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

  • One-Pager No. 56 | June 2018
    The 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.

  • 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.

  • 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.
    Associated Program:
    W. Lee Hoskins Walker F. Todd
    Related Topic(s):

  • Working Paper No. 907 | May 2018
    The 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.

  • Working Paper No. 906 | May 2018
    This 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.

  • Working Paper No. 904 | May 2018
    This 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.
    Associated Program(s):
    Esteban Pérez Caldentey Nicole Favreau-Negront Luis Méndez Lobos
    Related Topic(s):
    Latin America

  • Conference Proceedings | April 2018
    A 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.
    Associated Program(s):
    Michael Stephens
    Related Topic(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.

  • 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.

  • One-Pager No. 54 | February 2018
    The 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.