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

  • Public Policy Brief No. 135 | August 2014
    Contrary 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.

  • Conference Proceedings | August 2014
    This 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. 

  • 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.

  • 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.

  • 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.
  • 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.

  • 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.)
  • 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.) 
  • 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.) 
  • 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.