It seems the IMF aviary has turned on the hawks and embraced the deficit owls. Has the IMF joined the policy shift to MMT? Yes, in part, but it appears to be a viral form of MMT: according to Vitor Gaspar, the IMF’s head of fiscal policy, “Nations’ first priority should be vaccination, while the reduction of public debt is now far down the list of urgent actions… the main role of fiscal policy in the immediate future should be to be stimulative, to help restore economic growth, reduce unemployment and beat Covid-19.”

This is a big shift in IMF policy advice on post-crisis response, Chris Giles notes: “After the financial crisis a decade ago the fund recommended that countries should reduce their debt levels.”

But the pervasive pandemic is not the real reason for the change in feathered preferences: “Mr Gaspar said the IMF’s change of heart towards a relaxed approach to high levels of public debt stemmed from central banks’ reduction in interest rates. The drop in market funding costs means that, although advanced economies’ public debt has doubled as a share of GDP from 60 per cent to 120 per cent over the past 30 years, interest payments have halved from 4 per cent of GDP to 2 per cent.” Or perhaps the IMF is following Keynes’s wish for the euthanasia of the rentiers?

If fiscal policy is the weapon to fight the war against the coronavirus, then the same logic used by Wright Patman, MMT’er before his time, and every other sensible politician when faced with war finance, should raise the question of why the government should pay interest on the money it issues in order to spend. So, to follow the new IMF fiscal logic: If interest rates on government debt were zero, which is very close to conditions in many countries—indeed, some are negative—this should mean that the size of debt ratios should be even less of a concern. But zero interest rate debt is called currency. If government expenditure were financed by currency issue, following Congressman Patman, the government would not have to pay interest. And would it then follow the IMF could stop worrying about debt ratios?

But this is not the problem with the debt argument. Other things being equal, the level of interest rates has an impact on the total debt level associated with a particular level of the deficit. Higher interest rates should then be associated with higher debt ratios and vice versa, so it should be clear that the IMF position has not changed that much: it still prefers lower interest rates and the associated lower debt ratios because that means that it will require less austerity to reduce the debt burden in future.

However, while interest rates represent the costs of debt, they also represent income to someone in the system. Could higher interest rates make a lower deficit necessary to achieve a given impact on growth and employment and lead to lower debt ratios? It largely depends on who receives the interest as income—retired savers and pension recipients, or financial institutions, or even the Central Bank—and the impact on growth and employment. Low interest rates help some financial institutions, but for pension funds and insurance companies they can be a source of incipient financial instability.

The core philosophy of this Japanese defensive art used by the weak against the stronger Samurai is to mobilize the opponent’s greater force to your own advantage. Many have criticized the run-up in the quotation of the GameStop shares as a violation of market principles or regulations. Far from it, it simply represents the fact that day traders may be dumb money, but they have understood how to apply jiu-jitsu.

If the intent was simply to profit from trading the stock, no retail trader could ever compete with the institutions. To attempt to directly manipulate the price of the stock through outright purchase or sale would be impossible. The strategy that was used was simply to recognize, as Softbank had done earlier in the year, the nature of market hedging.

There is a myth that hedging can eliminate risk. This almost never happens, unless there is a perfect match between risk of gain and risk of loss. In all other cases, hedging requires compensation to transfer the risk—to those more able to bear the risk, as Greenspan would say. After the 2008 financial crisis, we learned that ability had nothing to do with it; it was who was willing to bear the loss, and most were not able and required the government to bail them out.

So in the run-up in the market quotes of GameStop shares, this was not really a question of the dubious behavior of a bunch of day traders; it was an application of market knowledge of how financial contracts work in practice. continue reading…

In this rare video from 1987 (there is very little surviving footage of Minsky discussing his work), Hyman Minsky summarizes his theory of the financial fragility at the heart of modern capitalist economies:

This was part of an event in Bogotá, Colombia (which is discussed in this working paper by Iván D. Velasquez).

The 10th anniversary of the September collapse of the US financial system has led to a number of commentaries on the causes of the Lehman bankruptcy and cures for its aftermath. Most tend to focus on identifying the proximate causes of the crisis in an attempt to assess the adequacy of the regulations put in place after the crisis to prevent a repetition. It is interesting that while Hy Minsky’s work became a touchstone of attempts to analyze the crisis as it was occurring, his work is notably absent in the current discussions.

While it is impossible to discern how Minsky might have answered these questions, his work does provide an indication of his likely response. Those familiar with Minsky’s work would recall his emphasis on the endogenous generation of fragility in the financial system, a process building up over time as borrowers and lenders use positive outcomes to increase their confidence in expectations of future success. The result is a slow erosion of the buffers available to cushion disappointment in those overconfident expectations. And disappointed these expectations must be, for, as Minsky argued, the confirmation of expectations of future results depends on decisions that will only be taken in the future. Since these decisions cannot be known with certainty, today’s expectations are extremely unlikely to be fully validated by future events. In a capitalist economy financial commitments are financed by incurring debt, so the disappointment of expectations will produce a failure to validate debt, leading to the inexorable transformation of financial positions from what Minsky called “hedge” to “speculative” to “Ponzi” financing structures. These structures refer to the ability of current cash flows to meet these commitments.

Thus, for Minsky, the crisis that broke out ten years ago would have been considered as the culmination of a process that started much earlier, sometime in the 1980s. An important aspect was the attack on the role of government and support for more restrictive fiscal policies that followed Reagan’s pronouncement “government is not the solution to our problem; government is the problem,” producing more procyclical budget policy that removed the “Big Government” floor under incomes during a recession. For Minsky, the sign of the budget was not important, but its role as an automatic stabilizer was crucial to financial stability. At the same time, the rise of monetarist monetary policies meant the “Big Bank” was no longer assured of placing a floor under asset prices by acting as a lender of last resort. By the early 1990s, Minsky had thus reversed his belief that a repetition of the Great Depression was unlikely because of the role of the “Big Government” and the “Big Bank.” Both had been diminished to the extent that they were no longer able to counter the inevitable translation of fragility into instability. By the 1990s, he clearly believed it could happen again. continue reading…

REGISTRATION IS NOW OPEN:

April 18–19, 2017

Levy Economics Institute of Bard College
Blithewood
Annandale-on-Hudson, New York 12504

The 2017 Minsky Conference will address the implications of the new administration’s “America First” policies, focusing on the outlook for trade, taxation, fiscal, and financial regulation measures to generate domestic investments capable of moving the growth rate beyond the “new normal” established in the aftermath of the Great Recession, without jeopardizing financial stability. It will also seek to assess the impact of different financing schemes on both infrastructure investment and the return of central bank monetary policies to more neutral interest rates. Since these new policy proposals will have a global impact, the conference will focus on their implication for the performance of European and Latin American economies.

Register here.

The preliminary program and list of participants is below the fold: continue reading…

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…

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.

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.

by Felipe Rezende

Introduction

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…