I have not seen too many longer articles about the “gilt crisis” in the United Kingdom, but have seen a variety of reactions on Twitter. My reaction is that the discussions reminded me why I mainly followed people who used the title “rates forecaster” and not “economist” when I was in finance. (The “rates forecasters” might have had economics degrees, but they knew that if they wanted people like me to take them seriously, they needed to not sound like the people with “economist” in their title.) It is rather impressive how the most interesting part of this crisis has been buried.

We finally have had the financial instability crisis that everyone was a bug about throughout the 2010s. Many people have spent more than a decade calling for a repeat of the Financial Crisis — well, we just had a small version of it. Based on the initial reporting (which may not be perfect), pension funds managed to blow themselves up with leverage (created by fixed income derivatives) by crowding into one side of a trade. This alleged distress forced the Bank of England to intervene to reduce gilt yields (and hence swap rates).

Targeted Versus Non-Targeted Stimulus

I've run across yet more lazy critiques of Modern Monetary Theory (MMT), arguing that "MMT says governments should just print money to stop the virus!", or similar nonsense. I may only be speaking for myself, my reading of MMT would lead to cautiousness with respect to the limits of fiscal policy at present. Given that we face considerable constraints on output capacity, we can see theoretical inflationary risks if fiscal policy was too active. (My base case view is in line with the collapsing inflation-linked market: inflation is likely to head lower, given the swoon in energy prices.)

Minsky Versus Steindl Debt Dynamics?

 In Marc Lavoie's Post-Keynesian Economics: New Foundations, he has an interesting discussion in Section 6.10.4, which is labelled "Minsky or Steindl Debt Dynamics?" The Minsky dynamics are the well-known Financial Instability Hypothesis (link to primer), while the Steindl dynamics refers to the discussion in Maturity and Stagnation in American Capitalism by Josef Steindl. Lavoie's discussion raises some issues with the limitations of aggregated analysis in this context. This is a brief comment on this topic.

Primer: Financial Instability Hypothesis (Part II)

The evolution of the financial sector in response to economic incentives and historical experience is the other key leg of Minsky’s Financial Instability Hypothesis. It lacks the catchy hedge-speculative-Ponzi unit (agent) scheme, and so is less well known. However, it perhaps poses a greater theoretical challenge, particularly to those who believe that only formal mathematical models are “rigorous.” The argument is that the financial sector changes the rules of the financing game over time – which invalidates any formal models based on the old rules.

(Note: This is an unedited draft from my manuscript of a book on recessions. Part I of this primer is found here. Please note that book links are affiliate links.)

Primer: Financial Instability Hypothesis (Part I)

The Financial Instability Hypothesis was associated with the economist Hyman Minsky, although it could be viewed as Minsky’s interpretation of Keynes. One summary of the concept is that stability is destabilising: economic stability leads to changes in behavioural changes that destabilise the economy.

Primer: Minsky's Financial Instability Hypothesis

The "Financial Instability Hypothesis" is a phrase describing the economist Hyman Minsky's views on the driver of the business cycle. The description here is based on the essays found in the book Can "It" Happen Again? Essays on Instability and Finance. The objective here is to capture highlights of his thinking, and not attempt to cover the breadth of his world view.

If the reader wishes to find a fuller description, I would recommend the essay "The Financial Instability Hypothesis: A Restatement" on pages 90-116. This article is a very high level overview of that summary article. At the end of this article, I will comment on some of the implications of the hypothesis.

Heterodox/Mainstream Views On Banking

David Andolfatto recently published "Reconciling Orthodox and Heterodox Views on
Money and Banking," which discusses the theoretical split between recent mainstream thinking and heterodox views on banking. From my perspective, he is addressing heterodox critiques of mainstream thinking that I am not particularly interested in; in fact, based on his criteria, I would be closer to "mainstream" than "heterodox" -- as would possibly be Hyman Minsky. I would view the problem with mainstream modelling as resulting from a blind spot regarding the business sector.

Why Lender-Of-Last-Resort Operations Are Inevitable

Lender-of-last-resort operations by central banks (or "bailouts of the financial system") are deservedly unpopular across the political spectrum. Malcontents have argued that risky lending ought to be handled by markets, and that deposits should be fully backed by reserves or Treasury bills. Unfortunately, the believers in these theories never bother to look at the economics of short-term lending. The money markets have the structure that they have for a reason, and they only will function if there is a lender-of-last-resort that is able to step in and prop the system up. Any attempts to make the system bailout proof would have far-reaching consequences into the structure of the economy.

No Banking Run In Our Lifetimes...

Fed Chair Janet Yellen was quoted by Reuters as believing that there would not be another financial crisis (presumably similar to the one in 2008) in "our lifetimes." Steve Keen was harsh, arguing that this is symptomatic of mainstream complacency about the financial system. I am not completely sure on the context of the comment, but it appears to me that it illustrates the ancient philosophical principle: you ask a stupid question, you get a stupid answer.

Primer: Funding Versus Credit Risk

The act of lending involves two fundamental operations: extending financing (funding) ans taking credit risk. These two roles are typically thought of together, which obscures what is happening. By decoupling these concepts, we can better understand the effects of debt issuance. If we can eliminate credit risk, the circular nature of financial flows means that the only limitations on debt issuance are real resource constraints. This understanding helps us better understand the behaviour of economic models (why they depart from real-world behaviour), governmental finance, and banking.

Central Banks as Pawnbrokers

 Lord Mervyn King (Governor of the Bank of England from 2003 to 2013) wrote “The End of Alchemy: Money, Banking, and the Future of the Global Economy.” [1]  In it, he discusses a proposal for the reform of the banking system, which he refers to as the “pawnbroker for all seasons” (Chapter 7). The proposal is very similar to one I discussed in Understanding Government Finance – which was proposed by Hyman Minsky, which in turn was based on central bank operating procedures from before World War II. I agree with Lord King about the proposal, however, my interpretation of how it should be implemented differs. At the root of the issue is my feeling is that his worldview shares too many assumptions taken from Monetarism.

(Note: This is an unedited first draft from my next book: Abolish Money (From Economics)! The text of the book is now complete, and I am in the editing process. I expect to publish it in January.)

The Case Against Growth And Stimulus

Larry Summers argued in this recent Financial Times article that progressives ought to favour growth policies, which prompted this response from John Cochrane. Although John Cochrane had some points of partisan disagreement, he strongly agreed with the premise that politicians in the United States need to talk more about growth. In my view, politicians talk too much about growth already. (H/T to Leo Kolivakis  @PensionPulse for ending me the Cochrane article link.)

The Radical Status Quo Canadian Federal Budget

The Canadian Federal Liberal Party, led by Justin Trudeau, unleashed its first budget this week (link to information page). Although the Canadian financial media played up the increase in the deficit (one major media outlet ran an article "Welcome back to the age of big government in Canada," which is a more sensationalist headline than even this random blogger uses), I am actually impressed at how radically the budget returns Canada back to the status quo. If you want to do long-term forecasting, this is a sign that projecting current policy settings forward is not particularly naive.

Book Review: Why Minsky Matters (Wray)

L. Randall Wray, one of economist Hyman Minsky's students, and one of academics behind the development of Modern Monetary Theory (MMT) provides us with an introduction to Minsky's thought in "Why Minsky Matters: An Introduction to the Work of a Maverick Economist." As the title suggests, it is not an attempt to explain the details of the evolution of Minsky's theories over his career, rather it is an attempt to relate his theory to contemporary events. The book is aimed at those who are unfamiliar with his work, and "post-Keynesian" economics in general. (I am using "post-Keynesian" here as a wide term; Minsky would probably not fit within a narrower definition of "post-Keynesian".)

Comments On Contemporary Inflation Control

Since the 1970s, conventional thinking about macroeconomics was consumed with the challenges of inflation control. This led to entrenched dogma surrounding inflation targeting and central bank independence. However, since the end of the financial crisis, there has been more discussion of the issues posed by slow growth -- although I believe that inflation control would come to the forefront if inflation rates started to rise again. In this article, I give a summary of why I think inflation will probably continue to remain relatively low in the developed countries, even taking into account what I see as politically feasible policy shifts.

Economic Stability And The Size Of Government

In "Fiscal stimulus does not necessarily mean large government", Bill Mitchell dissected a debate whether "if you support austerity it is because you really just want smaller government and vice versa." Professor Mitchell argues that this is incorrect, although I would note one small qualification - the government cannot be too small for fiscal policy to stabilise the economy.

The Debt Supercycle Versus Secular Stagnation

Kenneth Rogoff has been advancing theories that the current environment of disappointing growth rates is the result of a "debt supercycle", not "secular stagnation". He recently summarised his arguments within the article "Debt supercycle, not secular stagnation". Although would agree that some version of a "debt supercycle" theory is correct, I am unconvinced about Rogoff's description of the mechanisms. Meanwhile, I doubt that he will succeed in winning the argument - he is pushing against the unmoveable object that is the circular logic of the natural rate of interest.

Minsky On Bank Position-Making Instruments

Although the financial system appears extremely complex, the underlying principles tend to be stable over time. One of the fundamental needs of a banking system is for position-making instruments, which are financial instruments that can be bought and sold to manage liquidity. The economist Hyman Minsky often highlighted the importance of these instruments. This article summarises his discussion of this topic, which is useful for understanding some of the operations underlying government finance, in particular the repo market.

Consequences Of A Basic Income Guarantee

The idea of a Basic Income Guarantee (hereafter known as BIG) has become increasingly a topic of interest. My views have been greatly influenced by Hyman Minsky and Modern Monetary Theory (MMT), where a guaranteed job was preferred to guaranteed income. (Minsky referred to this as an Employer of Last Resort programme; MMT refers to this as a Job Guarantee.) I explain why I view a BIG as being essentially unfeasible within Canada, using logic similar to their analyses.

The Weakness Of Conventional Fiscal Policy

Brad DeLong has a good discussion on the convergence of views between New Keynesian and Market Monetarist theories of why economies face aggregate demand shortfalls. (Real Business Cycle theorists do not recognise the concept of an aggregate demand shortfall, so they are obviously not going to converge with the other groups.) The idea is that monetary and fiscal policy need to be coordinated, instead of a monetary policy-centric viewpoint that was the consensus before the crisis. In this article, I augment his analysis by applying the labour market analysis Minsky originally developed in the 1960s.