UNCERTAINTY “Quasi – rents” Yields/Profits Interest Rate Price of Capital Asset, P k vs. Price of Investment, P I Investment Spending Effective Demand, Output and Employment Multiplier Rush to liquidity in a crisis only reduces prices of securities  i U P (What it’s worth) (What it costs to build) Confidence and Effective Demand in Keynes’ Economics

Stabilizing an Unstable Economy Hyman Minsky Financial Instability Hypothesis: Hedge finance Speculative finance Ponzi finance Two types of risk affect the volume of investment. …The first is the entrepreneur's or borrower's risk and arises out of doubts in his own mind as to the probability of his actually earning the prospective yield for which he hopes. If a man is venturing his own money, this is the only risk which is relevant. …But where a system of borrowing and lending exists, a second type of risk is relevant which we may call the lender's risk. GT, Chapter 11. When expectations are disappointed, investment collapses … but debts remain A Minsky Cycle Displacement (invention, easy money) Boom…successful speculation Euphoria…financial innovation Profit taking Panic Student of Simons/ Schumpeter Investment Price of capital assets PKPK PIPI Internal funds Borrower’s Risk Lender’s Risk IoIo I1I1

Mehrling on Minsky How to infer financial conditions: –Speculative financing requires periodic refinance So Increased financial fragility  Increased difficulty rolling over loans  Increased demand for bank loans…But banks finance “speculatively”  Problems of bank refinancing Evolution of financial fragility: Post WWII: Treasury bills  refinancing “automatic” Banks reduced T-bill held  Money market financing But Fed not responsible for money market Fed policy of “brinksmanship”  lender of last resort only in crisis  Increased volatility of short-term rates Higher s-t rates  refinancing by pledging ever greater future cash amounts. So refinance increases fragility rather than restores robustness. Natural thrust toward fragility is amplified, not dampened, by financial system. Refinance becomes impossible for some overextended units  crisis erupts. They default  efforts of others to refinance upset. OR they attempt to “make position by selling position”  fire sale  Undermine collateral support for the existing debt structure.

Mehrling on Minsky Periods of tight liquidity  short rates rise (incentive for stretching liquidity) –Value of today’s cash flows rises relative to cash flows in the future. Demand price of capital assets (P k ) falls Supply price of investment goods (P i ) rises (interest is a cost of production). –The incentive to invest is reduced. The greater danger: »collapse of investment spending »reduced aggregate income »cash flows elsewhere in the economy fall short of expected levels »hedge finance units  speculative units »speculative units  Ponzi units, »the fragility of the system increases. –An investment slump might amplify the financial problems of a few units and bring the whole system down in a cascade of debt deflation.

Macroeconomics: Keynes’ Legacy LeftRight StateMarket InterveneLaissez-faire POLICYPOLICY FUNAMENTALSFUNAMENTALS ModernModern ProgramProgram KeynesFriedman Hicks Samuelson Modigliani Tobin Klein Brunner Meltzer Freshwater Lucas Sargent Prescott Saltwater Fischer Blanchard Taylor Bernanke Shiller

Paul Samuelson, Let those who will write the nation’s laws – if I can write the its textbooks. Economists have correctly predicted nine of the last five recessions. Investing should be more like watching paint dry or watching grass grow. If you want excitement, take $800 and go to Las Vegas. In this age of specialization, I sometimes think of myself as the last generalist in economics Funeral by funeral, theory advances. BA, Chicago, 1935 PhD, Harvard, 1941 –Foundations of Economic Analysis, published 1947 M.I.T – 2009 –Radiation Lab –Economics text 1 st edition, th edition, 2007 –Clark Medal 1947 –Nobel Memorial Prize, 1970

Paul Samuelson, Notable Concepts Mathematical economics: constrained optimization Revealed preference Factor price equalization The transfer problem: improved on Hume Economics of public goods Turnpike theorem for growth Overlapping generations framework Randomness of speculative prices  efficient market hypothesis The U.S. Phillips Curve (with Solow)  a policy menu? –1964 Kennedy – Johnson Tax Cut –1968 Vietnam War Surtax “…Adam Smith gave two resounding cheers for individualism; but for state interference of the pre-19 th century type he could muster only a bronx cheer. Make no mistake about it, Smith was right. Most inter- ventions into economic life by the State were then harmful both to prosperity and freedom…Good inten- tions by government are not enough; acts do have consequences that had better be taken into account…”

Keynesian Pantheon Alvin Hansen “The American Keynes” Economic Policy and Full Employment, 1946 A Guide to Keynes, 1953 Ragnar Frisch, 1895 – 1973 Econometrics, “Macroeconomics” Nobel Memorial Prize, 1969 Jan Tinbergen, 1903 – 1994 First econometric model Nobel Memorial Prize, 1969 Simon Kuznets 1901 – 1985 Nobel Memorial Prize, 1971 National Income and Its Composition: , John Hicks 1904 – 1989 Nobel Memorial Prize, 1972 Mr. Keynes and the Classics, A Suggested Interpretation, Econometrica, 1937.

Keynesian Pantheon Lawrence Klein 1920 – Clark Medal, 1959 Nobel Memorial Prize, 1980 A Textbook of Econometrics, 1953 The Empirical Foundations of Keynesian Economics, 1954 An Econometric Model of the United States: 1929 – 1952, 1955 An Introduction to Econometrics, 1962 James Tobin 1918 – 2002 Clark Medal, 1955 Council of Economic Advisors, Nobel Memorial Prize, 1981 Liquidity Preference as Behavior Towards Risk, Review of Economic Studies, 1958 Tobin q / Tobin tax Walter Heller, 1915 – 1987 Chair, Council of Economic Advisors, Franco Modigliani 1918 – 2003 Nobel Memorial Prize, 1985 Liquidity Preference in the Theory of Interest and Money, Econometrica, 1944 The Life Cycle Hypothesis of Saving, AER,1963 MPS: MIT-Penn-System Model

Keynesian Pantheon Robert Solow, 1924 – Clark Medal, 1961 Council of Economic Advisors, Nobel Memorial Prize, 1987 A Contribution to the Theory of Economic Growth, QJE, 1956 Analytical Aspects of Anti-Inflation Policy (with Samuelson), 1960 A.W. Phillips, 1914 – 1975 Paul H. Douglas, 1892 – 1976 “…the greatest of all Senators” Martin Luther King U.S. Senator (Illinois), Chair, Joint Economic Committee A Theory of Production (with Cobb), AER, 1928 Real Wages in the United States, 1930 The Theory of Wages, 1934