Research Programs

Monetary Policy and Financial Structure

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

  • 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. 
  • This 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. 

  • In the Media | April 2014
    The 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. 
  • 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.
  • 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. 
  • In the Media | April 2014
    NDTV, 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. 
  • 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.
  • In the Media | April 2014
    Morningstar 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.
  • 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.
  • In the Media | April 2014
    MNI | 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.