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

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What is the EU customs union and will Brexit make us leave?

International trade secretary Liam Fox's job makes more sense if we leave the customs union. 

Brexiteers and Remoaners alike have spent the winter months talking of leaving the "customs union", and how this should be weighed up against the benefits of controlling immigration. But what does it actually mean, and how is it different from the EU single market?

Imagine a medieval town, with a busy marketplace where traders are buying and selling wares. Now imagine that the town is also protected by a city wall, with guards ready to slap charges on any outside traders who want to come in. That's how the customs union works.  

In essence, a customs union is an agreement between countries not to impose tariffs on imports from within the club, and at the same time impose common tariffs on goods coming in from outsiders. In other words, the countries decide to trade collectively with each other, and bargain collectively with everyone else. 

The EU isn't the only customs union, or even the first in Europe. In the 19th century, German-speaking states organised the Zollverein, or German Customs Union, which in turn paved the way for the unification of Germany. Other customs unions today include the Eurasian Economic Union of central Asian states and Russia. The EU also has a customs union with Turkey.

What is special about the EU customs union is the level of co-operation, with member states sharing commercial policies, and the size. So how would leaving it affect the UK post-Brexit?

The EU customs union in practice

The EU, acting on behalf of the UK and other member states, has negotiated trade deals with countries around the world which take years to complete. The EU is still mired in talks to try to pull off the controversial Transatlantic Trade and Investment Partnership (TTIP) with the US, and a similar EU-Japan trade deal. These two deals alone would cover a third of all EU trade.

The point of these deals is to make it easier for the EU's exporters to sell abroad, keep imports relatively cheap and at the same time protect the member states' own businesses and consumers as much as possible. 

The rules of the customs union require member states to let the EU negotiate on their behalf, rather than trying to cut their own deals. In theory, if the UK walks away from the customs union, we walk away from all these trade deals, but we also get a chance to strike our own. 

What are the UK's options?

The UK could perhaps come to an agreement with the EU where it continues to remain inside the customs union. But some analysts believe that door has already shut. 

One of Theresa May’s first acts as Prime Minister was to appoint Liam Fox, the Brexiteer, as the secretary of state for international trade. Why would she appoint him, so the logic goes, if there were no international trade deals to talk about? And Fox can only do this if the UK is outside the customs union. 

(Conversely, former Lib Dem leader Nick Clegg argues May will realise the customs union is too valuable and Fox will be gone within two years).

Fox has himself said the UK should leave the customs union but later seemed to backtrack, saying it is "important to have continuity in trade".

If the UK does leave the customs union, it will have the freedom to negotiate, but will it fare better or worse than the EU bloc?

On the one hand, the UK, as a single voice, can make speedy decisions, whereas the EU has a lengthy consultative process (the Belgian region of Wallonia recently blocked the entire EU-Canada trade deal). Incoming US President Donald Trump has already said he will try to come to a deal quickly

On the other, the UK economy is far smaller, and trade negotiators may discover they have far less leverage acting alone. 

Unintended consequences

There is also the question of the UK’s membership of the World Trade Organisation, which is currently governed by its membership of the customs union. According to the Institute for Government: “Many countries will want to be clear about the UK’s membership of the WTO before they open negotiations.”

And then there is the question of policing trade outside of the customs union. For example, if it was significantly cheaper to import goods from China into Ireland, a customs union member, than Northern Ireland, a smuggling network might emerge.

 

Julia Rampen is the editor of The Staggers, The New Statesman's online rolling politics blog. She was previously deputy editor at Mirror Money Online and has worked as a financial journalist for several trade magazines.