This is an abbreviated post from our subscription series at Credit Writedowns Pro. Michael Pettis has a good piece on debt and credit that I ran on the blog this morning. His thoughts on loss socialization are important not just in the context of China but also of other markets like Europe, the US, Canada and Australia where private debt […]
Tag: Hyman Minsky
Burgeoning debt was not an unlucky accident. It is fundamental to the way the growth model works, and we have arrived at the stage, probably described most imaginatively by Hyman Minsky in his work on balance sheets, in which the system requires an acceleration in credit growth simply to maintain existing levels of economic activity. China’s debt problems, in other words, cannot be resolved administratively, by fixing the shadow banking system, by imposing discipline on borrowers, or indeed by eliminating financial repression (much of which, by the way, has already been squeezed out of the system by lower nominal GDP growth). Without a massive transfer of wealth from the state sector to the household sector it will be impossible, I would argue, for GDP growth rates of anything above 3-4% – and perhaps even less – to occur without a further unsustainable increase in debt, whether that increase occurs inside or outside the formal banking system and whether or not discipline has been imposed on borrowers.
From Minsky’s earliest work, he adopted what became known as the “endogenous money” approach that was revived by Post Keynesians in the 1980s. It is useful to return to Krugman’s critique of Minsky to compare Minsky’s early view of banking with the current view held by many macroeconomists. Minsky’s views over half a century ago are far more advanced than those held today by Krugman.
We need to abandon the Loanable Funds model of lending, which treats banks as “mere intermediaries” and therefore ignores them in macroeconomics. the Neoclassical belief in Loanable Funds is the biggest barrier there is to the development of a realistic, monetary macroeconomics. If Paul Krugman gives way on this belief, then maybe there’s hope that central banks and treasuries around the world will eventually do so too.
I don’t want to be too glib here. I recognize that policymakers are in an extremely difficult position and that there is no longer any easy solution, but railing at the markets rather than trying to understand why they are doing what they do (which anyway makes them far more rational than if they responded to the pronouncements coming out of Brussels) is counterproductive. In fact this kind of pouting is just a part of the self-reinforcing downward spiral that I have described many times before. Policymakers are complaining that economic agents are behaving in ways that reinforce the crisis, even as they do the very same thing.
I have a ton of links so I am going to break them up into groups. Here’s the first bunch from late last week. Three topics are most interesting.
Charles Kindleberger’s classic book on the Great Depression was originally published 40 years ago. In the preface to a new edition, two leading economists argue that the lessons are as relevant as ever.
Our brains are not calibrated to deal with the unexpected. Most of us believe we are good risk managers but in reality we are not. Most of us trust that risk can always be quantified and expressed through some fancy modelling whereas, often, it cannot. The world is not normal, yet universities continue to teach our young students the wisdom of Markowitz and Sharpe which brought us modern portfolio theory and, more specifically, the capital asset pricing model. Garbage In, Garbage Out, as they say. One of the fundamental assumptions behind modern portfolio theory is that asset returns are normally distributed random variables. The return profile of US equities fairly closely matches that of a normal distribution with the exception of large negative returns. They have come about more frequently than one would or should expect.
In his publications in the 1950s through the mid 1960s, Minsky gradually developed his analysis of the cycles. First, he argued that institutions, and in particular financial institutions, matter. This was a reaction against the growing dominance of a particular version of Keynesian economics best represented in the ISLM model. At the same time, he examined financial innovation, arguing that normal profit seeking by financial institutions continually subverted attempts by the authorities to constrain money supply growth. This is one of the main reasons why he rejected the LM curve’s presumption of a fixed money supply. With his 1975 book, Minsky provided an alternative analysis of Keynes’s theory. This provides his most detailed presentation of the “financial theory of investment and investment theory of the cycle”. Minsky continually developed his financial instability hypothesis to incorporate the extensions made to his investment theory over the course of the 1960s, 1970s, and 1980s. The Kalecki equation was added; the two-price system was incorporated; and a more complex treatment of sectoral balances was included. Minsky also continued to improve his approach to banks, recognizing the futility of Fed attempts to control the money supply.
Yesterday, we highlighted the talk that Steve Keen gave at the INET conference as our only post. Today, we present the full and in-depth version including his written analysis via Steve Keen’s DebtWatch website. Steve ends with two innovative solutions to this and future debt crises.
Steve Keen’s talk at INET is now up on the web (hat tip BT). His talk is billed as a primer on Hyman Minsky. In it, Steve argues that one cannot model Minsky using a New Keynesian or traditional neoclassical approach because of the reliance of these modelling approaches on the economic equilibrium assumption. Keen sees this assumption as the major flaw that cannot be remedied using standard modelling approaches.
In Paul Krugman’s view, banks are not very important since all they do is to intermediate between savers and investors, taking in deposits and packaging them into loans. Now, I know that Krugman’s own specialty is not money and banking, so one would not expect him to have a deep understanding of all the technical details. However, he is an important columnist and textbook writer, so if he is going to expound upon “what banks do”, he should at least have the basics more-or-less correct. But he doesn’t. we need Minsky—whose views even from the 1950s are far more relevant to today’s real world banks than are Krugman’s.