Hyman Minsky was not a guiding light for MMT

I am currently working on a book commissioned by Edward Elgar which will form an anthology of influential Modern Monetary Theory (MMT) literature – how it evolved – with a long introduction by me tying all this literature together. It has been a simmering project for the last 18 months and I haven’t mentioned it here until now. The first task was to assemble the literature and then the next task was that the publisher (EE) has to get copyright clearance from the original holders. The second process has taken some time and I have had to alter the proposed table of contents because we cannot get copyright clearance. The reason I mention this is that the work of Hyman Minsky is not among the literature I have selected as being influential in the intellectual development of MMT. That is not to say that some of his earlier work was of no interest. Quite the contrary. But when he makes statements that appear to be consistent with MMT propositions, he is, in my view, just channelling the likes of Abba Lerner and his functional finance. But later in his career, Minsky started to articulate ideas that were consistent with ‘sound finance’, which Lerner had opposed, and, which is anathema to MMT.

Many readers have E-mailed me in the last week after becoming aware of a rare video of – Hyman Minsky at Westminster College SLC – speaking in Salt Lake City on October 30, 1991.

The video and audio quality is very poor and the presentation goes for 1:32:59, so I congratulate anyone who bothered to watch the entire thing.

What prompted the E-mails, it seems, were comments made by Minksy starting around the 47 minute mark about the viability of government debt and fiscal deficits.

He is seen to be advocating what we call ‘sound finance’ the anathema to the ‘functional finance’, which underpins aspects of Modern Monetary Theory (MMT).

He says things such as:

1. “the government must validate our debt with taxes”.

2. In the context of rising government deficits in the 1980s, he claimed that “the quality of the government’s debt in international markets is deteriorating”.

3. “we lack the will to tax ourselves so that the government liabilities are fully validated by receipts”.

There were many other similar statements in the video, which appears to amount to a rejection of basic MMT propositions.

And that should not come as a surprise.

Earlier in his career, Hyman Minsky advocated Abba Lerner’s functional finance.

As my American MMT colleagues like to remind us, Minsky wrote in 1959 (in the paper, Bank Portfolio Determination):

Government securities are typical widely held. As the government has the sovereign right to issue fiat money, government debt is safe from danger of default of either interest or principal when due. If short dated they will not fluctuate much in market values whereas if longer dated they will fluctuate in market value as the current market interest rate varies. Hence government debt serves as an interest earning asset which is marketable. Being marketable they can be used to replenish the bank’s reserve position when there is an unusual loss of reserves.

This was in the context of how banks could reduce their risk exposure by buying more government bonds.

But later in his career, Minsky seemed to shift and started to advocate what we now term to be ‘sound finance’ principles merging with a softer ‘deficit dove’ narrative.

The difference between these two approaches is not hard and fast.

The idea that what is good for the homebuyer or a corporation is good for the government is a very typical progressive Keynesian argument used to defray the monetarists and others who eschew all fiscal deficits.

So it is a common ploy by ‘deficit doves’ who think deficits are fine as long as you wind them back over the cycle (and offset them with surpluses to average out to zero) and keep the debt ratio in line with the ratio of the real interest rate to output growth.

Torturous formulas are provided to students on all of this under the presumption that the government does have a financing constraint but as long as it is cautious things will be fine.

So just as a household or corporation can benefit by increasing their debt levels to expand their wealth or business as long as a sensible return is made that permits the servicing and payback the debt, the government can also benefit by increasing debt.

That is the argument. You can see the problem immediately. It presumes an analogy between an entity (household or corporation) which uses the fiat currency and is thus financially constrained in its spending – and an entity (the sovereign government) which is the monopoly issuer of the fiat currency that clearly has no financial constraint.

It presumes that the debt in some way ‘funded’ the government spending and was not used to defend the central bank’s interest rate targets.

It presumes that the sovereign government needs to generate a monetary return (how?) to repay the debt without problems.

As a conception of how a fiat monetary system works – it is just plain wrong.

Abba Lerner developed his notion of functional finance as a counter to what he called ‘sound finance'” (which is the precursor of modern mainstream (neo-liberal) thinking).

He juxtaposed the his “economics of control” policy thinking with the dominant laissez-faire approach that prevailed during the Great Depression.

Sound finance was all about fiscal rules – the type you read about every day even these days. So the goal is to balance the fiscal outcome over the course of the business cycle and only increase the money supply in line with the real rate of output growth; etc.

Lerner thought that these rules were based more in conservative morality than being well founded ways to achieve the goals of economic behaviour – full employment and price stability.

He said that once you understood the monetary system you would always employ functional finance – that is, fiscal and monetary policy decisions should be functional – advance public purpose and eschew the moralising concepts that public deficits were profligate and dangerous.

I consider that Hyman Minsky shifted from his earlier view that were consistent with Abba Lerner’s functional finance to a more ‘deficit dove’ position (bordering on ‘sound finance’) later in his career.

None of his later positions are consistent with Modern Monetary Theory (MMT).

Earlier work

Minsky is well-known for his work on financial instability, which seemed to help explain the GFC.

The mainstream had basically disregarded this aspect of Minsky’s work before the crisis because he was seen as operating in the Post Keynesian tradition, the anathema to the neo-liberalism of New Keynesian economics, the dominant paradigm of modern macroeconomics.

Once the GFC hit, a lot more people were claiming to know about Minsky and quoting him. Sort of a reversal of the phenomenon of ‘No Nazis to be found in Germany after 1945’.

Suddenly, everyone wanted to talk about financial fragility and over the last five years, the link to Minsky has faded as these new ‘experts’ try to take credit for warning the world about financial cycles. It was ridiculous really how brazen these characters are.

Two questions are raised by the aggregate demand structure above. First, what motivates and enables the private sector to run deficits over extended periods? Second, how long can this process continue?

Minsky’s Financial Fragility hypothesis provided insight into the motivations and enablers of private sector deficits and the viability of sustained private deficits.

The type of economic system envisaged by Minsky is a modern capitalist system consisting of long-lived, expensive, and privately owned capital assets with sophisticated financial arrangements (debt contracts) designed to fund the acquisition of such assets.

For Minsky, it is the processes and consequences of the investment in such capital assets in a modern capitalist system that forms the theoretical crux of the Financial Fragility hypothesis.

I discussed that hypothesis in detail in this blog (2010) – Counter-cyclical capital buffers.

By way of summary, the Financial Fragility hypothesis has two fundamental propositions:

• First, the economy has financing regimes under which it is stable and financing regimes under which it is unstable.
• Second, expansions driven by private spending are typified by agents taking increasingly fragile investment positions.

The articulation between expected income cash flows and contractual obligations are what Minsky terms ‘financial relations’ with three categories being identified:

• An investor is hedge financing if realised and expected income cash flows are sufficient to meet all their payment commitments.
• An investor is engaged in speculative financing if their balance sheet cash flows exceed expected income receipts and they roll-over existing debt.
• An investor becomes a Ponzi financial unit if they increase debt to meet the gap between their balance sheet cash flows and expected income receipts. So unlike hedge units, speculative and Ponzi financing units must engage in portfolio transactions to fulfill their payment commitments.

It is the relative weight of income, balance sheet, and portfolio payments in an economy that determines the vulnerability of the financial system to disruption. An economy in which income cash flows are dominant in meeting payment commitments is relatively immune to financial crises whereas an economy is potentially financially fragile and crisis-prone if portfolio transactions are relied on for meeting payments.

Over a period of prolonged prosperity, the economy endogenously transits from stable financial relations (an aggregate liability structure dominated by hedge finance) to unstable financial relations (an aggregate liability structure dominated by speculative and Ponzi finance).

While I am attracted to this approach to financial dynamics I do not see it as a core MMT idea.

Further, the causality is contestable. Minsky considered that it was lax lending by banks that led too much credit and pushed the economy into crisis.

However, it is also clear that a deteriorating economy led by traditional Keynesian concerns relating to pessimism of business firms over future sales that causes fluctuations in investment and economic activity, which in turn cause spending failures, lead to credit defaults and bank failures.

This perhaps can be cast in terms of whether a specific recession is sourced in balance sheets (source – financial sector) or investment pessimism (source – real economy).

Historically, more recessions have begun in the real sector than in the financial sector. The GFC is an exception rather than the rule.

Others think that the fact that Hyman Minsky advocated a public ’employer of last resort’ (that is, a Job Guarantee) he must be a driver of MMT.

But the Job Guarantee proposal does not come from Hyman Minsky even though he advocated a partial version of the idea. The difference is that the MMT-version of the Job Guarantee, full employment is used to stabilise prices. Minsky’s ELR idea never had that feature – it was a just a job creation program.

It is also clear that Hyman Minsky has been a champion of John Maynard Keynes’ The General Theory of Employment, Interest and Money and used Keynes’ ideas on endemic uncertainty to challenge the Monetarist ideas regarding rational expectations.

In his 1975 book – John Maynard Keynes – Minsky clearly extended the approach of Keynes to outline an economics where equilibrium (stability) was not the norm. Keynes had considered the monetary economy would equilibrate (reach a state of rest) at unacceptably high unemployment rates.

Minsky went further and advanced his financial instability hypothesis, which described, in his view, the intrinsic characteristics of the capitalist monetary system.

In this work, he also departed from Keynes, by downgrading the importance of monetary policy in stabilising fluctuations in economic activity.

In that context, he promoted the primacy of fiscal policy. In his 1986 book – Stabilizing an Unstable Economy – he wrote (p.304):

Fiscal policies are more powerful economic control weapons than monetary manipulations.

In Minsky’s words, government fiscal policy must be the primary counter-stabilisation tool.

This is consistent with MMT but really reflects the prior insights provided by economists like Abba Lerner, who introduced the notion of functional finance to the literature.

Please read my blog – Functional finance and modern monetary theory – for more discussion on this point.

In the video I mentioned at the outset, you will hear Minsky talk about the government using its “steering wheel” to offset the negative consequences of a decline in non-government spending.

This is straight functional finance.

Chapter 1 of Lerner’s 1951 book The Economics of Employment, was really a rewritten version of the 1941 article The Economic Steering Wheel where he elaborated his version of Keynesian thinking. He began the book as such (1951: 3-5):

Our economic system is frequently put to shame in being displayed before an imaginary visitor from a strange planet. It is time to reverse the procedure. Imagine yourself instead in a Buck Rogers interplanetary adventure, looking at a highway in a City of Tomorrow. The highway is wide and straight, and its edges are turned up so that it is almost impossible for a car to run off the road. What appears to be a runaway car is speeding along the road and veering off to one side. As it approaches the rising edge of the highway, its front wheels are turned so that it gets back onto the road and goes off at an angle, making for the other side, where the wheels are turned again. This happens many times, the car zigzagging but keeping on the highway until it is out of sight. You are wondering how long it will take for it to crash, when another car appears which behaves in the same fashion. When it comes near you it stops with a jerk. A door is opened, and an occupant asks whether you would like a lift. You look into the car and before you can control yourself you cry out, “Why! There’s no steering wheel!”

“Of course we have no steering wheel!” says one of the occupants rather crossly. “Just think how it would cramp the front seat. It is worse than an old-fashioned gear-shift lever and it is dangerous. Suppose we had a steering wheel and somebody held on to it when we reached a curb! He would prevent the automatic turning of the wheel, and the car would surely be overturned! And besides, we believe in democracy and cannot give anyone the extreme authority of life and death over all the occupants of the care. That would be dictatorship.”

“Down with dictatorship!” chorus the other occupants of the car.

“If you are worried about the way the car goes from side to side,” continues the first speaker, “forget it! We have wonderful brakes so that collisions are prevented nine times out of ten. On our better roads the curb is so effective that one can travel hundreds of miles without going off the road once. We have a very efficient system of carrying survivors of wrecks to nearby hospitals and for rapidly sweeping the remnants from the road to deposit them on nearby fields as a reminder to man of the inevitability.”

You look around to see the piles of wrecks and burned-out automobiles as the man in the car continues. “Impressive, isn’t it. But things are going to improve. See those men marking and photographing the tracks of the car that preceded us? They are going to take those pictures into their laboratories and pictures of our tracks, too, to analyze the cyclical characteristics of the curves, their degree of regularity, the average distance from turn to turn, the amplitude of the swings, and so on. When they have come to an agreement on their true nature we may know whether something can be done about it. At present they are disputing whether this cyclical movement is due to the type of road surface or to its shape or whether it is due to the length of the car or to the kind of rubber in the tires or to the weather. Some of them think that it will be impossible to avoid having cycles unless we go back to the horse and buggy, but we can’t do that because we believe in Progress. Well, want a ride?”

In other words, macroeconomics was all about “steering” the fluctuations in the economy. Fiscal policy was the steering wheel and should be applied for functional purposes. Laissez-faire (free market) was akin to letting the car zigzag all over the road and if you wanted the economy to develop in a stable way you had to control its movement.

His 1986 book outlined the way in which fiscal policy should be used. He advocated using fiscal policy to advance full employment but recognised that the private economy was not stable enough to ensure that state could be continuously maintained without government intervention.

In that context, he advocated the “employer of last resort” but it was really his belief that it would reduce government spending on transfer payments that attracted him to this approach.

He thought the impact on the fiscal balance would be small, whereas MMT proponents argue that the ‘cost’ of the Job Guarantee cannot be considered in terms of $ values in the fiscal statements. The latter are not policy concerns for MMT.

He also advocated using fiscal policy to reduce unemployment in order to stimulate private profits.

Even so, his earlier work was operating in the functional finance tradition which made it consistent with the way we have expressed MMT.

Minsky moves to sound finance

His 1986 book appeared to be a turning point. Minsky’s ‘sound finance’ path really began in 1986 with the release of that book – Stabilizing an Unstable Economy (Yale University Press).

Whereas he had previously considered government debt to be a stabilising force (to allow banks to diversify into risk-free assets etc) he changed his view in the 1980s when Ronald Reagan was President.

At this point, he increasingly argued that government debt was at risk of becoming non-credible in the face of non-government bond investors.

In his 1986 book, he wrote (pp.302, 304):

A government can run a deficit during a recession without suffering a deterioration of its creditworthiness if there is a tax and spending regime in place that would yield a favourable cash flow (a surplus) under reasonable and attainable circumstances …

Any deviation from a government budget that is balanced or in surplus must be understood as transitory- the war will be over, the resource development program will be finished, or income will be at the full employment level

His main message was that the fiscal outcome should be in balance or in surplus at full employment. However, that is not the MMT position at all.

I outlined the MMT position in this blog – The full employment fiscal deficit condition.

The point is that if the non-government sector desires to net save overall (taking into account the mix of private domestic and external sector balances), the government sector must run a deficit or else national income will change.

So, if at full employment, the non-government sector as a whole does not desire to spend all its income, then the government must run continuous deficits.

The idea of establishing some norm that a ‘balanced or surplus budget’ is the preferred outcome averaged over the economic cycle is soft neo-liberalism.

The Levy Institute in New York State has championed papers by Hyman Minsky that have advocated ‘sound’ rather than functional finance.

Building on his 1986 book, Hyman Minsky produced Working Paper 51 for the Levy Institute in April 1991 – Financial Crises: Systemic or Idiosyncratic – which was a paper presented at a Levy conference in that month.

The paper was about how the financial system could be ‘fixed’ in the face of increasing uncertainty from events such as the Savings and Loan crisis in the 1980s.

He constructed the Savings and Loan crisis in “Keynesian” terms as:

… the result of a tendency, over protracted periods of good times, for sectoral ndebtedness to outrun the ability of sectoral cash flows to validate the contracts. The current problem is not how to bail out the deposit institutions but how to sustain asset values and profit flows so that investment does not collapse and usher in a deep and long depression.

In terms of the government sector, he wrote (p.28):

The government is no different than any other organization in that it needs revenues to validate its debts. This means that the government should have a normal conditions balanced budget, allowing for deficits in recessions and depressions and major wars.

This is not an MMT position – not even remotely.

He wrote further (p.29) that:

Indexing as a mechanical device in social security and government pensions should be abolished, so that inflation leads to a substantial budget surplus.

Again, this is nothing that MMT proponents would advocate.

Finally, he wrote (p.29):

The main role of government spending is macroeconomic, to promote conditions that sustain profit flows. The microeconomic impact of government spending should aim to create conditions conducive to resource creation and to enterprise.

My MMT thinking tells me that the main role of government spending is to advance societal well-being, which may or may not be conducive to sustaining private profits.

Public goods and services, which generate no private profit (directly) are important sources of societal well-being.

In April 1996, Minsky produced another Working Paper (No. 155) for the Levy Institute – Uncertainty and the Institutional Structure of Capitalist Economies – which reinforced the view that he was advocating sound finance.

He wrote (pp.4-5):

Our rich economy has ample available resources for investment in people and in the material infrastructure of society. The question is not of the resources, but of a willingness to mobilize these resources, i.e. to tax and borrow for such projects. Poverty in the United States is due to an unwillingness to tax. Welfare, in the form of aid to families with dependent children, exist because it is the cheapest way, sort of a policy to let them die, of taking care of the population in want. Foster homes, orphanages and guaranteed work for parents are all more expensive …

The smart government that offsets the aggravated uncertainty associated with money manager capitalism will need adequate resources to support activities and to validate the government debt which accumulates as the contracyclical and even longer deficits accumulate.

Government debt, like any other debt, has to be validated by government revenues. A tax system adequate to support government employment and resource creating activities is needed. The explosion of the government debt relative to gross domestic product over the 12 years of Reagan-Bush was largely due to an irresponsible fiscal policy, which undermined the revenue system even as it did not reign in government spending, mainly on defense but also on transfer payments. In the present circumstances the role of tax policy is to assure that a downward trend in the ratio of Federal Debt to Gross Domestic Product rules, so that over a span of years the ratio of debt to income is lowered from the present 65% to about 50%.

Conclusion

I will not try to explain why I think this intellectual shift occurred in Minsky’s work in this blog – that would take me too long and is not something I am particularly interested in writing about, given that I don’t see Minsky’s work as being central to the development of Modern Monetary Theory (MMT).

I hope that answers some of the issues you have raised in this context.

And, if you haven’t already viewed the Minsky video on YouTube I would not waste any time doing so.

That is enough for today!

(c) Copyright 2016 William Mitchell. All Rights Reserved.