Archive for the ‘Financial Crisis’ Category

Minsky Meets Brazil

Michael Stephens | August 12, 2016

by Felipe Rezende

This is the first in a series of blog posts on the Brazilian crisis.

Part I

A consensus has emerged in Brazil (and elsewhere) blaming Rousseff’s “new economic matrix” policies for the country’s worst crisis since the Great Depression (see here, here, here, here, and here). With the introduction of policy stimulus through ad hoc tax breaks for selected sectors seen as failing to boost economic activity and the deterioration of the fiscal balance — which posted a public sector primary budget deficit in 2014 after fifteen years of primary fiscal surpluses — opponents argued that government intervention was the problem. It provided the basis for the opposition to demand the return of the old neoliberal macroeconomic policy tripod and fiscal austerity policies. There was virtually a consensus that spending cuts would create confidence, reduce interest rates, and stimulate private investment spending. Fiscal austerity, according to this view, would be expansionary and pave the way for economic growth.

However, there is an alternative interpretation of the Brazilian crisis: as the result of endogenous processes that created destabilizing forces, reducing margins of safety and increasing financial fragility. As Minsky put it, “stability is destabilizing.” The success of traditional stabilization policies over substantial periods has created endemic financial fragility and rising domestic and external private indebtedness, causing the deterioration of the current account and the fiscal balance. This crisis was aggravated by the pursuit of structural stabilization policies in 2015, in an attempt to produce a fiscal surplus, which caused further deterioration of fiscal deficits and government debt followed by the collapse of economic activity.

1. Minsky’s Instability Theory

In Minsky’s work, he extended Keynes’s investment theory of the cycle to add the financial theory of investment to demonstrate that, in a modern capitalist economy, investment decisions have to be financed and the liability structure created due to those investment decisions will generate endogenous destabilizing forces. His theory of the business cycle, grounded in his financial theory of investment, shows that a capitalist economy is inherently unstable due to the interconnectedness of balance sheets of economics units and cash flows. From this perspective, while the financial system in a capitalist economy plays a key role in providing the financing to business to promote the real capital development of the economy, it also plays a key role in creating destabilizing forces.

Minsky’s framework not only sheds light on how to detect unsustainable financial practices, the position adopted in this paper is that the current Brazilian crisis does fit with Minsky’s instability theory. continue reading…


Why Minsky Matters and Boom Bust Boom

Michael Stephens | February 25, 2016

Screening and Book Signing_Minsky Matters_Boom Bust Boom


Why Minsky Matters, Reviewed in Times Higher Education

Michael Stephens | January 13, 2016

L. Randall Wray’s recently published book on the work of Hyman Minsky (Why Minsky Matters: An Introduction to the Work of a Maverick Economist) was reviewed by Victoria Bateman for Times Higher Education. Here’s a taste:

Having experienced the pain of a new Great Depression, the very least we should expect is that economists try to learn from it. Unfortunately, still too few of them understand the importance of what Minsky had to say …. While Minsky is now quite well known, his contributions are still widely ignored or misunderstood.

In terms of name recognition or casual citation, there’s been a lot of progress made in raising Minsky’s profile. As for comprehension of his vision of economics and public policy (or the influence of that vision on policymaking), there’s a tremendous amount of work ahead. Here’s hoping the book helps us move a little further along that path. Read the entire review here.


Kregel on the Vulture Funds

Michael Stephens | September 28, 2015

Jan Kregel, the Levy Institute’s director of research, was recently interviewed by the Buenos Aires Herald regarding Argentina’s economic prospects and its ongoing situation with the “vulture funds.”

On Argentina’s policy challenges:

So there are no alternatives to devaluation?

Argentina has one net advantage. As a result of the vulture funds it’s relatively insulated from the global crisis. Now it has a decision to make on how it is going to respond. China and Brazil didn’t have a choice but Argentina does. There has to be an exchange rate adjustment and it will be difficult because everybody else is doing the same thing. You can do it on a gradual basis but you would be doing it in a non-gradual context, taking the real as an example.

The government claims that a devaluation isn’t necessary and can be replaced by a larger consumption thanks to counter cyclical measures. Do you agree?

If you continue to go counter-current, that means the exchange rate will remain low. The country has a big opportunity to do import substitution due to the global context. Now is the moment to support domestic industry. The question is if you do that by increasing consumption or by more direct policies to stimulate manufacturing industries. You should first do the second, that will then boost consumption.

Argentina saw huge economic growth in the first years of Kirchnerism but now the economy has slowed down. What are the reasons for that?

When I was working at the UN, I used to come to Argentina and present reports at the Economy Ministry. The first question I asked officials is how long they thought Argentina could grow at eight percent. Usually the response was, why I thought that was a problem. Everybody actually believed that eight percent was something that could go on forever—that’s the reason behind Argentina’s current situation. Still, Argentina survived the world economic crisis much better than any other developing country.

And on the vulture funds:

Can the legal conflict with the holdouts be solved?

The most reasonable thing is to do nothing and let it sit there. The current US administration doesn’t support the claims of US investors and if the issue would go to any other court it is unlikely that it would be resolved. If you want to change something you just have to wait for the people who did it to die. Griesa is not very young and eventually has to retire.

Read the entire interview here.


Endogenous Financial Fragility in Brazil: Does Brazil’s National Development Bank Reduce External Fragility?

Michael Stephens | September 22, 2015

by Felipe Rezende


The creation of new sources of financing and funding are at the center of discussions to promote real capital development in Brazil. It has been suggested that access to capital markets and long-term investors are a possible solution to the dilemma faced by Brazil’s increasing financing requirements (such as infrastructure investment and mortgage lending needs) and the limited access to long-term funding in the country. Policy initiatives were implemented aimed at the development of long-term financing to lengthen the maturity of fixed income instruments (Rezende 2015a). Though average maturity has lengthened over the past 10 years and credit has soared, banks’ credit portfolios still concentrate on short maturities (with the exception of the state-owned banks including Caixa Economica Federal [CEF] and the Brazilian Development Bank [BNDES]).

While there was widespread agreement that public banks, and BNDES in particular, played an important stabilizing role to deal with the consequences of the 2007-2008 global financial crisis, there is, however, less agreement on BNDES’ current role (de Bolle). BNDES has been subject to a range of criticisms, such as crowding out private sector bank lending, and it is said to be hampering the development of the local capital market (Rezende 2015). It is commonly believed that “development banks and other institutions in Latin America tend to replace markets rather than address collective action failures that lead to market incompleteness.” (de Bolle 2015). In particular, critics of Brazil’s national development bank have argued that large companies can borrow from private international capital markets and the bank extends credit to companies that have access to domestic capital markets.

Much of the policy discussion has been misplaced. Though the conventional belief assumes that capital markets are efficient and produce an optimal allocation of capital, this view is not supported by evidence. Free and competitive international capital markets have repeatedly failed to produce an optimal allocation of capital and privatized free-market banking systems have failed to assess risks properly thus misallocating resources (Kregel 1998, Wray 2011). Moreover, access to international capital markets has been based on the false premise of lack of domestic savings. As I have argued elsewhere (Rezende 2015) rather than justifying the existence of public banks —and BNDES in particular, based on market failures (Garcia 2011) — an effective answer to this question requires a theory of financial instability. continue reading…


A Cycle of Financial Fragility?

Greg Hannsgen | June 3, 2015


(click image above to enlarge)

Can a bull market founded largely on credit survive? A forthcoming Levy Institute working paper I wrote with Tai Young-Taft of Bard College at Simon’s Rock (link for those interested) represents an attempt to deal with the role of financial instability—along with other sources of economic fluctuations—in the dynamics of the economy. Here, I’ll focus mostly on the role of margin loans that are used by many investors and traders to leverage positions in stock. The model developed in the paper includes a role for several policy tools that might be used in attempts to stabilize the economy: a fiscal-policy rule with public production and unemployment rate targets, along with public-sector R&D, financial supervision and regulation, and a target for the inflation-adjusted interest rate on government debt.

Now, for the current situation. The figure above highlights one potential threat to stability designed to arise spontaneously in runs of the model: surges in the use of margin debt to finance investments in stock. The chart shows that the amount of such debt outstanding in the US relative to GDP rose sharply during the tech bubble and the period leading up to the financial crisis and recession of 2007–09, achieving a new peak each time. Subsequent financial market collapses led to cyclical declines in the use of this form of leverage. On average, for the first quarter of 2015, this ratio stood at more than .028, suggesting that the stock market’s vigor again rests to a great extent on heavy borrowing (see figure). (Moreover, some different but closely related uses of credit, such as bond issues that wind up financing stock buybacks, have also contributed to the post-recession bull market.) This column from the New York Times’s Floyd Norris from a couple of years back discussed evidence that margin-credit cycles helped fuel cyclical movements in stock prices and the economy. His column displayed a longer but now outdated margin loan series.

In the model, margin loans can generate positive feedback effects: a cycle of increasing margin loan balances and rising stock prices, or vice-versa.  The story is similar to that of the “levered losses” in housing that took place in a number of countries earlier in this decade (see the recent book House of Debt for one account of the story, although even in this version of the story, I am inclined to see excessive optimism about the usual cure by wage and price adjustments); indeed, big, unsustainable run-ups in asset prices tend to be driven at least in part by credit booms. The situation shown in the figure is only one of many somewhat worrisome signs of market fragility. At the moment, fragility generally seems to be manifested most clearly in big increases in the quantities of various assets and liabilities relative to flow variables such as income and GDP, rather than in yield data.

More on the new paper and the model in it, for those inclined to look into it: continue reading…


Austerity and Growth: Missing the Point

Michael Stephens | May 22, 2015

The pseudo-debate about whether Keynesians and other fellow travellers ought to be embarrassed when governments that engage in fiscal austerity nevertheless experience positive economic growth rates has become a distraction.

For countries like the US and the UK, it is possible under current circumstances for governments to implement budget cuts and still see their economies grow. But the truth of that statement is not fatal to the Keynesian-inspired critique of austerity policies; it is not by any means the end of the story. The more meaningful question is this: What would have to happen in these economies for significant growth to occur in the midst of budget tightening?

Finding an answer to that last question is one of the strengths of the approach to thinking about the economy pioneered by Wynne Godley, and fleshed out further in the Levy Institute’s strategic analysis series. This approach also provides a clear understanding of how deeply irresponsible it is to cut government spending under present economic conditions: because the danger, given the state of the US and UK economies, is not just that budget cuts might slow down the economy, but that they might not.

Let’s look at the United States in particular. In their just-released report, Dimitri Papadimitriou, Greg Hannsgen, Michalis Nikiforos, and Gennaro Zezza point out that, with the exception of a short cycle in the ’70s, “there has been no other recovery in the modern history of the US economy in which government spending decreased in real terms.”

Exceptional Austerity_Levy Institute Strategic Analysis_May 2015

The Congressional Budget Office is predicting that the budget deficit will continue to shrink over the next few years, from 2.8 percent of GDP in 2014 to 2.4 percent in 2018. At the same time, the authors note, the CBO is telling us that GDP will grow at 2.8 percent, 3 percent, 2.7 percent, and 2.1 percent in 2015, ’16, ’17, and ’18, respectively. If we assume that both of those forecasts (for the budget deficit and GDP growth) come true, what would the rest of the economy need to look like?

The United States has run current account deficits, which act as a drag on economic growth, for decades. And despite the recent increase in net exports of petroleum products, which has helped keep the US trade deficit from returning to its sky-high precrisis levels, there is little reason to think that the external deficit will substantially improve over the next few years (if anything, the authors argue, it is likely to get worse. There’s more on recent developments in the foreign sector beginning on p. 6 of the report).

That being the case, GDP growth rates of the sort projected by the CBO can only come to pass on the basis of a rise in private sector spending. In fact, Papadimitriou et al. show that private sector spending would have to expand so much that it would exceed private sector income for the first time since the crisis. In other words, growth would depend on rising private indebtedness.

If the dollar continues to appreciate further and the economies of US trading partners end up performing worse than the IMF expects (a very real possibility, the authors point out, given the optimism of IMF forecasts), this increase in private sector spending over income — and thus the increase in the private debt-to-income ratio — would have to be even larger. Here’s what that would look like (in the chart below, “Scenario 1” corresponds to slower growth among US trading partners [by 1 percent of GDP annually], “Scenario 2” to a 25 percent appreciation of the dollar over the next four years, and “Scenario 3” to a combination of the two):

Austerity and Private Debt_Levy Institute Strategic Analysis_May 2015

If private spending doesn’t blow up in this way, the CBO’s optimistic growth projections won’t come about. But if growth does occur, it can only do so (given the external deficit) through a process that raises the debt-to-income ratio of the private sector. As the authors point out, this is precisely the same process that led to the Great Recession and its aftermath.

What’s worse, the state of income inequality in the United States is such that this increase in private debt will be borne disproportionately by households in the bottom 90 percent of the income distribution. Unlike the federal government, which can service its debt through mere keystrokes, US households cannot sustain rising debt ratios of the sort portrayed in the chart above (though the amount of public hand-wringing spent on the debt of the former, as compared to the latter, would suggest the opposite). As Papadimitriou et al. write:

“Increased borrowing of one kind or another can often be sustained for a long time … but eventually, retrenchment takes place relative to incomes. The consequences of any further retrenchment in debt-financed consumer spending would be felt throughout industries that produce for the US consumer, and again, as we noted above, the recovery in real private domestic consumption is already weak relative to any previous recovery.”

To bring this back to the tired discussions surrounding austerity policies: yes, it is possible for the United States to have both tight budgets and rising GDP over the next few years. Fiscal conservatism doesn’t make economic growth impossible in the near term — it makes it impossible to grow without increasing financial fragility. In the absence of a significant increase in net exports, keeping the government budget on its current track will lead to either stagnation or an acute crisis.

Austerians in the United States and elsewhere have been allowed to portray themselves as the champions of steely-eyed realism and prudence. In reality, unless their budget proposals come attached with some workable plan to substantially reduce trade deficits, they are courting private-debt-driven financial crises. In any meaningful sense, they are the true practitioners of fiscal irresponsibility.


Deflation in the Air

Greg Hannsgen | December 22, 2014

A New York Times article over the weekend delves into the history and rationale of the 2 percent inflation target, beloved of central bankers everywhere and a fairly recent innovation. Of course, the US Federal Reserve has a dual mandate, which includes both inflation and employment goals. The Fed said last week that it was most likely to start raising interest rates around the summer of 2015, but many countries’ central banks are moving in the opposite direction, solely because inflation is falling short of their targets.

Private borrowers—who usually have higher propensities to spend than lenders—benefit from an easing of the burden of debt when wages and prices move broadly upward. Also, for governments with debts that they cannot service with their own currency, inflation eases the burden of making payments, as tax revenues tend to rise in step with nominal wages and prices. Of course, falling prices have the opposite effect. The resulting changes in spending reverberate through the rest of the economy. Recent data show that there exists a strong threat of deflation around the world in economies such as Japan and the Eurozone, where core inflation has recently turned negative.

The effect of deflation on spending by indebted households was noted by Keynes in Chapter 19 of the General Theory (pp. 268-269). Michal Kalecki also argued to this effect in a critique of the so-called Pigou effect (falling prices would supposedly restore full employment by raising the inflation-adjusted wealth of households). The New York Times emphasizes instead the point that lower inflation makes it easier for some inflation-adjusted wages to fall, given that wages do not move downward as easily as upward. It also mentions that modest inflation permits central banks to lower real short-term interest rates below zero. Thoughts that deflation might be coming in much of the world are very sobering.


Boom Bust Boom: Minsky at the Movies

L. Randall Wray |

I highly recommend a movie to be released next year (that is, the year that begins next week). Terry Jones, of Monty Python fame, is one of the key developers of the film. It is on the Global Financial Crisis, but also provides a quick history of bubbles and crashes. It is highly entertaining and as good as any that I’ve seen on the crisis.

The movie features Hyman P. Minsky as well as J. K. Galbraith, who appear as life-sized puppets. One of Terry’s crew told me they brought Minsky over from England on a plane as a fare-paying customer. I would have loved to have seen the look on the faces of the flight attendants. I hope they bought him a beer.

Originally they were to film Minsky in his office at the Levy Institute, but when they saw pictures of it they said that there’s no way such a big and important economist could have had such an inauspicious office (albeit in beautiful Blithewood overlooking the Hudson). So they used a nice library down in Manhattan.

As Terry puts it, ”I wanted to be part of this project as soon as I discovered economics students are taught crashes just don’t happen.”

Here’s the blurb on the purpose of the project:

In revealing the truth about our unstable economic system, the film acts as the starting point for global project – to get the world talking about change through education. A central hub for information, news and ideas, BoomBustClick is an online resource for everyone – can we change an unstable economic system? Can we adapt economics to human nature?

Terry interviewed me for the film. He’s as funny as you’d expect, but also deeply engaged and knowledgeable. Most of my interview ended up on the cutting room floor, but some bits survived.

You’ll also enjoy interviews with Steve Keen and Jamie Galbraith. Minsky’s son, Alan, is a natural before the camera. The actor John Cusack makes some memorable comments. Steve Kinsella and John Cassidy are good. My friend Zvi Bodie (best name in economics) is featured, as is Paul Krugman. The UK’s Andy Haldane–one of the regulators–does a bit of mea culpa for the profession’s failure to “see it coming.”

As an added bonus, the film has some catchy tunes that you won’t be able to get out of your head

Go to the project’s website for more info; I presume they’ll be posting up the film’s release date soon. There are some clips on the making of the film that you can enjoy now.

(cross-posted from EconoMonitor)


Galbraith and Skidelsky: The End of Normal and the Future of Work (Video)

Michael Stephens | November 13, 2014

Here are the keynote addresses delivered by James Galbraith (“The End of Normal”) and Robert Skidelsky (“The Future of Work”) at the 12th International Post Keynesian Conference (more videos from the conference can be found here):