Growth Pact, an agreement entered into by the member states of the European Union that has far-reaching implications for the long-run value of the euro, and therefore, on the real economy in terms of output growth and employment. Yet despite the fact that the pact underpins the adoption of the single currency and has fundamentally redefined the scope and nature of economic policymaking in the member states, public discussion about it is relatively scant, especially on our side of the Atlantic, even though the economic health of the European Union does matter to the economic and strategic position of the United States. The authors provide propose a critique of the pact that focuses on the shortcomings induced by the its regime of mandatory fiscal austerity, the separation between fiscal and monetary policy, the undemocratic structure and lack of accountability of the European Central Bank, and the paramount importance attached to price stability at the expense of other policy objectives. According to the authors, these shortcomings will have serious negative effects on the current and future economic performance of the member states and the material well-being of its citizens.Download:Associated Program:Author(s): -
Working Paper No. 326 | March 2001
Some Lessons from the 1990s
This paper investigates the lessons learned from Europe's convergence process of the 1990s. The paper challenges the conventional focus on labour market institutions and "structural rigidities" as the root cause of Europe's poor employment record. Instead, it is argued that macroeconomic demand management, particularly monetary policy, played the key role. Concentrating on Germany, the analysis shows that fiscal consolidation was accompanied by monetary tightness of an extraordinary degree and duration. This finding is of interest for the past as well as the future, for the Maastricht regime much resembles the one that produced the unsound policy mix of the 1990s: a constrained fiscal authority paired with an independent monetary authority free to impose its will on the overall outcome. The analysis thus highlights a key asymmetry in the Maastricht regime that is not unlikely to continue to inflict a deflationary bias on the system. It is argued that this policy bias may be overcome only if the ECB deliberately assumes its real role of generating domestic demand-led growth, thereby resolving Euroland's key structural problem: asymmetric monetary policy. Concerning the conventional structuralist theme, the analysis debunks the "Dutch myth" of supply-led growth through structural reform. Depicting a popular fallacy of composition, we stress that the peculiar Dutch strategy of demand-led growth does not present itself as an option for Euroland.
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Working Paper No. 325 | March 2001
A method advocated by Wynne Godley to model monetary macroeconomics, is presented. The method, based on a transactions matrix, essentially makes sure that every flow goes somewhere and comes from somewhere, so that there are no black holes. The method is put to use for several purposes: to illustrate the monetary circuit of credit money; to demonstrate that there can be a separate portfolio (stock) demand for money, but not one independent from the rest of the model; to show that there cannot be an excess supply of credit; to handle the cases of credit for speculation purposes and high liquidity preference; to underline that endogenous money at fixed interest rates is still compatible with any government deficit; and to show that even when banks have liquidity norms, larger amounts of loans do not necessarily induce higher interest rates. Briefly stated, the paper shows that many of the claims made by Horizontalist authors are confirmed when a fully coherent accounting framework is put in place to assess their claims.
Download:Associated Program:Author(s):Marc Lavoie -
Working Paper No. 324 | March 2001
This paper examines the causes of the general decline in the value of the euro. First, it assesses the various explanations proffered in existing literature, and then it offers a more satisfactory one. The argument prevalent in the literature that the decline in value of the euro is due to "US strength" rather than to any inherent difficulties with its imposition is viewed as somewhat undeveloped. We suggest that US strength is an important but only partial factor in the euro's decline; the other side of US strength is Eurozone weakness. We review the (poor) performance of the ECB and assess the level of macroeconomic convergence of Eurozone countries. We conclude that a combination of Eurozone weakness, endogenous to the inception of the euro, and US strength is the most plausible explanation for the euro's decline in value. We find that although the future value of the euro is uncertain, the prospects for the eurozone will remain bleak as long as the current institutions underpinning the euro, with their inherent tendencies to promote deflation, are in place.
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Working Paper No. 323 | March 2001
The Markets vs. the ECB
This paper assesses the performance of the European Central Bank (ECB) over the first two years of Europe's new policy regime. The verdict is that the ECB was not actually in charge, as the markets took over and imposed easy money on the euro zone. It is argued that the causes for the ECB's loss of effective control over the currency and monetary stance lie partly in the low-growth legacies of unsound macro policies inflicted upon Europe over the 1990s. The ECB made matters worse, though, first by failing to communicate effectively and coherently with financial market participants and, second, by playing against the markets' dominant theme: growth. This resulted in a time-inconsistency problem: attempts to prop up the euro through narrowing the current interest rate spread vis-a-vis the US dollar were perceived as risking the euro zone's growth prospects and hence the sustainability of tighter money in the future. Under such conditions, interest rate hikes might then weaken rather than strengthen the currency. A more balanced and proactive attitude toward growth, and medium-term orientation as regards inflation, might have both reduced inflation in the short run and improved growth in the longer run. The recent short run of impressive GDP and employment growth spurred by easy money embarrasses the structural myth, and underlines that the ECB was not actually in charge.
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Working Paper No. 322 | March 2001
It has been argued that the eurozone will face considerable economic difficulties. These will take a number of forms, two of which could qualify as "crises." First, the euro was launched at a time when unemployment levels were high (10 percent of the workforce) and disparities in the experience of unemployment and standards of living were particularly severe. These high levels of unemployment are likely to continue in the foreseeable future, and the policy arrangements that surround the operation of the euro, notably the objectives of the European Central Bank and the workings of the Stability and Growth Pact, will have a deflationary bias. These levels of and disparities in unemployment could be termed a crisis. Second, the introduction of the euro and the associated institutional setting could well serve to exacerbate tendencies toward financial crisis, including the volatility and subsequent collapse of asset prices and runs on the banking system. Some additional forces of instability may arise from the current trade imbalances and the relationship between the dollar and the euro as two major global currencies. Further, the operating arrangements of the European System of Central Banks can be seen as inadequate to cope with such financial crises.
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Public Policy Brief No. 63 | March 2001
Is There an Alternative to the Stability and Growth Pact?
This brief provides a detailed description of the Stability and Growth Pact, an agreement entered into by the member states of the European Union that has far-reaching implications for the long-run value of the euro, and therefore, on the real economy in terms of output growth and employment. Yet despite the fact that the pact underpins the adoption of the single currency and has fundamentally redefined the scope and nature of economic policymaking in the member states, public discussion about it is relatively scant, especially on our side of the Atlantic, even though the economic health of the European Union does matter to the economic and strategic position of the United States. The authors provide propose a critique of the pact that focuses on the shortcomings induced by the its regime of mandatory fiscal austerity, the separation between fiscal and monetary policy, the undemocratic structure and lack of accountability of the European Central Bank, and the paramount importance attached to price stability at the expense of other policy objectives. According to the authors, these shortcomings will have serious negative effects on the current and future economic performance of the member states and the material well-being of its citizens.
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Working Paper No. 313 | September 2000
Community Reinvestment Act of 1977 (CRA) ratings and performance evaluations are the only bank and thrift exam findings disclosed by financial institution regulators. Inflation of CRA ratings has been alleged by community activists for two decades, but there has been no quantification or empirical investigation of grade inflation. Using a unique grade inflation methodology on actual ratings and evaluation data for 1,407 small banks and thrifts under the revised CRA regulations, this paper concludes that nearly half of all CRA ratings are inflated. Results are presented for the four federal bank and thrift regulators and their 31 regional offices. These findings are consistent with the "Friendly Regulator Hypothesis."
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Working Paper No. 305 | July 2000
The euro was expected to become a substitute for the American dollar as an international currency. However, compromises made during its creation make it a less than perfect substitute in the medium term. Among these compromises was the application of macro convergence and micro diversity in financial markets and supervision at the national level. This now prevents the creation of a unified capital market and places EU banks at a disadvantage when competing with US banks in global markets. There were also peculiarities in the integration process that led to a single currency in the United States that suggest further institutional changes will be necessary.
Download:Associated Program:Author(s):Jan Kregel -
Public Policy Brief No. 60 | June 2000
The Pursuit of Price Stability and Full Employment
The Federal Reserve currently has two legislated goals—price stability and full employment—but a debate continues about making price stability the Fed’s primary and overriding goal. Evidence from the recent history of monetary policy contradicts arguments in favor of assigning primacy to inflation fighting and supports giving full employment equal importance. Economic performance under the dual mandate has been excellent, with low unemployment and low inflation, while many European countries whose central banks focus solely on inflation are experiencing double-digit unemployment. The costs of unemployment are high, but the costs of even moderate inflation are estimated to be low. Central bankers, who tend to be inflationaverse, need to be prodded to consider goals other than inflation. And, if the Fed pursues price stability exclusively, the price level is not free to increase in the event of an adverse supply shock to prevent large increases in unemployment. A dual mandate allows the Fed to focus on one goal or the other as conditions demand and to balance policy effects.
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Public Policy Brief Highlights No. 60A | June 2000
The Pursuit of Price Stability and Full Employment
The Federal Reserve currently has two legislated goals—price stability and full employment—but a debate continues about making price stability the Fed’s primary and overriding goal. Evidence from the recent history of monetary policy contradicts arguments in favor of assigning primacy to inflation fighting and supports giving full employment equal importance. Economic performance under the dual mandate has been excellent, with low unemployment and low inflation, while many European countries whose central banks focus solely on inflation are experiencing double-digit unemployment. The costs of unemployment are high, but the costs of even moderate inflation are estimated to be low. Central bankers, who tend to be inflationaverse, need to be prodded to consider goals other than inflation. And, if the Fed pursues price stability exclusively, the price level is not free to increase in the event of an adverse supply shock to prevent large increases in unemployment. A dual mandate allows the Fed to focus on one goal or the other as conditions demand and to balance policy effects.Download:Associated Program:Author(s): -
Policy Note 2000/5 | May 2000
A Minskyan View
Hyman P. Minsky’s insights into the relationship between profits, economic growth, and the public and private financial balances are particularly relevant to today’s conditions. How can a Minskyan view be applied to explain the processes that brought the economy to its current state and to recommend a policy stance for the future?
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Working Paper No. 298 | March 2000
Why Inflation Won't Bring Recovery In Japan
Paul Krugman has argued that Japan is in a liquidity trap and that it can recover only if the central bank there follows a policy of "credible inflation." This paper argues that Krugman's proposal, which is similar to what Fisher proposed during the Depression, is based on a different interpretation of the liquidity trap from that proposed by Keynes. As a result, his policy recommendations can result in neither the elimination of the trap nor in Japan's economic recovery.
Download:Associated Program:Author(s):Jan Kregel -
Working Paper No. 296 | March 2000
This paper proposes an alternative stability and growth pact among European Union (EU) governments that would underpin the introduction of a single currency and a "single market" within the EU. The alternative pact embraces a number of new aspects of integration within the EU that are based on a different monetary analysis (different from that of "new monetarism"), new objectives for economic policy (such as employment and growth), and new institutions to reduce various kinds of disparities across the EU. The paper begins by critically examining the Stability and Growth Pact, which accompanied the introduction of the euro in January 1999, but which has not received as much attention in the policy debates on the euro as some other aspects of it. This is followed by a discussion of the institutional underpinnings of the euro, with the argument made that the institutional arrangements have a number of weaknesses. An alternative pact governing monetary and fiscal policy, which contains the promotion of the objective of full employment and that requires the creation of new institutions, is proposed.
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Working Paper No. 294 | February 2000
From Inertial Inflation to Fiscal Fragility
This paper argues that the Brazilian crisis differs from the standard Minsky crisis in that it is Brazil's government that is engaging in Ponzi financing while private sector balance sheets are relatively robust. However, attempts to stabilize the economy through high interest rates and expenditure cuts may quickly produce private sector fragility. This is the dilemma faced by Brazilian economic policy today.
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Book Series | December 1999
Edited by Dimitri B. Papadimitriou
Since the 1980s many changes have taken place in the financial system in the United States and to some extent in other countries—uniform capital requirements have been instituted, regulations have been eased, and market share consolidation of firms in the financial services business has been allowed. But more substantive reforms are necessary to avert crises such as those that occurred in Japan, Korea, and other Asian countries.
Financial and technological innovations have brought new dimensions of credit risk, requiring sophisticated skills of bank manager and regulator alike. The modernization of the financial system must reflect the changing and competitive nature of the market and be framed in a regulatory and supervisory environment that, first, ensures the safety of the payment system and, second, offers incentives for prudent risk taking and sound portfolio investments. This book offers a number of policy avenues that merit serious consideration.
Published By: Palgrave Macmillan, Ltd.
St. Martin's Press -
Public Policy Brief Highlights No. 56A | November 1999
Realities and Fallacies in International Financial Reform
The causes for the instability that has marked the financial system over the past decade lie deep in the economic theory that urges easy and efficient substitution of one piece of paper for another, in the technology-driven tight articulation of receipts and payments, and in the growth of leverage that diminishes the creditworthiness of major institutions when an interruption in their receipts requires them to seek funds. Many of the proposals aimed at reducing risk in the financial system, however, do not recognize these changes or their importance. The call for greater bank transparency, for example, fails to take into account both that bankers and regulators are jealous of their "privacy" and that financial markets, not banks, have lately become the more important player in the financial system. Guidelines are needed that reflect the new financial architecture: controls on the creation of leverage in the repo and derivatives markets and limits on banks' freedom to back away from borrowers' cross-border liabilities in currencies other than their own. When such preventive measures fail, then crisis management will require "standstill" agreements to encourage the continuation of something like normal economic life while the losses from financial failure are sorted out.Download:Associated Program:Author(s):Martin Mayer -
Public Policy Brief No. 56 | November 1999
Realities and Fallacies in International Financial Reform
The causes for the instability that has marked the financial system over the past decade lie deep in the economic theory that urges easy and efficient substitution of one piece of paper for another, in the technology-driven tight articulation of receipts and payments, and in the growth of leverage that diminishes the creditworthiness of major institutions when an interruption in their receipts requires them to seek funds. Many of the proposals aimed at reducing risk in the financial system, however, do not recognize these changes or their importance. The call for greater bank transparency, for example, fails to take into account both that bankers and regulators are jealous of their “privacy” and that financial markets, not banks, have lately become the more important player in the financial system. Guidelines are needed that reflect the new financial architecture: controls on the creation of leverage in the repo and derivatives markets and limits on banks’ freedom to back away from borrowers’ cross-border liabilities in currencies other than their own. When such preventive measures fail, then crisis management will require “standstill” agreements to encourage the continuation of something like normal economic life while the losses from financial failure are sorted out.
Download:Associated Program:Author(s):Martin Mayer -
Working Paper No. 287 | November 1999
What, Why, and How?
The purpose of this paper is threefold. First, the theory of functional finance, as explicated by its originator, Abba Ptachya Lerner, is put forward; second, the reader is introduced to the use, standard in money and banking texts, of T-account balance sheet entries. Although no important conclusions will rest solely on the reader's ability to cope with these entries, comfort with their use will ease the exposition. An appendix therefore is provided to assist those not yet exposed to this method of recording balance sheet changes and for those who merely wish to refresh themselves. The third purpose of the paper is to demonstrate the need for policies governed by the principles of functional finance.
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Working Paper No. 282 | October 1999
Current and Future Prospects
The euro was adopted as legal tender, albeit in a virtual form, by 11 countries of the European Union on January 1, 1999. The intention was that notes and coins denominated in euros would be introduced and the national currencies phased out during the first six months of that year, and that the euro would be fully operational by 2002. This paper first reviews the current position of the EMU member states in relation to the convergence criteria under the Maastricht Treaty and finds that there must have been a considerable degree of "fudge" for the criteria to have been met. The paper next looks at the central role of aggregate demand in the EMU and at concerns about unemployment. It then examines the prospects of the current EMU arrangements, concluding that they are highly deflationary. To overcome the deflationary bias of current proposals and as a means to alleviate the serious unemployment problem, the authors recommend that the European Central Bank be enhanced by (1) the development of a new institution, the European Union Development Bank, and (2) a modification of the Stability and Growth Pact.
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Working Paper No. 281 | September 1999
The following paper presents a series of two-country models, each of which makes up a whole world. The models are all based on a rigorous and watertight system of stock and flow accounts and can be used to generate numerical simulations of the way in which of the whole system evolves through time on various assumptions regarding institutions, policies, and behavioral responses. The paper emphasizes that the supply of internationally traded assets is as important as demand in the determination of exchange rates. All the models describe income determination and inflation as well as international trade and intercountry dealings in assets. Apart from deploying a method of analysis believed to be capable of substantial further development, the paper finds that no vestige of the "price-specie flow" mechanism remains once asset demands and supplies are comprehensively represented and inter-related with income flows. It also finds that once the supply of internationally traded assets (for instance, as a result of imbalances in trade) are taken into account, the role of expectations in determining exchange rates—though very important—is exaggerated in much contemporary theorizing.
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Working Paper No. 279 | September 1999
The theory of capital market inflation argues that the values of long-term securities markets are determined by a disequilibrium inflow of funds into those markets. The resulting overcapitalization of companies leads to increased fragility of banking and undermines monetary policy and stable relationships between short- and long-term interests rates, such as that postulated by Keynes in his theory of the speculative demand for money. Moreover, while the increased fragility of banking is an immediate effect, capital market inflation also creates an unstable Ponzi financing structure in the capital market as a whole.
Download:Associated Program:Author(s):Jan Toporowski -
Policy Note 1999/9 | September 1999
An Impending Cash Flow Squeeze?
Modest sales expectations and limited access to bank credit may be curtailing small businesses’ plans for hiring and capital investment.
Download:Associated Program:Author(s):Jamee K. Moudud -
Working Paper No. 278 | August 1999
Has Recent Research Rediscovered Financial Keynesianism
Hyman Minsky's research emphasized the central role of finance in modern economics at a time when finance was not important in most mainstream macroeconomic research. But in the 1980s, mainstream research began to explore the role of finance in firm and consumer behavior. This paper examines the extent to which this recent mainstream research captures Minsky's insights and whether it extends his work. I argue that recent work on micro foundations-the link between economic behavior and finance—complements Minsky's contributions and corresponding empirical research provides strong support for his argument that financial conditions affect expenditures. But large differences remain between Minsky and the mainstream paradigm, especially in the role played by the financial system in macroeconomic fluctuations. Furthermore, there is much in Minsky's Big Government—Big Bank policy framework that does not appear in recent mainstream work.
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Working Paper No. 277 | August 1999
During the last decade of his life, Hyman P. Minsky drew on insights acquired from Joseph Schumpeter in an effort to explore the long-term development of capitalism. He believed such an exploration would underscore the economic implications of postwar financial-system innovations and could encourage a broad discussion regarding the appropriate structure of the US economy. This paper focuses on the theory of capitalist development that Minsky produced during that decade.
After describing the purposes of Minsky's exploration, his theory is outlined both in terms of its essential elements and as it applies to the US economy. In addition to emphasizing the relations between finance and business, Minsky identified a transition through at least five distinct stages of capitalism: from the merchant-capitalist era to a recent period dominated by money managers. A concluding section identifies a number of research directions suggested by Minsky's analysis.
Download:Associated Program:Author(s):Charles J. Whalen -
Working Paper No. 276 | August 1999
A Central Banker's Perspective
This paper presents a central banker's perspective on the Asian crisis. Central banks have two core missions: the pursuit of monetary policy to achieve broad macroeconomic objectives and the maintenance of financial stability, including the management of financial crises. The management of financial crises is closely connected to the regulation and supervision of the banking system, so it, as well as broader issues related to systemic risk in the financial sector, is included as part of the central banker's perspective. Central banks also often have or share with finance ministries control over exchange rate policy, including the choice of an exchange rate regime and the management of that regime. Therefore, the roles of exchange rate policy, macroeconomic policy, and bank supervision and regulation in the crises are examined and some lessons in each case are suggested. The author's interpretation of the sources of and appropriate policy responses to the crises among the Asian emerging economies draws heavily upon the work of Hyman P. Minsky.
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Public Policy Brief Highlights No. 52A | July 1999
Fiscal Policy and Growth Cycles
Based on neoclassical theory, cutting budget deficits has come to be seen as a principal way to increase long-run growth, but the empirical evidence is ambiguous on the outcome of this macropolicy. A new model, the classical growth cycles (CGC) model, offers an alternative theoretical framework for analyzing the complex effects of fiscal policy. The CGC model holds that the impacts of fiscal policy on growth are transmitted through its effects on business profitability and the business saving rate. Investigation of both short-run and long-run effects of government spending and of the distinctive long-run effects of different types of government spending suggests that indiscriminate deficit cutting will not lead to a rise in the long-run profit rate and may exacerbate poverty and inequality in the short and the long run.Download:Associated Program:Author(s):Jamee K. Moudud -
Working Paper No. 274 | July 1999
Keynesian Alternatives
In this paper, Visiting Senior Scholar Philip Arestis questions the assumptions underlying the economic case for the independent European Central Bank (ECB). Arestis argues that although a European Clearing Agency (ECA) of the type Keynes envisaged for the international economy is not a panacea for the economic problems of the European Union (EU), it is nonetheless a better way forward and far superior to the ECB. The paper (1) outlines the theoretical basis of Keynesian monetary and financial theory; (2) aims to ascertain the extent to which credit availability is affected by the creation of an ECB and, on that basis, to offer a critical analysis of current proposals for an ECB; (3) looks closely at the case for the ECA, seen as performing a range of functions rather than having a remit defined simply in terms of strict monetary control, including a commitment to providing the necessary finance for full employment and a responsibility for ensuring that the burden of balance-of-payments adjustment falls upon both deficit and surplus countries.
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Working Paper No. 273 | July 1999
An Assets-based Approach to Full Employment and Price Stability
William Vickrey's single-minded commitment to full employment is evident in a series of papers written in the last years of his life. In these works Vickrey formulated an assets-based approach to macroeconomic analysis that has definite implications for budgetary and employment policy. For Vickrey the relation between desired and actual holdings of net financial assets--or net nominal savings--is crucial to understanding macroeconomic processes, and the government budget is the key policy instrument in the necessary recycling of net nominal savings to bring the desired and actual levels into equality at the full employment level of output and income. Vickrey believed that the major task for economists and policymakers was to devise the means whereby the necessary recycling of net nominal savings can take place without unexpected changes in the rate of either inflation or deflation. This paper proposes government deficit-financed, guaranteed public employment as an automatic stabilizing policy instrument capable of serving as just such a means.
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Working Paper No. 272 | July 1999
Lessons from Lerner for Today?
Recent global economic developments invite a reconsideration of orthodox macroeconomic theory and policy and encourage a revisiting of the ideas of unorthodox thinkers of the past. This paper reviews fifteen lessons to be learned from the work of Abba Lerner. These lessons, which fall under the general categories of functional finance and full employment, are as relevant today as they were when they were first put forward some five decades ago. They include insights into the workings of the macroeconomy that provide a basis for analyzing current macroeconomic developments and for formulating effective macroeconomic policies.
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Public Policy Brief No. 52 | July 1999
Fiscal Policy and Growth Cycles
Based on neoclassical theory, cutting budget deficits has come to be seen as a principal way to increase long-run growth, but the empirical evidence is ambiguous on the outcome of this macropolicy. A new model, the classical growth cycles (CGC) model, offers an alternative theoretical framework for analyzing the complex effects of fiscal policy. The CGC model holds that the impacts of fiscal policy on growth are transmitted through its effects on business profitability and the business saving rate. Investigation of both short-run and long-run effects of government spending and of the distinctive long-run effects of different types of government spending suggests that indiscriminate deficit cutting will not lead to a rise in the long-run profit rate and may exacerbate poverty and inequality in the short and the long run.
Download:Associated Program:Author(s):Jamee K. Moudud -
Working Paper No. 269 | May 1999
In recent years the United States has seemed to achieve the best of all possible worlds: robust economic growth, very low unemployment, and low inflation. Many attribute this performance to fewer supply-side constraints, as the country has moved away from stifling regulations and other impediments to trade. When compared with the very high unemployment rates suffered in European countries, our lower unemployment rates appear to be due to freer labor markets and to a less generous social safety net that saps private initiative.
In this paper we show that although it is true the United States has enjoyed a higher employment rate than all of our major competitors, we lag behind all other major countries in per capita GDP growth since 1970. The reason is our dismal rate of productivity growth. We show that when one decomposes per capita GDP growth into its component parts—growth of employment rates and growth of output per employee—the US experience is quite different from that of the other countries. In some sense, countries "choose" high employment paths or low employment paths, but regardless of that choice, economic growth does not appear to be much affected. We argue that this is because countries have not faced significant supply constraints; rather, per capita GDP growth has been largely demand constrained. For this reason policies aimed at removing supply constraints do not lead to more rapid economic growth. The conclusion is that, if one is to trying to increase growth rates, Keynesian "demand side" policies are preferable to "supply side" policies.
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Working Paper No. 268 | April 1999
Realities, Fallacies, and Proposals
Five times in a decade not yet completed, financial markets have floated to the edge of a whirlpool. In October 1998, they were about to drown when Alan Greenspan threw them a piece of string that, surprisingly, turned out to be a lifeline. The causes for this financial instability lie deep—in the economic theory that urges easy and efficient substitution of one piece of paper for another, always and everywhere; in the technology-driven tight articulation of receipts and payments that Hyman Minsky warned against a generation ago; and in the growth of leverage that diminishes the creditworthiness of major institutions when an interruption in their receipts requires them to seek funds. Meanwhile, as decision-making in finance moves from banks to markets, and the creators of derivative instruments find ways to present uncertainties as risks that can be modeled, time horizons fall and spurious interrelations promote "dynamic hedging" that communicates financial disturbance anywhere to price volatility everywhere. Prevention should be sought in rules to control the creation of leverage in the repo and derivatives markets and in limits on banks' freedom to back away from borrowers' cross-border liabilities in currencies other than their own. Crisis management when prevention fails will require "standstill" agreements to encourage the continuation of something like normal economic life while the losses from merely financial failure are sorted out.
Download:Associated Program:Author(s):Martin Mayer -
Policy Note 1999/4 | April 1999
Growing government budget surpluses combined with growing trade deficits have generated record private sector deficits. Unless households continue to reduce their saving—creating an increasingly unsustainable debt burden—the impetus that has driven the expansion will evaporate.
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Working Paper No. 266 | March 1999
The paper begins with a brief review of the main ideas associated with Hyman Minsky and their implications for economic policy and the achievement of full employment. There is a focus on the financial instability hypothesis, the role of the central bank as lender of last resort, and the requirements for regulation of the financial system. The implications of these ideas for economic policy are then explored at the level of the European Union and the global economy. It is argued that the Minsky analysis would suggest that at the level of the nation state, the general drift of economic policy and changes in institutional arrangements have made the prospects for full employment bleak. For the European Union, the institutions that are emerging in the context of EMU and the euro are considered in terms of their impacts on the level of economic activity. At the global economy level, the need for international institutions to regulate the global financial system is considered.
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Working Paper No. 264 | February 1999
The performance of the United States' economy between 1994 and 1998 was so good that some pundits began to call for the Federal Reserve to increase interest rates to depress economic activity and reduce asset prices. However, slowing the economy to stabilize asset prices would have adverse distributional effects. Impulse-response functions from identified vector autoregression (VAR) indicate that unexpected increases in the federal funds rate increase unemployment among blacks and Hispanics by 50 to 90 percent more than among whites. A narrative approach applied to two disinflationary periods shows that higher interest rates in the 1974 disinflation decimated the housing industry and that two interest-rate-sensitive sectors-construction and durable goods-showed the largest declines in 1980 and 1981 (periods following the 1979 tightening). Utilizing the Romer and Romer examination of the minutes of Federal Open Market Committee meetings to determine dates on which the Fed attempted to create a recession to reduce inflation, antiinflationary policy shocks can be estimated to increase unemployment among nonwhites more than twice as much as they do among whites. A social accounting matrix (SAM) indicates that in the sectors that were hardest hit by recession following the 1974-1975 and 1979-1982 disinflations (construction and durable goods), blue-collar workers were harmed more than other workers in terms of lost income and urban households were hurt much more than rural households. Minorities bear the brunt of disinflationary policy and do not share proportionately in the benefits of keeping the stock market stable, a factor that the Fed should take into account when contemplating actions aimed at stabilizing asset markets.
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Working Paper No. 263 | February 1999
A Historical Perspective of European Economic and Monetary Integration
This paper traces the history and the institutional background of European integration to the establishment of the economic and monetary union in the European Union (EU). After the establishment of the European Economic Community (EEC) in the late 1950s, attempts at monetary integration, and ultimately monetary union, tended to assume importance only as a result of financial crisis and then returned to being a vague objective as soon as the crisis recedes. In recent years, however, monetary integration has assumed greater urgency. Economic union, on the other hand, has followed a smoother transition.
Economic integration was used after the Second World War to realize political goals, chiefly to anchor West Germany within the western European alliance. Since that time the economies of member states have slowly integrated. The economic environment of the 1950s is a far cry from the integrated community of today. In the 1950s European currencies were not convertible and domestic trade was highly protected. Intra-European trade was based on bilateral clearing arrangements institutionalized by the European Payments Union. Today EU currencies are fully convertible; capital controls, intra-EU tariffs, and quotas have been eliminated; and the single market has been completed.
Monetary union has gone through a number of stages. The Werner Plan of the early 1970s, which set the goal of economic and monetary union by the end of the decade, was only partially implemented. Its failure can be put down to unfavorable international economic conditions and poor institutional structures. In the early 1980s a new monetary initiative, the European Monetary System (EMS), was launched. It struggled through its initial phase until it was replaced by the current euro arrangements. These successive stages ultimately culminated in the Maastricht Treaty, which laid out a precise path and timetable for economic and monetary union.
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Working Paper No. 262 | January 1999
A Case of Minskian Instability?
The so-called credit crunch of 1966 has long been recognized as the first significant postwar financial crisis and one that required the first important intervention by the Federal Reserve Bank. In the midst of the robust postwar expansion, the Fed began to fear inflation and tightened monetary policy to the point at which profitability of financial institutions was threatened. As Minsky argued, "By the end of August, the disorganization in the municipals market, rumors about the solvency and liquidity of savings institutions, and the frantic position-making efforts by money-market banks generated what can be characterized as a controlled panic. The situation clearly called for Federal Reserve action." The Fed was forced to enter as a lender of last resort to save the muni bond market, which in effect validated practices that were stretching liquidity. As a result of Fed intervention, the economy continued to expand, new financial practices emerged and were validated, leverage ratios increased, memories of the Great Depression faded, and markets came to expect that big government and the Fed would come to the rescue as needed. That 1966 crisis was only a minor speed bump on the road to Minskian fragility. To some extent, 1966 proved to be the first verification of the "financial instability hypothesis" that Minsky had been developing since the late 1950s, and the events of that year would stimulate further development of his analysis of the early postwar transition from a "robust" financial system toward a "fragile" financial system.
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Working Paper No. 260 | December 1998
Fiscal Policy in a Dynamic Context
In this paper the impact of fiscal policy is analyzed within the context of an endogenous growth and cycles model. The investigation shows the different situations in which government expenditure can lead to both crowding-in and crowding-out of output and employment. With regard to the cycle, an increase in the share of government spending leads to an expansion of output, which is given a greater stimulus with a higher degree of monetization. Expansionary monetary policies accompanying the fiscal expansion tend to make the upswing longer and the downswing more shallow, i.e., the cycle becomes more asymmetric. The medium-run dynamics of the model along its warranted growth path essentially rest on the relative movements of business retained earnings (i.e., the private savings rate since household savings are ignored) and the government spending share. With the private savings rate fixed, a rise in the government spending share leads to medium-run crowding-out. On the other hand, if policies such as investment tax credits, lower rates of corporate taxation, and accelerated deductions for capital depreciation stimulate the growth of the business retained earnings, then an increase in the government spending share may either not have any effect on the warranted path or may even raise it, i.e., there might be crowding-in. Moreover, abstracting from any changes in retained earnings, an increase in the level of government spending produces an expansionary cyclical effect with no medium-run crowding-out. Finally, the model exploits the empirical finding that infrastructure investment by the government lowers business costs. This relationship is used to demonstrate that the warranted growth path can be increased via a shift from government consumption expenditures to infrastructure investment. In contrast to mainstream analyses these complex results imply that, within limits, the state has a number of policy levers at its disposal to regulate output and employment.
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Working Paper No. 257 | November 1998
An Irreverent Overview of the History of Money from the Beginning of the Beginning to the Present
This paper poses that the one commonality between institutionalist thought and Keynesianism (as presented in his General Theory) was money. Tracing the origins and uses of money, the myth of the development of money as a medium of exchange is dispelled and replaced with money used as evidence of debt, specifically, government debt. This paper was presented as the Presidential Address to the 1998 Association for Institutionalist Thought conference. As such, the paper should be taken in the same spirit as the [in]famous neoclassical Robinson Crusoe story, or Paul Samuelson's story of the evolution of money. The only significant change that has been made is to add several endnotes that will make some of the references more clear; this might make the piece more accessible for students.
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Working Paper No. 253 | October 1998
The aim of this paper is to derive an endogenous growth and cycles model that integrates sectoral incomes, expenditures, and finance requirements into an ex ante social accounting matrix (SAM) in the spirit of the Cambridge Economic Policy Group. The SAM includes households, businesses, a banking sector with non-zero net worth, and the government. Investment in circulating capital, endogenous bank credit to finance accumulation, and the negative feedback effect of debt on investment are at the core of the short-run cyclical dynamics. The business cycle dynamics are described by the dual disequilibria relationship that relates monetary and goods market disequilibria to each other. Market disequilibria result from the discrepancy between ex ante plans and expectations and ex post outcomes. The short-run cycle in the model is the three-to-five-year inventory cycle in which aggregate demand and supply chase each other ceaselessly in order to reach equilibrium. Firms respond to excess demand by lowering inventory stocks and increasing investment in circulating capital, which expands output via the L�ontief input-output relationship. Over the medium run, they respond to imbalances between actual and normal capacity by increasing fixed capital investment. Over the medium to long run, the path of accumulation is internally financed and regulated by the rate of profit. One can conclude that the macrodynamic model is a synthesis of the Physiocrats' "circular flow" approach to modeling the economy and the endogenous growth perspective of some classical economists, von Neumann, and Harrod. Finally, the endogenous cyclical dynamics are very much in the spirit of Kalecki and Minsky.
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Public Policy Brief No. 44 | September 1998
Regulation of Cross-border Interbank Lending and Derivatives Trade
Asia presents a cumulation of apparently rational decisions that produced disastrous results—a textbook illustration of “financial instability” developing from the economics of euphoria. A combination of factors produced the crisis as enormous capital inflows were drawn to the “Asian miracle“-pegged exchange rates with fluctuating interest rates, integrated economies, moral hazard created by central banks, and short-term lending and derivatives trade without sufficient evaluation of risk and credit analysis of borrowers. The Asian tragedy demonstrates the need for improved regulation of cross-border interbank lending, improved accounting for both borrowers and lenders, and separation of the close links between governments and their banking sector.
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Public Policy Brief No. 43 | September 1998
The Relationship between Public Capital and Economic Growth
Investment in infrastructure is necessary for a strong, flexible, and growing economy. However, the relationship between public capital and economic growth is not linear. At a certain level, the tax burden associated with financing and maintaining public capital reduces the returns to private industry, which in turn reduces growth; also, different types of spending have different effects on growth. The short- and long-term growth-maximizing effects of public investment increase as the ratio of public to private capital stock rises to an optimal level (found to be about 61 percent); above that level, the growth effects decrease. The public-to-private ratio is below the optimal level throughout much of the country and government spending is not always directed toward the types of investment that have the most positive effects on growth. Good economic policy requires both increasing the public capital stock and reorienting government spending from consumption to investment in physical capital stock.
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Public Policy Brief Highlights No. 44A | September 1998
Regulation of Cross-border Interbank Lending and Derivatives Trade
Asia presents a cumulation of apparently rational decisions that produced disastrous results—a textbook illustration of "financial instability" developing from the economics of euphoria. A combination of factors produced the crisis as enormous capital inflows were drawn to the "Asian miracle"-pegged exchange rates with fluctuating interest rates, integrated economies, moral hazard created by central banks, and short-term lending and derivatives trade without sufficient evaluation of risk and credit analysis of borrowers. The Asian tragedy demonstrates the need for improved regulation of cross-border interbank lending, improved accounting for both borrowers and lenders, and separation of the close links between governments and their banking sector.Download:Associated Program:Author(s):Martin Mayer -
Public Policy Brief Highlights No. 43A | September 1998
The Relationship between Public Capital and Economic Growth
Investment in infrastructure is necessary for a strong, flexible, and growing economy. However, the relationship between public capital and economic growth is not linear. At a certain level, the tax burden associated with financing and maintaining public capital reduces the returns to private industry, which in turn reduces growth; also, different types of spending have different effects on growth. The short- and long-term growth-maximizing effects of public investment increase as the ratio of public to private capital stock rises to an optimal level (found to be about 61 percent); above that level, the growth effects decrease. The public-to-private ratio is below the optimal level throughout much of the country and government spending is not always directed toward the types of investment that have the most positive effects on growth. Good economic policy requires both increasing the public capital stock and reorienting government spending from consumption to investment in physical capital stock.Download:Associated Program:Author(s):David Alan Aschauer -
Working Paper No. 246 | August 1998
Applications to Asia
Four factors in the current financial crisis in Asia have surprised observers. First, although capital flows in Asia appeared stable, the crisis was precipitated by the reversal of the very large proportion of short-term lending. Second, although Asia appeared to be an example of the maxim that capital flows to the region with the highest rates of return, now it appears that risk-adjusted returns were lower in Asia than in other regions. Third, although the foreign lending banks are the most sophisticated operators in global finance, they seem to have had difficulty assessing risk. Fourth, contrary to the belief that foreign equity investors will not liquidate their positions in response to currency devaluation, the equity and foreign exchange markets collapsed together. According to Visiting Scholar Jan Kregel, these four factors may be explained by the role of derivatives contracts in the flow of funds to Asia.
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Working Paper No. 244 | July 1998
This paper investigates the commonly held belief that government spending is normally financed through a combination of taxes and bond sales. The argument is a technical one and requires a detailed analysis of reserve accounting at the central bank. After carefully considering the complexities of reserve accounting, it is argued that the proceeds from taxation and bond sales are technically incapable of financing government spending and that modern governments actually finance all of their spending through the direct creation of high-powered money. The analysis carries significant implications for fiscal as well as monetary policy.
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Working Paper No. 242 | July 1998
This paper formally integrates the theory of money and credit derived ultimately from Wicksell into the Keynesian theory of income determination, with assets allocated according to Tobinesque principles. The model deployed has much in common with the modern "endogenous money" school initiated by Kaldor which emphasizes the essential role played by credit in any real life economy, since production takes time and the future is always uncertain. New ground is broken methodologically because all the propositions are justified by simulations of a rigorous (60-equation) model, making it possible to pin down exactly why the results come out as they do. One conclusion of the paper is that there is no such thing as a supply of money distinct from the money which agents wish to hold or find themselves holding. This finding is inimical, possibly in the end lethal, to the way macroeconomics is currently taught as well as to the neoclassical paradigm itself.
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Working Paper No. 235 | May 1998
The Difference between Balance of Payments Crises and Debt Deflations
What was different about the collapse of the Asian emerging markets in 1997? The free fall of the Mexican peso and the collapse of the Mexican Bolsa produced a "Tequila effect" that spread through most of South America. But it did not create a sell-off in the global financial markets similar to that which occurred on 27 October 1997. Normally, sharp declines in prices in emerging equity markets produce a "flight to quality," in which international investors shift their funds back into developed-country markets and local investors seek to protect their wealth by diversifying into developed-country assets. Yet the collapse in the Asian emerging markets, that started in Thailand, spread to the other second-tier Newly Industrialising Economies (NIEs), and eventually extended to the first-tier NIEs produced the largest absolute declines ever experienced in the major developed-country equity markets. If equity markets can suffer from what Alan Greenspan has called "irrational exuberance," the Asian crisis suggests that they may also suffer from "irrational pessimism." Yet there is much to indicate that in this case the financial markets in Japan, Europe, and the United States were quite rational in assessing the global implications of the financial crisis in Asia.
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Working Paper No. 234 | April 1998
A Minsky Crisis Happened in Asia
The title of Visiting Senior Scholar Jan Kregel's working paper is a reference to Hyman P. Minsky's book Can “It” Happen Again? The Minskian “it” is the debt deflation scenario that led to the Great Depression, and Kregel makes the case that the recent Asian crisis is just such a scenario.
Minsky defined three types of financing. Hedge financing is a position in which a firm's expected cash flow always exceeds the financing costs and operating expenses by a wide margin of safety. Speculative financing is a position in which a firm has a positive net present value, but the expected cash flow will not be sufficient to meet all financial commitments in all periods. Ponzi financing is a position in which a firm has to borrow funds just to meet its current cash flow commitments. According to Minsky, a change in macroeconomic variables, such as the interest rate, can change a firm's financial position from hedge to speculative or even to Ponzi by reducing the present value of the firm's current cash flow and increasing its cash flow commitments. A bank will respond to a deterioration of the financial position of its debtors by reducing lending and attempting to recall lending. If so, firms will find themselves in Ponzi positions and will be forced to sell assets just to meet their current cash flow commitments. Selling assets creates a generalized downward pressure on output and asset prices. Thus, the term “debt deflation.”
According to Kregel, the above scenario could also result from a depreciation in the exchange rate if firms have a high proportion of imported inputs or foreign debt—and this is precisely what happened in Asia in 1997.
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Working Paper No. 233 | April 1998
Issues of Quantity, Finance, and Efficiency
Empirical research largely suggests that there is a positive role for public capital and a negative role for taxation and debt, and the effectiveness of public capital depends critically on its efficiency. Research Associate David Alan Aschauer develops a common framework to investigate the importance of three aspects of public capital: how much you have, how you pay for it, and how you use it.
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Working Paper No. 232 | April 1998
Plausible Diagnoses, Possible Remedies
The Asian crisis is a textbook case of the "financial instability hypothesis" first expressed in 1966 by the late Hyman P. Minsky.
Minsky's "hypothesis" was proposed to explain instability in a large, insulated, developed economy. Despite its intuitive appeal, it was not widely accepted among financial economists (Charles Kindleberger being a notable exception) because, they said, they could not find historical illustrations to fit the theory. The financial economist's machine runs smoothly in the best of all possible worlds. What makes trouble in the financial economist's world is the exogenous shock that affects everyone (war, oil prices) or government error (fiscal imbalance, monetary policy). "Financial distress," Barry Eichengreen and Richard Portes write in their study of sovereign debt rescheduling, "normally results from a real shock or bad policies." But Asia presents a cumulation of apparently rational decisions that are precisely those Minsky predicted.
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Working Paper No. 231 | April 1998
This paper attempts to bring together several of Hyman P. Minsky's insights in order to suggest a relationship between the state's ability to tax and the money of the economy. Minsky recognized that money represents an IOU or promise to pay and that "acceptability" is its important feature. He further recognized that the State can play an important role in determining whose IOUs will be accepted (both publicly and privately). I will argue that support for the Chartalist vision of money as a 'creature of the State' can be found in Minsky. Finally, I will apply the Chartalist theory to Minsky's notion of a 'hierarchy of money' in order to suggest that the State determines not only the unit in which all of the monies in the hierarchy are denominated but also influences the positioning of certain monies within the hierarchy.
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Working Paper No. 225 | January 1998
The international financial system might be said to be in crisis. It requires frequent intervention by central banks and other national and international bodies to reduce fluctuations of currencies. It does not tend to eliminate current account deficits or surpluses; exchange rate fluctuations do not lead to movements toward balanced trade, nor do they appear to follow from flows of international reserves: some countries run persistent surpluses while others run persistent deficits.
This paper first examines the functioning of the modern international financial system in order to design a reformed system that will make it easier to deal with some of the problems that face the international financial system today. The paper advocates reformation of the international financial system along the lines of Keynes's famous bancor proposal. Most importantly, the reform would eliminate the current bias toward "austerity" that results from the way in which existing international financial institutions operate.
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Public Policy Brief No. 38 | December 1997
Disinflationary Monetary Policy and the Distribution of Income
Using theoretical predictions, econometric results, and the example of the Volcker disinflation, Willem Thorbecke establishes that through disinflation’s burden on the durable goods and construction industries, small firms, and low-wage workers and its benefits to bond market investors, it effects a redistribution of wealth from the poor to the rich. Because of this distributional consequence, he argues, engineering a disinflationary recession now to wring more inflation out of the economy would be inappropriate. On the contrary, with inflation as low as it is and with upward pressure on wages that could trigger a rise in inflation also low, now is the time for the Federal Reserve to let the economy grow—to seek policies that promote distributive justice and that help those individuals most at risk for shrinking income.
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Public Policy Brief Highlights No. 38A | December 1997
Disinflationary Monetary Policy and the Distribution of Income
Using theoretical predictions, econometric results, and the example of the Volcker disinflation, Willem Thorbecke establishes that through disinflation’s burden on the durable goods and construction industries, small firms, and low-wage workers and its benefits to bond market investors, it effects a redistribution of wealth from the poor to the rich. Because of this distributional consequence, he argues, engineering a disinflationary recession now to wring more inflation out of the economy would be inappropriate. On the contrary, with inflation as low as it is and with upward pressure on wages that could trigger a rise in inflation also low, now is the time for the Federal Reserve to let the economy grow—to seek policies that promote distributive justice and that help those individuals most at risk for shrinking income.Download:Associated Program:Author(s): -
Working Paper No. 217 | December 1997
Varieties of Capitalism and Institutional Reform
Financial economist Hyman P. Minsky believed that because there are many types of capitalism determined by circumstances and an evolving set of institutional structures, an abstract economic theory could not be applicable in all times and places but must be institution-specific. Therefore, he focused his attention on the changing institutional structure of developed capitalist economies in the 20th century. Minsky refused to accept the interpretation of Keynes that was being popularized in the 1950s by Alvin Hansen and others. He saw this version of Keynesianism as flawed because it was almost a mechanistic use of countercyclical fiscal policy that ignored the role of uncertainty and finance in the complex capitalist economic system. In the first of several papers examining Minsky's contributions, Executive Director Dimitri B. Papadimitriou and Senior Scholar L. Randall Wray assess Minsky's integration of post-Keynesian theory with an institutionalist appreciation for the varieties of past, current, and feasible future economic institutions.
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Working Paper No. 209 | October 1997
Is European Monetary Union Economically and Politically Sustainable?
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Working Paper No. 196 | July 1997
The Seignorage Loss from Monetary Stabilization in Ukraine
After the collapse of the Soviet bloc many of the transition economies experienced significant inflation, largely because their new monetary authorities and undeveloped tax infrastructure induced them to resort to generating revenue through seignorage. In Ukraine inflation rates reached as high as 133 percent per month. Traditional monetary theory holds that raising revenue through money creation causes a simple trade-off: a higher rate of money growth generates higher seignorage, but the associated inflation causes a decline in demand for real cash balances, reducing seignorage. The higher the monetary growth rate, the larger the real balance effect. Therefore, the revenue-maximizing rate of money creation must be realized before the decline in demand for real cash balances becomes the dominant effect. Visiting Scholar David Alan Aschauer cautions, however, that there may be not one revenue-maximizing rate but short and long rates subject to exogenous shocks caused by, for example, changes in inflation expectations.
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Working Paper No. 185 | March 1997
Some economists and others argue that, despite years of low inflation, a further decrease in the rate of price growth would be beneficial by reducing the dead-weight losses created by inflation-induced distortions. According to Research Associate Willem Thorbecke, of George Mason University, such arguments fail to consider the costs and benefits of changes in the distribution of income arising from deflationary policies. In this working paper, he examines the relative costs and benefits of such policies for firms (by size and sector) and workers (by income group and race).
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Public Policy Brief No. 27 | September 1996
The Effects of Monetary Policy on the CPI and Its Housing Component
The targets for monetary policy adopted by the Fed in recent years have not proven to be closely correlated with inflation, leading some theorists and policymakers to advocate the use of a price index, such as the consumer price index (CPI), as both the target and the goal of monetary policy. The authors of this brief show that such a choice is not wise because the CPI does not accurately reflect market-caused price increases and is not under the control of monetary policy. Their analysis extends beyond that of recent reports to show how and why the transmission mechanisms through which monetary policy is thought to affect the CPI are tenuous at best. The authors focus on the housing component of the CPI to illustrate their point. They conclude that those components of the CPI that monetary policy is likely to affect have been declining in importance, meaning that to produce a given reduction in the overall rate of inflation will require that monetary policy have an increasingly larger impact on an ever-diminishing portion of the consumer basket. Therefore, careful reconsideration of an alternative ultimate target, such as the rate of economic growth or the unemployment rate, is warranted.
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Book Series | September 1996
Edited by Dimitri B. Papadimitriou
The S&L crisis of the 1990s led many analysts to review the events that culminated in the banking crisis of the 1930s and the subsequent passage of the Emergency Banking Act, the Banking Act of 1933, the Banking Act of 1935, and other related legislation. The restructuring of the financial system accomplished by this legislation brought about the longest period of financial stability in American history, lasting half a century. This book has two goals: to show why the banking reforms enacted in the 1930s were so successful and to present policy proposals that include the institutional provisions necessary for the financing of the capital development of the economy and a safe payments system.
Published By: Palgrave Macmillan, Ltd.
St. Martin's Press -
Working Paper No. 167 | June 1996
An Integrated Approach
Traditional economic models have largely failed to account adequately for the roles of money and finance in economic operations. For example, traditional models assume an exogenously determined, fixed money stock and ignore the outcomes of spending changes that result from changes in bank loans. As such, traditional models take place outside of historical time and have no role for institutions in determining economic outcomes other than to promote optimizing behavior. In this working paper, Distinguished Scholar Wynne Godley presents a formalized stock-flow model consistent with the ideas of Keynes, Kaldor, and especially Hicks. Godley's model takes place in historical time and under conditions of uncertainty and incorporates a role for the financial sector in providing funding for both capital investment and firm operations, should expectations prove false. The model was subjected to numerical simulation and found solvable and stable.
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Working Paper No. 165 | May 1996
In this working paper, Distinguished Scholar Hyman P. Minsky and Visiting Scholar Charles Whalen search for reasons to account for the split in post-World War II economic performance—that is, the difference in performance between the 1946–66 period and the 1966–96 period. The authors discuss a number of economic problems that have arisen during the past quarter of a century, including slower growth, stagnant earnings, rising financial instability, and increasing inequality. Minksy and Whalen concede that factors such as globalization and technological change have undoubtedly played a role in the split performance. An additional important and often overlooked element is the evolution of the US financial structure. The authors explain that a key component influencing the evolution of the financial sector during recent decades has been the rise of "money manager" capitalism. Important features of money manager capitalism are increased financial fragility (lower margins of safety in indebtedness and a greater reliance on debt relative to internal finance) and the introduction into the financial structure of a new layer of intermediation. In particular, managers of pensions, trusts, and mutual funds currently control the largest share of the liabilities of corporations. These managers are judged by only one criterion: how well they maximize the value of funds. As a result, business leaders have become increasingly sensitive to the stock market valuation of their firm.
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Working Paper No. 164 | May 1996
A consensus is emerging among economists and policymakers that the consumer price index (CPI) as a measure of cost of living has an upward bias. As a result, downward revisions of cost-of- living adjustments are frequently recommended, especially in discussions about deficit reduction. Such revisions would lower the rate of increase of some entitlements and raise the rate of increase of federal government revenue by reducing future adjustments to tax brackets. In this new working paper, Dimitri B. Papadimitriou, executive director of the Levy Institute, and L. Randall Wray, research associate of the Levy Institute and associate professor of economics at the University of Denver, express their surprise that this discussion has not been broadened to include the use of the CPI as a measure of inflation and a target of monetary policy. The Federal Reserve has increasingly pursued the single goal of price stability, or zero inflation, although according to Papadimitriou and Wray, it has been unable to find a target that it can hit and to demonstrate a consistent link between any of its targets and inflation. The authors argue that if the CPI overstates inflation and the Federal Reserve uses it as a target, the Fed is basing its policy on a measurement error. Given recent findings of measurement bias in the CPI, they contend that it is inappropriate at this time to identify zero inflation with a constant CPI. In a detailed analysis of the components of the CPI they conclude that the CPI is not a reliable guide for policy purposes. They question whether tight money can reduce inflation as measured by the CPI, and they note that the impact of such a policy could be perverse.
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Working Paper No. 163 | May 1996
The Experience of Korea, Thailand, Malaysia, and Indonesia
Between 1990 and 1994, developing countries in Asia posted $261 billion in net capital inflows, an amount equivalent to about half the total inflows to all developing countries. Although foreign direct investment accounts for the largest portion of net inflows to Asia, the share of portfolio investment has been steadily rising, from an average of 8 percent of net inflows between 1983 and 1989 to 24 percent between 1990 and 1994. Suggested reasons for the increase in portfolio investment have been a high demand for capital coupled with favorable growth prospects, deregulation and liberalization of capital accounts, domestic financial reform (which has facilitated foreign investment in domestic securities), lower interest rates, and international portfolio diversification. Capital inflows have been important in supporting high rates of investment, particularly in Indonesia, Malaysia, and Thailand, but short-term capital inflows also have threatened macroeconomic instability by inducing volatility of key financial variables such as the exchange rate. Threats to stability have, in turn, led countries to install direct control measures to dampen large swings in short-term capital inflows. In this working paper, Yung Chul Park, of Korea University and the Korea Institute of Finance, and Chi-Young Song, of the Korea Institute of Finance, analyze the experiences of Korea, Thailand, Malaysia, and Indonesia in managing these capital inflows.
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Working Paper No. 162 | May 1996
Two Latin American Experiences
A resurgence of perceived opportunities by international investors has resulted in a new policy debate regarding the regulation of capital flows into certain South American countries. The integrationist camp defends totally open markets on the grounds that they result in a more efficient financial sector, greater asset diversification, and other benefits; those in the isolationist camp support regulating capital inflows on the grounds that they generate macroeconomic instability and reduce the effectiveness of monetary policy. Noting that there are both costs and benefits associated with external capital flows, Guillermo Le Fort, international director of the Central Bank of Chile, and Carlos Budnevich, manager of financial analysis for the Central Bank of Chile, argue against both extremes, opting instead for a policy falling somewhere between the two. An intermediate policy of gradual and limited financial integration has been adopted in Chile and Colombia, two countries experiencing capital account surpluses. Le Fort and Budnevich examine the macroeconomic and financial results during the 1990s of the countries' policies regarding external capital accounts.
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Working Paper No. 161 | May 1996
In the postwar period prior to 1990 policy proposals aimed at reducing the instabilities associated with increased capital flows focused on increasing market efficiencies so that nominal variables would reflect real conditions in the economy. However, those in charge of financial resource flows applied theories largely unconcerned with fundamentals, resulting in such financial market instabilities as volatility in the foreign exchange market. Andrew Cornford, of the Global Interdependence Division of UNCTAD (United Nations Conference on Trade and Development), and Jan Kregel, of the University of Bologna, examine the policies of the postwar period and the reasons for their failure to produce economic stability. They then explore the means by which instability might be reduced.
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Working Paper No. 160 | May 1996
The Role of the IMF in Crisis Prevention and Management
This new working paper investigates the roles the International Monetary Fund (IMF) might play given its mandate to provide institutional support for a global capital market that can promote trade and investment, and given current worldwide economic instabilities such as highly volatile exchange rates.
The experience of steady growth and price stability under the Bretton Woods system is often cited in support of a return to a managed fixed-rate system. Author E. V. K. FitzGerald contends, however, that although exchange rate instability might be related to the major financial crises of the past 20 years, such instability is not the source of financial crises; rather, factors such as the worldwide integration of financial markets and the development of heterogeneous financial instruments have created new sources of instability. In the new worldwide financial system exchange rates function as asset prices (that is, they reflect international capital flows) as well to regulate trade flows. Current account balances are, then, more likely a function of internal imbalances than of trade imbalances. Moreover, because interest rates reflect the desire to hold a given stock of bonds, their fluctuation does not cause international capital markets to clear (that is, cause saving to equal investment on a global scale).
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Working Paper No. 159 | May 1996
The bond market sell-off of 1994 has begun to show up on lists of market events against which risk management systems are judged, but there has been little analysis of the cause of the 1994 decline. This new working paper fills the void by examining a number of factors that might explain the rise in volatility during that year. The authors investigate four types of one of these factors, market dynamics—volatility persistence, relationships in the direction of market movements, foreign disinvestment, and volatility spillover effects from other markets—and find that persistence has strong explanatory power.
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Working Paper No. 158 | May 1996
Little has been written about capital flows to sub-Saharan Africa (SSA), largely because of the flows' small size and data limitations. In this working paper, Louis Kasekende, executive director for policy and research at the Bank of Uganda; Damoni Kitabire, commissioner for the Macroeconomic Policy Department for the Ministry of Finance and Economic Planning in Kampala; and Matthew Martin, Ministry of Finance, United Kingdom, explore these inflows, noting that although they are small compared to those into other countries, they are in proportion to the size of the recipient economies. The authors examine the scale and composition of capital inflows, their causes and sustainability, their effect on macroeconomic stability, and their responsiveness to policy measures for six SSA nations: Kenya, South Africa, Tanzania, Uganda, Zambia, and Zimbabwe.
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Book Series | May 1996
The Post-Keynesian and Circulation Approaches. Edited by Ghislain Deleplace and Edward J. Nell
In its analysis of money, contemporary economics has focused on money’s function as a store of value, neglecting its role as a medium of circulation. When circulation is put center stage, it becomes apparent that the supply of money does indeed adapt to the needs of trade, and it does so in myriad ways that are often difficult for a central bank to control because they reflect the responses of banks and other financial institutions to market incentives. But money’s role in circulation must be coordinated with its function as a store of value, and both must be coordinated with finance. Failure in coordination can lead to instability. The essays in this volume, by internationally renowned economists, provide original and contrasting analyses of these issues, presenting the points of view of the American Post-Keynesian approach on the one hand and the French circulation school on the other.
Published By: Palgrave Macmillan, Ltd.
St. Martin's PressAssociated Program:Author(s):Ghislain Deleplace Edward J. Nell -
Working Paper No. 155 | April 1996
In this new working paper, Distinguished Scholar Hyman P. Minsky points out that capitalism in the United States is an evolving construct that recently entered a new stage: "money manager" capitalism. In money manager capitalism, nearly all businesses are organized as corporations, pension and mutual funds are the predominant owners of financial assets, and managers of these funds are judged solely on the total return on fund assets (dividends and interest plus appreciation in share value). One consequence of such a structure is the predominance of short-run considerations in decision making.
Public tolerance for uncertainty is limited. During the New Deal era it led to the creation of institutions and arrangements to create transparency in both financial markets and corporate governance; for example, crop insurance set floors to farmers' incomes and deficits run by the federal government set floors to aggregate profit flows. However, the focus of money manager capitalism on short-run returns and uncompromised profit margins has increased economic uncertainty at the firm and plant levels through the chronic need to downsize overhead and reduce variable costs. These activities have unraveled the traditional relationships between firm and worker and increased economic insecurity among employees.
Minsky asserts that existing institutions and programs cannot contain this uncertainty, and that new arrangements must be created to offset the effects on "losers" in the structure of money manager capitalism. He suggests that full-employment programs analogous to certain New Deal programs (e.g., the Work Progress Administration and the Civilian Conservation Corps) should be considered to meet this goal.
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Public Policy Brief No. 24 | February 1996
Proposals for Reforming the International Monetary Institutions
Raymond F. Mikesell outlines the activities of the International Monetary Fund (IMF) and the World Bank over the course of their history and evaluates the organizations' success in meeting their original and subsequent goals. He analyzes the debate over the IMF's role in managing the international monetary system, managing currency crises, and providing credit to newly capitalist countries and examines proposals that the World Bank do more to promote private investment in developing countries, make more loans for expanding social and economic objectives, and improve the efficiency of its operations. Mikesell recommends that (1) the World Bank Group and IMF should be merged to form a single organization, the World Bank and Fund Group (WBFG); (2) neither the IMF nor the WBG should be given responsibility for establishing and managing an exchange rate target zone system or for stabilizing the exchange rates of the major currencies; (3) the establishment of additional institutional constructs to deal with financial crises should be deferred; (4) the WBG should move rapidly to change the composition of its lending by making fewer loans to governments and state enterprises and more loans to the private sector, including nongovernmental, nonprofit entities; and (5) the WBG should be gradually downsized by reducing the number of countries eligible for loans.
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Working Paper No. 150 | December 1995
The 50th anniversary of the signing of the Articles of Agreement of the International Monetary Fund (IMF) and the World Bank was celebrated at meetings in Washington, DC: at Bretton Woods, New Hampshire; and at the Annual Meeting of the Boards of Governors of the two institutions held in Madrid. The many addresses at the 1994 meetings praising the contributions of the Fund and Bank were overshadowed by the widely held conviction that both institutions are seriously in need of overhauling. However, there is no consensus on how they should be changed. Some believe that one or both have outlived their usefulness and should be abolished, while others believe the institutions should continue to operate as in the past, but with new responsibilities and enhanced resources. This Working Paper is mainly concerned with proposals for major changes in the Fund, but because the proposals are also related to the operations of the Bank, a brief background on both institutions is included.
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Working Paper No. 148 | November 1995
The question of central bank independence is one of degree. A completely independent central bank is impossible as long as a country has provisions for altering central bank powers, even if that requires constitutional amendments. On the other hand, any central bank has at least some discretion in monetary policy unless it is either in the pocket of a dictator or required by mandate to follow a mechanical rule, such as the central bank in Argentina where monetary policy is effectively determined by the currency board.
In the United States and many other countries, people question the degree of central bank independence, often citing the need to better insulate central bankers from pressure to serve either the political motives of government officials or the financial interests of private individuals and organizations. This school of thought argues that the central bank should be left alone to pursue one monetary policy goal: price stability. It is feared that either government officials with too much influence over central bankers or laws setting inappropriate priorities for them undermine this independence. The Federal Reserve already enjoys a good measure
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Public Policy Brief No. 17 | January 1995
The Functional Approach to Financial Reform
The functional approach to reforming the financial system advocates the structural separation of the depository and lending functions of banks. As a result of such a separation, monetary and credit policy undergo a parallel separation, and government supervision and regulation of the banking industry are modified. The policy prescription developed within this approach is narrow banking, the creation of separate monetary and financial service companies with the elimination of or a substantial reduction in deposit insurance. Narrow banking not only meets the safety and soundness goals of bank regulation, but also maintains an institutional structure that accommodates market forces and technological innovation. The author recommends the creation of monetary service companies that would serve strictly a payments function and would hold only safe assets and the establishment by the federal government of a mutual fund that holds only government securities as assets.
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Public Policy Brief No. 15 | September 1994
Flying Blind: The Federal Reserve’s Experiment with Unobservables
Experience with a variety of targets has cast doubt on the likelihood that a single variable can be found to be closely and reliably linked to future inflation; it is even less likely that such a variable, should it be found, would somehow be under the control and manipulation of the Federal Reserve. This brief provides a review of the experiments with various targets undertaken by former Fed Chairman Paul Volcker and current Chairman Alan Greenspan. The authors contend that there is no reason to suppose that the Fed will discover a target variable whose control will yield stable prices. Finally, they conclude that economists lack sufficient information to calculate the costs of achieving stable prices in terms of unemployment and lost output.
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Public Policy Brief No. 9 | October 1993
Investment and U.S. Fiscal Policy in the 1990s
The author of this brief offers evidence that policies aimed at stimulating private sector investment through interest rate reductions are, at best, misguided. He concludes that, while there may be benefits from policies aimed at increasing saving or lowering the budget deficit, a higher level of business investment is not one of them. Rather, because of the sizable effects of the business cycle and financial channels on investment, such a program will weaken the economy in the short run and curtail investment, with lower interest rates having little counteracting effect. A similar argument can be made about programs that attempt to reduce interest rates by promoting a rise in saving. If policymakers aspire to raise investment, they should look to actions that affect firms’ access to internal finance directly, such as an investment tax credit.
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Public Policy Brief No. 8 | September 1993
The Changing World of Banking: Setting the Regulatory Agenda
The authors of this brief propose a series of reforms aimed at making bank regulations compatible with the changing financial system. They present evidence to support their contention that change in the market for financial services has reduced the importance of depositories as they have traditionally operated. A dramatic increase in nonbank competition has contributed to a substantial shrinkage in the proportion of total financial assets held by depository institutions. The authors assert that any reforms should take into account the dynamic nature of the financial marketplace. Effective reforms tackling bank regulation must pass a two-part test: they must protect the payments and credit mechanisms in order to promote systemic stability, and they must promote competition within the financial services industry.
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Public Policy Brief No. 6 | May 1993
The Community Reinvestment Act, Lending Discrimination, and the Role of Community Development Banks
The establishment of a system of federally regulated, for-profit community development banks (CDBs) would help to fill the financial gap in areas inadequately served by traditional banks, requirements of the Community Reinvestment Act (CRA) notwithstanding. These organizations would be charged with delivering credit, payment, and savings opportunities and providing basic financing to households and small businesses in underserved areas. Such a system would not substitute for the CRA, but rather act as a supplement to current regulation. Proposed exemptions from CRA compliance for depository institutions that invest in the equity of a CDB would weaken the existing law by diluting the investment of the depository institution in its own particular community. Such proposals (under which “investment” has been defined to be as little as one-quarter of one percent of total assets) are not consistent with the spirit of the CRA and would negate the beneficial dialogue that takes place between the institution and the community in which it operates.
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Public Policy Brief No. 5 | May 1993
Reorganizing the Federal Bank Regulatory Agencies
According to Bernard Shull, although the recent round of banking legislation—most notably the Financial Institutions Reform, Recovery, and Enforcement Act (FIRREA) and the Federal Deposit Insurance Corporation Improvement Act (FDICIA)—did take steps toward preventing financial crises, it did not go far enough in the area of unifying the regulatory structure. Shull proposes unifying federal bank regulatory agencies that presently have flexible authority over competing institutions. In essence, the reorganization would integrate monetary policy and deposit insurance authority with the conventional functions of regulation and supervision. Shull contends that such an integration would foster greater efficiency, improved policy planning, and better accountability while protecting against the hazards of excessive concentration of power. Among the possibilities for a consolidated regulatory agency, Shull prefers consolidation in the Federal Reserve because it is the only banking agency whose structure was originally designed to deal with concerns about concentration of power.
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Public Policy Brief No. 3 | January 1993
A Proposal to Establish a Nationwide System of Community Development Banks
This brief proposes that the establishment of a nationwide system of community development banks (CDBs) would advance the capital development of the economy. The proposal is based on the notion that a critical function of the financial system is not being adequately performed by existing institutions for low-income citizens, inner-city minorities, and entrepreneurs who seek modest financing for small businesses. The primary goals of the CDBs are to deliver credit, payment, and savings opportunities to communities not well served by banks, and to provide financing throughout a designated area for businesses too small to attract the interest of the investment banking and normal commercial banking communities.
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Book Series | November 1992
Essays in Honor of Hyman P. Minsky. Edited by Steven Fazzari and Dimitri B. Papadimitriou
This collection of papers on financial instability and its impact on macroeconomic performance honors Hyman P. Minsky and his lifelong work. The papers consider the clear and disturbing sequence of events described in Minsky’s definitive analysis: boom, government intervention to prevent debt contraction, new boom that causes progressive buildup of new debt and eventually leaves the economy more fragile financially. The collection is based on a 1990 conference at Washington University and contains papers by Benjamin M. Friedman, Charles P. Kindleberger, Jan A. Kregel, Steven M. Fazzari, and others.
Published By: M. E. Sharpe, Inc.
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Public Policy Brief No. 1 | July 1992
Personal Views on Financial Reform, by Anthony M. Solomon; Fundamental Change Little by Little: Banking Evolution, by Alex J. Pollock
To avoid excessive concentration of economic and financial power, Athony M. Solomon recommends institutional and regulatory reform of the financial system by such means as nationwide banking, restrictions on federal deposit insurance, consolidation of financial regulation, balancing numerical standards with supervisory discretion, increased accountability of banks’ management boards, and leveling the playing field across institutions, markets, and countries. Alex J. Pollock notes that technological advances, demographic changes, and other dynamics have not been adequately absorbed in the theoretical or practical functions of financial institutions. He recommends narrow banking as the framework for the optimal banking system.
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Working Paper No. 74 | May 1992
The Financial Instability Hypothesis (FIH) has both empirical and theoretical aspects that challenge the classic precepts of Smith and Walras, who implied that the economy can be best understood by assuming that it is constantly an equilibrium-seeking and sustaining system. The theoretical argument of the FIH emerges from the characterization of the economy as a capitalist economy with extensive capital assets and a sophisticated financial system.
In spite of the complexity of financial relations, the key determinant of system behavior remains the level of profits: the FIH incorporates a view in which aggregate demand determines profits. Hence, aggregate profits equal aggregate investment plus the government deficit. The FIH, therefore, considers the impact of debt on system behavior and also includes the manner in which debt is validated.
Minsky identifies hedge, speculative, and Ponzi finance as distinct income-debt relations for economic units. He asserts that if hedge financing dominates, then the economy may well be an equilibrium-seeking and containing system: conversely, the greater the weight of speculative and Ponzi finance, the greater the likelihood that the economy is a "deviation-amplifying" system. Thus, the FIH suggests that over periods of prolonged prosperity, capitalist economies tend to move from a financial structure dominated by hedge finance (stable) to a structure that increasingly emphasizes speculative and Ponzi finance (unstable). The FIH is a model of a capitalist economy that does not rely on exogenous shocks to generate business cycles of varying severity: business cycles of history are compounded out of (i) the internal dynamics of capitalist economies, and (ii) the system of interventions and regulations that are designed to keep the economy operating within reasonable bounds.
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