Polish Draft Law Restructuring Foreign Currency Denominated and Indexed Loans and the ECB Counterattack
Periodically I will be posting interesting things that have slipped under the radar. This is one of those posts. Apparently Poland has a “draft law” aimed at getting rid of past and future foreign denominated and indexed private debt. This is important as foreign denominated currency loans have been seen as an important part of many of the crises over the last 40 years (at least) and a crucial risk to financial stability. The lure of lower interest rates helps banks manipulate borrowers into taking much more risk and uncertainty than they realize. The ECB says:
“The purpose of the draft law is to facilitate the restructuring of loans denominated or indexed in a foreign currency (hereinafter ‘foreign currency loans’) that were granted after 1 January 2000 for a period exceeding 60 months, even if such loans have been repaid in full or terminated and settled. The draft law also prohibits granting of any future loans involving settlement in a foreign currency”
Under the law any “natural persons” can request to have their loan restructured. If it is, “Any contractual obligation of the borrower denominated in a foreign currency or indexed to a foreign currency is deemed to be null and void”. The loan is then converted into domestic currency.
“The ECB reiterates its comments regarding risks associated with foreign currency loans made in a previous opinion. In particular, in the case of Poland, such risks do not, at present, appear to be of a systemic nature for the financial system and are not seen as representing a particular risk from a financial stability perspective.”
It of course also notes that if you reduce the burden of foreign denominated loans people were tricked into taking that could reduce bank profits and thus have a “ significant impact on the financial stability of the Polish banking sector”. Thus, the ECB comes out firmly on the side of creditors, as one would expect. These smaller, more obscure incidents are a good example of the insidious power of European wide technocratic institutions. For all the problems with the Federal Reserve, it can be reigned in by congress if need be and especially in a situation of ascendant social democratic/leftist politics. It’s legal commentary really is advisory and the Federal Reserve knows to tread carefully when interfering. It is tolerated to the extent it is perceived as giving informed advice and not trying to overtly control or bully congress.. However, for smaller countries like Poland entities like the ECB are able to “throw their weight around” with a pile of seemingly technical objections and overwhelm local politics. For opponents of the law, the ECB is indeed a powerful ally to have. It is also capable of obliquely threatening Poland with retaliation from the EU as a whole, without particularly strong legal basis for its innuendo. I strongly recommend you read the ECB’s 6 page commentary in full.
A note: I caught this because I read this press release from the ECB. In general press releases and speeches from important organizations like the ECB are great reads
For those uninitiated in the technicalities of NIPA and national accounting logic in general, this comment may seem strange. What's the issue with the Financial sector running a "nonzero" balance? As you'll see though, there are a number of ways where such an approach comes into conflict with the traditional treatment of the NIPA accounts and need readjustment if the approach I would like to take is to be seen as consistent.
As it Happens Ruggles and Ruggles, in their excellent book "National Accounting and Economic Policy: The United States and UN Systems" tackle precisely this issue. The crux of the issue Mason refers to is summarized at the beginning of the chapter:
"The approach of the United Nations System of National Accounts (SNA) to privately funded pensions and insurance is essentially a neo-classical one.Apart from the costs of operation, private pension contributions and life insurance premiums are considered to be a form of household saving, part of the accumulation of wealth by households that should appear as a category of assets on the household balance sheet. But publicly funded schemes- social security arrangements-- are not treated in this way. Entitlements under public programs are not credited to households until such time as the benefits are actually received. "
Thus, in one treatment there are private transfer payments and in the other only the government makes transfer payments. To make the difference between these two approaches clear, the two sets of T accounts below may be of some use. One Note: here subscripts (e.g. HH, MM, C etc) denote the sector making payment
As you can see from the above, by definition Institutional Investors are in financial balance at all times. Any shortfall or excess of cash flow is counteracted by an offsetting change in their obligation to households. Thus what we would otherwise consider to be the financial net worth of institutional investors is counted as part of household wealth.
From the point of view of flow of funds analysis, there are a number of problems with this type of approach. For one one's claim on "future pension obligations" is not transferrable and thus is not a financial asset as such. The fact that I'll eventually have a certain income in some undetermined future has a very different impact on current spending programs than having assets one can sell or pledge. Second, "excess" cash flow into pension funds, insurance companies etc don't guarantee me or even the household sector as a whole future payments. The conditions under which these institutions pay out are very strongly defined in contracts and aren't very sensitive to current financial surpluses. Someone looking at household wealth with these numbers included will get a very misleading picture of what's going on. Ruggles and Ruggles argue that treating them as transfer payments and thus separating out Institutional Investors net worth from household wealth is the best way of approaching this issue and I agree
So to finally get around to answering Mason's question in brief: transfer payments between private sectors change saving rates in such a way as to make Institutional Investor financial surpluses and financial deficits a consistent accounting concept.
UPDATE: I forgot to add the sectoral balance equation with private transfers
Ruggles, Nancy D., and Richard Ruggles. National accounting and economic policy: the United States and UN systems. Edward Elgar Publishing, 1999.
Since I did a post on increasing returns to devoting resources to producing rice, I think it is time to focus on the opposite. That is, it’s time to focus on resource depletion and decreasing returns.
To do this, it may be useful to introduce some concepts from ecological economics. First there is throughput. Throughput is the amount of energy and matter involved in a production process. A big argument of ecological and biophysical economics is that many of what have appeared as “productivity increases” to economists has historically actually been increasing throughput of energy. Regeneration meanwhile is the idea that when natural resources are left unused they start to regain their original characteristics. Thus the essential distinction between non-renewable and renewable resources is their rate of regeneration. Technically fossil fuels, even considering the greenhouse gas effect, do have a rate of regeneration. However since we are thinking in terms of human resource use the time scale for regeneration, and the level of resource unemployment required to get there, these resources can be called non-renewable given how extremely slow their rate of regeneration is. That last point is worth emphasizing, renewability only matters relative to human time scales. No humans and the time it will take for oil to reform in the ground is irrelevant- at least to us.
This leads us to our final concept: the maximum sustainable scale. This refers to the idea that there is a level of employing a natural resource where the rate of throughput, ie the rate at which this material or energetic natural resource is used, is equal to the rate of regeneration. In other words there is a rate of use where the stock of this natural resource remains constant. A scale of production beyond that will deplete the natural resource and, for our purposes here especially important, lead to diminishing returns over time. This can potentially end with the resource being used up all together. Thus, to simplify here we’re only going to be dealing with homogenous nature. In reality of course, there are many different material forms of nature that are important to different production processes and techniques and have different rates of regeneration.
Thus, rather than dealing with increasing returns in rice, I’m going to deal with decreasing returns in grapes. In this example “Monocropping” grapes leads to an overuse of the soil and less returns each year. At maximum production, Friday produces one less grape meal each year. The less resources devoted to producing grapes, the slower the “decreasing returns” are. For simplicity’s sake I’ve not only assumed the midpoint of the production possibility frontier is the point that maximizes utility but that it is also the spot of maximum sustainable production for Grapes. For those not up on the jargon, I’m assuming that the combination of rice and grape Robinson Crusoe or Friday would choose to produce without specialization both leads to them getting the most enjoyment but also involves producing grapes at the maximum sustainable scale. In other words they would be led by their “short run” self interest to choose to produce the level of grapes and rice that leaves their stock of natural resources constant. With all that in mind, let’s go to the data. I’m starting with the same numerical values as i used in the first post and will try to stick to those numerical values for every Crusoe post I do.
So what’s going on here? What happened is that there was a jump to the no specialization “special case”. That is, there is a point at which Crusoe’s absolute advantage is identical for both goods and thus there are no gains from trade. Because of decreasing returns in grape production, the gains from trade were eliminated by changing relative prices . This is a point that never gets discussed enough- the difference in the absolute advantage Robinson Crusoe has and thus the difference between the opportunity costs of production are changed under any situation that isn’t constant returns to scale. This is why the handwaving when discussing the situation where Crusoe’s absolute advantage of both goods in undergraduate economics classes are so misleading. Yes it is a “special case” but in a situation where some fundamental forces are driving changes in relative prices it becomes a point that all models will pass through. Thus as we’ve seen, if you assume “short run” maximization in a situation where relative prices aren’t constant (which is most situations) then eventually short run gains from trade will disappear or explode. As we’ve also seen however, in both cases “short run” optimization is inconsistent with intertemporal optimization.
The reason we get the result that output is actually lower in “equilibrium” even as the decreasing returns end is the nature of “maximum sustainable production”. The jump to no specialization led to production at the midpoint of both Crusoe’s and Friday’s production possibilities frontier. This led to no further decreases in natural resources but also not a return to the original “stock”.
What is truly galling about this result is decreasing returns to scale with regard to natural resources was an essential part of Ricardo’s rent theory. That following static comparative advantage when one good experienced diminishing returns not only eliminated gains from trade but lowers equilibrium output relative to the no specialization case makes discussions of comparative advantage infuriating to those with some knowledge of the history of economic thought and the inherent limitations of this perspective.
The point of this isn’t that professors should be using the Robinson Crusoe analogy to convince their students of protectionism and militate against specialization instead of convincing them of free trade and specialization. The point is, are you sure your students could follow either of these broadsides against the way the usual comparative advantage model is used? If not, and i suspect the answer is no, then this part of every undergraduate economics education is propaganda and not education as such. Students should be able to explain and use economic concepts and because the basic example isn’t intuitive and isn’t really connected to their lived experiences, they generally don’t. Instead they are rushed along to more baroque and mathematically complex versions of the same models that are also not very understandable. This leaves students in a mass of confusion, but they still remember the slogans long after which, to a cynical man, might appear to be the point.
The Comparative Advantage story is famous. It is an essential part of nearly every undergraduate economics education. It’s propagandistic benefit is also well known. To review, I’m going to run through a numerical example.
Here we see that Robinson Crusoe has an absolute advantage in everything. That is, he can produce more of either type of output than Friday can. Oh no! Poor Friday! But wait, David Ricardo is to the rescue! As long as Crusoe’s absolute advantage over Friday is different for producing Rice than producing Grapes, the opportunity cost (what else he could be doing with that time and resources) of Crusoe producing grapes is higher than Friday producing grapes! Boom, gains from specialization and trade.
You can see here that this is precisely what we find. The table is clearly telling us that Friday should produce grapes while Crusoe produces rice. However, what happens if there are increasing returns to scale? Below I run through such an exercise.
Below I’m assuming that for each year Crusoe spends producing rice with specialization he is able to produce 4 more rice meals the next year.Poor friday can only produce the same amount of rice year after year and he just continues producing grape meals. For each year Crusoe spends producing Rice without specialization, he can produce 3 more rice meals the next year. For each year Friday produces Rice without specialization, he can produce 2 more rice meals the next year. Of course you could do these assumptions in all different ways, that is sort of the overarching point with regard to how these models are used.
nonetheless, I chose these assumptions specifically. First, output isn’t growing by some percentage rate of the previous years output because recall that in this model all factors of production are fully employed and constant. There is no investment here. Thus the growing returns are relative to the underlying stock of capital and land and are thus exponential relative to them. There is no reason to think exponentially accelerating returns are possible under these conditions. However, there is reason to suppose that applying all factors of production will lead to returns growing more quickly than just applying some percentage of your factors of production. This is why rice output is growing faster for Crusoe under specialization than without specialization.
Second, Friday does not only start out less efficient but he is also less efficient at expanding output. I made this assumption to show that if you move to increasing returns there is a case against specialization even if Friday starts out less efficient at producing rice and is always less efficient at producing rice even if he focuses on it. I didn’t do the analysis here because it was obvious, but if you had perverse specialization- that is Friday specializes in rice- Friday produces 3 more rice meals every year, leading to the least total rice output of all the cases.
There are a number of interesting things here to say. This does a good job of making Cameron Murray’s point, which I’ve agreed with ever since I took a look at “Robinson Crusoe’s Economic Man”, that the Robinson Crusoe story is a great pedagogical tool for getting across a number of important concepts in economics. Here we have not only increasing returns and time but Baumol’s cost disease, inequality/distribution and intertemporal optimization. Relative prices are shifting in this economy because of labor productivity increases that exist in one good but don’t exist in another. Within an economy, those working in the low/no productivity growth sectors get wage increases to induce them to do these jobs. Hence the “cost disease” is the rising prices in these industries. This example clearly and easily expresses that idea. On the flip side, in other social contexts there may be no inherent reason for productivity increases to be shared.
If I felt particularly inclined to troll economists, I’d say that what they ignore in their arguments over comparative advantage is intertemporal optimization. That is a bit of a dig but it does get at an important truth. At each Individual point the traditional argument for comparative advantage applies. In fact, the gains to trade as conventionally measured are growing along with Crusoe's labor productivity! Yet taken together this is wildly suboptimal. The argument for protectionism in a very real sense has for a long time been about intertemporally increasing output by inducing production and investment decisions that seem perverse given current production possibilities and prices. The model also makes the important point that protectionism doesn’t have to ever give the protected country's protected industries absolute advantages in producing output over other countries for there to be an intertemporal maximization (or at least improvement) case for protectionism.
Then there is the issue of distribution which increasing returns under specialization brings to mind. If Robinson Crusoe and Friday were more conflictual, say because of property rights or because they represent different countries, in the specialization case Crusoe may not share any gains at all. After all Friday was gaining from specialization in the first year and should be willing to specialize for that benefit 25 years later. Of course the cost of not specializing to Crusoe is increasing all the time precisely because of his productivity increases. If the opportunity cost of not specializing for Friday was lowered by some probability of Crusoe giving in and sharing gains not specializing could be an optimal strategy for Friday for a sustained period of time. That is Friday may be well positioned to strike for higher wages and this example could be a case where striking improved overall welfare. After all economists typically say there is declining marginal utility to more of the same kind of output.
I hope you found this as interesting and entertaining as I did. I suspect that the different ways you can use the Robinson Crusoe story to express concepts in economics will become a running series on this blog.
As I reviewed in my first post , the sectoral balance equation for one country is typically written as
One problem with this equation is the definition of (M-X), otherwise known as the external balance. In the world of MultiNational Corporations, is this balance really meaningful? For example the output that corporations transfer between subsidiaries is subject to what is called transfer pricing. It is quite famous that if someone wants to smuggle financial assets out of a company one way is to find a willing partner in another country and who overcharges you while you undercharge him. The output is then sold at market prices and something close to the difference between the “true balance” and the actual transaction values is set aside for the other party. This is of course enormously easier when both parties are in reality the same corporation. As if that wasn’t complicated enough, corporations also transfer intellectual property and financial assets between subsidiaries.
Why would entities systematically charge inaccurate prices to transfer funds out of a country? The primary reasons are capital controls and, in our modern world the most important one, tax avoidance and evasion. It is precisely these sorts of strategies that have made domiciling in another country profitable. This causes some difficulties in doing sectoral balances analysis, particularly in regards to the behavior of the corporation. They also make us systematically misunderstand balance of payments dynamics. It makes an enormous difference whether we are truly running a trade deficit with the rest of the world or whether export and import prices (as well as transfer payments disguised within property, investment good or financial purchases) are being systematically manipulated to hide foreign investment. After all, definitionally a lower current account deficit means a smaller capital account surplus . In recent literature debating the United States Net International Investment Position (the culmination of current account deficits and the revaluation of foreign owned domestic assets and domestic owned foreign assets), this has been referred to as a “black hole”. If the strong form of the “black hole thesis is true”, that the U.S. is actually running something close to trade balance, foreign holdings of treasuries and other low return assets are essentially permitting the continuation of foreign investment. Thus our NIIP may be systematically underestimated. This would help to explain why despite the supposedly large negative NIIP, foreign return on U.S. assets is systematically and greatly lower than domestic return on foreign assets.
Mona Ali, New School Graduate and Assistant Professor at SUNY New Paltz, has two very interesting recent papers on this issue titled respectively "Dark matter, black holes and old-fashioned exploitation: transnational corporations and the US economy." and "Global imbalances and asymmetric returns to US foreign assets: fitting the missing pieces of the US balance of payments puzzle”. She covers many important issues in balance of payments (so please go read both those papers). However, what I want to focus on is her commentary on “systematic” mismeasurement of u.s. trade deficits because of multinational activity:
“These new and rapidly growing types of off-shoring activities may artificially inflate the US deficit. In fact, a declining trade balance might very well be consistent with higher profitability for US multinationals (Milberg 2006; Milberg and Schmitz 2011). Thus, to view the current account balance simply as the ‘passive outcome’ of movements in the capital account – as does a sizable swathe of the contemporary global imbalances literature – is misleading. Godley (1995) debunks financially motivated explanations of the trade deficit because of their disengagement from the disaggregated firm-level decisions that influence the trade balance. However, Godley-type structuralist trade models where a country’s trade deficit reflects a loss of competitiveness also fail to account for international outsourcing.”
This is of course a simplification. There are a great many corporations with a variety of percentages are owned by foreign sectors and vice versa. Ownership of a company’s debt can also involve influence over managerial decisions. Nonetheless there is no satisfactory “shades of gray” definition so here I will be treating plurality or greater ownership of equity shares as a “domestically owned” corporation. If we have to choose between not analyzing domestic ownership of foreign corporations and analyzing them with perhaps an overestimation of the U.S.’s NIIP so be it. Unfortunately, national statistics in a multinational world are always going to be not quite suited to the task at hand.
Nonetheless, there are strong advantages in accuracy this kind of approach provides. First of all, intra-company transfers disappear in this approach. Thus we don’t have to deal with the headaches of trying to figure out the true market value of Disney and Apple’s intellectual property transferred between subsidiaries. Nor do we have to deal with complicated intracompany insurance schemes or, god forbid, financial derivatives. These are still important, however they can no longer affect (at least directly) the financial surpluses or deficits of individual sectors. This also provides a clear why of understanding balance of payments issues. The result of such an analysis for the United States might reveal that
This sort of analysis actually has a long pedigree in post Keynesian economics. In a paper from the 1970s entitled "Financial Interrelations, the balance of payments and our crisis" cites and discusses Victoria Chick’s paper "Transnational enterprises and the evolution of the international monetary system" (this paper appears to have never been published). The strongest statement on this issue comes from foundational Post Keynesian economist Paul Davidson (who also cites Victoria Chick). In a chapter of the first edition of “International money and the real world” entitled "Multinational Corporations and International Transactions." he says:
”In other words, the existence of multinational corporations (MNCs) who maintain production and trading activities in many nations, can affect, via decisions which are internal to the firm, the accounting magnitudes which measure the balance of trade of any nation during any period. These decisions involve accounting transfer pricing transactions among subsidiaries which are chartered in various nations. These transfer prices need not have any equivalent value magnitude in real world markets. Hence, extreme caution must be exercised before interpreting any balance of trade statistics as symptomatic of a fundamental national disequilibrium, rather than an accounting imbalance due, in large part, to decisions of MNCs' comptrollers to take advantage of different regulations or tax laws in various national jurisdictions...National balances of payments have therefore become, in some significant measure, an appendage of MNC decisions on income distribution and liquidity needs within the MNCs”
It is very difficult tell what these modifications to the sectoral balances approach would mean for measurements of balance of payments deficits, surpluses and Net International Investment Positions. This essentially “GNP” conception of balance of payments would certainly reduce the United States NIIP, but by how much is very debatable and is subject to how accurate data on MultiNational corporate activities. It may even be possible, with adequate data, that such a measure would mean a balanced balance of payments. I haven’t yet dug into the data issues so I don’t know how close to such a measure we could get. Michael Hudson’s “Financial Payments Flow Analysis” is a masterful approach to producing a flow of funds balance of payments measure that shares a similarity to what I’m discussing. However, his work shows just how much careful effort needs to be put in such a project and my impression is it has only gotten more difficult since the late 1960s. At the very least, I hope readers keep the complications of MultiNational corporations involved when doing sectoral balances analysis.
The word “real” has an extremely tangled and messy history in economics. Because of economist’s penchants for price level indices and the constant division of monetary sums by price level indices, this is a common implication of the word real. However, economists ALSO love talking about the “veil of money” and looking at the “real” things that are going on. Further, economists have historically been interested in barter economies and the existence of a “neutral money” that would provide a common method of transaction (dealing with the “inconveniences of barter”) without any effects on how the economy functions. This still gets attention (as I’ve written about previously here ) in the notion of a “natural” rate of interest and is if anything having rising policy influence. Thus economists mean by real both the exchange value ie the relative prices of various forms of output that are also sometimes summed together AND the underlying use values and physical structures that underlie the economy. Thus real wages can mean a sum of money a worker receives deflated by a price level OR the basket of output a worker is paid or both at the same time. As the reader can Imagine, this causes enormous confusion (I wrote about this last year here here.
I personally think (as I’ve written before) that deflation by composite price level indices is extremely overused and that ratios of flows to stocks, flows to flows and stocks to stocks should come more in vogue. These ratios do much to contextualize nominal sums in a way that makes sense and does so without having to mess around with price levels. A nominal to nominal ratio has the same value as a real to real ratio and a nominal to real ratio is invalid. Price level indices are also used without any true grasp of what underlies them, as Morten Jervens has shown in his both hilarious, infuriating and depressing work around african national statistics and their abuse by western mainstream economists. For example asking the question of how price level movements could improve the household income to household debt ratio would lead clearly to the notion that it is not inflation that workers need but wage increases and the deflating debt sums is a fun exercise with no practical meaning. It tells you nothing about the worker’s experience. Saying the “real” value of the debt is decreasing or increasing because you’re dividing it by a price level is like saying the temperature value of the debt has risen or fallen because the temperature rose or fell.
For all these reasons I will be using the term biophysical in the places most mainstream economists (and even some heterodox economists) use the term real to refer to underlying input-output relationships, production processes, physical amounts of output etc. I’m attracted to the term biophysical because it is precise, clear and because it reminds the reader that monetary economies where production decisions are made in monetary terms have impacts on the world in which we live and on the consumption of resources, both renewable and nonrenewable. It also is aimed at reminding the reader that any argument in nominal terms which implies impacts on the biophysical world that violate the laws of thermodynamics are prima facie invalid even if the assumptions are all otherwise consistent in balance sheet terms.
I will refer to price level deflated sums as price level deflated sums as economics has not developed an adequate alternative. Alternatively direct payment in biophysical goods will be referred to as a “basket of goods”. If anyone has an alternative pithy word for price level deflated sums please let me know!
What I’m going to explore in this post is whether “money manager capitalism”, as Minsky defined it, impacts the behavior of various sectors and in particular what it has to tell us about the private sector balance. This post will be running through a lot of sectoral balance concepts and accounting. For those familiar with MMT and the stock-flow consistent approach, these will be familiar. Nonetheless, I will be reviewing them below.
It may seem obvious that the private sector’s financial balance would persistently be positive, thus necessitating persistent budget deficits , but it is not actually clear that this would generally be the case. Why is the private sector accumulating surpluses? The standard response in MMT social media is that the private sector “desires to net save”. I do not think this gets us very far. First it is our job to explain these “desires”. Second, the private sector of the U.S. (or any other economy) is huge with a myriad of differently structured organizations. In this context assigning such a “human passion” to explain such an important macroeconomic phenomenon seems problematic. Third, many people “desire” a great many things; they often aren’t able to accomplish them. I personally desire to “net save” equal to 5% of next year’s GDP. Unfortunately, I do not think my “desire” will become a reality. This silly example is meant to emphasize the point that we have to look at how sectors or particular sub sectors make decisions and understand how those decisions result in certain recorded financial surpluses or financial deficits at the end of a recording period. To be clear, I don’t think people have been “wrong” to use such turns of phrase, just that to do a more in depth analysis requires putting them aside.
In this context the greatly underappreciated paper “Household and Enterprise Saving and Capital Formation in the United States: A Market Transactions View” by the great economist couple Nancy and Richard Ruggles is crucial. They argue that once you reorganize the NIPA accounts so that households invest in houses, cars and other “durable consumer goods”, while removing insurance premiums and pension contributions from household savings, households on average over the post-war period invested roughly as much as they saved. They found the same to be true for non-financial businesses for the most part, with the notable exceptions of mining and publicly regulated utilities. Thus the big private sectors running persistent financial surpluses were Institutional Investors ie those sectors controlled by money managers. It is this phenomenon that I want to focus in on and its effect on the behavior of sectoral balances.
In the popularized version of Keynes’s “argument”, it is commonly said that he thought governments should run surpluses during booms and deficits during recessions. The purpose of this is to be in balance on average. Post-Keynesians and others rightly ridicule this simplified story, especially because it makes governments seem like they have more control over their deficit position than they do. Nonetheless, the Ruggles and Ruggles analysis suggests that something like that may be possible in a closed economy with households, non-financial corporations, and governments. Households and non-financial corporations would invest more leading to rising tax revenues, drops in government expenditures (especially on transfer payments) and ultimately saving below investment. Conversely they would cut their investment expenditures in recessions, leading to drops in incomes, drops in tax revenues and rises in government transfer payments. Intuitively, we can see that this process would lead to roughly balanced sectoral balances, sans the business cycle being overweighted to either boom or depression, over long periods of time if these were the only sectors of the economy.
This is easier to understand when we look at the structure of these sector’s spending decisions. Both households and non-financial corporations invest to acquire capital goods required for their continuation. Households invest in houses to live in, cars to get around in and items like washing machines because they expect their lifetime cost to be much lower than a lifetime of renting. Non-financial corporations invest to create capacity to produce more, to replace depreciated assets and to increase specific infrastructures required to continue doing business. Recall that paying off debts are a form of saving in NIPA. Thus individual households and corporations either run up financial surpluses to make a large investment good purchase (ie run a gigantic financial deficit for one period) or they make a large investment good purchase on credit and save by paying off their debts.
Either way at the individual level this appears as financial surpluses interrupted by a discontinuous and discrete tremendous financial deficit. Since these decisions in the aggregate don’t happen all at once and are spread unevenly over many different periods, the large dissavings to purchase investment goods are more or less counterbalanced by the fixed contractual payments many other households and corporations are making and/or the savings being built up to make an internally financed purchase. In other words at the aggregate sector level these sector’s saving and investment should be near each other. Thus there are reasons to expect that over long periods of time these sectors average financial balances would be near balanced. This is because both households and corporations income and investment are sensitive to the business cycle. This leads us to a thesis- those sectors whose expenditures and income have large room to react to business cycles will see their financial balances be in rough equality over a long period of time.
Below is a simplified disaggregation of the private sector to focus on two things, Ruggles and Ruggles analysis of businesses and households and the anomalous role of Money Managers and the institutions they control in financial sectoral analysis. Representing all private sectors as they exist in the NIPA accounts would be a time consuming and unnecessary process for these purposes. The point I would like to make is capable using the accounting identity below.
The defining feature of the institutional investors money managers control is that their income and expenditures are tightly contractually defined. Households and non-financial corporations are more or less obligated to “make contributions” of a certain level during any given year and it is very difficult for the state of the economy to change these obligations (sans bankruptcy and the freezing of pension plans or the like). In addition, the assets that institutional investors hold are for the most part contractual obligations such that there is very little flexibility in adjusting payments to financial conditions sans mass bankruptcy. On the spending side, these organizations are both obligated to make certain levels of required payments and obligated to hold financial assets as “reserves” for future payments. This again would require mass institutional investor bankruptcy to change as a sector.
Thus in the absence of government deficits households and/or corporations would be pushed to run deficits to support the balance sheets of institutional investors which of course would eventually lead to mass bankruptcy. As Minsky showed so well in his other work, large automatic stabilizer spending and taxation programs are designed to avoid this outcome. In other words, the structure of the economy and institutional investors is tilted away from institutional investor capital losses being the adjustment mechanism and towards continued financial surpluses through government deficit spending.As a result, these sectors whose expenditures and income are strongly insensitive (but not completely insensitive) to the business cycle will have a tendency to accumulate financial surpluses over long periods of time.
Ruggles and Ruggles wrote their paper around the same time as Minsky started to develop his “money manager capitalism” analysis. As noted earlier, Minsky’s thesis was not just that these large institutions were changing the behavior of the economy and financial assets, but also they were changing corporate behavior. In particular they generated stronger uncertainty at the firm and plant level. Thus we may expect that corporations are less likely to invest in the same business cycle situations as earlier and thus may be expected to run financial surpluses over many business cycles in the future. We won’t know until a strong boom gets going. Either way, the central fact is that it is large sectors like institutional investors that has biased the private sector to running financial surpluses over the long run.
In my research into the antebellum financial system, this is a process I closely researched. It is very difficult to gather data but my strong sense from reading up on these periods is the process by which savings banks, insurance companies etc started being chartered tilted the economy more towards private sector financial surpluses as time went on. Large losses were likely taken in crisis periods in the “balance sheet simplification” process Minsky identified in his work. Nonetheless capital losses likely didn’t come close to balancing out the surpluses and as government budgets became more important this process was intensified. The way business cycle insensitive sectors impact financial dynamics and financial net worths need closer examination in the future and need to be at the center of our stories for why governments as a whole can’t balance their budgets over the business cycle.
My name is Nathan Tankus. I’m a writer and Research Scholar with the Modern Money Network. I’ve started to blog here because I have an overflowing multitude of interdisciplinary interests in economics and social sciences generally that are starting to overwhelm me. I read about a bewilderingly large maze of different topics all connected by a (sometimes loose) relationship to economics. I do this because many different things topics and issues catch my interest at any given time. By blogging here I hope to catalogue things I’ve read since I’m sure I’ve lost track of many interesting papers and ideas from the time I read without cataloguing.
In short this blog will mostly be public notes to myself. I’m making these public because an audience helps to improve my writing, get other people thinking and arguing about things I think are interesting and to provoke others to rethink what they think they know. I will also likely post more formal blog posts meant to garner attention on the results of my research or other projects in relation to MMN.
Especially considering that this is something closer to organized notes to myself rather than traditional public writing, nothing written here can be construed as representing the opinions of the Modern Money Network or any other organization I currently have, or in the past had, a relationship.
Because this is meant to document what I’m reading on any given day, I expect to produce multiple entries per week. This may not be the case during certain particularly busy times, or times I’ve finally managed to put everything else away and work towards finishing the main research projects that are still on my to do list. However, I expect those times to be few and far between. If you follow me on twitter at @nathantankus I will be promoting any new posts on that platform. You can also follow the RSS Feed here
I will write to you soon!