Charting the Minsky moment: the new disequilibrium thinking of the ECB
from Merijn Knibbe
For quite some time, the European Central Bank (and quite some millions of unemployed people in the European Union) has been a victim of the kind of neo-classical economics pioneered by people like Robert E.
Disney Lucas jr., which, according to two economists from the Bank of International Settlements (BIS), Claudio Borio and Piti Disyatat, neglects ‘credit’, ‘debt’ and the disequilibrium nature of financial markets, as the ‘natural rate of interest’ assumed by neo-classical economists and based upon the loanable funds idea (i.e. the idea that banks can not create money) is just a figment of the mind:
“Monetary analysis comes alive in disequilibrium, when the market and natural rates differ. In this analysis, when the market rate is below the natural rate, banks create additional credit, thereby adding to the money stock, in order to meet the additional investment demand (the “cumulative process”). If goods prices are fully flexible and output cannot expand, prices rise and “crowd out” household consumption, ie they generate disequilibrium (sometimes termed “forced”) saving to match actual investment ex post. The ex post real interest rate declines, investment expenditures rise and households are prevented from reaching their preferred consumption level. Investment crowds out consumption. Banks, and their ability to expand credit, play a key role in this story. Through the creation of deposits associated with credit expansion, banks can grant nominal purchasing power without reducing it for other agents in the economy. The banking system can both expand total nominal purchasing power and allocate it at terms different from those associated with full-employment saving-investment equilibrium. In the process, the system is able to stabilise interest rates at an arbitrary level. The quantity of credit adjusts to accommodate the demand at the prevailing interest rate … In textbooks and in typical references, the loanable funds theory of the interest rate is purely couched in terms of saving and investment (eg Mankiw (2008)). This, however, refers only to a full equilibrium state and ignores the role of the credit market. Therefore, it only describes the determination of the natural rate. This widespread representation of the theory encourages the failure to appreciate the distinction between saving and financing.”
But there is some good news. Thinking at the ECB is definitely changing. Today they published a new Composite Indicator of Systemic Stress in the financial system” (CISS, pronounced Kiss). Once, I developed composite indicators for a living and a more thorough analysis will follow. For the moment however, it suffices to say that the very idea that disequilibrium (and involuntary unemployment…) can exist is a
welcome long overdue addition to the philosophy of the ECB. Also, the graphs (figure 3!) are highly consistent with ‘Minskyan’ thinking, showing as well the lull before the storm in 2004-july 2007 as the Minsky moment in July 2007. Mind that it was during this lull that current account deficits became completely unsustainable in Portugal, Spain, Greece and the Baltic states!