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II ENCONTRO INTERNACIONAL 2ND INTERNATIONAL
CONFERENCE
Basic Principles for Formulating Crisis
Policy
Jan Kregel
Director, 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
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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
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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