Kalecki, Minsky, and “Old Keynesianism” Vs. “New Keynesianism” on the Effect of Monetary Policy

By Tracy Mott, Professor, University of Denver. Originally published at the Institute for New Economic Thinking website

In a postco-authored with Anna Stansbury, Larry Summers repudiates economic orthodoxy in regard to whether interest rate cuts suffice to restore full employment and looks at a more “original” Keynesianism to find adequate responses to secular stagnation. Tracy Mott walks us through answers many careful readers of Kalecki, Keynes, Steindl, and Minsky knew all along.

A version of what Lawrence Summers and Anna Stansbury (2019) recently pointed to as “original” Keynesianism can be found in the work of Michał Kalecki and Hyman Minsky, Their work offers analysis of the determination of investment spending and effective demand which avoids the deficiencies found in the New Keynesian economics in which Summers and Stansbury find shortcomings. In the paragraphs below, I describe how their insights and those of other economists sharing their approach provide an answer to the questions with which Summers and Stansbury are grappling, and more.

The problems facing monetary policy with which Summers and Stansbury are concerned are handled by Kalecki and Minsky as follows: Kalecki’s “principle of increasing risk” argues that the limit to investment spending comes from the percentage of own wealth sunk into the project as well as the expected demand for the use of the new productive capacity. (Kalecki 1937 [1990], Mott 2010). This reduces the role of the cost of finance in the form of interest relative to that of the quantity of finance available in the form of retained earnings in affecting business investment spending. Similarly, we have Minsky’s (1986) emphasis on the way that cash commitments on outstanding debt relative to cash flow being received by firms affect the financial fragility faced by a firm when considering investment expenditure. Bruce Greenwald and Joseph Stiglitz (1993) have rediscovered this view of the financing of investment, basing it on bankruptcy costs.

Summers and Stansbury make the point that also the amount of interest-sensitive assets may not be enough for a policy of lowering rates to overcome unemployment. Kalecki’s and Minsky’s ideas reinforce this tremendously. Minsky adds the point, made by Kalecki, John Maynard Keynes (1964 [1936]), Irving Fisher (1933), James Tobin (1980), and others as well, that price deflation in a recession will make the burden of debt worse.

Concerned with the explanation of the extraordinary ineffectiveness of the usual monetary instruments, Summers and Stansbury talk about moving from a type of Keynesianism basing unemployment on price rigidities (“New Keynesianism”) to a Keynesianism based on aggregate demand insufficiencies (“Old Keynesianism,” or the ideas of Keynes’s General Theory). This is what the Kalecki-Minsky framework is about. For Keynes himself in the General Theory, the main point is that the attempt to save does not automatically result in investment spending. But, if low aggregate demand or monetary policy easing push interest rates to fall enough, wouldn’t we get enough investment to have full employment? Keynes discusses the failure of monetary policy or the intransigence of speculators to let long-term interest rates fall enough. This of course is what would also happen at the zero/lower bound, unless negative interest rates low enough could be reached, but this should be prevented by a flight to currency. Since holding currency is costly, we have found that wealth-holders will allow some degree of negativity in interest rates. At some point, however, they will surely figure out a way to store currency at some cost that is less than receiving severely negative interest on these holdings. Kenneth Rogoff (2017) has proposed that eliminating currency would allow interest rates to reach whatever negative rate is necessary to give us full employment. However, some other asset that has low carrying costs would probably emerge to avoid punishingly low interest rates.

The idea that rigidities were necessary to have unemployment in a Keynesian framework came from A.C. Pigou (1943) and his effect of deflation on increasing consumption. In an article published the year after Pigou’s Kalecki (1990 [1944]) showed that this was nonsense. The past 30 years in the Japanese economy also reveal the implausibility of the workings of the “Pigou effect.” The “neoclassical-Keynesian synthesis,” however, was said to allow the long-run equilibrium to be one of full employment. (The theory known as “New Keynesianism” differs from that of the synthesis by basing the rigidities that gave “Keynesian” results on rational maximizing behavior, e.g., appealing to price-changing costs being greater than the advantages of changing prices when demand changes.)

For Keynes in the General Theoryinvestment plus consumption doesn’t provide enough aggregate demand to give full employment. Falling money wages would not lead to higher employment but they will simply lower prices proportionally. The only benefit to aggregate demand would have to come from lower prices lowering the demand for money for transactional purposes and thus, ceteris paribus, interest rates. Lower prices, however, would raise the burden of debt, lowering aggregate demand, as argued above.

In a Kalecki-Minsky framework, and as spelled out by Joseph Steindl (1976 [1952]), investment per unit of productive capacity is a function of retained earnings per unit of productive capacity, national output per unit of productive capacity (capacity utilization), debt service per unit of productive capacity, and interest rates (Fazzari and Mott, 1996-97). Cycles in investment spending come from the interactions among investment, retained earnings, national output, capacity, and debt. Hence, the room for interest rates to affect business investment is very slight. Consumption is largely determined by the level of real wage income, which should rise and fall with investment. Changes in interest rates similarly affect housing and consumer durables spending. As long as that channel works well, monetary policy can influence the economy, stopping an upswing or turning a downswing around after a time.

As Minsky pointed out, over time household debt can pile up as raising rates to slow down an inflationary economy won’t likely restrict the growth of debt enough to offset its growth when rates are lowered to stimulate borrowing to spend on housing and consumer durables (Mott, 2002). Then we will reach a time like 2007, when lowering rates won’t be able to accomplish enough because of too much outstanding debt.

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  1. diptherio

    Kenneth Rogoff (2017) has proposed that eliminating currency would allow interest rates to reach whatever negative rate is necessary to give us full employment.

    I think Rogoff’s proposal is to eliminate paper currency. Not currency, per se, but just the physical variety of it.

      1. diptherio

        Well, sure, that might be an unfortunate side effect [/sarc], but his stated reason is to remove holding cash as an alternative to accepting negative interest rates in an account. At least that seems to be his thinking. Hence, the sentence following the one quoted above is “However, some other asset that has low carrying costs would probably emerge to avoid punishingly low interest rates.”

        1. jsn

          And, of course, we’ll just starve to death anyone without a bank account: “useless eaters.”

          These people (Rogoff, not the “useless eaters”) are psychotic.

          1. notabanktoadie

            There’s no good reason that every citizen should not have a FREE* debit/checking account at the Central Bank itself.

            Or should only a government-privileged usury cartel be allowed to use the Nation’s fiat in inherently risk-free account form at the Central Bank? Anyone care to defend that proposition?

            *Up to a reasonable limit on account size.

    1. Susan the other`

      Is Rogoff saying that we should go digital with all transactions and if those digital balance sheets get lopsided with accumulated digits then they should be invested in some new “currency” instrument that might be designed to be neutral, like a treasury note which fluctuates in a playoff between the price of the note and the (positive) interest rate offered? That made no sense in any other context. So Rogoff is suggesting that we have two different currencies, one for digital transactions which can go-to-hell-negative and a different one which is limited to some minimum of positive interest as a store of value?

    2. chuck roast

      This fits perfectly with the idea of all-digital currency. Then Rogoff’s masters, the banks as intermediaries, can impose negative interest rates on the entire populace.
      Negative interest rates on digital currency. In my neighborhood there is a simple term for this phenomena…theft.

      1. notabanktoadie

        The debt of a monetary sovereign, including account balances at the Central Bank, is inherently risk-free and therefore should return AT MOST zero* percent. Subtract overhead costs and we’re in negative territory.

        That said, individual citizens have a natural right to use their Nation’s fiat FOR FREE but only up to a reasonable limit. Beyond that limit or in the case of non-individual citizen accounts at the Central Bank, negative interest is as natural as making heavy trucks pay more for using the Nation’s roads than lighter vehicles.

        So negative interest is not theft so long as individual citizens are exempt from it up to a reasonable account limit but merely paying for a public utility.

        As for physical fiat, coins and paper bills, these need not be abolished so long as may not be used to substantially escape negative interest. Some possible ways to prevent that are:
        1) Forbid the issue of new physical fiat to anyone but individual citizens and only under a certain amount per citizen per year.
        2) Use date stamps on physical fiat to enforce negative interest on it.

        *to avoid welfare proportional to account balance.

    3. Karen

      Negative interest rates are an asset tax. Taxing assets is a good idea, but this has got to be one of the worst ways to do it. On top of all the other negatives associated with a cashless society, negative interest rates are inequitable: they punish small savers that hold money in banks, while the wealthy find other ways to store their loot. On top of that, low/negative interest rates drive up asset prices (more inequity) and distort borrowing incentives in terrible ways…until the whole thing goes pear-shaped.

      A straight-up wealth tax is more transparent and less likely to destroy bank intermediation. Not that any of us should care too much about banksters, but the folks leading the charge toward a cashless economy typically do. The only reason negative rates are “working” abroad is because there is a large financial market that still offers a positive yield…for now.

      There will be myriad problems enforcing a wealth tax in our globalized financial system, but I would rather the uber-wealthy lose THEIR privacy than every ordinary person who would like to help a friend, keep a few innocent secrets, or make an anonymous gift.

      1. notabanktoadie

        they punish small savers that hold money in banks, Karen

        Why are small savers held captive in a usury cartel to begin with? Where is their natural right as citizens to use their Nation’s fiat in account form? Via debt/checking accounts of their own at the Central Bank? Where they can be shielded from negative interest up to a reasonable account limit while levying it on banks and other large accounts?

  2. TMoney

    Currency is a zero coupon bearer bond.
    . Bearer bonds are out of favor due to their anonymous nature. On the other hand, bearer instruments are great when the power is down, disaster strikes, etc. Bearer instruments have a (physical) resilience that digital systems don’t.

    Rogoff and their ilk need to find themselves on the wrong side of a disaster without something important food, water, clothes – then they can start their war on cash, while waving an Amex card complaining – as opposed to a fist full of Benjamin’s.

  3. Portlander

    Steve Keen, a minskyian macro-modeler, argues we need to bring in chaos theory and complexity theory into these arguments. There are non-linearities in the economic system that have the potential to make economies behave like, well, hurricanes. His models demonstrate the Minsky “stability begets instability” hypothesis very well.

    1. Dick Swenson

      Ken Rogoff’s book The Curse of Cash proposes the elimination of paper currency mostly. He discusses the pros and cons well and argues that everyone should have a bank account much as everyone should have a social security number.

      He agrees that small bills, say $1s might be necessary for a while, and one idea is to make large amounts, say $5 and 10K be in coins. He only proposes phasing out paper currency initially.

      One of the pros is that this will make it very difficult for illicit drug dealing. Can you imagine a drug dealer carrying $5K in coins? Or better yet, keep illicit drug dealers but tax them. The latter might put them out of business.

      As to privacy, this system would eliminate Trumpy talk, and would establish the “reality” of the wealth of billionaires. Having lots of wealth in stocks and bonds and foreign currencies presumes that these can be converted through sales or transfers into their nominal price. And when the wealth becomes “real” then it becomes taxable.

      Make him a bit wealthier than are Harvard professors normally and buy or borrow his book. There’s lots to think about.

    2. Tomonthebeach

      Portlander make an excellent point. The line in this article that nicely sums up why Washington cannot look beyond FED interest rates was this: “…price deflation in a recession will make the burden of debt worse.” To me that observation cries out for a dynamical model. Someday, after the oceans are a meter deeper, we might finally shelve linear models for ones capable of explaining complexities.

  4. Sound of the Suburbs

    In 5,000 years of human history those at the top have designed systems to maintain themselves in luxury and leisure.

    They got started almost immediately.

    Mankind first started to produce a surplus with early agriculture.

    It wasn’t long before the elites learnt how to read the skies, the sun and the stars, to predict the coming seasons to the amazed masses and collect tribute.

    They soon made the most of the opportunity and removed themselves from any hard work to concentrate on “spiritual matters”, i.e. any hocus-pocus they could come up with to elevate them from the masses, e.g. rituals, fertility rights, offering to the gods …. etc and to turn the initially small tributes, into extracting all the surplus created by the hard work of the rest.

    The elites became the representatives of the gods and they were responsible for the bounty of the earth and the harvests. As long as all the surplus was handed over, all would be well.

    It’s been the same ever since, the extraction methods have just got more sophisticated over time. Money and capitalism were very handy when belief in the supernatural and religion started to fade.

    The land scam (feudalism)
    We will let you use this piece of land and leave you with enough to provide a basic subsistence existence and we will take the rest.

    The money scam (capitalism)
    You do the work, and we will pay you a wage that will provide a basic subsistence existence and we will take the rest as profit.

    As the money scam (capitalism) replaced the land scam (feudalism) the UK’s aristocracy barely noticed. They lived in luxury and leisure and other people did all the work.

    This is capitalism in the raw, before those at the bottom started fighting to improve their lot.

    All for ourselves, and nothing for other people seems, in every age of the world, to have been the vile maxim of the masters of mankind.” Adam Smith

    They don’t change; every human society is some sort of scam to leave those that do the work with the bare minimum. The archaeologists find the malnourished, well worn bones of those that did all the work; their skeletons show they existed at the bottom of society.

    The early Classical Economists didn’t expect those at the bottom ever to rise out of a basic subsistence existence as that was the way things had always been.

    The early Classical Economists noticed those at the top lived in luxury and leisure, but never did a stroke of real work.

    Economics was going to be a big problem that could never be allowed to reveal the truth.

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