What Janet Yellen and Mark Carney could learn from macroeconomist Hyman Minsky

Gordon Brown, as Chancellor in the UK, and the Federal Reserve’s Alan Greenspan, notably, violated Minsky’s ideas - what will the new twin peaks of global finance do differently?

After the cold turkey of Christmas there is a good slice of humble pie being eaten for New Year dessert. One by one, and a little too easily for my liking, the über-bears of the financial system have been falling into line, accepting that things are OK and the bull market for equities can continue. Nouriel Roubini is only the latest voice to turn from a growl to an apologetic whimper. Hugh Henry did his exit stage right, pursued by his own personal bear, before Christmas. Only Marc Faber carries the torch now.

In any event, they are all being consistent with what the American economist Hyman Minsky (1919 - 1996) recognised, which is that investors have a tendency to exaggerate what is happening rather than seek under-valued investments as a home for their money. Most people follow the momentum of current thought and this is what leads to manias, bubbles and financial crises. In other words, financial institutions are by their very nature unstable, mainly because they are inhabited by faulted human beings whose conscious, rational, self is a slave to the subconscious and the chaotic id that powers it. Consequently, they need managing and regulating, actively, and cannot be left to the self-limiting actions of those involved in the financial system, mainly because they are unable to self-limit.

Although he didn’t live to see it, Minsky got a number of notable things right about the interaction between money and the psyche. It is a moot point whether he would have found any pleasure in watching his theories play out in the post-2000 era leading, eventually, to the ignominious collapse of once-useful financial institutions. But his theories have proved better models for what happened than any statistically-based piece of software that I have seen.

Gordon Brown, then Chancellor in the UK, and the Federal Reserve’s Alan Greenspan, notably, violated Minsky’s ideas. Brown advocated "light-touch" regulation (a euphemism for no regulation) while Greenspan looked on helplessly as the Glass-Steagall act (already ineffectual in many people’s eyes) was dismantled in front of him, allowing the walls to come down between commercial banks and securities firms. Brown took the revenues from the financial system and built up state spending. Greenspan had no such ideological or electoral agenda. But when the financial crisis struck all that was left for both of them was to cut interest rates to lower and lower levels while propping up failing financial institutions with unconventional policies like quantitative easing which have now become uncomfortably accommodated and habituated into our lives.

Minsky has powerful followers, not least of which is the soon-to-be Chair of the interest rate-setting Federal Reserve Open Market Committee, Janet Yellen. One of the conclusions of the Minsky approach is that policy makers need to follow "contra-cyclical" policies to take the mania out of the system. In other words, when the good times roll those in charge should be tightening regulation and rules around financial institutions to stop them from experiencing manic boom and bust.

So the Yellen Federal Reserve, like the Mark Carney Bank of England, will be fundamentally different animals from their predecessors. Not for them the macho rate setting and systematic policy making that has characterised the previous 30 years. We should be looking for something more administrative, more touchy-feely and circumstantial, gradualist even. Because if you were going to start placing the regulatory corset around a financial system you wouldn’t do it to this one and you wouldn’t start now, not with the current need for a bit of reckless lending.  And, as a final corollary, given that these are both most likely one-term governors of their institutions, maybe staying for just five years, sponsoring Minsky-esque regulatory change via the carrot of low interest rates means that neither of them may touch interest rates during their entire term of office.

Chair of the National Reserve, Janet Yellen. Photograph: Getty Images.

Head of Fixed Income and Macro, Old Mutual Global Investors

Photo: Getty
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How a small tax rise exposed the SNP's anti-austerity talk for just that

The SNP refuse to use their extra powers to lessen austerity, says Kezia Dugdale.

"We will demand an alternative to slash and burn austerity."

With those few words, Nicola Sturgeon sought to reassure the people of England, Wales and Northern Ireland last year that the SNP were a party opposed to public spending cuts. We all remember the general election TV debates, where the First Minister built her celebrity as the leader of the anti-austerity cause.

Last week, though, she was found out. When faced with the choice between using the powers of the Scottish Parliament to invest in the future or imposing cuts to our schools, Nicola Sturgeon chose cuts. Incredible as it sounds the SNP stood shoulder to shoulder with the Tories to vote for hundreds of millions of pounds worth of cuts to schools and other vital public services, rather than asking people to pay a little bit more to invest. That's not the choice of an anti-austerity pin-up. It's a sell-out.

People living outside of Scotland may not be fully aware of the significant shift that has taken place in politics north of the border in the last week. The days of grievance and blaming someone else for decisions made in Scotland appear to be coming to an end.

The SNP's budget is currently making its way through the Scottish Parliament. It will impose hundreds of millions of pounds of cuts to local public services - including our schools. We don't know what cuts the SNP are planning for future years because they are only presenting a one year budget to get them through the election, but we know from the experts that the biggest cuts are likely to come in 2017/18 and 2018/19. For unprotected budgets like education that could mean cuts of 16 per cent.

It doesn't have to be this way, though. The Scottish Parliament has the power to stop these cuts, if only we have the political will to act. Last week I did just that.

I set out a plan, using the new powers we have today, to set a Scottish rate of income tax 1p higher than that set by George Osborne. This would raise an extra half a billion pounds, giving us the chance to stop the cuts to education and other services. Labour would protect education funding in real terms over the next five years in Scotland. Faced with the choice of asking people to pay a little bit more to invest or carrying on with the SNP's cuts, the choice was pretty simple for me - I won't support cuts to our nation’s future prosperity.

Being told by commentators across the political spectrum that my plan is bold should normally set alarm bells ringing. Bold is usually code for saying something unpopular. In reality, it's pretty simple - how can I say I am against cuts but refuse to use the powers we have to stop them?

Experts - including Professors David Bell and David Eiser of the University of Stirling; the Resolution Foundation; and IPPR Scotland - have said our plan is fair because the wealthiest few would pay the most. Trade unions have backed our proposal, because they recognise the damage hundreds of millions of pounds of cuts will do to our schools and the jobs it will cost.

Council leaders have said our plan to pay £100 cashback to low income taxpayers - including pensioners - to ensure they benefit from this plan is workable.

The silliest of all the SNP's objections is that they won't back our plan because the poorest shouldn't have to pay the price of Tory austerity. The idea that imposing hundreds of millions of pounds of spending cuts on our schools and public services won't make the poorest pay is risible. It's not just the poorest who will lose out from cuts to education. Every single family and business in Scotland would benefit from having a world class education system that gives our young the skills they need to make their way in the world.

The next time we hear Nicola Sturgeon talk up her anti-austerity credentials, people should remember how she did nothing when she had the chance to end austerity. Until now it may have been acceptable to say you are opposed to spending cuts but doing nothing to stop them. Those days are rapidly coming to a close. It makes for the most important, and most interesting, election we’ve had in Scotland.

Kezia Dugdale is leader of Scottish Labour.