Can the Government go Broke? An Examination of Hyman P. Minsky’s PositionL. Randall Wray, Levy Economics Institute and Bard College

Minsky’s early writings

Lerner and functional finance Big government and Big debt Financial instability Employer of last resort Sectoral balances

Minsky and Adelman 1960

“Much of the following is related to the principles of functional finance” Cites Economics of Control and Economics of Employment Shows: “the national debt which yields full employment at constant prices must grow. It

obviously follows that in a growing economy, the correct fiscal policy normally involves budget deficits.”

“An old fashioned assumption underlies this paper: that full employment and price stability are compatible.”

“In developed western economies, the national debt is unique…for there is no default risk attached to this asset…. [the only risks are] that the interest rate and the price level may change.”

“[T]he total wealth of private units equals the value of things in the economy plus the value of the national debt.”

Best policy: low interest rate, with national debt growing at same rate as private debt, both equal to rate of growth of productivity

Minsky 1964

Minsky takes a more nuanced position

1957 QJE: Efficacy of policy depends on the financial institutions and practices that exist 1959 Bank Portfolio Determination: 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.

1968 Effects of shift of AggD: Tight full emp should be 3%; he had thought this could be achieved through undirected increase AggD, now says it cannot:

It will increase financial instability and crunches Expansion of 1960s did not shift distribution of wages toward bottom

So: we must pay attention to structure of AggD; we need directed Agg D Two policy instruments to affect distr:

Factor payments Transfer payments; this is an admission we cannot make the productive process work to provide factor payments

Need ELR to achieve and sustain tight full emp; not trickle down but bubble up; will reduce inequality

Implications

Budget stance important for price, currency, and financial stability Need countercyclical swing; thrust toward euphoric boom must be contained by swing to surplus Early postwar: needed govt debt as safe asset; leveraged for growth

But too much govt debtOMP rather than discount window; lose control of banks Impact of budget on economy depends on where spending/taxing directed

Military and transfers are less “productive”, thus more inflationary Unproductive spending lose competitive advantage current acct deficit Large outstanding stock of govt debtmuch harder to use countercyclical deficits to stabilize

(interest has to be paid even in upswing)

Hyman Minsky at Westminster College Oct 30, 1991

Context at Approx 45 min

Discussing New Deal programs that created productive capacity Now spending is on transfer payments, military, and interest on debt: not resource

creating. We need to shift spending priorities to aid and abet private resource creation Problem: American debt is higher than ever before; we need the gov’t steering wheel to

ensure income remains high enough to service it Until 1980 govt debt was declining as a percent of GDP; Reagandeficit of 5% of GDP. Quality

of gov’t debt in international mkts is deteriorating There is no question of affording it; but we lack the will to raise taxes to validate it.

Govt must validate our debt with taxes. In the Golden Age govt spending and debt propped up private resource creation; we need to put

in place a financial system to promote resource creation

Context at Approx 65 min

Taxes are the price you pay for civilization We are not now in the position we were in in the 1960s; now we have competitors: Yen, Mark We increased the proportion of income coming from interest; in large part assets are held

abroad, by higher income people, and by the FIRE sector. We are in danger of becoming Argentina: spending without taxes; means printing money,

could lead to inflation The alternative to taxation is the inflation tax

WOW! Violation of Lerner’s Laws!

Explanation

Loose talk? Political reaction? Reagan. Evolution or Revolution of thought?

Abandoned functional finance? Embraced deficit hawk or at least deficit dove?

Grounding in writing? 1984-86 writing on Reaganomics 1991-93 book manuscript

1984 Minsky and Fazzari

Reagan tax cuts and increased military spending loosened fiscal stance excessively; inflation danger: The fiscal system must yield a balanced budget or a controlled

modest deficit at a realistically attainable level of income, shift toward deficit if income falls, and shift sharply toward surplus if either output pushes against full capacity or inflation takes hold.

We need to develop an institutional structure for a fiscal policy in which the budget moves toward deficit as employment falls and toward surplus when inflation occurs.

1986 paper: Stabilizing an unstable economy: the lessons for industry, finance and govt

The tax reduction of 1981 compromised the revenue system. As a result of its programmed tax cuts, the deficit remained at depression levels even as the expansion took hold. Because of the deficits of 1981-1985 the total national debt increased by about $1000 billions. This means that the revenues needed for any given spending program and any given desired deficit is now some $100 billions greater than would have been needed when Reagan took office.

1986 Stabilizing book

Government must have a budget that could generate “a positive cash flow in circumstances that it is reasonable to expect will occur…A government can run a deficit without suffering a deterioration of its creditworthiness if there is a tax and spending regime in place that would yield a favorable cash flow (a surplus) under reasonable and attainable circumstances.” (ibid p. 302)

For federal government debt to retain value, it—like any other debtor—“has to be able to generate a positive cash flow in its favor.” (ibid p. 302)

He concluded “there will either be a run from the dollar or a substantial debt repudiation through inflation. Either way, interest rates will rise to new highs as markets react and as the Federal Reserve either moves to protect the dollar or stop inflation.” (ibid p. 303)

In other words, the problem is NOT that government will run out of money or default in nominal terms, but that there could be pressure on the dollar exchange rate and/or pressure on the Fed to raise interest rates. Pressure on the dollar can generate run out of the dollar Higher rates will cause capital losses on longer term bonds

1994 Why Are the Capitalist Economies Now in Crisis? Domestic Issues

Reagan and Thatcher tried to overthrow the big-government interventionist capitalisms that they inherited. In the United States the major substantive economic changes of the Reagan years were: (a) the destruction of the revenue system; (b) the emergence of an economy that was structurally dependent upon the government’s

deficit financing of a budget that was mainly devoted to transfer payments (including interest on the government’s debt) and military spending;

(c) a high-consumption economy due to the increases in the inequality of income distribution and in entitlements;

(d) the fall in the real wage of a large portion of the labor force; (e) a fragile financial system; and (f) a rising tide of un- and underemployment.

1994 Long-term consequences: the failure of Laissez Faire

After a spurious prosperity, largely based upon (a) an unproductive government deficit, (b) an enormous expansion of the financial services industry, and (c) financing schemes that left the country with an excess supply of office structures, highly indebted

firms, and nonperforming assets, the economy of the United States has virtually stagnated for some five years.

Furthermore, government spending became even more inefficient as an instrument to create resources, because the high interest rates that were a long-lasting legacy of the experiment in practical monetarism of the Volcker era and the great expansion of the government debt resulted in a huge item in the budget called “interest on the debt.”

The Reagan–Thatcher–Bush experience is a second failure of the laissez-faire model. It showed that the laissez-faire model of capitalism cannot meet the performance standards established in the 1950s and 1960s.

Legacy of Reagan: Growing International Indebtedness

The Reagan era saw a vast increase in the outstanding government debt as well as a fundamental shift in the international indebtedness position of the United States. As a result the United States enters the 1990's with its fiscal independence greatly reduced. In this situation monetary and fiscal interventions to sustain United States profit flows in a recession, or in the aftermath of a financial trauma, may not be effective unless the trading partners adjust their international posture.

The dominance of finance capitalism was broken by the Great Depression and the reform of capitalism that followed. Financial reforms of the 1930's in the United states, which were designed to break the concentration of power and to prevent another Great Depression, weakened the hold of these groups.

The great era, during the depression and the war, of constructive government deficits meant that major industrial organizations became well-nigh free of debt. Banks, other financial institutions and households became holders of government debts. With recovery, the wartime household savings led to a large number of small holdings of stocks. This meant that management of many of the great firms was virtually free of stockholder control. This era can be characterized as managerial capitalism.

A third major change in the financial-economic structure over the 1980'S has been the change in the financial position of the United States from being the world’s major creditor country to becoming the major debtor. This means that at some point of time in the near future the ability of the United States to fund further government and international payment deficits will need to be earned in the market. A crisis in which the United States will be forced to face up to its changed position is likely unless fiscal wisdom prevails.

Erosion of US International Position 1991-93 Draft

The fiscal posture offset the recessionary thrust from the financial problems: deficits make profits available to business. However instead of stimulating American business, the deficits sparked a burst of imports of a vast array of consumer products. A huge international trade deficit emerged which transferred profits induced by the fiscal deficit in the United States to those countries that had a surplus in their trade account with the United States.

In the competition among firms for profits, American firms lost to Japanese and other offshore firms in the 1980's. As a result of the siphoning off to other economies of profits induced by deficit spending, the government deficits of the 1980's did not lead to a commensurate rise in domestic profits and improvement in domestic balance sheets.

It therefore did not trigger a sufficient rise in domestic investment, domestic profits and the consumption of domestically produced consumer goods so that income could become sufficiently high so that the deficit was sharply reduced or eliminated. The uneven prosperity of the 1980's rested upon a fiscal deficit.

The economy never took off, so that high income and employment levels could be sustained without the crutch supplied by massive government deficits.

Fiscal Reform 1991-3 Draft

1. The spending side requires a large overhaul. The Keynes phrase "the socialization of investment" means that the government spending program needs to finance a significant part of the resource creation of the economy .

2. 2. Income from work, where if necessary the work is provided by government, should replace much of today's transfer payment schemes. I see no way to create a society in which the socially divisive transfer payment systems are within bounds that are broadly acceptable without a revival in one form or another of the depression era work schemes: the WPA, NYA and CCC of the 1930's need to be in the arsenal of social and economic policy.

3. Such a package of reforms, where the government debt, though growing, is always in principle, ie when the economy is at a close approximation to full employment, being validated by revenues will not return the economy to full employment overnight. It will mean that the accumulation of government debt in private portfolios will be an accumulation of default free and readily transferable assets.

4. One reason why the massive deficits of the Reagan years did not lead to a buoyant expansion was that the revenue system had been compromised. This meant that the increases in the government debt was not a one for one increase in liquidity. A fiscal system based upon an in principle balanced budget is a way of assuring that a period of government deficit financing is followed by a period in which buoyant private demand does the job.

Return to a “balanced budget”?

[T]he cumulative effects of the growth of the dead weight debt*, the well-nigh destruction of the revenue system over the 1980's and the loss of the dominant international asset position have combined to diminish the fiscal autonomy of the United States.

Fiscal reform must accompany financial reform: the reform needs to be on both the revenue and the spending side. On the revenue side an "in principle" balanced budget must be achieved. This means that a tax system needs to be in place which will not only pay for current operations but will also pay interest on the public debt: "Ponzi" financing by the government needs to come to a halt.

Even though the government, unlike private institutions may not exhaust its balance sheet equity, Ponzi financing by government means that an inflation tax will in time contain the real size of the government debt. The threat of an inflation tax means that private long term debt financing needs to be at rates that compensate for the expected erosion of the purchasing power of the principle due in the future. This inflation premium in interest rates is in fact an amortization of the principle.

*Deadweight government debt is debt that is not the result of government resource creating activity.

Did Minsky violate Lerner’s Principles of Functional Finance?

No, and Yes. NO: he adopted a more nuanced version that recognizes what government spend on; recognized inflation pressures; took

account of changed international position of dollar; and incorporated his theory of financial instability YES: and so did Lerner! Lerner and Inflation: Lerner’s Review of JMK: Minsky’s vision of cyclical instability is no more likely than the Neoclassical’s vision of continuous

full employment; the usual Keynesian monetary and fiscal policy will be sufficient Lerner and Post Keynesians: Rejects Kalecki view of profits 1977: Lerner embraces Monetarism: his FF had been too focused on macro, neglected micro or mkt analysis stagflation Proposes Peace Settlement between Keynesians&Monetarists and Sound&Functional Finance:

1. issue wage-increase permits equal to desired rate of wage inflation 2. Set rate of money growth equal to real output; Put control of AggD in hands of Fed. 3. Divorce govt budget from total level of AggD, and focus fiscal policy on social efficiency, internalizing externalities, and alleviating

poverty Any increase of Govt spending should be offset by increase of Taxes to avoid interfering with Fed’s task of regulating AggD