II ENCONTRO INTERNACIONAL 2ND INTERNATIONAL

CONFERENCE Basic Principles for Formulating

Crisis Policy

Jan KregelDirector, Monetary Policy and Financial Structure Program,

Levy Economics Institute of Bard College,Distinguished Research Professor

Center for Full Employment and Price Stability, University of Missouri, Kansas City

Why is Post Keynesian theory absent from crisis policy framework?

• The Crisis should have been the Golden Opportunity

• Return of Government Stimulus• Recognition of Minsky Moment• But Policy has taken little notice• Basic Discussion in G-20 – EXIT STRATEGY– RISK OF INFLATION

Does Crisis Produce Shift in Policy Paradigm?

• Crisis Produces “Left Wing” Government that Adopt Non-Keynesian Policies– UK – Keynesian Policy introduced to Fight the War– US -- Roosevelt – Supported Fiscal Surplus– Brazil -- Lula – Supported Fiscal Surplus– Argentina -- Kirchner– Supported Fiscal Surplus

Stimulus is Evaluated in Terms of

• Impact on the size of sustainable deficit• Impact of “Ricardian Equivalence” on Spending• Impact on Inflation• Impact on External Balance – Value of Dollar• Impact on Role of the Dollar as Reserve

Currency• Planning for “Exit” Strategy– For Government Spending– For Central Bank support of Financial System

How to Communicate

• How do we convey the Basic Principles? • How do we get them into Policy discussion?• Is there another way to do this?• What are the Basic Principles we want to

defend?

Some basic principles -- I• Marx: market capitalism based on ownership• Minsky: ownership is financed by debt– Investment driven economies multiply debt– Real wage driven consumption is more stable

• Whithers: loans create deposits– Money is endogenous

• Robertson: reserves are endogenous • Kahn: banks hold debt not held by the public• Keynes: economy is demand constrained– Government deficit allows private dissaving– Cutting wages will not increase demand

• Kalecki: Increasing profits will not increase demand

Some basic principles -- II• Lerner: Functional Finance

– taxes don’t balance budget they balance the economy

• Innis- Knapp: government not tax constrained• Domar: economy is not supply constrained– There is no internal debt constraint– There is no external deficit constraint

• Keynes: Let finance be national – – capital controlled by policy decision not markets

• Triffin Dilemma: cannot be solved by substituting Dollar

• Prebisch-Myrdal-Nurkse: – Reject Static Comparative Advantage

Private property Market economy (Marx)

• Everything must be owned—no free goods– Government determines what can be owned

• Capital assets– Financial Markets– Disposition of physical assets– Rights to services – non-physical assets

• Labour power—Labour Markets• Consumption Goods – Retail markets

• Only those things that can be owned can be traded in the market– Law of contract determines the “market”

• Without Government there is no market economy

Basic characteristic of Capitalist System (Minsky)• Requires large scale, long-lived, capital intensive

production• Thus, under a private property market economy “debts

are used to finance control over capital assets”• Ownership a claim on future income that must validate

the debt used to acquire control of the asset• Financing can be “to-the-asset” or “to-the-person”• Incorporation allowed “to-the-asset” financing to be

replaced by “to-the- person (corporation)” financing– perpetual liabilities to match infinite-lived corporations

• But also allowed short-term funding of long-term assets – maturity mismatch on balance sheets

Financial Institutions -- Banks• Assets are acquired by issuing debt• Income from assets must meet commitments on debt– Net interest margin – liquidity of liabilities greater than the

assets– “the fundamental banking activity is accepting, that is,

guaranteeing that some party is creditworthy” – “A bank loan is equivalent to a bank buying a note that it

has accepted. Banks make financing commitments because they can operate in financial markets to acquire funds (reserves) as needed

• Because banks also have a maturity mismatch – Banks hold assets that are negotiable in markets and hold

credit lines at other banks– Final ability to meet commitments – central bank lending

What determines final means of Payment?

• Has to be acceptable to all –Why can’t I issue generally accepted IOU’s?

• Because they can’t be used to extinguish my claims on others

• Innis: liabilities generally acceptable only if they can extinguish debts owed to you

• And everyone is indebted to you• Knapp: Only Govt is in this position

• by levying taxes it creates a general liability that can only be extinguished by its own liabilities

Constraints on Bank Lending• Banks lend, and then seek funding through

issue of liabilities • Hartley Withers – Loans Create Deposits• Dennis Robertson – central bank will always

provide the reserves required to meet the banks’ desired reserve requirements

• Central bank can set interest rate at which it provides reserves, but not the quanitity– Bank lending is thus endogenously determined

• Liquidity preference determines spread between assets and liabilities, bank profits

What determines asset values?• Ability to meet commitments on liabilities– Firms: • earnings from sale of asset services• ability to borrow from banks• sales of assets

– Banks: • payment of interest by firms• ability to borrow from central bank• sales of firms’ liabilities

What determines ability to meet commitments?

• Level of aggregate income– Expenditure by households and firms• Borrowing from banks

– Deficit expenditure by Government

• Ability to borrow from Central Bank– Acceptance of Banks’ assets– Acceptance of Firms’ assets– Acceptance of Government’s Liabilities

Crisis: failure to meet commitments

• Failure – private sector desire to save/hold liquid assets

• Can only be offset by Govt decision to dissave• Is there a limit to Govt dissaving to counter

Private sector desire to save?– Ability to raise taxes? Ability to borrow?

Is Government Investment expenditure constrained by Saving?

• This was the whole point of the Keynes-Kahn multiplier (and the source of hydraulic Keynesianism).

• Savings is always equal to investment since it is the endogenous variable, determined by income

• Basic National Income Equation– Private Sector Saving = Government Deficit

• Income is an endogenous variable determined by consumption and investment

Is Government spending constrained by its ability to borrow?

• Govt spending is financed by debiting the Treasury account at the Central Bank

• The spending is a credit to the private sector• The credit is a debit to the banking system– This creates excess reserves, OTBE– This drives down interbank lending rates to zero

• To keep interest rate target, govt must borrow• The borrowing is credited to Treasury account

Is Govt spending be capacity constrained?

• In the Domar version of the Harrod-Domar model, Domar shows that an act of investment by the government today to offset current private sector desire to save will increase productive capacity in future, leading to excess capacity in the future

• Demand thus cannot be capacity constrained• It cannot be inflationary except bottle necks

Is Govt credit rating constrained by outstanding debt?

• If Govt does borrow – Domar theorem on relative interest rates – debt to GDP ratio will converge to stable value

• If Govt lends abroad – Domar theorem on foreign lending rates below rate of increase in lending – current account surplus to GDP ratio will stabilise

• Same is true for Govt borrowing as long as it is denominated in domestic currency

Reform of International System• Triffin Dilemma -- National currency cannot

be a permanent store of value and source of global liquidity

• But, substitution of the dollar by some other national or private asset will not work

• Keynes – Control International Capital Flows– Let Finance be National

• Store of value cannot be a means of payment or created without multilateral policy agreement