Archive for August, 2012

Keynes on low interest rates

Greg Hannsgen | August 30, 2012

Whatever the outcome of efforts to resolve severe economic difficulties in Europe and elsewhere, it is becoming increasingly clear that the next big economic crisis may not hinge on interest rates at all. One reason is that the world’s central banks, many of them following something like a Robinsonian “cheap money policy,” have managed to keep interest rates reasonably low in many countries. For example, it seems clear that yields on Spanish and Italian bonds are under control for now, after statements last month by Mario Draghi, the president of the ECB, that he was “ready to do whatever it takes,” to keep interest rates down. As made clear in this interesting and enlightening 2003 book edited by Bell and Nell (Stephanie Bell Kelton and Edward Nell), the theoretical argument for the Eurozone was badly flawed from the beginning.  (Indeed, many in the world of heterodox economics saw these  flaws from the beginning.) But, returning in this post to a key theme in Joan Robinson’s writings on the interest rate, I will offer some of the thoughts of John Maynard Keynes himself, who wrote in 1945 that:

The monetary authorities can have any rate of interest they like.… They can make both the short and long-term [rate] whatever they like, or rather whatever they feel to be right. … Historically the authorities have always determined the rate at their own sweet will and have been influenced almost entirely by balance of trade reasons [Collected Writings*, xxvii, 390–92, quoted from L.–P. Rochon, Credit, Money and Production, page 163 (publisher book link)].

Here in the United States, the Fed has shown its ability as a liquidity provider to keep interest rates on relatively safe investments very low across the maturity spectrum, despite spending much more than it received in tax payments in calendar years 2009–2011, and presumably the current year.  Keynes’s statement, much like the quote from Robinson mentioned above and the one in this earlier post, foretells this outcome.

Hence, recent US experience supports the view that calls for cuts in government spending and/or tax increases cannot be justified by fears that high deficits cause high interest rates at the national or global level.

* Note: The complete set of Keynes’s  works is out of print in hardback and will be reissued as a 30-volume set of paperbacks later this fall, according the Cambridge University Press website. – G.H., September 3


Minsky and Narrow Banking

Michael Stephens | August 24, 2012

The idea of breaking up the big banks, while seemingly growing in popularity, leaves a lot of unanswered questions.  And one of the biggest questions is probably this:  what will be the structure of the smaller institutions that remain after such a break up?  If these smaller institutions are allowed to entangle themselves in the same complex activities as before, then we will still be a long way from stabilizing the financial system.

In this context (and with a recent IMF paper reconsidering the Depression-era “Chicago Plan”), Jan Kregel looks at one potential proposal for simplifying the financial structure; an alternative to Dodd-Frank’s partiality and complexity.  In his latest policy brief (“Minsky and the Narrow Banking Proposal: No Solution for Financial Reform“), Kregel looks at Hyman Minsky’s consideration of a narrow banking proposal in the mid-1990s (at the time, Minsky was looking at potential reforms for a post-Glass-Steagall financial system).  In this narrow banking proposal, commercial and investment banking functions would be separated into distinct subsidiaries of a bank holding company, with 100 percent reserves required for the deposit-taking subsidiary and a 100 percent ratio of capital to assets for the investment subsidiary.

Minsky eventually turned against the proposal, and Kregel likewise concludes that narrow banking is not the answer.  Among other reasons, Kregel notes that in such a narrow bank holding company system there would be no leverage, no liquidity creation, and no deposit-credit multiplier.  Banks would not be able to act as the “handmaiden to innovation and creative destruction,” as he puts it.  And for all that, the system would still be vulnerable to destabilization.  “[T]he real problem that must be solved,” Kregel writes, “lies in the way that regulation governs the provision of liquidity in the financial system.”


Endgame for the Eurozone Bank Runs

Michael Stephens | August 23, 2012

Over at The Nation, Dimitri Papadimitriou writes about the accelerating eurozone bank runs, in which euros have been flowing out of Spanish and Greek banks and into Germany at an eye-popping rate, and lays out scenarios for how this whole things ends:

The migration of money into Germany is quickening. And under TARGET 2, the trillions of euros that the ECB has loaned out to finance this race will be uncollectable.

How to counteract a disaster of these proportions? Unlimited deposit insurance for all euros in EMU banks, backed by the creation of a strong European federal treasury, would end the bank runs, just as deposit insurance in the United States has prevented them here ever since the Great Depression. The insurance liability would be on Europe’s central bank, which would become insolvent if Spain or Italy abandoned the euro. Since, unlike the United States, the ECB doesn’t have a unified European treasury to backstop it, Germany would presumably get the bill for a default.

As Randall Wray and I predict in a new Levy Institute policy paper, “That’s a bill Germany will not accept, hence, probably no deposit insurance.” And no future for the euro.


Papadimitriou was also interviewed on the topic for Ian Masters’ Background Briefing radio program (listen here).


The Paradox of Euro Survival and Other Lessons from the Crisis

Michael Stephens | August 21, 2012

Since eurozone governments don’t issue the currency in which their debts are denominated and can’t borrow euros directly from the European Central Bank, member-states essentially have to run budget surpluses—generating euros by taxing the private sector—if they’re going to reliably meet their debt servicing costs, according to Jan Kregel, and they have to run even bigger surpluses if they’re going to reach the debt limits set by the Stability and Growth Pact.  Kregel puts this in Minskyan terms:  “member-states should be engaged in ‘hedge’ finance, which means producing a fiscal surplus well in excess of debt service. If it cannot do this, it must issue additional debt to the private sector, since it cannot borrow from the ECB. In this case, the government would be engaging in what Minsky called ‘Ponzi’ finance: it would be borrowing to meet debt service.”

But in order to maintain such budget surpluses, Kregel points out, the eurozone needs higher economic growth, and this sets up a fundamental paradox:

…governments cannot produce this growth through deficit spending; it must come from either domestic or foreign demand. Lowering government expenditures or raising taxes to generate the required fiscal surplus will only reduce domestic demand. This leaves external demand as the only solution. But without the ability to improve external competitiveness through exchange rate adjustment, internal depreciation through wage reductions or productivity increases in advance of wage increases will be required. However, this is also a policy that reduces domestic demand, offsetting the benefits of higher foreign demand. And here is the paradox: all the policies proposed to increase growth of incomes and generate fiscal surpluses ultimately have a negative impact on income growth. Keynes called it the paradox of saving; here, it is the paradox of euro survival.

This is partly why, he argues in a new Policy Note, more political integration can’t solve the most fundamental problem facing the eurozone.  According to Kregel, this is one of the six lessons we ought to have learned from the crisis.

The other five lessons: continue reading…


Why Time Poverty Matters

Michael Stephens | August 20, 2012


by Rania Antonopoulos and Michael Stephens

Poverty is often measured by the ability to gain access to some level of minimum income, based on the premise that such access ensures the fulfillment of basic material needs. But this approach neglects to take into account the necessary (unpaid) household production requirements without which basic needs cannot be fulfilled. In fact, because the two are interdependent, evaluations of living standards ought to consider both dimensions; otherwise, the poverty numbers produced by statistical agencies and used by policy makers are flatly wrong.

Consider, for instance, two identical households of two adults and two children whose annual household incomes are also identical.  In the first household, while the mother or father works and brings in all the income, the other spouse is a stay-at-home parent that raises the children. In the second household, both adults are employed and, as it turns out, they work long hours because their hourly wages are relatively low. Nonetheless, they pull in the same income as the first household (with only one adult working). Income-wise, the two households are identical. What differentiates them is “time”: the first household has an adult with ample amounts of time to devote to cooking, maintenance work, raising the children, etc. The second household does not: it faces a time deficit in that there are not enough hours in the day to work for pay, commute, do the shopping, and then clean, cook, supervise the kids, iron the clothes, etc. This household must either buy the “missing” but essential goods and services or learn to do without. Some households facing time deficits earn sufficient income that allows them to hire a nanny or send the kids to a childcare center; to pay for a domestic worker who can clean the house and prepare home-cooked meals, etc. But others cannot. Simply put, they do not earn enough to afford market substitutes. The second household, as compared to the first one, suffers from material deprivations that are invisible, and hence their poverty, real as it may be, remains hidden from the policy radar.

With the support of the United Nations Development Programme, Ajit Zacharias, Rania Antonopoulos, and Thomas Masterson have developed an analytical and empirical framework that includes unpaid household production work in the very conceptualization and calculations of poverty: the Levy Institute Measure of Time and Income Poverty (LIMTIP). Based on this new analytical framework, empirical estimates of poverty are presented and compared with those calculated according to the official income poverty lines for Argentina, Chile, and Mexico. In addition, an employment-generating poverty-reduction policy is simulated in each country, and the results are assessed using the official and LIMTIP poverty lines.

Clearly, while employment is the key to escaping poverty for some households, for many others, according to our study, it is no answer at all.  Due to low wages, even if time-deficits are not newly created, some households in our study end up joining the working poor. Perversely, for others, as low wages combine with household production time deficits, they end up trading one type of poverty (time) for another (income). Unless supplemented by a living wage policy, regulation or reduction of working hours, and interventions that reduce household production time requirements (childcare, eldercare, after school programs), the newly employed cannot but replicate pre-existing patterns of inequalities and deprivation.


A Cautionary Note about Stagflation in the 1970s

Greg Hannsgen | August 15, 2012

For those who worry that elevated federal deficits and quantitative easing (QE) by the Fed will lead to high inflation, a word about the macroeconomics of the 1970s. The topic came up in the news recently with the passing of economist and former presidential adviser Paul McCracken. In keeping with many orthodox accounts of the era, an obituary in the New York Times cast much of the blame for the stagflation [slow growth combined with high inflation] of the 1970s on “Keynesian” macro policies, in particular large budget deficits:

A wide-ranging thinker, Mr. McCracken was part of a postwar generation of economists who believed that government should play an active role in moderating business cycles, balancing inflation and unemployment, and helping the disadvantaged.

His nearly three years at the White House coincided with a turbulent era marked by rising deficits, rampant inflation, the imposition of wage and price controls, and the breakdown of the system of fixed exchange rates that had governed the world’s currencies since World War II.

As a result, by the early 1980s, Mr. McCracken, like other economists, questioned the Keynesian assumptions that had been dominant since the war. He concluded that high inflation had resulted from “a cumulative paralysis in our will” and called for greater fiscal discipline to limit the growth of government spending — a topic that continues to vex Washington….

Working for Nixon, Mr. McCracken was confronted with an inflation rate that had been rising since 1965, a byproduct of the deficits that the federal government had amassed during the Vietnam War…..

The article paints a picture in which McCracken stood in the middle ground between Keynesian “fine-tuners” of macro policy on the one hand and opponents of “activist” policies, such as Milton Friedman, on the other, who blamed inflation on excessive government spending and erratic growth in the money supply.

The view represented by the Times article is far from the only reasonable account of the causes of the stagflation of the 1970s, in particular the episodes during which the US experienced double-digit inflation (see figure below, in which year-over-year CPI inflation is shown in blue). continue reading…


Wray on Monetary Policy and Financialization

Michael Stephens | August 14, 2012

Randall Wray joined Suzi Weissman for radio KPFK’s Beneath the Surface to discuss monetary policy, financial fraud, and a number of other issues.  The interview kicked off with Wray explaining his skepticism of the effectiveness of monetary policy, and in particular of quantitative easing, under current conditions, touching also on the question of why this long-term bias in favor of monetary over fiscal policy has developed.  The interview turned to LIBOR and the long string of recent financial scandals and outright fraud, with Wray tying it all to a broader (and growing) financialization of the economy.  Elaborating on the dominance of the FIRE sector in our economy, he discussed the increasingly fuzzy boundaries between, say, finance and industry.

Listen to the interview here.


Which LIBOR Scandal?

Michael Stephens | August 6, 2012

In his recent commentary on the LIBOR scandal, Jan Kregel elaborates on a distinction that is crucial to understanding this story.  The scandal centers around revelations that financial institutions had been manipulating their LIBOR rate submissions to the British Bankers’ Association (BBA).  Questions have subsequently been raised as to whether regulators were aware of and condoned, or actively encouraged, these manipulations.  But as Kregel explains, there were two very different types of manipulation that were going on, and the distinction between the two is acutely relevant to evaluating attempts to pin a major share of the blame for this scandal on regulators and central bank officials.  (LIBOR is a proprietary index put out by the BBA that is supposed to represent an average of the rate at which banks are able to borrow from each other short term.  It is composed of rate submissions from banks selected for a panel who are asked to give the rate at which they have borrowed or could hypothetically borrow.  The highest and lowest 25 percent of the submissions are thrown out.  LIBOR sets the benchmark for things like mortgages, student loans, credit cards, etc.  See Kregel’s piece for a more detailed explanation.)

Prior to the most recent financial crisis, LIBOR was rigged by banks in an attempt to benefit their trading positions (the banks had made bets whose payoffs depended in part on what was happening to LIBOR).  The investigative reports from the Financial Services Authority in the UK and the Commodity Futures Trading Commission and Department of Justice in the US point to evidence of such manipulation as far back as 2005.

But during the heart of the financial crisis there was a different type of misreporting going on, this time driven by the collapse of interbank lending.  While regulators appeared to have been aware of the latter misreporting, the evidence does not suggest they were aware of the former, more nakedly venal, pre-crisis manipulation.  A lot of the controversy on this question stems from a confused reading of the 2012 testimonies of Paul Tucker (currently deputy governor of the Bank of England) and Robert Diamond, the former head of Barclays Capital, before a House of Commons committee.  The testimonies are being read as providing the smoking gun evidence that the Bank of England was aware of the scandal from the beginning and failed to stop it—but this interpretation only works, as Kregel demonstrates, if you confuse or fuse together the two varieties of LIBOR manipulation.  And there are good reasons to keep them separate in our analyses. continue reading…