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Autocatalytic process : the outcome of the process is itself a catalyst for the process  Chain Reaction! Viking success PowerPoint Presentation
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Autocatalytic process : the outcome of the process is itself a catalyst for the process  Chain Reaction! Viking success propelled Viking success. … but then came Collapse (Jared Diamond) Realized profits repay debts … propel more debt … but then comes collapse (Hyman Minsky ).

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slide1

Autocatalytic process: the outcome of the process is itself a catalyst for the process

 Chain Reaction!

  • Viking success propelled Viking success.

… but then came Collapse (Jared Diamond)

  • Realized profits repay debts … propel more debt

… but then comes collapse (Hyman Minsky)

minsky s world

Minsky’s World

Quasi – rents: cash flows available to pay debts

PI– [supply] price of investment goods

PK– [demand] price of kapital goods

Borrower’s risk

Lenders risk

Hedge finance: E(cash flows) > Payment commitment

Speculative finance: E(cash flows)<Commitment

… but > Interest commitment  Roll over debt

Ponzi finance: E(cash flows)<Interest commitment

… Expect to increase debt

Financial fragility: mix of Hedge – Spec – Ponzi

Good times  Confidence  Risk-taking  Fragility

minsky s world keynes world
Minsky’s World – Keynes’ World

Y = C + I

Fluctuations in I  Fluctuations in Y

  • Expectations and degree of confidence
      • Animal spirits
      • Subject to sudden and violent change
  • Complex interactions of decisions/outcomes/liquidity/confidence

Booms and Busts

slide4

The Minsky FootprintRealized expectations  Increased profits & Reduced risk  BOOMDisappointed expectations  Reduced profits & Confidence BustRush to liquidity  Debt deflation

Pk

Borrower’s Risk

Internal funds

Marginal lender’s risk

Lender’s Risk

PI

Investment

stabilizing an unstable economy
Stabilizing an Unstable Economy
  • Financial Instability Hypothesis:
  • Hedge finance
  • Speculative finance
  • Ponzi finance

Two types of risk affect the volume of investment.

…The first is the entrepreneur's or borrower's risk

and arises out of doubts in his own mind as to the

probability of his actually earning the prospective

yield for which he hopes. If a man is venturing his

own money, this is the only risk which is relevant.

…But where a system of borrowing and lending

exists, a second type of risk is relevant which we

may call the lender's risk. GT, Chapter 11.

Hyman Minsky

1919 - 1996

Student of Simons/Schumpeter

  • A Minsky Cycle
  • Displacement (invention, easy money)
  • Boom…successful speculation
  • Euphoria…financial innovation
  • Profit taking
  • Panic

PK

Borrower’s Risk

Price of capital assets

Lender’s Risk

PI

When expectations are disappointed,

investment collapses … but debts

remain

Internal funds

Io

I1

Investment

akerlof and shiller animal spirits
Akerlof and Shiller, Animal Spirits
  • Confidence – Keynes-Minsky
      • Hopes, Exuberance, Fears
      • Waves of optimism and pessimism
  • Corruption - Bad Faith  Loss of Trust
      • S&Ls – Enron – Sub-prime crisis – Goldman Sachs
  • Fairness
      • Punish cheaters, even at own expense
      • Relative position
  • Money illusion
      • “Illusion” is real in view of nominal contracts/accounts
      • Money illusion  Inflation – unemployment tradeoff

“So long as money retains its age-old power to deceive, inflation can be used to resolve economic conflict.” James Tobin

  • Stories
      • New eras – Irrational exuberance

Downward wage rigidity

akerlof and shiller a brief history of macroeconomics
Akerlof and Shiller: A brief history of macroeconomics
  • Pre – Keynes: Say’s Law  Automatic adjustment to full employment
  • Keynes: Animal spirits  Excesses Inherent instability

Minsky, JMK, Stabilizing an Unstable Economy, Can “It” Happen Again?

  • Hicks: IS – LM  Keynes without animal spirits
      • Consumption function – Liquidity preference function
  • Hydraulic Keynesians
      • Original Phillips Curve  Policy Menu
  • Friedman: Monetarist counter-revolution
      • Dispense with money illusion/enter expectations/natural rate

 Wage Setting: W = PeF(u,z)

  • New Classical Economics
      • Rational expectations
      • Real business cycles (dynamic stochastic general equilibrium)
  • New Keynesian Economics
      • Rational expectations – but sticky adaptation
akerlof and shiller prescription for today
Akerlof and Shiller: Prescription for Today
  • A Second Target – A Credit Target

“It is fairly easy now to project the fiscal and monetary stimulus necessary for aggregate demand to be at full employment—if financial markets are freely flowing…But, with the loss of confidence in the financial sector, macroeconomic planners must have a second target…—the amount of credit that would normally be given [to qualified borrowers] if the economy were at full employment.”

Methods: Discount window (TALF)/Capital injections/GSEs

      • Gotta replace the fallen Humpty-Dumpty (Securitization)
  • A Credit Target—Whom to credit?
      • Bernanke and Blinder (1988) Credit, Money and Aggregate Demand, AER, May.
        • In liquidity trap, expansion of credit is effective stimulus

Aside: Also in AER, May 1988. Akerlof and Yellen, Fairness and Unemployment

“…where it is advantageous to pay some employees highly, it is also … fair to pay other employees well.” Unfair pay  shirking

back to minsky keynes
Back to Minsky – Keynes
  • Variables:

PK = volatile demand price of kapital asset

PI = sluggish supply price of investment goods

q = expected quasi-rent from the asset

M = quantity of money  ease of credit

c = cash-flow commitment from finance arrangements

ĉ = “acceptable” cash flow commitments

Then, PK = K(q, M, ĉ – c)

“If the demand price of a capital asset … is not less than its replacement costs, new investment will take place.”

slide10

The Minsky FootprintRealized expectations  Increased profits & Reduced risk  BOOMDisappointed expectations  Reduced profits & Confidence BustRush to liquidity  Debt deflation

Pk

Borrower’s Risk

Internal funds

Marginal lender’s risk

Lender’s Risk

PI

Investment

slide11

A “Global Saving Glut”

The best

of times

Capital Inflows

Easy Money

Policy

Escalating

House Prices

Eager Home Buyers

Ambitious

Mortgage Brokers

Developer Clout

Innovative

Banks

Securitization

MBSs

Rating

Agencies

Gov’t Sponsored

Enterprises

Bank Regulators

slide12

The best

of times

Capital Inflows

Escalating

House Prices

Easy Money

Policy

Eager Home Buyers

Ambitious

Mortgage Brokers

Developer Clout

Innovative

Banks

Rating

Agencies

Securitization

MBSs

Gov’t Sponsored

Enterprises

Bank Regulators

slide13

Financial System Meltdown

At home

Interventions/

Nationalizations/

Pre-privatizations

Bankruptcies

  • Gov’t Supported Takeovers
  • Countrywide  BofA
  • Bear Stearns  JPMorgan Chase
  • Silver State Bank Nevada State
  • Merrill Lynch  BofA
  • Washington Mutual  JPM Chase
  • Wachovia  Wells Fargo
  • Security Saving  Bank of Nevada
  • IndyMac
  • Fannie Mae/
  • Freddie Mac
  • AIG
  • New Century Financial
  • Lehman Brothers
  • Washington Mutual Inc.

Abroad

  • Northern Rock
  • Royal Bank of Scotland
  • Dexia
  • Glitnir/Kaupthing/
  • Landsbanki
  • HBOS  Lloyds Bank
  • Fortis  PNB Paribus
slide14
Baa-AAA Interest Differential The Good News: 1932 was worseThe Bad News: This downturn isn’t over until 2010
responses lender of last resort spender of last resort
Responses Lender of Last Resort / Spender of Last Resort
  • Tax Rebate $124 bil.
  • Fed Fund Rate Cuts
  • Fannie/Freddie $200 bil.
  • Bear-Stearns $29 bil.
  • AIG $174 bil.

Fed “Facilities”

  • Primary Dealer Credit Facility (PDCF) $58 bil.
  • Treasury Security Loan Facility (TSLF) $133 bil.
  • Term Auction Facility (TAF) $416 bil.
  • Asset- Backed Commercial Paper Funding Facility (CPFF) $1,777 bil.
  • Money Market Investor Funding Facility (MMIFF) $540 bil.
  • More Fed Fund Rate Cuts … Hold At ~0%
  • Fed Purchases of Long-Term Securities: GSEs & MBSs $600 bil.
  • Term Asset-Backed Securities Loan Facility (TALF) $200 bil.
  • Emergency Economic Stabilization Act/TARP $700 bil.

Government Loans

Government Equity

  • Stimulus Package $787 bil.

aka The American Recovery and Reinvestment Act

  • TARP II
      • Stress Tests