Last time we ran through two types of recessions, “Keynesian” type and “monetarist” type—the one we saw in 2002 and the other we saw in 1982.
In a “Keynesian” downturn the fundamental financial excess demand in the economy is an excess demand for bonds: an excess of (planned) savings over business investment. Households try to shift their spending from purchasing current goods and services to purchasing bonds and other investment vehicles to carry purchasing power forward into the future. The shift in spending away from currently-produced consumption goods and services puts downward pressure on employment and production in those industries. But where is the excess demand for labor to pull the newly-unemployed into new occupations? Perhaps as bond prices rise and interest rates fall businesses become exuberant about expanding their productive capacity, boost business investment spending, and excess supply in consumption-goods industries is offset by excess demand in investment-goods industries and the economy smoothly rebalances. But perhaps not—perhaps businesses don’t become exuberant, or perhaps (as happened in 2002) interest rates fall to their floor near zero, and there still is not enough incentive for businesses to invest enough to make them want to borrow enough to soak up the savings glut. And then the downward spiral of the multiplier kicks in: falling production and employment means falling incomes means further reductions in spending and further reductions in production, employment, and incomes. The cures for a Keynesian downturn are for something to happen that brings the supply and demand for bonds back into balance—for interest rate reductions to induce exuberant businesses to print bonds so as to borrow and fund investment spending to expand capacity, for interest rate reductions to reduce the value of the currency and so boost exports which are then paid for by foreigners’ selling their own dollar-denominated bondholdings into the market, for the government to sell bonds and use the proceeds to bring spending forward into the present and push taxes back into the future. Standard monetarist cures—for the Federal Reserve to buy short-term government bonds for cash—are ineffective because an excess demand for liquid cash money is not the problem, except insofar as the Federal Reserve’s open-market purchases trigger enough of a reduction in interest rates to sufficiently boost either business investment spending (and bond issues) or net exports (and foreigners’ bond sales).
In a “monetarist” downturn the fundamental financial excess demand in the economy is an excess demand for liquid cash money: an excess of (desired) cash holdings over the economy’s money stock. Households try to shift their spending from purchasing current goods and services to building up their cash balances to achieve their desired liquidity. The shift in spending away from currently-produced consumption goods and services puts downward pressure on employment and production in those industries. But where is the excess demand for labor to pull the newly-unemployed into new occupations? Perhaps as households dump bonds on the market to try to build up their cash holdings bond prices fall and interest rate rise enough that households notice the high opportunity cost of holding cash and reconfigure in order to be satisfied with much lower liquid cash money holdings. But perhaps not—perhaps (as happened in 1982) interest rates rise but households and businesses still want to build up their cash holdings. And then the downward spiral of the multiplier kicks in: falling production and employment means falling incomes means further reductions in spending and further reductions in production, employment, and incomes. The cures for a monetarist downturn are for something to happen that brings the supply and demand for liquid cash money back into balance—for interest rate increases to induce households and businesses to reconfigure their operations in order to get along with much smaller liquid cash money holdings, for a general fall in the price level to reduce the flow of nominal spending needed to maintain the economy at full employment and normal capacity, for the central bank to simply expand the money stock by buying bonds for cash, or for the banking system to accept more deposits for each dollar of its own reserves and thus run itself a little closer to the edge of vulnerability to a panic. Keynesian cures—for the government, say, to print up a bunch of bonds and engage in deficit spending—are ineffective because an excess demand for bonds is not the problem, except insofar as the government’s bond issues trigger enough of a rise in interest rates to induce a sufficient reconfiguration so that households and businesses can carry out their normal spending plans with less liquid cash money in their reserves.
But today we have a different type of economic downturn: not a Keynesian downturn triggered by an excess of (planned) saving over investment, not a monetarist downturn triggered by an excess of desired liquid cash money holdings over the available money stock, but a Minskyite downturn triggered by an excess (planned) demand for safe high-quality assets. On the one hand, a great deal of the asset pool that people had regarded as safe and high quality—as nearly as good as Treasuries—is gone, or at least definitely no longer regarded as a safe place to park your wealth so that it will still be there when you come back. On the other hand, the fact of panic and the lack of trust in governments’ abilities to stabilize the economy has greatly increased the share of portfolios that investors wish to hold in high-quality even if low-yielding vehicles.
There have been lots of Keynesians and monetarists developing their approaches and fighting it out since, well, since the days of Irving Fisher and Knut Wicksell more than a century ago. That is the reason why their arguments go so smoothly. But there have been fewer Minskyites. And I am not smart enough to make the argument as polished. So this lecture will be considerably rougher.