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2010 | OriginalPaper | Buchkapitel

15. Background and Tools for Understanding and Dealing with Recurrent Financial Crises

verfasst von : Lester D. Taylor

Erschienen in: Capital, Accumulation, and Money

Verlag: Springer US

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Abstract

The events since 1970 make it clear that current-day mainstream macroeconomics does not provide an adequate framework for dealing with the financial crises that are increasingly part and parcel of free-market economies. As noted by Skidelsky (as well as others), the financial collapse of 2007–2009 reflects in great part “the intellectual failure of mainstream economics.” Neither of what are now the two standard textbook macroeconomic frameworks, the New Keynesian and New Classical Models, even admit of the possibility for financial crises to emerge, let alone offer provision for their alleviation. The problem is that neither framework allows for money to play its truly unique real-world role, namely, that of a risk-free store of value in the face of uncertainty. Missing, as well, is any notion in either model of a theory of production in which investment is determined not only by present-value considerations, but also by the availability and terms of finance. The purpose of this chapter is to develop a framework, based in substantial part on the long overlooked Chaps. 12 and 17 of the General Theory (and the equally overlooked work of the late Hyman Minsky), in which money and finance, on the contrary, are center-stage in determining the level and pace of economic activity. Our point of departure will be a revisit of uncertainty and liquidity preference as described and discussed by Keynes in Chap. 17 of the General Theory and in his 1937 rebuttal of Viner in the Quarterly Journal of Economics.

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Vorheriges Kapitel Themes and Counterthemes: Fluid Capital in Retrospect

Nächstes Kapitel Booms, Busts, and Financial Panics: The Financial Meltdown of 2007–2009

Skidelsky (2009, p. 168).

These two research programs have essentially dominated academic macroeconomic research since the 1970s. The New Classical Model derives from the “Rational Expectations Revolution” associated with Robert Lucas, Jr., Thomas Sargent, Edward Prescott, Finn Kydland, Robert Barro, and others, while the New Keynesian Model is based upon the thinking of John Taylor, Olivier Blanchard, Gregory Mankiew, David Romer, Michael Woodford and others. Hoover (1988) and Woodford (2003) provide textbook treatments and discussions of the two models. Cf., also, Woodford (2009). For devastating critiques of the current-day conventional macroeconomic theory in terms of its irrelevance to the 2007–2008 financial meltdown, see Buiter (2009), Krugman (2009), Skidelsky (2009), and the July 18–24th, 2009, issue of The Economist (pp. 65–69).

Keynes (1937a).

This stricture, it is important to note, does not apply (in the United States) to the so-called Post-Keynesian interpreters (Paul Davidson, Hyman Minsky, and others) of the General Theory, for whom Chaps. 12 and 17 of the GT play a critical role.

Ibid., p. 114.

Like a fog or vapor that can enter and leave the collective psyche (with apologies to Sandburg) like a “cat on silent little feet.”

Cf., Shackle (1974, p. 76). Shackle (1967, Chapter 15) provides (in the author’s opinion) far-and-away the best exposition of the liquidity preference theory of interest, better even than Keynes’s own in the General Theory and his 1937 QJE paper.

Or what henceforth will be referred to as simply the basis.

Indeed, the usual effect on expected quasi-rents of an increase in uncertainty will be to reduce expected revenues and increase expected avoidable costs, a double whammy that might in itself be sufficient to kill what had been a planned investment.

Obviously, these effects are reversed for a change in basis that reduces uncertainty.

Cf., Minsky (1975, Chap. 5).

As Minsky mentions, this “falling away” could start even before the point I ^*.

Cf., also, Duesenberry (1958, Chap. 5).

See Chap. 4 of Minsky (2008).

Public finance becomes Ponzi finance when governments are forced to borrow in order to pay the interest due on the public debt.

Recall (from Chap. 5) that avoidable cost in this context refers to the cost of all inputs that vary with the rate at which a plant is operated, most of which will consist of materials and labor costs. Also, as in Chap. 5, if the firm has multiple plants of differing efficiency, it is assumed that the avoidable cost curve is constructed from left to right in terms of plants of decreasing efficiency.

Pretty much the standard terminology, after Hicks (1972), for these two types of markets is fix-price and flex-price.

Cf., Minsky (2008, p. 179).

Minsky, in his various writings, usually refers to quasi-rents as here defined as gross profits (or often simply as profits).

An advantage of this way at looking at the burdens of quasi-rents is that, for firms with market power in their product markets (i.e., face demand curves with at least some downward slope), it allows for income taxes to be viewed as input into pricing decisions, as opposed to their incorporation into present-value calculations [as in the manner of Jorgenson (1996) and his followers].

Firms in the airline industry are especially fragile in this regard, for, in the short run, most costs are fixed, and what avoidable costs there are tend to increase only gently with utilization. Hence, competition that drives prices toward marginal avoidable cost often leaves insufficient revenues to cover the fixed costs. Essentially the only market power that most airlines have is to price seats non-linearly in the very short run, so as to extract as much consumer surplus as possible according to individual passengers’ willingnesses-to-pay.

This way of addressing firms’ pricing decisions yields yet another useful observation. Since a firm facing contractual payment commitments has strong incentives to cut costs, this occurs in many cases by transferring a good part of direct production costs off-shore (i.e., through outsourcing). The extreme, of course, is where production is totally off-shore, with output coming back into the country as imports. In this case, the unit cost of output becomes a fixed cost that has to be covered by price in the same way as any other non-production-varying cost. While total costs are obviously decreased by this process, prices will almost certainly be reduced less in flex-price markets than in fix-price markets. A second consequence relates to the impact on the distribution of income. Many of the jobs that are lost in an outsourcing will be high-wage blue-collar jobs that those laid off cannot find elsewhere, with the result that, for them, the only alternative is a lower-wage job in a service industry. On the other hand, some (though obviously not all) of the production jobs lost in the outsourcing will be offset through the hiring of new non-production workers, some of which will be at a lower wage than for the blue-collar jobs lost and some at a much higher wage. In either case, the result will be a worsening of the distribution of income.

A few additional examples of this principle in operation include exits from theaters, ATM machines, and even public restrooms!

The two terms are intended to distinguish between those whose activities tend to make markets more efficient (speculators) and those whose motivation is to outwit the expectations of existing conventional bases (wagers).

Put another way, a rising asset market is bumptious, and draws attention to itself.

“Speculators [our wagers] may do no harm as bubbles on a steady stream of enterprise. But the position is changed seriously when enterprise becomes the bubble on a whirlwind of speculation. When the capital development of a country becomes a by-product of the activities of casino, the job is likely to be ill-done.” (Keynes, General Theory, p. 159)

A simple example involving an economy with a firm, a commercial bank, an investment bank, and a saver will hopefully add clarity at this point. Assume (1) that the saver saves 100 dollars out of his/her current income, (2) that the firm undertakes to invest in new capacity at an expected cost of US $85, which (3) is financed by a loan of that amount from the commercial bank. Assume that both the construction period and the period of the loan is 1 year. The addition is completed, the firm then sells new equity shares in the firm to the investment bank for US $85 (which also had been borrowed from the commercial bank), which it uses to pay off its US $80 loan (plus interest of US $5) to the commercial bank. The investment bank then sells the new equity shares in the firm to the saver for US $95, which the saver pays for by drawing down his/her savings deposit at the commercial bank. The investment bank then uses the proceeds to pay off its loan of US $85 from the commercial bank (plus interest of US $2), thereby keeping US $8 as an underwriting fee. Question: What is the maximum that the saver could have paid (in the absence of any new money creation) for the new shares? Clearly, the most that could be paid would be US $100, which is the point being made in the text.

It might seem that, in view of standard capitalization procedures, the wealth of an economy would be calculated as the present value of the prospective stream of its National Income. However, for this to hold would require that there be some entity with both sufficient wherewithal and willingness-to-pay to purchase it at such a “price.”

Put another way, we ordinarily think of the value of money in terms of prices of goods and services. However, we must also think of the value of money in terms of the prices of assets (both real and financial), which connects money to liquidity preference.

Banks are unique amongst financial intermediaries in that, while anyone, by penciling a promise to pay, can create a potential means of payment, banks’ liabilities are actually accepted as money. However, since banks not only operate according to the Banking Principle in pursuing profit, they are also subject, in times of financial distress, to the brutal devastation of the Banking Disease.

To attempt to visualize uncertainty is a bit like the remark of the great theoretical physicist Paul Dirac concerning quantum mechanics: “To draw its picture is like a blind man sensing a snowflake. One touch, and it’s gone.” (Farmelo 2009, p. 146)

The words of Bagehot (1873, p. 24) come to mind at this point that, in times of financial crisis, money should be freely available, but at a penalty rate. While Bagehot was obviously focused on the circumstances of his time, the admonition to lend at a penalty rate also makes sense in modern-day panics because of the strong incentive it provides for excessive liquidity to be removed once a crisis passes.

It should be emphasized that the reference here is to the effect of a collapse of confidence on the entire consumption function, not movement along a given consumption function caused by changes in income. The sharp increase in the US personal saving rate in late 2008 and early 2009 is a case in point.

See Minsky (2008, Chap. 13, pp. 330–343).

All data are from the Economic Report of the President (2009).

This “shortfall” of US $700 billion in federal spending vis-à-vis private investment for 2007 puts an interesting perspective on the US $787 billion “stimulus” package passed by the US Congress in early 2009.

This is not a political (or moral) argument for greater federal spending as a proportion of GDP, but rather just a statement of an arithmetical fact. The deficit-spending of the 1930s was unsuccessful in eliminating unemployment because it was simply not large enough in relation to the collapse in private investment.

Bagehot, W. (1873), Lombard Street: A Description of the Money Market (reprint, The Echo Library, 2005).

Buiter, W. (2009), “The Unfortunate Uselessness of Most ‘State-of-The-Art’ Academic Monetary Economics,” Financial Times, http://www.blogs.ft.com/maverecon/, March 3, 2009.

Duesenberry, J.S. (1958), Business Cycles and Economic Growth, McGraw-Hill, New York.

Economic Report of the President (2009), U.S. Government Printing Office.

Farmelo, G. (2009), The Strangest Man: The Hidden Life of Paul Dirac, Quantum Genius, Faber and Faber, Ltd, London.

Hicks, J.R. (1972), Economic Perspectives, Clarendon Press, Oxford.

Hoover, K.D. (1988), The New Classical Macroeconomics: A Sceptical Inquiry, Basil Blackwell, Oxford.

Jorgenson, D.W. (1996), Capital Theory and Investment Behavior, MIT Press, Cambridge.

Keynes, J.M. (1937a), “The General Theory of Unemployment,” Quarterly Journal of Economics, Vol. 51, No. 2, pp. 209–23.CrossRef

Krugman, P. (2009), “How Did Economists Get It So Wrong,” New York Times Magazine, http://www.nytimes.com/2009/09/06/magazine, September 2, 2009.

Minsky, H.P. (1975), John Maynard Keynes, Columbia University Press, New York.

Minsky, H.P. (2008), Stabilizing an Unstable Economy, McGraw-Hill, New York, (First Edition, Yale University Press, 1986).

Shackle, G.L.S. (1967), The High Years of Theory, Cambridge University Press, Cambridge.

Shackle, G.L.S. (1974), Keynesian Kaleidics, Edinburgh University Press, Edinburgh.

Skidelsky, R. (2009), Keynes: The Return of the Master, Public Affairs.

Woodford, M. (2003), Interest and Prices: Foundations of A Theory of Monetary Policy, Princeton University Press, Princeton, NJ.

Woodford, M. (2009), “Convergence in Macroeconomics: Elements of the New Synthesis,” American Economics Journal: Macroeconomics, Vol. 1, No. 1, pp. 267–79.CrossRef

Titel: Background and Tools for Understanding and Dealing with Recurrent Financial Crises
verfasst von: Lester D. Taylor
Verlag: Springer US
Buch: Capital, Accumulation, and Money
Print ISBN: 978-0-387-98168-0

Electronic ISBN: 978-0-387-98169-7

Copyright-Jahr: 2010
DOI: https://doi.org/10.1007/978-0-387-98169-7_15