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Congressman Ron Paul held a subcommittee hearing on reform of the Federal Reserve system a couple days ago that featured testimony from Senior Scholar James Galbraith, Alice Rivlin, John Taylor, Jeffrey Herbener, and Peter Klein.  There were a wide variety of topics addressed, including the size of the Fed’s balance sheet, proposals to make the Fed an arm of the Treasury, and changes to FOMC governance. Also raised was the question of whether to (formally) drop the employment side of the Fed’s dual mandate (because with unemployment at the dangerously low level of 8 percent and inflation sky high around 2 percent, clearly we’d be better off if the Fed were more like the ECB …).  As Galbraith recounts, he himself was part of the team that drafted the Humphrey-Hawkins Act (“at a time of acute theoretical conflict in economics,” he points out), and he offers his defense of the dual mandate here: As for the decided and observable tilt toward the price stability arm of the dual mandate, Galbraith collaborated on a working paper a few years back that identified the “real reaction function” of the Fed:  an aversion to full employment (“after 1983 the Federal Reserve largely ceased reacting to inflation or high unemployment, but continued to react when unemployment fell ‘too low.’”).  Although the working paper only… Read More

The recent Greek elections, which did not produce a party (or a viable coalition) with a majority in Parliament, have occasioned  a lot of excited speculation about Greece either leaving the eurozone or being nudged out.  Dimitri Papadimitriou comments today in a CNN Money piece about this possibility and offers a slightly more sober assessment, suggesting there are signs that European leaders may give Greece more leeway.  Read it here.

“In late 2007,” writes Peter Orszag, “the midpoint of the range that the Fed projected for real gross-domestic-product growth in 2008 was more than 2 percent.”  Most analysts were still expecting the fallout from the subprime crisis to be largely contained because, as Orszag puts it, their models “had at best a very rudimentary financial sector built into them.”  What would it have looked like to have taken finance more seriously?  In late 2007, Jan Kregel wrote the following in a Levy working paper: The stage is set for a typical Minsky debt deflation in which position has to be sold to make position—that is, the underlying assets have to be sold in order to repay investors. This will take place in illiquid markets, which means that price declines and, thus, the negative impact on present value will be even more rapid. In this environment, declining short-term interest rates can have little impact. . . . The damage from a debt deflation will be widespread—borrowers who lose their homes, hedge funds that fail, pensions that are reduced—so the net overall impact will be across a number of different sectors. However, in difference to what Alan Greenspan argued in defense of financial engineering to produce more complete markets—that it provided for a better distribution of risk across those who are willing… Read More

In last week’s Bloomberg column, Peter Orszag (former head of CBO and OMB) lamented that most “official forecasters” relied (and still rely) on economic models that led them to completely underestimate the severity of the downturn that resulted from the subprime mortgage crisis.  These “bad models,” as Bloomberg‘s headline writers call them, whiffed badly on the most critical economic question of the day, says Orszag, because they ignored financial leverage. Jared Bernstein points to Hyman Minsky as an economist whose work stands out for taking finance seriously.  But although Minsky’s account of financial fragility is fairly well known nowadays, less attention is being paid to his related proposals for reregulating and restructuring the financial system.  And as Jan Kregel and Dimitri Papadimitriou point out, there is an intimate connection between how we think about the generation of financial fragility and how we approach financial reform.  The limitations of the Dodd-Frank approach to regulation, we might say, are in part a reflection of our continuing neglect of the implications of the endogenous creation of instability: As Minsky emphasized, you cannot adequately design regulations that increase the stability of financial markets if you do not have a theory of financial instability. If the “normal” precludes instability, except as a random ad hoc event, regulation will always be dealing with ad hoc events… Read More

Levy Institute Senior Scholar James Galbraith was interviewed by the Washington Post‘s Brad Plumer about his new book Inequality and Instability:  A Study of the World Economy Just Before the Great Crisis.  Galbraith explains that the rises in inequality we’ve witnessed globally since the 1980s can be traced to changes in finance and the macroeconomy (“when something’s happening at the same time around the world, in different countries that are widely separated, that’s a macro issue”): Between the end of World War II and 1980, economic growth in the United States is mostly an equalizing force, and job creation isn’t dependent on rising economic inequality. But after 1980, economic booms and rising inequality go hand in hand. So what’s going on? In 1980, we really went through a fundamental transformation. We stopped being a wage-led economy with a growing public sector that was providing new services. Programs like Medicare and Medicaid were major drivers of growth in the 1970s. Instead, we became a credit-driven economy. What the evidence in the U.S. shows is that the rise in inequality is associated with credit booms, which are often periods of great prosperity. We had one in the late 1990s with information technology and one in the 2000s with housing, before everything fell apart. But this is also a sign of instability —… Read More

If there is a pundit on the topic of the Federal Reserve, surely William Greider is one. (Recall his famous book, Secrets of the Temple.) This recent piece from Greider in the progressive magazine the Nation offers  some helpful historical perspective on the role of the nation’s central bank in recent years.

In a good blog post for the Financial Times that did get money (mostly) right, Martin Wolf promised a Part II on the topic of appropriate monetary and fiscal policy in a “liquidity trap,” which he has provided here. Wolf also indicated he would write a piece on Modern Money Theory, an approach he does not address in either of these two articles. I look forward to that. Meanwhile, let me say that I do not disagree with the substantive points made in his Part II—which examines an article by Brad DeLong and Larry Summers. The main argument is this: when there is substantial excess capacity and unemployed labor, fiscal expansion is a “free lunch”. There really should be no surprise about that—it was a major conclusion of J.M. Keynes’s 1936 General Theory, and indeed already had some respectability even before his book. Expansionary fiscal policy can put otherwise unemployed resources to work, so we can enjoy more output. So what DeLong and Summers do is to show that given assumptions about the size of the government spending multiplier as well as a link between income growth and tax revenues (so that economic growth increases revenues from income taxes and sales taxes, for example) then it is entirely possible for a fiscal expansion to “pay for itself” in the sense… Read More

We may not have a high degree of success at predicting precisely when a financial crisis will occur or exactly how big it will be, but what we can and should do, says Éric Tymoigne, is develop effective ways of detecting and measuring the growth of financial fragility in a system.  “[S]ignificant economic and financial crises do not just happen,” he writes, “there is a long process during which the economic and financial system becomes more fragile.” One of the purposes of the Financial Stability Oversight Council (FSOC) that was created by Dodd-Frank is to provide regulators with an early warning system regarding threats to financial stability.  In light of this, Tymoigne provides his latest contribution to the construction of a measure of systemic risk and identifies specific areas in which we need better data.  With the aid of Hyman Minsky’s theoretical framework, Tymoigne has developed an index of financial fragility for housing finance in the US, the UK, and France.  The point is not to attempt to predict when a shock to the system is likely to occur, but to measure the degree to which such a shock would be amplified through a debt deflation.  From the abstract of his latest working paper: … instead of focusing on credit risk … financial fragility is defined in relation to the… Read More

That’s one of the questions the Levy Institute’s latest Strategic Analysis asks as it examines the Congressional Budget Office’s projections for growth and employment in the context of tighter and tighter government budgets.  At the federal level alone we’re facing a well-publicized “fiscal cliff” in 2013, featuring large scheduled spending cuts and the expiration of a number of tax cuts. As Dimitri Papadimitriou, Gennaro Zezza, and Greg Hannsgen note, the CBO “expects real GDP to grow by 2.2 percent in 2012 and by only 1 percent in 2013, and to accelerate once most of the fiscal adjustment has taken place, with growth reaching 3.6 percent in 2014 and 4.9 percent in 2015.  The unemployment rate is expected to rise to 9.1 percent with the slowdown in economic activity, and to fall rapidly from 2014 onward, once the economy recovers.”  This is all expected to take place in the presence of shrinking government deficits (based on the CBO’s “current law” projections for the federal budget). Using the CBO’s numbers, the Institute’s macro team ran a simulation to find out what would have to happen in the rest of the economy to make this combination of budget austerity and even tepid-to-moderate growth possible.  The answer:  dramatic increases in private sector borrowing.  Here’s their graph showing, through 2016, the rise in private sector… Read More

Over at his Concerted Action blog, Ramanan has a post featuring some of Wynne Godley’s Levy Institute publications with special attention paid to Godley’s prescient “Seven Unsustainable Processes,” which appeared in 1999 as part of the Levy Institute’s continuing Strategic Analysis series.  Ramanan (whose blog derives its name from Godley’s last Strategic Analysis [2008]) quotes this passage from “Seven Unsustainable Processes” in which Godley, in the context of the budget surpluses of the ’90s, contrasted his approach to macro modeling (and its policy upshots) with what he regarded as the “consensus view” at the time: The difference between the consensus view and that put forward here could not exist without a profound difference in the view of how the economy works. So far as the author can observe, the underlying theoretical perspective of the optimists, whether they realize it or not, sees all agents, including the government, as participants in a gigantic market process in which commodities, labor, and financial assets are supplied and demanded. If this market works properly, prices (e.g., for labor and commodities) get established that clear all markets, including the labor market, so that there can be no long-term unemployment and no depression. The only way in which unemployment can be reduced permanently, according to this view, is by making markets work better, say, by removing… Read More

From a February 2012 presentation delivered by Research Associate Michael Hudson: Suppose you were alive back in 1945 and were told about all the new technology that would be invented between then and now: the computers and internet, mobile phones and other consumer electronics, faster and cheaper air travel, super trains and even outer space exploration, higher gas mileage on the ground, plastics, medical breakthroughs and science in general. You would have imagined what nearly all futurists expected: that we would be living in a life of leisure society by this time. Rising productivity would raise wages and living standards, enabling people to work shorter hours under more relaxed and less pressured workplace conditions. Why hasn’t this occurred in recent years? In light of the enormous productivity gains since the end of World War II – and especially since 1980 – why isn’t everyone rich and enjoying the leisure economy that was promised? If the 99% is not getting the fruits of higher productivity, who is? Where has it gone? Read the rest here at Naked Capitalism.

Below is the abstract of a presentation to be delivered by Frank Veneroso on Monday April 30th (1:30pm) at the Levy Institute: Most orthodox explanations of what we call asset bubbles and financial crises attribute them to exogenous shocks to the economy.  For example, a Fed monetary policy error supposedly caused the Great Depression with its three great banking crises, and a Greenspan monetary policy excess led to the asset bubbles and eventual financial crisis of the last two decades. For Hyman Minsky financial fragility and eventual financial crisis was endogenous to capitalist economies.  Minsky saw this process occurring over two time frames.  First, over the course of a single business cycle, fading memories of the cash flow shortfalls of the most recent recession led to more positive profit expectations, greater fixed investment, a higher reliance on debt finance, and an overall condition of greater financial fragility.  In addition to this “financial instability” hypothesis appropriate to a single business cycle, Minsky also saw an endogenous process of ever greater financial fragility from business cycle to business cycle throughout the post war period.  This endogenous process resulted from ever greater bailouts by Big Government and the Big Central Bank in the recurrent post war recessions that threatened financial crisis and debt deflation.  In effect, an interplay between private risk taking and… Read More