Saturday, November 26, 2022

Minsky, Inflation, And The Deflationary Bloc

From Phenomenal World:

“An effective way to write the history of the last thirty years of the twentieth century,” economist Albert Hirschman wrote in 1985, “may well be to focus on the distinctive reactions of various countries to the identical issue of worldwide inflation.” Writing just as the global “great inflation” of the 1970s was abating, Hirschman couldn’t have foreseen how right he was. As Claudia Sahm recently wrote in the New York Times, fear of the great inflation of the 1970s still dominates the thinking of the Federal Reserve, even as its recent messages indicate changing winds. (In recent comments, Larry Summers’s warning that two-thousand-dollar checks would cause the economy to run too “hot” and generate inflation betrayed an almost generational blindness on the topic.)

Economists lack a good understanding of what causes inflation. In introductory macroeconomics curricula, the mantra of Milton Friedman remains central: “inflation is always a monetary phenomenon.” By this, Friedman meant that excessive price growth happens when a state loosens the supply of money, thus over-expanding the monetary base. But recent research has brought this popular doctrine into question. While expanding the money supply seems to be a necessary condition for uncontrolled inflation to occur, it is not sufficient: increases of the monetary base have occurred without any inflationary episodes, and inflationary episodes have happened with only very small increases in the monetary base.

Contra Friedman, Hirschman suggested that uncontrolled inflation is primarily a political phenomenon that occurs when groups compete over resources. The rapid increase of the price level is a signal that the state can no longer control this competition. What exactly happened in the waning decades of the twentieth century, and why do the ghosts of inflation still haunt our economic and political reality?

Hyman Minsky’s writings on the collapse of the so-called golden age of capitalism offer some insight by forcing us to engage with how distributive struggles have driven the inflationary and deflationary cycles of the past fifty years. In doing so, we can construct an account of the political economy underpinning the “deflationary coalition” that rules the common sense of our economic policymakers and the policy they write—and the path to a new one.

Hyman Minsky’s moment
Minsky became posthumously famous as a prophet of the inherent instability of financial markets. The term “Minsky moment”—the point where a bubble caused by the accumulation of private debt bursts—was coined by PIMCO’s Paul McCauley in the context of the 1998 Russian financial crisis and has become ubiquitous in the financial media. But Minsky’s Financial Instability Hypothesis (FIH), the idea that capitalism has a tendency toward financial crisis, was part of a more elaborate theory of advanced capitalist economies. Minsky believed that as a financial system, capitalism was best defined by the fact that all economic units, including individuals and households, must survive by making cash inflows and matching commitments. This is what he called a “survival constraint”: everyone from industrial firms to individual workers must have cash on hand to pay their debts or else find credit to roll their liabilities over to some future date when they will have cash flows. The ways that societies arrange for the extension and management of these cash flows and credit is a function of their institutions. For Minsky, changes in capitalist distribution and price dynamics can be understood by studying the evolution of these regimes in historical time.

In his first book-length work, John Maynard Keynes, Minsky analyzed what he called “big government” capitalism. His goal was two-fold. First, he sought to re-interpret Keynes by distinguishing the so-called hydraulic Keynesianism of the postwar era from the author’s actual written work. He argued that postwar governments which boosted inflation through private profits contradicted Keynes’ original system. Keynes believed that the state should facilitate long term economic development by directly planning economic activity, including the distribution of investment over the long run. Postwar American policymakers, however, created a policy that protected private sector profits during downturns. The United States government did not create the structures which could sustain the production of a baseline basket of goods and services from market instability during upswings. Instead, it pumped up aggregate demand via employment in the military-industrial complex and its attendant investment goods.

The second goal of the book was to warn about the inflationary tendencies of this approach. Government was forcing “overinvestment” in capital intensive industries like auto manufacturing and aerospace. While this created good jobs, it also meant that workers would have more money to spend on things made by less capital intensive, nondurable consumer goods industries. Wage inequality between these two sectors caused increasing industrial conflict. In the United States and Western Europe, a pattern emerged in which managers made wage concessions to the most highly productive workers to keep at bay demands for greater union participation in company decisions, thereby further increasing the demand for consumer goods.

Because returns to capital intensive goods were high, the investment capital needed to expand capacity in consumer goods was scarce. With rapidly increasing demand, the price of these goods began to rise, leading to a wage-price spiral. In industries with no anticipated profits, capitalists had no incentive to expand capacity. Consequently, output remained stable while prices rose. In the labor market, some workers held on to their jobs while others were relegated to chronic underemployment.

Minsky’s account differs significantly from those we see in most textbooks....