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

  • Working Paper No. 1051 | May 2024
    This paper examines the dynamics of euro-denominated (EUR) long-term interest rate swap yields. It shows that the short-term interest rate has an economically and statistically significant effect on EUR swap yields of different maturity tenors, after controlling for various key macroeconomic variables. It presents several autoregressive distributive lag (ARDL) models of the dynamics of EUR swap yields. The estimated econometric models of EUR swap yields of different maturity tenors imply that the European Central Bank (ECB) exerts substantial influence on interest rate swap yields, primarily through the effect of its actions on the current short-term interest rate. Examining the case of EUR interest rate swaps, the findings of the paper lend additional credence to John Maynard Keynes’s hypothesis concerning the ability of a central bank to influence long-term market interest rates.

  • One-Pager No. 72 | May 2024
    Recently, the neglected question of why the US government borrows, given that it can print money, has arisen in the context of discussions surrounding a new documentary, Finding the Money. As L. Randall Wray observes in this one-pager, Modern Money Theory has been providing answers to this question for some time; and, he argues, it is a topic that mainstream economists are ill-equipped to address, since very few concern themselves with the monetary operations that underlie the question of why a currency-issuing government issues debt.

  • Working Paper No. 1050 | May 2024
    The Guyana government, from 2015 to 2021, accumulated a large overdraft on its central bank account. It owed this overdraft to a binding debt ceiling limit and fractious political environment that prevented an increase in the ceiling, allowing for the auctioning of Treasury bills to create the liquidity reflux necessary to refill the account. This paper studies the macroeconomic effects of reflux (one-sided sales of Treasury bills) and broken or incomplete reflux (base money expansion) by focusing on domestic inflation, the foreign exchange (FX) rate, and the quantity of FX traded in the local market. The empirical results suggest that the inflation rate is largely driven by foreign price and oil shocks. Nevertheless, the broken reflux adversely affected the local FX market by increasing the demand for foreign currencies, marginally depreciating the exchange rate, and slightly increasing the inflation rate. The latter finding has important implications for the enormous post-2020 budget spending since the discovery of offshore oil. However, reflux was found to have a stabilizing effect on the demand for FX and inflation. Granger predictability tests provide strong evidence that the government spends first from its central bank account before reflux occurs. Finally, the paper discusses a few novel institutional features of Guyana which resemble the monetary circuit framework (with government) of neo-chartalists.
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    Author(s):
    Tarron Khemraj
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  • Working Paper No. 1048 | April 2024
    This paper econometrically models the dynamics of Swedish government bond (SGB) yields. It examines whether the short-term interest rate has a decisive influence on long-term SGB yields, after controlling for other macroeconomic and financial variables, such as consumer price inflation, the growth of industrial production, the stock price index, the exchange rate of the Swedish krona, and the balance sheet of Sweden’s central bank, Sveriges Riksbank. It applies an autoregressive distributive lag (ARDL) approach using monthly data to model SGB yields across the Treasury yield curve. The results of the estimated models show that the short-term interest rate has a marked influence on the long-term SGB yield. Such findings reaffirm John Maynard Keynes’s view that the central bank’s monetary policy affects long-term government bond yields through the current short-term interest rate.  It also shows that the interest rate behavior observed in Sweden is in concordance with empirical patterns discerned in previous studies related to government bond yields in both advanced countries and emerging markets.

  • Working Paper No. 1046 | March 2024
    This paper offers a retrospective view of the key pillar of Solow’s neoclassical growth model, namely the aggregate production function. We review how this tool came to life and how it has survived until today, despite three criticisms that undermined its raison d’être. They are the Cambridge Capital Theory Controversies, the Aggregation Problem, and the Accounting Identity. These criticisms were forgotten by the profession, not because they were wrong but because of the key role played by Robert Solow in the field. Today, these criticisms are not even mentioned when students are introduced to (neoclassical) growth theory, which is presented in most economics departments and macroeconomics textbooks as the only theory worth studying.

  • Working Paper No. 1044 | February 2024
    This paper econometrically models the dynamics of long-term Chinese government bond (CGB) yields based on key macroeconomic and financial variables. It deploys autoregressive distributive lag (ARDL) models to examine whether the short-term interest rate has a decisive influence on the long-term CGB yield, after controlling for various macroeconomic and financial variables, such as inflation or core inflation, the growth of industrial production, the percentage change in the stock price index, the exchange rate of the Chinese yuan, and the balance sheet of the People’s Bank of China (PBOC). The findings show that the short-term interest rate has an economically and statistically significant effect on the long-term CGB yield of various maturity tenors. John Maynard Keynes claimed that the central bank’s policy rate exerts an important influence over long-term government bond yields through the short-term interest rate. The paper’s findings evince that Keynes’s claim holds for China, implying that the PBOC’s actions are a driver of the long-term CGB yield. This means that policymakers in China have considerable leeway in fiscal and monetary operations, government deficit finance, and central government debt management.

  • Working Paper No. 1043 | February 2024
    This paper critically reviews both mainstream and Keynesian empirical studies of interest rate dynamics. It assesses the key findings of a selected number of these studies, surveying the debates between the mainstream and the Keynesian schools. It also explores the debates on interest rate dynamics within the Post Keynesian school of thought. Lastly, the paper identifies the critical questions relevant for future empirical research.

  • Working Paper No. 1035 | January 2024
    In this paper, we discuss the balance sheet mechanics of the Swedish government. We examine spending, government bond purchases, and tax payments. As long as the Swedish central bank, which is created through Swedish laws, supports the Swedish central government, it cannot run out of money. The Swedish government therefore plays a large role in the Swedish economy. It can and should target full employment and price stability, bringing to bear its fiscal power.
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    Author(s):
    Dirk Ehnts Jussi Ora
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    Europe

  • Working Paper No. 1034 | December 2023
    This paper models the month-over-month change in euro-denominated (EUR) long-term interest rate swap yields. It shows that the change in the short-term interest rate has an economically and statistically significant effect on the change in EUR swap yields of different maturity tenors, after controlling for various macroeconomic and financial variables, such as the month-over-month change in inflation or core inflation and the growth of industrial production, and the percentage change in the equity price index, the exchange rate, and the size of the European Central Bank’s (ECB) balance sheet. It uses a generalized autoregressive conditional heteroskedasticity (GARCH) approach to model the dynamics of the monthly change in EUR swap yields and their volatility. The results of the estimated models of EUR swap yields of different maturity tenors extend the Keynesian view that the central bank’s monetary policy actions have a decisive influence on long-term government bond yields and long-term market interest rates, primarily through their effects on the current short-term interest rate.

  • Working Paper No. 1025 | August 2023
    A Financial Post-Keynesian Comparison
    The purpose of public policy, expansionary or contractionary, is to encourage the expansion of income, output, and employment. Theory decides the nature and kind of policy, and the underlying mechanics that result in expansion. Keynes (1964) brings money and a monetary production economy to the forefront of economic analysis, yet in the General Theory, he is skeptical of the efficacy of monetary policy. This paper analyzes how prices of assets, liabilities, and commodities interact in response to unconventional monetary policy and fiscal policy (namely automatic stabilizers) to create conditions that stimulate private investment and economic activity. Modern economics, after accepting the need for intervention, tends to attempt to use monetary policy to steer aggregate demand. “Unconventional” monetary policy such as zero and negative interest rates, and quantitative easing have been instituted in an attempt to fight slumps and stimulate economic activity without increasing government deficits. In this paper, we point out—using Davidson’s (1972) financial post-Keynesian framework—how unconventional monetary policy is not sufficient to create the conditions of backwardation that stimulate production. Finally, we explain how automatic stabilizers, using the Kalecki profits (price) equation, are the best avenue to create the conditions for backwardation that stimulate economic activity. We conclude, like Keynes, that fiscal policy is the reliable path to economic expansion.