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Financial regulation might stifle financial innovation. And that would be a good thing. But is it likely to happen?

(This is the testimony of Levy Institute Senior Scholar James K. Galbraith before the Senate Subcommittee on Crime, Senate Judiciary Committee, May 4, 2010.) Chairman Specter, Ranking Member Graham,  Members of the Subcommittee, as a former member of the congressional staff it is a pleasure to submit this statement for your record. I write to you from a disgraced profession.  Economic theory, as widely taught since the 1980s, failed miserably to understand the forces behind the financial crisis. Concepts including “rational expectations,” “market discipline,” and the “efficient markets hypothesis” led economists to argue that speculation would stabilize prices, that sellers would act to protect their reputations, that caveat emptor could be relied on,  and that widespread fraud therefore could  not occur. Not all economists believed this – but most did. Thus the study of financial fraud received little attention. Practically no research institutes exist; collaboration between economists and criminologists is rare; in the leading departments there are few specialists and very few students. Economists have soft-pedaled the role of fraud in every crisis they examined, including the Savings & Loan debacle, the Russian transition, the Asian meltdown and the dot.com bubble.  They continue to do so now.  At a conference sponsored by the Levy Economics Institute in New York on April 17, the closest a former Under Secretary of the Treasury,… Read More

There is nothing lovable about Goldman Sachs, and its recent grilling by the ominously named Senate Permanent Subcommittee on Investigations understandably drew a lot of attention. We should not, however, obscure the reality. Goldman Sachs is a bank, and except for questions about the Abacus deal, in which it’s accused of disclosure failings, Goldman was doing what modern banks do. In collateralized debt obligations and credit default swaps, it wasn’t the biggest player. So question for Congress isn’t whether Goldman did the right thing. The real question is, why on earth were banks allowed to do the things that Goldman was doing? The late Hyman Minsky had something to say about this. In a paper from 1993, he was clear-eyed about the role of institutions like Goldman: Essentially these operators have superior knowledge about their customers who need financing. . . and their customers who have a need for outlets in which money can be placed. They turn this private knowledge of the conditions under which funds are desired and the conditions under which funds are available to their own advantage, even as they perform the social function of selecting the investments that the economy makes. Each of these financial intermediaries, Minsky well knew, “has an agenda of its own: they are not charitable institutions.” But they play a crucial… Read More

On reading a recent post by Ed Dolan at Economonitor with some evidence of the lack of a strong Phillips relationship for consumer-price inflation in US data, it occurred to me to try a measure of total compensation per hour with recent data. The wage relationship estimated over all available quarters, using averaged monthly observations for the civilian unemployment rate, is shown above, with a scatter plot and an estimated regression line. Like the relationship estimated by Dolan, the regression line above suffers from a rather loose fit (constant: 6.87; slope coefficient: -.29; R-squared = .02). A complete explanation of inflation is complicated and of course also involves other costs, including raw materials such as fuel. The latter costs are subject of course to “cost-push”-type inflation at times, as are wages. Exchange rates of course affect these costs. A time series graph below displays both series over the entire sample period, 1948q1 to 2014q1. As some have observed, the exceedingly high unemployment rates of the post-financial-crisis era (blue line) have resulted in very weak or negative compensation growth rates (red line). The latter are not adjusted for inflation in the figures, since we are focusing on nominal data in this post.  The downward trend in nominal wage growth in the right side of the figure (red line) helps to explain… Read More

Previously we have argued that “taxes drive money” in the sense that imposition of a tax that is payable in the national government’s own currency will create demand for that currency. Sovereign government does not really need revenue in its own currency in order to spend. This sounds shocking because we are so accustomed to thinking that “taxes pay for government spending.” This is true for local governments, provinces, and states that do not issue the currency. It is also not too far from the truth for nations that adopt a foreign currency or peg their own to gold or foreign currencies. When a nation pegs, it really does need the gold or foreign currency to which it promises to convert its currency on demand. Taxing removes its currency from circulation making it harder for anyone to present it for redemption in gold or foreign currency. Hence, a prudent practice would be to constrain spending to tax revenue. But in the case of a government that issues its own sovereign currency without a promise to convert at a fixed value to gold or foreign currency (that is, the government “floats” its currency), we need to think about the role of taxes in an entirely different way. Taxes are not needed to “pay for” government spending. Further, the logic is reversed:… Read More

“The biggest obstacle to a sustainable recovery,” according to the Levy Institute’s newest strategic analysis of the US economy, “is the inequality in the distribution of income.” In their latest, Dimitri Papadimitriou, Michalis Nikiforos, Gennaro Zezza, and Greg Hannsgen begin with a familiar point: the Congressional Budget Office has been predicting fairly rosy economic growth rates for the coming years (rising to 3.4 percent in 2015 and ‘16)—rosy, that is, given the CBO’s expectation that government budgets will remain tight, and get even tighter, over this period (with the federal budget deficit shrinking to 2.6 percent of GDP by 2015). As Papadimitriou et al. point out, the only way to make these growth and budget forecasts both come true, assuming there are no significant changes in net exports (a safe assumption), is if the private sector substantially increases its indebtedness. There really isn’t any other option. If we don’t see a return to ballooning private debt-to-income ratios, then either government budgets will have to be loosened or we won’t get the growth rates the CBO is telling us to expect. Now, there are reasons to think that the reappearance of accelerated growth in private debt is unlikely (a theme the authors dealt with in their last US strategic analysis), but if it does happen, rising private debt ratios—which played the… Read More

Pavlina Tcherneva participated in a conference on youth unemployment at Middlebury College and shared her ideas for a youth employment safety net (beginning at 38:45): [iframe src=”//player.vimeo.com/video/89719577?title=0&amp;byline=0&amp;portrait=0″ width=”450″ height=”253″ frameborder=”0″ webkitallowfullscreen mozallowfullscreen allowfullscreen></iframe]

Economic pundits who predicted the collapse of the euro at the start of the eurozone crisis have been proven wrong. But those who say the crisis is over are equally wrong. Four years after the start of the euro crisis, the bailed-out countries of the eurozone (Greece, Ireland, Portugal, and Spain) are still facing serious problems, as the austerity policies imposed on them by the European Union (EU) authorities and the International Monetary Fund (IMF) not only failed to stabilize their economies, but actually made matters worse; in fact, much worse: the debt load increased substantially, national output was seriously undermined, unemployment reached potentially explosive levels, a credit crunch ensued, and emigration levels rose to historic heights. Because of these highly adverse effects, the citizens in the bailed-out countries have grown indignant and mistrustful toward parliamentary democracy itself, euroskepticism has taken firm roots, and a cleavage has reemerged between north and south. Take unemployment, for example. The current unemployment rates in the four bailed-out eurozone countries are: 27 percent for Greece; 25 percent for Spain; 15 percent for Portugal; and 12 percent for Ireland, the nation with the highest emigration rate in all of Europe, and whose government was actually asking the unemployed recently to leave and take jobs in other European countries. A similarly dramatic picture emerges when one… Read More

L. Randall Wray appeared on Thom Hartmann’s radio show yesterday for a lengthy and wide-ranging interview: [iframe width=”480″ height=”270″ src=”//www.youtube.com/embed/q8YND_N_6ms?feature=player_detailpage” frameborder=”0″ allowfullscreen></iframe]

In previous installments we have established that “taxes drive money.” What we mean by that is that sovereign government chooses a money of account (Dollar in the USA), imposes obligations in that unit (taxes, fees, fines, tithes, tolls, or tribute), and issues the currency that can be used to “redeem” oneself in payments to the government. Currency is like the “Get Out of Jail Free” card in the game of Monopoly. Taxes create a demand for “that which is necessary to pay taxes” (and other obligations to the state), which allows the government to purchase resources to pursue the public purpose by spending the currency. Warren Mosler puts it this way: the purpose of the tax is to create unemployment. That might sound a bit strange, but if we define unemployment as a situation in which job seekers want to work for money wages, then government can hire them by offering its currency. The tax frees resources from private use so that government can employ them in public use. To greatly simplify, money is a measuring unit, originally created by rulers to value the fees, fines, and taxes owed. By putting the subjects or citizens into debt, real resources could be moved to serve the public purpose. Taxes drive money. So, money was created to give government command over socially… Read More

Monetary Mechanics: A Financial View Éric Tymoigne “This paper presents an alternative framework that can be used to analyze monetary systems by drawing on the work of Smith, MacLeod, Knapp, Innes, Hawtrey, Keynes, Murad, Olivecrona, Wray, and Ingham, among others. The analysis asks what “money” is instead of what “money” does. Monetary instruments are not defined by what they do, or by what a researcher thinks they do, but by specific financial characteristics. By defining explicitly what “money” is, this framework provides some insights into past monetary systems and into monetary mechanisms.” Autonomy-enhancing Paternalism Martin Binder and Leonhard K. Lades “Behavioral economics has shown that individuals sometimes make decisions that are not in their best interests. This insight has prompted calls for behaviorally informed policy interventions popularized under the notion of “libertarian paternalism.” This type of “soft” paternalism aims at helping individuals without reducing their freedom of choice. We highlight three problems of libertarian paternalism: the difficulty of detecting what is in the best interest of an individual, the focus on freedom of choice at the expense of a focus on autonomy, and the neglect of the dynamic effects of libertarian-paternalistic policy interventions. We present a form of soft paternalism called “autonomy-enhancing paternalism” that seeks to constructively remedy these problems.” The Political Economy of Shadow Banking: Debt, Finance, and Distributive… Read More

MMT has emphasized that there is a close relation between sovereign power to issue a currency and its power to impose tax liabilities. For shorthand, we say “Taxes Drive Money.” I’ve dealt with that topic in the previous installments of this series on MMT’s view of taxes. We’ve also demonstrated (as if it needed demonstration!) that sovereign governments do not “need” tax revenue in order to spend. As Beardsley Ruml put it, once we abandoned gold, federal taxes became “obsolete” for revenue purposes. I’ll have more to say about good old Beardsley in the next installment. In today’s installment I want to step back a bit to ask a more fundamental question: does the issuer of a money-denominated liability need to obtain some of those liabilities before spending or lending them? In this installment I will examine three analogous questions (each of which has the same answer): 1. Does the government need to receive tax revenue before it can spend? 2. Does the central bank need to receive reserve deposits before it can lend? 3. Do private banks need to receive demand deposits before they can lend? If you’ve already answered “Of course not!”, you are probably up to speed on this topic. If you answered yes (to one or more), or if you haven’t a clue what the questions… Read More