The Financial Innovation Hypothesis: Schumpeter, Minsky and the <i>sub-prime</i> mortgage crisis

Neo-Schumpeterian economics inspired by the work of Schumpeter and the financial Keynesianism of Minsky are often regarded as unrelated theoretical strands. In this paper, we try to combine these two literature building on a parallelism between non-financial and financial firms. We focus on recent financial innovations, highlighting how the evolution experienced by US financial institutions led them to transcend their traditional role of credit providers, shaping as 'producers' of financial products, through securitization. This allows on the one hand to broaden the application of Neo-Schumpeterian insights to the financial sector and, on the other, to provide an original explanation of the so-called sub-prime crisis by applying the Financial Instability Hypothesis of Minsky to the alternative context of financial production. We maintain that the 2007-8 crisis was not the result of an innovation in the real sector, but came from an innovation (or a series of innovations) intrinsic to the financial system itself, which fostered credit creation. We argue that this 'cluster of innovations' can be placed under the label 'securitization', defined as the business of packaging and reselling loans, with repo agreements as the main source of funds

Financial-real side interactions in the monetary circuit: loving or dangerous hugs?

Monetary circuit theory is one of the most known attempts to formally describe the functioning of a monetary production economy as centered around the concept of flux-reflux of money. Endogenous money creation by commercial banks allows the circuit to open and firms to implement production processes. Financial markets ‘passively’ close the circuit by intermediating savings via bond and equity issuance. Despite its natural focus on financial-real side links, the monetary circuit literature has paid relatively little attention to ‘financialization’ and the way it has modified real-financial dynamics. In this paper, we analyze whether the flux-reflux perspective of the circuit may be fruitfully applied to the description of the real-financial linkages in a financialized economy. We propose two interconnected circuits, one for the real economy and one for the financial one. In this context, finance can still ensure a consistent closure of the whole system, thus directly allowing the functioning of the real economy. Newly developed inside-finance interactions, however, may indirectly influence real world dynamics by easing/restricting access to credit/financial markets and give rise to boom-and-bust cycles. Our aim is twofold: modeling modern financial worlds within a MC framework and understanding how financialization could have modified real-financial interactions

The endogeneity of money and the securitizing system. Beyond shadow banking

Financialization is not just a phenomenon regarding the exponential growth of the financial sector with respect to the real side of the economy. This paper aims shedding some light on the nature and the systemic impact of new elements in the financial realm and particularly on the so-called shadow banking through a macroeconomic perspective. Our analysis shows how financial evolutions have had an impact on the monetary system and on the whole economy at multiple levels. It involved the channel through which money enters the economic system, the rise of new financial institutions and activities, the implementation of monetary policies, and the relation between the real and the financial sector. What we are witnessing is not the rise of a shady version of something old whereas the surge of new forms of financial accumulation

Fighting the COVID-19 emergency and re-launching the European economy: debt monetization and recovery bonds

In this policy brief, we first highlight some peculiar characteristics, from an economic point of view, of the current Covid-19 crisis. We stress its exogenous and symmetric nature with respect to Eurozone countries, as well as the complex mix of supply and demand shocks it entails. Given these features, we then suggest two intertwined policy measures in order to tackle the emergency phase of the crisis and the subsequent recovery. We first advice the pervasive intervention of Eurozone governments in support of business and households income in the context of the “suspended” economy that measures against the diffusion of Covid-19 have forcefully given rise. We advise the ECB to monetize all public expenditures linked to this emergency plan by purchasing public bonds in the primary market, and to subsequently write them off or exclude these issuances from the computation of public debt-to-GDP ratios. With no signs of inflationary pressures coming, the ECB intervention would avoid Eurozone governments to pile up considerably higher stocks of debts and would help to bypass the current political impasse among Eurozone Member States as to the creation and realise of Eurobonds. In the aftermath of the emergency phase, we suggest the implementation of a massive Europe-wide recovery plan centred on public investment addressing the long-lasting technological and environmental challenges of these years, and financed by the European Investment bank through the issuance of Recovery Bonds

The macroeconomics of shadow banking

In this paper, we propose a simple short-run post-Keynesian model in which the key aspects of shadow banking, namely securitization and the production of structured finance instruments, are explicitly formalized. At the best of our knowledge, this is the first attempt to broaden purely real-side post-Keynesian models and their traditional focus on shareholder-value orientation, the financialization of non-financial firms, and the profit-led vs wage-led dichotomy. We rather put emphasis on the role of financial institutions and rentier-friendly environment in determining the predominance of specific growth and distribution regimes. First, we illustrate the macroeconomic rationale of shadow banking practices. We show how, before the 2007-8 crisis, securitization and shadow banking allowed for an increase in profitability for the whole financial sector, while apparently keeping leverage under control. Second, we define a variety of shadow-banking-led regimes in terms of economic activity, productive capital accumulation, and income distribution. We show that both an ‘exhilarationist’ and a ‘stagnationist’ regime may prevail, nevertheless characterized by a probable increase in income inequality between rentiers and wage earners

Stock-Flow Consistent Modeling Through the Ages

Dieser Vortrag muss hier angekündigt werden: "15. Juli 2008, 19.30 Uhr, Universität [Augsburg], Hörsaalzentrum, Universitätsstr. 10, HS III Schatzwächter und Zauberworte: Flucht ins Archiv. Über Literatur und Wissenschaft, Sammelwahn und Kanonbildung Moderation: Prof. Dr. Joachim Jacob, Neuere Deutsche Literaturwissenschaft mit Schwerpunkt Ethik" Quelle: http://www.uni-protokolle.de/nachrichten/id/15503

Same old song: on the macroeconomic and distributional effects of leaving a low interest rate environment

This paper analyzes the macroeconomic and distributional implications of central banks’ decisions to raise interest rates after a prolonged period at near the Zero Lower Bound (ZLB). The main goal of our study is to assess the interaction between monetary policy, inequality, and financial fragility, in a financialized economic system. Financialization is here portrayed as the presence in the economy of complex financial products, i.e., asset-backed securities, produced via the securitization of banks’ loans. We do so in the context of a hybrid Agent-Based Model (ABM). We first compare the prevailing macroeconomic and financial features of a low interest rate environment (LIRE) with respect to a “Great Moderation”(GM)-like setting. As expected, we show that LIRE tends to stimulate faster growth and higher employment, and to reduce income and wealth inequality, as well as (poor) households’ indebtedness. Consistent with existing empirical literature, this comes at the cost of higher inflation and some signs of financial system’s fragility, i.e., lower banks’ profitability and Capital Adequacy Ratio (CAR), and higher “search for risk” given by credit extension to poorer households. We then show that increases in the central bank’s policy rate, as motivated by the central bank’s willingness to reduce inflation, effectively curb price dynamics and accomplish with central bank’s inflation targeting mandate. Higher interest rates also improve commercial banks’ CAR and profitability. However, they also cause a pronounced increase in non-performing loans (stronger than what possibly observed in a GM scenario) and some worrisome macro-financial dynamics. In fact, higher interest rates give rise to higher households’ and overall economy indebtedness as allowed by wealthier households’ demand for high-yield complex financial products and mounting securitization. We finally show how financialization structurally changes the functioning of the economy and the behavior of central banks. Financialization actually contributes to create a (private sector) debt-led economy, which becomes structurally more resistant to central bank’s attempts to control inflation. Central bank’s reaction in terms of higher interest rates could likely come with perverse distributional consequences

When complexity meets finance: a contribution to the study of the macroeconomic effects of complex financial systems

In the last decade, complexity economics has emerged as a powerful approach to the understanding of the most relevant factors influencing economic development. The concept of economic complexity has been applied to the study of different economic issues such as economic growth, technological change and inequality. This work represents a first step towards the application of this concept to the study of the financial side of the economy, and particularly of the macroeconomic effects of rising financial complexity. In this paper, we present an agent-based macroeconomic model including an increasingly complex financial sector, characterized by the presence of Collateralized Debt Obligations with different seniorities next to more standard assets, like bonds and commercial papers. Simulations results suggest that financial complexity exerts major economic effects: while financial engineering makes securitized loans very attractive and opaque assets, the disperse interaction among different agents and financial institutions generated by these complex financial instruments shapes the behavior of the economies and allows for the diffusion of financial distress

Inequality and finance in a rent economy

The present paper aims at offering a contribution to the understanding of the interactions between finance and inequality. We investigate the ways through which income and wealth inequality may have influenced the development of modern financial systems in advanced economies, the US economy first and foremost, and how modern financial systems have then fed back on income and wealth distribution. We focus in particular on securitization and on the production of complex structured financial products. We analyse this topic by elaborating a simulated hybrid Agent-Based Stock-Flow-Consistent (AB-SFC) macroeconomic model, encompassing heterogeneous (i.e. households) and aggregate sectors. Our findings suggest that the increase in economic growth, favoured by the higher level of credit supply coming with securitization, may determine a more unequal and financially unstable economic system

Fighting the COVID-19 Crisis: Debt Monetisation and EU Recovery Bonds

This paper highlights some peculiar characteristics of the economic crisis induced by the spread of COVID-19. It suggests two intertwined policy measures in order to tackle the emergency phase of the crisis and to support the economy in the subsequent recovery phase. The proposed short-term policy measures offer policy responses in the event of a second wave of coronavirus infections in the coming months. In the aftermath of the emergency phase, the current proposal puts forward the implementation of a massive EU-wide recovery plan addressing the long-lasting technological and environmental challenges of these years, which will be financed by European institutions through the issuance of European Pandemic Recovery Bonds