Part 1: INTRODUCTION TO MINSKY Revisiting the Unstable Economy

L. Randall Wray, Levy Economics Institute and UMKC Wrayr@umkc.edu www.levy.org; www.cfeps.org

MINSKY’S Early Contributions •  Innovation is endogenous, responds to profit

opportunity: fed funds mkt, endog Ms •  Innovation stretches liquidity, increases

fragility •  Intervention validates innovations •  Multiplier-Accelerator with ceilings and floors:

time path can be steady growth, cycles, booms, long depressions; depends on institutions

•  Institutions of early post war economy promoted stability; but stability is destabilizing

Extensions: 1960s-1970s

•  JMK: financial theory of investment –  2 Price system –  Lender’s and Borrower’s risk

•  Kalecki view of profits –  I today forthcoming only if I expected in future

•  Financial Instability Hypothesis –  Apparent stability changes expectations and

behavior in a way that generates fragility

Can “It” Happen Again? •  Anti-Laissez Faire Thm: “in a world where the internal

dynamics imply instability, a semblance of stability can be achieved or sustained by introducing conventions, constraints and interventions into the environment.”

•  “To contain the evils that market systems can inflict, capitalist economies developed sets of institutions and authorities, which can be characterized as the equivalent of circuit breakers. These institutions in effect stop the economic processes that breed the incoherence and restart the economy with new initial conditions…”.

•  “The aptness of institutions and interventions will largely determine the extent to which the path of the economy through time is tranquil or turbulent: progressive, stagnant, or deteriorating.”

The Policy Problem

•  Stability cannot be achieved because it changes behavior in ways that make “it” likely

•  “The policy problem is to devise institutional structures and measures that attenuate the thrust to inflation, unemployment, and slower improvements in the standard of living without increasing the likelihood of a deep depression”

•  Relative stability of Post-War period led to development of Money Manager Capitalism—a much more unstable version of the “57 Varieties of Capitalism”

Part 2: The Minsky Crisis

L. Randall Wray, Levy and UMKC Wrayr@umkc.edu

www.levy.org www.umkc.edu www.cfeps.org

http://neweconomicperspectives.blogspot.com/

The rise and fall of “Keynesian” economics Old Neoclassical Synthesis developed slowly; deviated

substantially from Keynes, retained key neoclassical concepts: utility, intertemporal optimization, equil = mkt clearing. –  Never adopted Keynes’s uncertainty or unknowledge, LT expec’s

cannot rely on knowledge or even rational belief –  Accepted effectiveness of M policy; sticky W&P is the barrier –  Led to Phillips curve and fooling hypotheses

Decimated by 1970s stagflation, debates with Friedman, and rationality of Lucas. Had no effective response

Developments after 1975

•  Skidelsky: Rarely in history can such powerful minds have devoted themselves to such strange ideas.

•  New Keynesians adopted almost all of these strange ideas: Having swallowed the elephant of rational expectations, they strained at the gnat of the continuous full employment implied by it, and developed theories of mkt failure to allow a role for govt.

•  In other words they reduced Keynes to a charlatan: nothing new—just adds some frictions to mkts

•  Exploded by recent events

The Great Moderation: It can’t happen again

•  World is now more stable, due to: –  Better monetary management: dampened inflation and

business cycle swings –  Globalization, absorbs shocks –  Improvements in information technology –  Rising profits, declining corporate leverage –  Securitizationrisks mangd and allocated –  Derivatives ensure against risk A Radical Suspension of Disbelief

Money Manager Capitalism and the Real Estate Bubble

•  Mngd Money needed returns when stock mkt tanked

•  Fed low interest rate policy fueled mortgage market

•  “Affordability products” substituted for income •  Banks, Mortgage Lenders had learned lessons

from S&L fiasco: Securitize! Earn fee income and sell securitized mortgages

Virtuous Cycle Stability

Innovation

Leverage

Competition

Credit Availability

Asset Prices

Macro Transformation of Economy

Three Balances: trade imbalance = huge leakage that requires govt or private sector deficits to create offsetting injection

Tighter Fiscal Stance

Growing Inequality

Willingness to leverageprivate debt-led expansion

Global crisis: The Minsky “moment” or Minsky Crisis

•  Crisis represents –  an institutional failure (banks mutated from

utilities to casinos); –  an intellectual failure (dangerous view of efficacy

of mkts); –  and moral failure (system built on money values)

•  Instinctive and quick return to Keynes •  With Minsky’s insights on the transformation

that led to the crisis

Discredited Notions

•  Efficient Markets, Deregulation, Self regulation, Great Moderation

•  New Classical, Real Business Cycle, Rational Expectations, Neutral Money

•  New Monetary Consensus, Inflation Targets, Taylor Rule, Quantitative Easing

•  Ricardian Equivalents, Impotent Fiscal Policy, Crowding Out

Policy Response •  Policy actions are directed at saving the system, not

reforming it

•  Too big to fail institutions even bigger today than they were before the crisis

•  Few criminal prosecutions of those responsible for the current crisis

•  Reliance on Wall Street to reform itself, belief that gov’t only needs to get the incentives right for market discipline to work

Paulson/Geithner Plans: Trying to restore Money Manager Capitalism

Part 3: Minsky: Policy to Enhance Stability

L. Randall Wray, Levy and UMKC Wrayr@umkc.edu www.levy.org www.umkc.edu www.cfeps.org http://neweconomicperspectives.blogspot.com/

How did Consumption become Destabilizing?

•  Investment theory of the cycle and financial theory of investment

•  Kalecki: Profit = I + Def + NX – Sw + Cp •  What if Sw < 0? •  Minsky 1963: private-sector led expansion

inherently unstable •  Financed consumption drives the cycle?

Fragility Rises as wage share falls but consumption share rises

•  Stagnant real wages, and falling wage share since early 1970s

•  Low wage competition, union busting •  Debt-fueled consumption •  Rising share of financial sector

Wages and Salaries, %GDP

Profits Grow relative to GDP

Financial Liabilities Relative to GDP

Financialization of the US Economy

Minsky’s policies to promote stability •  High consumption, high employment

–  Greater equality, rely on income, not debt •  Favor small to medium size banks; CDBs, not predatory

lending; debt relief •  Don’t waste a crisis: De-financialize; downsize. Resolve

–  Definancialize healthcare, retirement, education

•  Enhanced oversight; strengthened regulation –  Nothing off-balance sheet

•  Institutions and practices to favor stability –  Automatic stabilizers: countercyclical budget –  Institutional Circuit breakers

•  No “final” solution to fundamental flaw of capitalism

Minsky’s Agenda for Reform

•  Big Government (size, spending, taxing) •  Employment strategy (ELR) •  Financial Reform •  Reduce Market Power

Levy Proposals: Institutions for modern capitalism

•  Capitalism is dynamic and comes in many forms

•  1930s reforms not appropriate for Money Mngr Capitalism

•  Free Mkt ideology is dangerous •  New policies are need to reduce insecurity,

promote stability, and encourage democracy

Macro Challenges

1.  Trade Deficit Leakage must be matched by Budget Deficit Injection, but Fiscal Stance is too tight

2.  Unequal Distribution of Income 3.  Continuing budget shift toward transfers (Social

Security) 4.  Barriers to Work

Toward a New Paradigm

•  Government-Centered Approach – Sovereign Currency – Public Purpose of Monetary System: create and

mobilize resources •  Analysis Disciplined with Balance Sheets

– Financial Assets = Financial Liabilities – Stock-Flow Consistent Modeling – Macro Sectoral Balances

Revised View of Monetary Policy •  Interest Rate Target Horizontal Reserves

– Reserves Are Nondiscretionary – Reserves Are Not A Constraint

•  Effects of Rate Change Indeterminant –  In usual circumstances, lower ratedeflationary

•  Central Bank Is Never Independent •  Best Practice: Pay 50bp on Reserves, Lend at

25bp, Operate Clearing for Treas & Banks

Revised View of Fiscal Policy

•  Sovereign Issuer of Currency –  Spends by Crediting Accts, Taxes by Debiting

•  Sovereign Cannot Borrow –  Bond Sales Are Part of Monetary Policy

•  Sovereign Supplies Net Financial Saving –  Govt DeficitNongovt Surplus

•  Fiscal Policy Dominates –  Appropriate Goals: Full Employment with Price

Stability; Rising Living Standard

Revised View of Finance

•  Conventional View Confuses “Paying For” with “Finance” –  Saving don’t finance nothing –  The “Finance” Is Created Simultaneously with the

Spending (System of Credits and Debits) •  Financialization Is Not Finance; It is Leverage or

Layering –  Securitized Mortgages, Life Settlements, Private

Pensions, Health Care “Reform” = Financialization –  Finance is Not a Scarce Resource –  Wall St Became the Tail that Wags the Dog