Minsky: Turning neoclassical economics on its head
This post is going to be a bit wonkish. I apologize for those of you who are not economics geeks. Hopefully, you will find it interesting nonetheless.
At the urging of my good friend Marshall Auerback, I have been looking into the Minskyian twist to the neoclassical view of the world. Economists who follow Hyman Minsky believe that the basic traditional identity of Private Savings – Investment = (Government Outlays – Taxes) + (Exports – Imports) has it all wrong – not wrong literally, but rather in terms of stress.
The problem here is that setting up the identity this way makes one believe there is something called ‘national savings’ that in a post-gold standard world of fiat money doesn’t really exist. Scott Fullwiler puts it best (emphasis added):
The right-hand side of equation 2 [the neoclassical identity I presented above] is usually referred to as “national saving” by neoclassical economists, and more “national saving” is thereby thought necessary to raise more business investment that in order to raise the economy’s long run capacity to produce goods and services. This interpretation is nearly ubiquitous in the profession.
However, this interpretation is inapplicable except for a fixed exchange rate monetary system operating under a gold-standard or currency-board type of regime in which there is in fact a “fixed” quantity of savings that exists or can be created. But in our flexible-exchange rate monetary system, saving does not finance spending; indeed, banks create loans without any prior deposits or reserves being necessary, as I have explained in previous posts to this blog.
Those of us employing the framework of J. M. Keynes, Hyman Minsky, Wynne Godley, and others mentioned by Rob [Parenteau], instead use the above equation to understand the financial status of the various sectors of the economy. That is, instead of saving to finance capital investment (which is not actually what happens), we have “private sector net saving,” which is the addition/subtraction to net financial wealth for the private sector in a given period. If the private sector is net borrowing, then its balance will be negative; if it is net saving, then its balance will be positive.
Most importantly, the economy’s financial flows are a closed system, so one sector’s deficit is another’s surplus, and vice versa. There is no way around it, just as it is impossible for every country in the world to have a trade surplus—at least one country must have a trade deficit for the others to have surpluses. Thus, “national saving” as defined in the textbooks (private saving + government surplus + foreign saving) is a misleading concept in our monetary system, since if the government is “saving” some other sector (or combination of them) must not be, by definition.
This leads then to the identity: Private Sector Net Saving = Government Deficit + Current Account Balance. I mention this because, in my last article, I had said the following, which I believe to be consistent with both neo-classical thinking and the Minsky sector financial balances view:
The reason that the Federal Government is deficit spending to begin with has to do with the loss of consumption in the private sector due to increased deleveraging and savings. In the U.S., we have seen the savings rate rise from negative territory (i.e. saving nothing and spending even more by drawing down accumulated wealth) to almost 7% in a few years’ time. This behavorial change is a positive for America as it is a recognition of the excess consumption that an asset-based economy created. It puts America in a much better position on its current account and helps to reduce debt from unsustainable levels.
In the Minsky world, the increase in net savings in the private sector and reduction of the current account deficit is axiomatic when the government is increasing deficits. The point is that the private sector net saving and current account deficit must equal the government deficit. So, when the combined private savings and current account deficit increases, the government’s financial balance must become more negative.
What this implies is this (diagram from Paul Krugman’s post with the unfortunate title “Deficits saved the world”):
To make the graph easier to follow we start with sector balances at zero i.e. where sector surplus/deficit equals zero for both the private sector including the current account deficit and for the government sector. And just to be clear, points above the line show private sector savings or public sector deficit.
We start where the red circle is.
When an economic shock hits which precipitates a massive deleveraging, the entire demand curve shifts to the left to a new lower GDP level, everything else being equal. Thus, deleveraging equals recession. And we now see the private sector curve hitting the public sector curve where the blue circle is. The private sector is now saving and the public sector is in deficit. That is where we are today.
However, to bring things back to neutral i.e. where sector surplus/deficit equals zero for both sectors, one could cut government spending dramatically. That shifts the entire government curve to the red line on the left, leaving us where the green circle is: in a deep, deep depression. Krugman calls this the Great Depression outcome.
I am still coming to grips with the Minsky view of things – so I may have a few things wrong here. But, I would say this: under the Minsky model, cuts in government spending would lead to the green circle outcome and its attendant deflationary impact. In such an environment corporate profits would be much lower, implying much lower stock prices as well.
As I do more research on this framework, I will keep you informed.
The Sector Financial Balances Model of Aggregate Demand – Scott Fullwiler
Coherently Confronting US Macro Challenges – Rob Parenteau
Employing Krugman’s Cross: Farewell, Mr. Hicks? – Rob Parenteau