Monetary Policy and Financial StructureThis 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.
In the Media | September 2015
By James M. Larkin and Zach GoldhammerThe 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/
Working Paper No. 845 | September 2015
Assessing the ECB’s Crisis Management Performance and Potential for Crisis ResolutionThis 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
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
November 21–22, 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 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.Download:Associated Program(s):Region(s):Europe
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 BankThe 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.Download:Associated Program:Author(s):Mariana Mazzucato L. Randall WrayRelated Topic(s):
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):