PUBLICATIONS
Senior Scholar L. Randall Wray offers an alternative
view to the Federal Reserve’s (Fed) policy model.
Based on Hyman P. Minsky’s approach, his framework
for policy formation includes rebuilding U.S. public
infrastructure (with the federal government acting as
employer of last resort), along with a New Deal–style
institution to support home ownership patterned after
President Roosevelt’s Home Owners’ Loan Corporation.
Furthermore, the Treasury guarantees the debts of Fannie
Mae and Freddie Mac, and similar rules are imposed across
all institutions operating in the same markets. Since
the “Big Bank” Fed cannot do much more than
it has already done, the rest is up to what Minsky called “Big
Government” policy operating in the public interest.
The Fed’s interventions have done little to settle markets because the problem is not simply one of liquidity but also of solvency, which cuts off credit. Relief would come by dealing with the sources of the problem: the purchase of commodities futures by managed money funds and oligopoly pricing by oil producers. Thorough reform is needed to make it more difficult for banks and thrifts to participate in the next speculative boom or collapse, says Wray, adding that the collapse of commodities prices already appears to be under way.
This brief by Pedro Nicolaci da Costa focuses on the actions of the Federal Reserve during asset bubbles. He finds that improved regulatory oversight would enhance policymakers’ ability to fend off financial instability before it reaches crisis levels and threatens to engulf the entire (global) system.
Contrary to the Fed’s current premise that policymakers cannot and should not target asset bubbles, recent experience has bolstered the view that asset prices must come under the central bank’s purview in order to maintain a stable economy. There was plenty the Fed could have done to discourage speculative behavior and stop predatory lending in the residential mortgage sector, says da Costa. Furthermore, attitude changes among regulators are more important than shifts in mandate in ensuring that regulatory bodies do their job properly. The Fed failed to employ its most effective policy tool: the power of persuasion.
Under Alan Greenspan’s leadership, the Fed embraced fads like the “new economy” and “financial innovation” (e.g., securitization) that were little more than euphemisms for overvalued stock and home prices. As a result, Greenspan presided over the most reckless debt binge in history. Inflating and reflating asset bubbles is no way to run a stable economy in the long term.
The standard approach to the financing of investment in a modern capitalist economy is based on the “efficient markets hypothesis,” which presumes that money is neutral. Minsky, however, believed that money is not neutral in an economy with complex, expensive, and long-lived capital assets. Rather, the method used to finance positions in assets is critically important both for theory and for real-world outcomes.
According to the authors, the financial crisis that began with the collapse of the U.S. subprime mortgage market provides a compelling reason to show how Minsky’s approach explains the workings of financial capitalism. They present an alternative to the standard approach based on the addition of Minsky’s financial theory of investment to John Maynard Keynes’s “investment theory of the cycle.”
Minsky emphasized that a flaw of the capitalist system is that instability is a normal result of modern financial capitalism (even with appropriate policy), and that policy has to continually adapt to changing circumstances. Two decades ago, he predicted the explosion in home-mortgage securitizations that eventually led to the U.S. subprime crisis in 2007. Moreover, the actions of the Fed tipped the balance of sentiment away from fear and toward greed. Therefore, the authors maintain, it is necessary to recognize how investment is financed, and how this action can lead to cyclical behavior that, in the absence of government intervention and apt policymaking, can degenerate into a debt deflation on the order of the Great Depression.
The Summary, published three times a year,
is aimed primarily at an academic audience. It updates
current Levy Institute research, with synopses of new
publications, special features on continuing research
projects, accounts of professional presentations by the
research staff, and an overview of Levy Institute events.
This issue includes the 17th Annual Hyman P. Minsky Conference, as well as a special lecture on the costs of the Iraq War by Nobel Laureate Joseph E. Stiglitz that was based on his book The Three Trillion Dollar War (coauthored with Linda J. Blimes, 2008).
