Minsky on Fiscal vs. Monetary Stimulus

      I have since the Krugman-Keen brouhaha read some of Minsky and am quite intrigued. For those who want to understand what MMT is about and where they get their ideas, Minsky is no doubt the large piece in the puzzle. When you read Minksy you realize that just how much they get from Minsky, from the importance of banks in our economic system to the JG-it was Minsky who suggested the government as Employer of Last Resort (ELR) as a bookend to the Fed as Lender of Last Resort (LRR).

     The MMTers are essentially Minskyan Post-Kenyesians. Randall Wray even writes introductions in most of Minsky's books and Minsky finished his years at the MMT Levy Insitute.

     To understand this debate about fiscal vs. monetary stimulus that has been long debated on the econo blogs between Monetarists and Keynesians I think Minsky gives us a new way to think about it. We have the Monetarist line from folks like Sumner and company who insist that fiscal policy plays very little part in recoveries even in deep recessions and depressions. MMT on the other hand provides a nice counterweight in putting much less stock in monetary policy.

     Minsky's analysis of the 1974-75 recession neatly crystallizes the relative importance of each. Minsky argues that had it not been for government intervention in that recession we would have had a worldwide depression.

    Instead the economy was in strong recovery by the 2nd quarter of 75. What did it? Both monetary and fiscal stimulus had their impact. Fiscal stimulus from the US government was very strong. Government transfer payments, especially via Unemployment Insurance exploded. UI payments increased by 400% during the downturn. This lead it to being the first recession to not see a decrease in personal income during a recession.

    On the financial side the Fed's deep intervention steered the banks from crisis-if not for the Fed there would have been a financial crisis. In other words they were both important. Without both intervening there would have been a much longer downturn.

    The talk about what is more important or if one is needed and the other is superfluous then misses the point. The other day in a piece Dan Kervick had suggested that a major difference is that fiscal policy is set by elected members of Congress whereas the Fed are made up of unelected bureaucrats-so we should prefer fiscal policy.

    That's an interesting point though I wasn't wholly satisfied with it. One reason is that I'm not clear that this is enough to always prefer policy. I mean the current leaders of Congress are Boehner, Cantor, and Mitch McConnell. Compared to that I'd rather take my chance with Bernanke.

   It's not that it isn't a legitimate point. But it doesn't wholly explain just what monetary as opposed to fiscal actions actually are. Are they the same actions and the only question is who you want doing them? For me there was something missing from this story.

   I think Minsky's analysis of 1975 in his 1986 book on instability touches on a major essence. What it comes down to is this. Monetary policy relates to the financial economy primarily and directly. When the Fed takes actions to shore up the banks this is supposed to be an externally benefit for us who are in the private non-banking sector.

    Fiscal policy on the other hand is more directly about the real economy. The trouble with Sumner's claim about monetary policy being superior to fiscal policy is that the two are not the same kind of operations. You could say that monetary policy is medical help for the financial economy fiscal is for the real economy.

    So as to which we need the answer is both. How much of each relatively speaking is related more to the nature of a downturn than anything else. It's not true that monetary policy is not important. Without it we would be back in the Dark Ages prior to the Federal Reserve Act in 1913 when we saw bank panics and runs every 3 to 5 years.

    But it can't all be solved through monetary policy either. So in that way the Fed's many actions in 2008 and 2009 as well as Tarp were important as the financial system was threatened. That isn't to say that these actions can't be questioned. You can argue that the agenda of Bernake and Paulson was too much directed to returnting to the bull credit market in the hey days of 2003-05 credit expansion. Maybe the whole TBTF nature of the bailout was constructed wrongly. But something needed to be done.

    Sumner is on the other hand wrong to turn it into a mutually exclusive game between fiscal and monetary policy. He wants to make fiscal policy the same thing as monetary policy except only the former leads to higher debt. This is a wrongheaded way to look at it as the two kinds of policy are qualitatively different. It's as if Sumner is saying that you shouldn't got to the ear doctor when you have problem hearing that you should go to the eye doctor. He's saying whether your ears or your eyes give you trouble only go to the eye doctor. Never go to the ear doctor.