Financial Fragility and Banking Sector in a Macroeconomic Model with Minskyan Insights

In light of the recent global financial crisis, the notion of financial fragility has become a cornerstone in current research programs of the dynamics of modern monetary production economies. This paper intends to contribute to the literature that focuses on the macroeconomic modelling of financial fragility drawing on Minsky’s theoretical framework. Our aim is to extend this literature whereby considerable emphasis has been placed on the fragility of firms, but much less attention has been paid to the fragility of banks and its impact on macroeconomic performance. The paper develops a simple macroeconomic model that links the fragility of banks with the level of output. We put forward a Minskyan categorization for the economy’s financial structure, which takes into account both the fragility of banks and the fragility of firms. Our analysis intends to illustrate under what conditions the interaction between banks and the real economy is likely to lead to financial structures that are susceptible to financial instability

Securitisation, wage stagnation and financial fragility: a stock-flow consistent perspective

Securitisation and wage stagnation have been viewed as two main root causes of the global financial crisis. This paper develops a stock-flow consistent model that allows the investigation of the macroeconomic channels through which securitisation and wage stagnation can jointly affect financial fragility. Particular attention is paid to their role in enhancing a borrowing-induced expansion, a housing boom and an appreciation in the prices of mortgage-backed securities that are of temporary nature. The results from simulation experiments provide support to the view that the combination of risky financial practices with wage stagnation can increase the likelihood of financial instability in a macro system

Bank liquidity and macroeconomic fragility: Empirical evidence for the EMU

The supervision of bank liquidity has been one of the core topics in the recently developed regulatory framework of banks (Basel III). This paper investigates two issues that have not been addressed in Basel III and which are of particular importance for the attainment of a more effective liquidity regulation. The first is the need for a dynamic definition of liquidity that takes into account the time-varying liquidity and stability of banks’ balance sheet items. The paper develops a new liquidity ratio that explicitly considers this changing nature of liquidity, by assigning weights that depend on financial risks and perceptions. The ratio is estimated and assessed for the EMU-12 countries. The second issue is the need for macro fragility-related liquidity requirements. We provide empirical evidence which suggests that the banking sector does not self-impose such requirements. Based on this evidence, it is argued that the regulatory agents should introduce a positive link between bank liquidity and macroeconomic fragility

Debt crisis, fiscal austerity and the financial fragility and instability in the Greek economy

Drawing on Minsky’s theoretical framework, we critically assess the effectiveness of the currently implemented fiscal austerity measures in the Greek economy. We develop and apply two indexes that encapsulate the financial fragility in the public sector and the macroeconomy. The statistical evidence suggests that over the last 5-6 years prior to the onset of the crisis the public sector was situated in the ultra-ponzi area and the financial fragility of the Greek economy was steadily increasing, making the economy extremely vulnerable to potential shocks. We show that the fiscal austerity measures do not produce a substantial decline in the financial fragility of the public sector; they also set the stage for chronic financial instability in the economy. We call for a fundamental change in the policy mix currently implemented in the Greek econom

Macrofinancial policies for a green and caring economy: Feminist Green New Deal policy paper

The transition to a green and caring economy necessitates fundamental changes to how our economies and societies are organised, produced and reproduced. A key component of these changes is the redesign of macroeconomic and financial policies. These policies determine how the public sector invests in physical and social infrastructure, how governments use taxes and subsidies to support or prevent specific types of economic activities, as well as how the financial system provides credit to the real economy. Macrofinancial policies have, therefore, significant implications for gender equality, our well-being and the environmental effects of our economies. This report sets out our vision for transforming UK macrofinancial policies in line with the transition to a green and caring economy. The main messages and recommendations of the report are as follows: -Public investment and public sector jobs that support decarbonisation and care should be put at the core of the UK fiscal strategy, with targeted subsidies and taxation playing a supportive role in reducing the environmental footprint of the activities and investments of the private sector. Fiscal policies need to be conducive to the transformation of polluting activities (for example, through re-tooling and a reduction of their carbon intensity), the contraction of sectors that are inconsistent with the Paris Agreement targets (such as fossil fuels) and the expansion of sectors with a low environmental footprint that are conducive to a better quality of life (such as care). -Low-carbon transport, green social housing, caring activities and the creation of parks and green spaces should be the focus of a public investment strategy that will target both the decarbonisation of our physical infrastructure and the expansion of social infrastructure. The design of public investment projects, such as the construction of social housing units and the development of urban transport systems, should take explicitly into account everyday practice and facilitate caring responsibilities. But they should also be combined with interventions and regulatory initiatives that transform our consumption norms. -No one should be left behind because of the decarbonisation of our economies. Some workers might become unemployed due to the decline in high-carbon activities. To achieve a just transition for these workers, appropriate reskilling and upskilling are essential. -The funding and financing of public investment and public sector jobs can rely on a combination of tools: (i) progressive taxation, wealth-related taxes and energy windfall taxes, (ii) the purchase of government bonds by the Bank of England within a new fiscal-monetary policy coordination institutional framework, and (iii) the issuance of government bonds linked specifically to the green and caring economy. A potential increase in public debt should not be viewed as a barrier, in contrast to what has been argued in standard austerity narratives. -Public banking should be expanded and play a central core in the financing of green and caring activities. -The decarbonisation of the UK private financial system should include both the operations of the Bank of England and financial regulation and should rely on a ‘carrot and stick’ approach that encourages the financing of green activities and discourages the financing of dirty activities. The current financial system suffers from a gender bias and does not support activities that are essential for developing a caring economy. A diversity-based transformation of the UK financial system is, therefore, essential. Gender and diversity criteria should be introduced in the lending practices and operations of public banks, private banks and the Bank of England

A coordinated mix of public investment and incomes policies for sustainable development in Europe

This policy brief presents the impact of a coordinated policy mix of increased public investment together with more progressive taxation and labour market policies to improve income distribution in Europe. Based on an econometric model for individual EU Member states, we simulate a policy scenario of a simultaneous increase in public investment by 1% of GDP along with more progressive taxation (increasing effective tax burden on capital by 1% and decreasing tax burden on labour by 1%) and an increase in the wage share by 1% of GDP in each country. The result is 6.6% higher GDP in the EU. Even private investment increases by 1.5% as a ratio to GDP (on average in Europe) as an outcome of this policy mix; i.e. public spending does not crowd out but rather crowds in private investment. Despite the rise in public spending, the budget balance in Europe improves (by 0.8% as a ratio to GDP) because the beneficial fiscal effects of higher economic growth and higher tax rates on capital prevail. Growth and private investment improves both in the periphery and core countries of Europe. The concerns regarding the inflationary effects of wage increases are also not supported by empirical evidence. This policy mix will lead to only a modest 1.5 percentage point increase in price level in Europe on average. Hence wage-led and public investment-led growth are complimentary and feasible. Such a coordinated policy mix, along with a properly designed industrial policy can ensure genuine regional convergence and social cohesion in Europe

Minsky's financial instability hypothesis

Since the Global Financial Crisis, Minsky’s Financial Instability Hypothesis (FIH) has been receiving a growing attention in macroeconomic analyses and policy making. In this contribution I discuss the key dimensions and extensions of Minsky’s FIH, focusing on how Minskyan frameworks have analysed the drivers of endogenous instability and cycles associated with corporate, household and external debt. I cover recent theoretical and empirical developments in the Minskyan literature and emphasise the unique evolutionary macrofinancial aspects of Minsky’s approach. I also analyse the policy implications of Minsky’s FIH and explain how Minsky’s analysis can be used for our understanding of climate-induced financial instability, in light of the recent developments in the area of climate-related financial risks

The role of public spending and incomes policies for investment and equality-led development in the UK

This policy brief presents how a mix of fiscal and labour market policies could affect growth, investment and public budget in the UK. Based on an econometric model, we simulate the joint impact of an increase in public spending by 1% of GDP (about £20bn per year) along with more progressive taxation (increasing effective tax burden on capital by 1% and decreasing tax burden on labour by 1%) and an increase in the wage share by 1% of GDP. As a result, GDP increases by 3.7%. Private investment increases as well by 0.7% as a ratio to GDP. The budget balance in the UK improves by 0.2% as a ratio to GDP. Inflation increases only slightly: the price level goes up by 1.8 percentage points. The effects are even more favourable if policies are implemented simultaneously together with our trade partners in the EU

The effect of income distribution and fiscal policy on growth, investment, and budget balance: the case of Europe

This paper develops a multi-country Post-Kaleckian model augmented by a government sector with public spending and taxes on consumption, labour and capital and estimates it for the EU15 countries. We estimate country specific equations to find the effect of income distribution, public spending and taxes on growth, on each component of private aggregate demand (i.e., consumption, investment, and net exports) and on budget balance for the EU15 countries. Next, we calculate a Europe-wide multiplier based on the responses of each country to changes not only in domestic income distribution, taxation and government expenditure but also to changes in the other European countries’ wage share, taxes and public spending. One novelty of this paper is that it goes beyond an isolated country-by-country analysis and integrates cross-country effects of a simultaneous change in the wage share on demand in Europe in a government augmented Post-Kaleckian model.Extending the model by taxes on labour and capital increases the likelihood of a wage-led economic regime. The fiscal multiplier effects are much stronger when policies are implemented simultaneously, and wage, tax and public spending policies are integrated into the policy mix. The impact of egalitarian wage policies are positive but small; the overall stimulus becomes much stronger when mixed with fiscal expansion. Expansionary fiscal policy is sustainable when wage, public spending and progressive tax policies are combined. The analysis of the paper can guide the development of a fiscal and wage policy mix conducive to equitable development

Essays on financial fragility, instability and the macroeconomy

The aim of this thesis is to shed some new theoretical and empirical light on the issues of financial fragility and instability of the macroeconomic systems. The thesis consists of four independent essays. The first essay develops a macrodynamic model in which firms’ and banks’ desired margins of safety play a central role in macroeconomic performance. Mathematical analysis and numerical simulations illustrate that the endogeneity of the desired margins of safety during the investment cycles is conducive to instability. Moreover, it is indicated that fiscal policy can reduce the destabilising forces in the macroeconomic system. The second essay explores, via a stock-flow consistent model, the macroeconomic channels through which securitisation and wage stagnation can jointly affect financial fragility. The results from simulation experiments provide support to the view that the combination of risky financial practices and higher inequality can substantially increase the likelihood of financial instability in the macro system. The third essay proposes a new bank liquidity ratio that explicitly considers the time-varying nature of liquidity by assigning weights on banks’ balance sheet items that depend on financial risks and perceptions. This ratio is estimated and assessed for the EMU-12 countries. Furthermore, the essay investigates the link between macroeconomic fragility and bank liquidity for the EMU. The empirical results suggest that banks in the EMU do not self-impose higher liquidity requirements when macroeconomic fragility increases. The fourth essay puts forward a liquidity index that extends Minsky’s well-known financial taxonomy of economic units to the government sector. The index is estimated for Greece over the period 2001-2009. The data analysis supports the view that the financial fragility of the Greek government sector increased significantly before the sovereign debt crisis