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Monday, March 27, 2023

Learning From The Crisis (MMT Perspective)?

The panel I am on is shifting its topic a bit to include some discussion of the latest crisis. Although this is more topical, it is not exactly moving in a direction that fits my knowledge of Modern Monetary Theory (MMT). I see two broad issues. The first is the discussion of bank failures (so far!) which I have a limited ability to comment on. The second is more useful for a MMT debate: interest rate policy is not exactly as costless as neoclassical arguments suggest.

Bank Failures

I do not see that recent events offer any new information for anyone other than free market ideologues.

  1. The Silicon Valley Bank (SVB) failure just tells us that banks will blow themselves up in very stupid ways if there are no functioning adults around to stop them. Larger banks have some element of self-preservation as a result of being divided into fiefdoms, but SVB was too concentrated strategically to have useful internal checks and balances. Any sane regulatory framework that takes into account what we know in the early 2020s could have prevented that implosion. Unless the Federal Reserve can convincingly argue that its hands were tied by the letter of the law, this was a regulatory failure. The only lessons we can draw from this are (a) have a sane regulatory framework and (b) regulators have to be willing to enforce regulations. “Regulatory capture” was a big problem going into 2008, and unless it is dealt with, reforming regulations only gets you so far.

  2. The demise of other crypto-adjacent banks seems to be a belated recognition that regulatory forbearance towards crypto was a mistake. The crypto industry was an experiment to see what happens if we let people sell what are obviously securities without making them subject to securities laws. Anyone other than a free market ideologue could predict exactly what would happen: scam artists would prey on dupes.

  3. The Credit Suisse takedown tells us how hard it is to deal with systemically important banks. It was a weak bank, it was forced into a shotgun marriage. Although what happened to the AT1 capital holders appears unfair, they were getting a fat coupon for a reason.

The handling of subordinated bank capital is an interesting but awkward topic. On one hand, passing an emergency law to change priority in a restructuring is awkward. On the other, banks need to raise equity to shore up their capital base, so blowing out the subordinated contingent capital before equity can be viewed as the lesser evil. Maybe after a few decades, we will have sensible conventions to follow, and contingent capital notes will have a well-defined place in the capital hierarchy.

The MMT View? I’m Not the Person to Ask

There are MMT discussions of reforms to the banking system — a lot of which are specific to the United States. From a generic perspective that is applicable to Canada, I would offer a high level summary that there is a desire for stronger regulation and re-risking, in exchange for universal deposit insurance. The mantra is that there should be more regulation on the asset side (i.e., limiting bank activities). From a Canadian perspective, I would describe this as a reversion back to the pillar system, where different financial market activities were walled off from one another.

I do not spend too much time worrying about such recommendations based on my political realism. The political problem we face in the Western democracies is getting regulators to enforce laws at all; free market ideologues want to burn the whole edifice down.

To the extent that this discussion comes up in the panel, Eric Tymoigne would have to bail me out.

Interest Rate Policy Is Not Cost-Free

The neoclassical literature ahead of the 2008 Financial Crisis (we now need to keep the year in the crisis name!) was a long love letter to interest rate policy managed by an independent central bank. A previously mentioned article co-authored by one of the other side of the panel had a long discussion of this. I will have to take a look at the article in more detail later, but I will just make some generic remarks.

The 1990s was a period of coordinated tightening fiscal and labour market policies (the OECD Jobs Study, as pinpointed by Full Employment Abandoned: Shifting Sands and Policy Failures by Bill Mitchell and Joan Muysken). This is at least partly secret sauce behind the 1992-2020 period of inflation stability — not just the inflation targets being hit by independent central banks.

Structurally tight policies needed to be offset by monetary policy — low interest rates created a coordinated real estate boom. The bull market in Canadian housing lagged behind the United States — it needed the brain trust in the neoliberal Canadian establishment to progressively scrap prudential limits in CMHC mortgage insurance (which were backtracked slightly after the horrible example of the United States in 2008 was seen).

Other than for the young people who maybe wanted to have a place to live, fuelling a housing boom to hit macroeconomic targets looks like a free lunch. However, the strategy relies on other levers of policy to be tight. The pandemic and its aftermath invalidated that assumption. Slamming on the brakes with rate hikes is only going to be an “optimal” option if the housing market does not melt down. To be clear — that is not happening (yet).

I have not downloaded the data yet, but statistics released last week tell us that Canada has set a post-1957 record for population growth — largely courtesy of immigration. Canada no longer expects (or allows) immigrants to build their own sod houses, so this is obviously putting pressure on the housing market. Any predictions of imminent housing doom have to keep this dynamic in mind. That said, sufficiently high interest rates would eventually trump immigration. I might get back to Canadian housing in a later article.

What would happen if Canadian governments decided to keep fiscal policy loose? Well, the Bank of Canada either gives up or keeps hiking — and would such hikes cause a crisis in the real economy? We cannot pretend that independent central banks are a magic elixir to make inflation go to the target — they need cooperation from fiscal policy. If inflation targeting only works because of self-imposed austerity by fiscal policymakers, this is hardly a revolution in policymaking.

On top of the risks to housing, the dread spectre of “fiscal dominance” pops up. That is, the stimulative effect of interest payments. We can get away with ignoring them when debt/GDP ratios were around 30%, but not now. We cannot just wave a magic wand to reduce debt/GDP ratios, so to the extent that this effect matters, it complicates the assumed dominance of monetary policy for inflation control.

Concluding Remarks

I will have to return to the paper critiquing MMT, but I just wanted to write out what I am currently thinking about.

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(c) Brian Romanchuk 2023

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