Summary

Booms and busts • Historical view of business cycles • Henry George Week 11, ECON7040, Semester 1 2017 Dr Cameron K. Murray • Non-neoclassical theories about their cause Minsky - Koo - Keynes - Shiller etc.

• How your view informs the remedies for the cycle

1800s So many

• In the 1800s United States there were around a six major recessions (every 18-20 years), and many minor downturns.

• 10-30% declines in industrial output!

• ⇒ . similar.

• The “” from 1873 to 1896. http://upload.wikimedia.org/wikipedia/commons/2/23/US-GNP- per-capita-1869-1918.png Two views (as of 1915) Two views (as of 1915)

• Cycle theories: “crises tend to recur and that • Special disturbances: Industry will be in a stable prosperity, crisis, and depression succeed each state of equilibrium but for unpredictable outside other with such regularity as to warrant the use of disturbance. the word ‘cycle’.”

• Eg. harvest failures, discovery of new mineral 1. Originates in human mind (psychological cause) deposits, inventions, change to trade routes, war 2. From forces of natures (crop yields, climate etc) and revolution, depreciation of the currency. 3. Structure of modern economic life (institutions)

https://www.jstor.org/stable/pdf/1012901.pdf

Stanley Jevons Economic structure

• "I can see no reason why the human mind, in its own spontaneous action, should select a period of just 10.44 years to vary in. Surely we must go beyond the mind to its industrial environment." • General glut: Debated as possible or not. Came - Jevons, S. 1878. down to the view that you cannot have a glut.

• He also observed that the latest available study of the sun-spot period, that of Mr. J. A. Broun, showed an “There may be, however, an under-supply of interval of 10.45 years between them. This close money" correspondence led to the suggestion of a connection between the two phenomena and the famous "sun-spot and harvest" theory was the re Henry George Marx too

• of 1873–96 led to a meteoric rise of American political scientist Henry George.

• Progress and Poverty: An Inquiry into the Cause of Industrial Depressions and of Increase of Want with • “In a situation where men produce for themselves, Increase of Wealth: The Remedy (1879) there are indeed no crises, but neither is there capitalist production.” • Thought exercise - if everyone could access their own land - Marx, K. 1861. Theories of Surplus Value to undertake production, could their be ?

• Problem must be hoarding of land in his view, and proposed a land value tax to address this.

Recall mainstream State of the art in 1915

• That the economy is on the equilibrium growth path • A correct explanation of the persistent, recurring (depending on you choice of model) causes, however, must rest upon a recognition of the fact that: • Deviations come from outside the economic from external (exogenous) “shocks” "the industrial process of making and the commercial process of distributing goods are • What are these shocks - financial crisis, currency, thoroughly subordinated to the business process Real says coordinated holiday. of making money” Must be money Baby-sitting club

• “The Capitol Hill co-op … issued scrip - pieces of • We have a similar type of property right in modern paper equivalent to one hour of baby-sitting time. society - money. Baby sitters would receive the appropriate number of coupons directly from the baby sittees. This • Be clear about this! made the system self-enforcing: Over time, each couple would automatically do as much baby-sitting • In a recession those with it don’t want to spend it, as it received in return. As long as the people were meaning those without it can’t earn and income! reliable - and these young professionals certainly were - what could go wrong?”

Babysitting recession ‘78 What could they do?

• “…the number of coupons in circulation became quite low. …most couples were anxious to add to their reserves by baby-sitting, reluctant to run them down by going out. But one couple's decision to go • Spend 10 minutes talking in a group and write down out was another's chance to baby-sit; so it became two alternative options you think would work to difficult to earn coupons. Knowing this, couples overcome the babysitting recession. became even more reluctant to use their reserves except on special occasions, reducing baby-sitting • Which view from 1915 does this seem to support? opportunities still further.

In short, the co-op had fallen into a recession.” Warcraft

• A new exchange rate of tokens to battle.net balances led to fluctuating price of tokens in “gold”

http://www.polygon.com/2017/2/20/14667728/world-of- warcraft-tokens-blizzard-hearthstone-overwatch

Minsky - Koo - Keynes

• For lack of a better name, this is a generalised non- mainstream theory of endogenous cycles relying on https://www.youtube.com/watch?v=W39TtF14i8I the behaviour of credit (money) markets.

• Strange that it is not standard economics.

• But it does not conform with the attractive view of market equilibrium that leaves the money-makers unregulated. Minsky Minsky

• “the internal dynamics of capitalist economies leads, over a period dominated by the successful • Financial instability hypothesis: Periods of operation of a capitalist economy, to the emergence stability lure investors (and banks, who control the of financial structures which are conducive to debt money supply) to take more risk, overpay for deflations, the collapse of asset values and deep assets, inflating their value. depressions” - Minsky, H. 1992. • Process: hedge finance⇒ speculative finance⇒ ponzi finance • Two pricing systems coexist - in asset markets, and real goods markets.

Say borrowing p = income + Δpricet-1 interest rate is 12.5%. Types of finance i That is 13.6% over 20yr amortisation. • Hedge: borrowers can meet all debt payments (interest Essentially price capitalises total return and principle) from their cash flows from investment (income plus capital gains), and banks facilitate this. • Speculative: borrowers can meet their interest Time i Price Income ΔPricet-1 Total Eff(i) payments from investment, but must roll over their debt over to pay back the original loan 0 0.15 100 15.0 0 15.0 0.15 1 0.15 102 15.0 0 15.0 0.15 • Ponzi: borrowers can neither repay the interest nor the original debt from the original investment, and rely 2 0.15 115.6 15.0 2.0 17.0 0.13 entirely on rising asset prices to allow them continually 3 0.15 194.9 15.0 13.6 28.6 0.08 to refinance their debt 4 0.15 641.0 15.0 79.2 94.2 0.02 • The price increase required willing lenders and Koo willing new borrowers to support the price.

• What happens when there are no willing borrowers left? • Says that the problem with dealing with a recession is that the value of debts is larger than Time i Price Income ΔPricet-1 Total of assets. 5 0.15 640 15 0 15 • Priority is now not spending and investing (as in 6 0.15 100 15 -540 -525 real investment, not financial), but paying off debt 7 0.15 0 to restore their balance sheet.

Rush to the exits!

All added using $, but are conceptually distinct! Using incomes to pay off debt instead of spend in the real economy!

Real Time i Price Income ΔPricet-1 Total Debt spend

5 0.15 640 15 0 15 320 15

6 0.15 100 15 -540 -525 320 5

7 0.15 33 5 0 5 310 2

8 0.15 13 2 0 2 297 0

Link between asset prices and real economy! Debt accelerator

• Based in this idea, it would be interesting to know if there is a metric of debt balances that predicts economic activity

Level: Private debt balance (debt) Rate of change: ∆debt Acceleration: ∆∆debt

• Debt accelerator reliably predicts asset market values, and hence underlying economy if Minsky cycle exists. http://www.macrobusiness.com.au/2016/03/keen-why-the- house-price-bubble-hasnt-burst/

Keynes Multiplier

• Dealing with a recession means addressing the lack of demand due to incomes being used to pay off debts instead of spending in the real economy. • The point of Keynes’ remedy is that new government spending will increase incomes, • Can lead to deflation if everyone doing it (less generating positive feedbacks - my spending is your money circulating), exacerbating the situation. income, etc. • Due to private sector ‘debt overhang’, only the • Is this a good thing? government can spend to keep incomes up.

• Sovereign state has no limit on money creation Your view informs remedies Monetary policy

• If you view the cycle as caused form outside the • Current trend is monetary policy economy, you haven’t really got a preventative prescription. • This involves the Central Bank buying short-dated assets in the market in exchange for reserves (ESA • However the remedy could be the same. You would in Australia). simply have in mind a “shortage of real spending” or a “glut of real ”. • This has the dual effect of propping up asset prices, • If you view the cycle as a financial, driven by herd and reducing the interest burden on outstanding behaviour and facilitate by lending (money creation), than debt that is has a flexible rate. you can prescribe preventative measures as well as curative ones. • Intention is to stop

Now what? Fiscal policy Lending controls

• Idea here is to facilitate private actors paying off • Prevention: Regulations on lending to stop debts, by increasing spending by the public sector speculative and ponzi finance in banking system on real activity. • Can be done during “cure” as well to prevent next cycle.

Jubilee Japan

• Idea here is to “write off” debts.

• Lender (owner of asset) and borrower (in debt) • Transferred debts from private to public balance agree to forgive a share of the debt. This reduces sheets on balance through monetary policy, QE, the asset position of the lender, but improves it for and fiscal policy. the borrower - a net transfer. • What happens now? • Widely proposed by Prof. Steve Keen

• Iceland did in fact do this. http://business.financialpost.com/midas-letter/bank-of-japans- sovereign-debt-endgame-is-the-naked-emperor

Links to trade and growth

• Exchange rate shocks will change the real balance of debts for exporters or importers, who rely on incomes in a different currency.

• Growth requires lending for investment. But asset values aren’t a good predictor of future growth (and may predict a bust).