Minsky on the Non-Neutrality of Money

I try not to spend too much time criticizing orthodox economics. I think that heterodox people who spend all their energy pointing out the shortcomings and contradictions of the mainstream are, in a sense, making the same mistake as the ones who spend all their energy trying to make their ideas acceptable to the mainstream. We should focus on building up our positive knowledge of social reality, and let the profession fend for itself.

That said, like almost everyone in the world of heterodoxy I do end up writing a lot, and often obstreperously, about what is wrong with the economics profession. To which you can fairly respond: OK, but where is the alternative economics you’re proposing instead?

The honest answer is, it doesn’t exist. There are many heterodox economics, including a large contingent of Post Keynesians, but Post Keynesianism is not a coherent alternative research program. [1] Still, there are lots of promising pieces, which might someday be assembled into a coherent program. One of these is labeled “Minsky”. [2] Unfortunately, while Minsky is certainly known to a broader audience than most economists associated with heterodoxy, it’s mainly only for the financial fragility hypothesis, which I would argue is not central to his contribution.

I recently read a short piece he wrote in 1993, towards the end of his career, that gives an excellent overview of his approach. It’s what I’d recommend — along with the overview of his work by Perry Mehrling that I mentioned in the earlier post, and also the overview by Pollin and Dymski — as a starting point for anyone interested in his work.

* * *

“The Non-Neutrality of Money” covers the whole field of Minsky’s interests and can be read as a kind of summing-up of his mature thought. So it’s interesting that he gave it that title. Admittedly it partly reflects the particular context it was written in, but it also, I think, reflects how critical the neutrality or otherwise of money is in defining alternative visions of what an economy is.

Minsky starts out with a description of what he takes to be the conceptual framework of orthodox economics, represented here by Ben Bernanke’s “Credit in the Macroeconomy“:

The dominant paradigm is an equilibrium construct in which initial endowments of agents, preference systems and production relations, along with maximizing behavior, determine relative prices, outputs and allocation… Money and financial interrelations are not relevant to the determination of these equilibrium values … “real” factors determine “real” variables.

Some people take this construct literally. This leads to Real Business Cycles and claims that monetary policy has never had any effects. Minsky sees no point in even criticizing that approach. The alternative, which he does criticize, is to postulate some additional “frictions” that prevent the long-run equilibrium from being realized, at least right away. Often, as in the Bernanke piece, the frictions take the form of information asymmetries that prevent some mutually beneficial transactions — loans to borrowers without collateral, say — from taking place. But, Minsky says, there is a contradiction here.

On the one hand, perfect foresight is assumed … to demonstrate the existence of equilibrium, and on the other hand, imperfect foresight is assumed … to generate the existence of an underemployment equilibrium and the possibility of policy effectiveness.

Once we have admitted that money and money contracts are necessary to economic activity, and not just an arbitrary numeraire, it no longer makes sense to make simulating a world without money as the goal of policy. If money is useful, isn’t it better to have more of it, and worse to have less, or none? [3] The information-asymmetry version of this problem is actually just the latest iteration of a very old puzzle that goes back to Adam Smith, or even earlier. Smith and the other Classical economists were unanimous that the best monetary system was one that guaranteed a “perfect” circulation, by which they meant, the quantity of money that would circulate if metallic currency were used exclusively. But this posed two obvious questions: First, how could you know how much metallic currency would circulate in that counterfactual world, and exactly which forms of “money” in the real world should you compare to that hypothetical amount? And second, if the ideal monetary system was one in which the quantity of money came closest to what it would be if only metal coins were used, why did people — in the most prosperous countries especially — go to such lengths to develop forms of payment other than metallic coins? Hume, in the 18th century, could still hew to the logic of theory and and conclude that, actually, paper money, bills of exchange, banks that functioned as anything but safety-deposit boxes [4] and all the rest of the modern financial system was a big mistake. For later writers, for obvious reasons, this wasn’t a credible position, and so the problem tended to be evaded rather than addressed head on.

Or to come back to the specific way Minsky presents the problem. Suppose I have some productive project available to me but lack sufficient claim on society’s resources to carry it out. In principle, I could get them by pledging a fraction of the results of my project. But that might not work, perhaps because the results are too far in the future, or too uncertain, or — information asymmetry — I have no way of sharing the knowledge that the project is viable or credibly committing to share its fruits. In that case “welfare” will be lower than it the hypothetical perfect-information alternative, and, given some additional assumptions, we will see something that looks like unemployment. Now, perhaps the monetary authority can in some way arrange for deferred or uncertain claims to be accepted more readily. That may result in resources becoming available for my project, potentially solving the unemployment problem. But, given the assumptions that created the need for policy in the first place, there is no reason to think that the projects funded as a result of this intervention wil be exactly the same as in the perfect-information case. And there is no reason to think there are not lots of other unrealized projects whose non-undertaking happens not to show up as unemployment. [5]

Returning to Minsky: A system of markets

is not the only way that economic interrelations can be modeled. Every capitalist economy can be described in terms of interrelated balance sheets … The entries on balance sheets can be read as payment commitments (liabilities) and expected payment receipts (assets), both denominated in a common unit.

We don’t have to see an endowments of goods, tastes for consumption, and a given technology for converting the endowments to consumption goods as the atomic units of the economy. We can instead start with a set of money flows between units, and the capitalized expectations of future money flows captured on balance sheets. In the former perspective, money payments and commitments are a secondary complication that we may want to introduce for specific problems. In the latter, Minskyan perspective, exchanges of goods are just one of the various forms of money flows between economic units.

Minsky continues:

In this structure, the real and the financial dimensions of the economy are not separated. There is no “real economy” whose behavior can be studied by abstracting from financial considerations. … In this model, money is never neutral.

The point here, again, is that real economies require people to make commitments today on the basis of expectations extending far into an uncertain future. Money and credit are tools to allow these commitments to be made. The more available are money and credit, the further into the future can be deferred the results that will justify today’s activity. If we can define a level of activity that we call full employment or price stability — and I think Keynes was much too sanguine on this point — then a good monetary authority may be able to regulate the flow of money or credit (depending on the policy instrument) to keep actual activity near that level. But there is no connection, logical or practical, between that state of the economy and a hypothetical economy without money or credit at all.

For Minsky, this fundamental point is captured in Keynes’ two-price model. The price level of current output and capital assets are determined by two independent logics and vary independently. This is another way of saying that the classical dichotomy between relative prices and the overall price level, does not apply in a modern economy with a financial system and long-lived capital goods. Changes in the “supply of money,” whatever that means in practice, always affect the prices of assets relative to current output.

The price level of assets is determined by the relative value that units place on income in the future and liquidity now. …  

The price level of current output is determined by the labor costs and the markup per unit of output. … The aggregate markup for consumption goods is determined by the ratio of the wage bill in investment goods, the government deficit… , and the international trade balance, to the wage bill in the production of consumption goods. In this construct the competition of interest is between firms for profits.

Here we see Minsky’s Kaleckian side, which doesn’t get talked about much. Minsky was convinced that investment always determined profits, never the other way round. Specifically, he followed Kalecki in treating the accounting identity that “the capitalists get what they spend” as causal. That is, total profits are determined as total investment spending plus consumption by capitalists (plus the government deficit and trade surplus.)

Coming back to the question at hand, the critical point is that liquidity (or “money”) will affect these two prices differently. Think of it this way: If money is scarce, it will be costly to hold a large stock of it. So you will want to avoid committing yourself to fixed money payments in the future, you will prefer assets that can be easily converted into money as needed, and you will place a lower value on money income that is variable or uncertain. For all these reasons, long-lived capital goods will have a lower relative price in a liquidity-scare world than in a liquidity-abundant one. Or as Minsky puts it:

The non-neutrality of money … is due to the difference in the way money enters into the determination of the price level of capital assets and of current output. … the non-neutrality theorem reflects essential aspects of capitalism in that it recognizes that … assets exist and that they not only yield income streams but can also be sold or pledged.

Finally, we get to Minsky’s famous threefold classification of financial positions as hedge, speculative or Ponzi. In context, it’s clear that this was a secondary not a central concern. Minsky was not interested in finance for its own sake, but rather in understanding modern capitalist economies through the lens of finance. And it was certainly not Minsky’s intention for these terms to imply a judgement about more and less responsible financing practices. As he writes, “speculative” financing does not necessarily involve anything we would normally call speculation:

Speculative financing covers all financing that involves refinancing at market terms … Banks are always involved in speculative financing. The floating debt of companies and governments are speculative financing.

As for Ponzi finance, he admits this memorable label was a bad choice:

I would have been better served if I had labeled the situation “the capitalization of interest.” … Note that construction finance is almost always a prearranged Ponzi financing scheme. [6]

For me, the fundamental points here are (1) That our overarching vision of capitalist economies needs to be a system of “units” (including firms, governments, etc.) linked by current money payments and commitments to future money payments, not a set of agents exchanging goods; and (2) that the critical influence of liquidity comes in the terms on which long-lived commitments to particular forms of production trade off against current income.

[1] Marxism does, arguably, offer a coherent alternative — the only one at this point, I think. Anwar Shaikh recently wrote a nice piece, which I can’t locate at the moment, contrasting the Marxist-classical and Post Keynesian  strands of heterodoxy.

[2] In fact, as Perry Mehrling demonstrates in The Money Interest and the Public Interest, Minsky represents an older and largely forgotten tradition of American monetary economics, which owes relatively little to Keynes.

[3] Walras, Wicksell and many others dismiss the idea that more money can be beneficial by focusing on its function as a unit of account. You can’t consistently arrive earlier, they point out, by adjusting your watch, even if you might trick yourself the first few times. You can’t get taller by redefining the inch. Etc. But this overlooks the fact that people do actually hold money, and pay real costs to acquire  it.

[4] “The dearness of every thing, from plenty of money, is a disadvantage … This has made me entertain a doubt concerning the benefit of banks and paper-credit, which are so generally esteemed advantageous … to endeavour artificially to encrease such a credit, can never be the interest of any trading nation; but must lay them under disadvantages, by encreasing money beyond its natural proportion to labour and commodities… And in this view, it must be allowed, that no bank could be more advantageous, than such a one as locked up all the money it received, and never augmented the circulating coin, as is usual, by returning part of its treasure into commerce.” Political Discourses, 1752.

[5] This leads into Verdoorn’s law and anti-hysteresis, a topic I hope to return to.

[6] Daniel Davies should appreciate this.

23 thoughts on “Minsky on the Non-Neutrality of Money”

  1. Very interesting. (I should say that I have also enjoyed a number of your other recent posts.)

    It sometimes seems to me that there are two different aspects of the question of money neutrality.

    First, there is the question of whether a monetary economy can be analysed by considering a barter economy. Part of the problem here is determining what actually constitutes each. A barter economy might well include contracts for future delivery of goods and services (i.e. deliver good A now, receive good B next year). These have an implicit credit element – the party due to deliver at the later date may fail to do so. So we might expect to see some of the same sort of issues due to information asymmetry that you described. But I wouldn't see this as a monetary economy. What you can have in a monetary economy, but not a barter one, are contracts denominated in abstract units, i.e. contracts that, even ignoring credit risk, have no guarantee of conversion into anything of inherent value, so that the ongoing acceptability depends on faith.

    The other aspect of money neutrality takes it as read that a monetary economy is different to a barter economy, but is simply the idea that the (nominal) quantity of money is irrelevant "in the long run". In some sense, it is obviously true that if all the nominal quantities and prices were scaled up or down by the same factor, then nothing interesting would change. The more difficult question concerns the impact of different policies differentiated by their intended impact on the money supply. Would we reach a time (in a meaningful timeframe) in which there was no differences in the real outcomes of these policies, merely a difference in the price level? (My own feeling is not.)

    1. Aren't these really the same question? If you assume that the long-run trajectory of the economy is unaffected by monetary factors (including presumably credit and balance sheets) then aren't you analyzing the long-run path of the economy as if it were a barter economy?

      I'm also not sure what it means to talk about exogenous changes in the money supply in a modern credit economy.

    2. No, I think they're different questions.

      It is probably true that if you believe a monetary economy can be analysed as a barter economy, then you necessarily believe that the quantity of money has no real effect. However, I don't think that believing in money neutrality in the second sense requires believing it in the first sense.

      In a barter economy, no special value attaches to particular assets due to their liquidity attributes, since it is implied that all assets are equally liquid as they can all be used in exchange. There is therefore no need to hold something like money balances purely for liquidity purposes. However, even accepting that people do desire to hold money for its liquidity attributes and that this desire may vary from time to time, the actual amount that people want to hold is determined in real terms. It is therefore still coherent to believe that changes in the money supply only effect prices.

      I think the distinction matters, because I feel that attempts to question money neutrality by focussing on the first question sometimes miss the point.

      I agree with you that it can be difficult to interpret what an exogenous change in the money supply might mean, which is why I used the rather awkward wording: "the impact of different policies differentiated by their intended impact on the money supply".

  2. My two cents:

    An important problem of the view of the economy as "a set of agents exchanging goods", is that these agents are implicitly assumed to be motivated just by consumption. If every actor is motivated just by consumption, then "everyone produces to sell in order to buy (and consume) something else", that is another way to state Say's law.
    If we think in terms of intertemporal maximization, this means, for example, that China today is running an account surplus because it plans to have a consumption binge sometime in the future, which is clearly very irrealistic.
    A more realistic view is that China runs an account surplus because it accelerated China's technologic growth; this implies that Chinese economy can grow faster if the chinese consume less than what they produce; this is consistent with the idea that some big economic actors (enterpreneurs, multinationals,etc., in short capitalists) are motivated by a drive for accumulation of abstract value, not for consumption of goods.
    Since "abstract value" is often (but non exclusively) stored as money or credit, this idea of a "drive for accumulation" can explain how a continuous rise in debt levels (whose other side is credit, aka abstract value) can be beneficial and possibly necessary to keep the economy running. In short the drive for accumulation requires some fort of continuous umbalance, that often takes the form of credit.
    Then a "money view" can be useful to understand the effects of continuous increases in debt levels, increasing fragility etc.
    But IMHO if you take out the "drive for accumulation", and you give less space to the "drive for consumption" that is implicit in the "materialist view", you end up with a lot of equation that end up being accounting identities where it isn't obvious who is doing what and why.

    From this point of view, I think that while the "money view" is more realistic than the "materialist view", most monetary problems should be seen as distributional problems at their hearts.

    1. I think this is exactly right. To get from the dominant Walrasian paradigm to the story we want to tell, there are two steps. First, we have to recognize that economic transactions are carried out in terms of money and take the form of money payments and money commitments; and that the dominant actors have the goal of accumulating wealth measured in money, not consuming real goods. But that's only the first step — and you could fairly criticize Perry Mehrling (not so much Minsky) for stopping there. The second step is to ask how the organization of economic life in terms of this money game transforms the social activity of production. How does accumulation of money-value develop the division of labor, revolutionize the organization of labor, and so on? Because historically it certainly has.

  3. One think I simply don't get about the heterodox: you realize the orthodoxy, by reclining in their chairs and imagining equilibrium, has gotten it wrong. And yet you write:
    "Once we have admitted that money and money contracts are necessary to economic activity, and not just an arbitrary numeraire, it no longer makes sense to make simulating a world without money as the goal of policy. If money is useful, isn't it better to have more of it, and worse to have less, or none?"

    Why isn't the next step: "let's go out into the world and find out"?

    Why the orthodox devotion to the reclining in ones chair method of empirical investigation?

  4. Great post, really enjoyed it.

    All I have to add is a comment on something you said in the introduction:

    "To which you can fairly respond: OK, but where is the alternative economics you're proposing instead?"

    I actually don't think this is a far response at all. You're effectively conceding that your own theory is not up to the task, but are using excuses to continue using it anyway. Would you use a map of New York in London, just because you didn't have an alternative? No! You'd fall back on rules of thumb, observation and probably ask someone for assistance. Theory is supposed to advance our understanding, and if it can't do that I see no point in using it just for the sake of it.

    Having said that, the response is obviously easy to fall back on from a position of hegemony, which is why it's so widespread.

  5. As usual, a great post about an interesting subject. I agree that there is still no coherent heterodox theory of economics, but at least the modern heterodox schools are in position to possibly create it.

    I find the following incomplete: the vision of economy as a hierarchy of units linked by financial relations. I think that what is missing from this vision, and what is crucial, is the flow of 'real' resources: from fossils to high-tech electronics. We live in the world where commodities produce commodities, but if we rise to the level of planetary economics, we have to account even for such factors as climate and influence of catastrophes. And there is no way to reduce our globalized world to isolated economies, and as such things as supply of oil, energy and metals deeply affect everything else.

    So it follows that a good theory and good model of economy must consist of this interwoven sides: 'financial' and 'industrial', tied together. I am optimistic that such models will eventually be made, and perhaps our understanding of economies will be furthered by that.

    1. That's right. However, I think it's important to avoid the temptation of thinking that the non-monetary relations of production and interface with the natural world has the same quantitative character as money values — that the monetary economy is a reflection of an underlying "real" economy. The relation of economic activity to the climate, say, is real and vitally important, but it can't be quantified in the same way that, say, the evolution of debt-income ratios can be.

  6. Minsky's Kaleckian side is very interesting. One of the best chapters in Stabalizing an Unstable Economy was chap 7 where he analyzed the price level using Kalecki's profit equation. I have been surprised that this method isn't used more by hetrodox economists. It is directly relevent to the arguments around market moneterists and NGDP targeting. From an empirical prespective it would be interesting to see how the mark up has changed over time as well.

  7. I'm also short nitpicking orthodoxy, and long observing and learning about reality.

    So a follow-on question: isn't the desire to have "a coherent programme" not only premature, but also needless? "Schools of thought" are handy for freshmen or for those who want to sweep away a large group of people with a unitary motion of the hand.

    But it seems to me that the desire to totalise is the opposite of "humble, competent people"—studying specifics rather than looking over the shoulder for a method of interpretation even while looking and listening.

    1. They at least avoid sign errors 😉

      But yeah, is his thesis that "Derivatives have replaced credit money" true in the sense of the larger economy? Aaron Brown is wicked smart, but I think that thesis encroaches in the realm of Big Questions (theory), not personal experience.

    2. How about we restate that thesis as "Money, credit, and derivatives exist on a continuum of financial devices for trading off income and liquidity."

      What I really liked about that piece was the point — correct IMO — that financial contracts are not, in general, used to hedge real risks. It's not farmers who trade corn futures, etc.

    3. And sorry, I've become a cantankerous snob whenever the word "continuum" is deployed. You mean something like: "Several tools do the same job in different ways"?

  8. But, given the assumptions that created the need for policy in the first place, there is no reason to think that the projects funded as a result of this intervention wil be exactly the same as in the perfect-information case. And there is no reason to think there are not lots of other unrealized projects whose non-undertaking happens not to show up as unemployment. [5]

    I would agree even if you removed the double negative. Picture the balance sheets of commercial banks, and ask yourself what they would do more of with a lower cost base, versus innovation by an entrepreneur (which is what I think you mean in the higher-up story about a person who can't get funded).

    Particularly, I think of commercial-bank balance sheets as being, in shorthand, car loans + home loans. Entrepreneurs (and stock-market investors) do use home equity both as savings and as a collateralised source of capital — but this is a few steps away from what the bank itself is doing. (eg, insert their ideas of who is creditworthy, their risk models, etc.)

    cf, Carolyn Sissoko: http://writingcapital.tumblr.com/post/21255474235/equity-capital

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