The argument against stabilisation is akin to a broader, more profound form of the moral hazard argument. But the ecological ‘systems’ approach is much more widely applicable than the conventional moral hazard argument for a couple of reasons:
- The essence of the Minskyian explanation is not that economic agents get fooled by the period of stability or that they are irrational. It is that there are sufficient selective forces (especially amongst principal-agent relationships) in the modern economy that the moral hazard outcome can be achieved even without any active intentionality on the part of economic agents to game the system.
- The micro-prudential consequences of stabilisation and moral hazard are dwarfed by their macro-prudential systemic consequences. The composition of agents changes and becomes less diverse as those firms and agents that try to follow more resilient or less leveraged strategies will be outcompeted and weeded out – this loss of diversity is exacerbated by banks’ adaptation to the intervention strategies preferred by central banks in order to minimise their losses. And most critically, the suppression of disturbances increases the connectivity and reduces the ‘patchiness’ and modularity of the macroeconomic system. In the absence of disturbances, connectivity builds up within the network, both within and between scales. Increased within-scale connectivity increases the severity of disturbances and increased between-scale connectivity increases the probability that a disturbance at a lower level will propagate up to higher levels and cause systemic collapse.
Macro-stabilisation therefore breeds fragility in the financial sector. But what about the real economy? One could argue that in the long run, it is creative destruction in the real economy that drives economic growth and surely macro-stabilisation does not impede the pace of long-run innovation? Moreover, even if non-financial economic agents were ‘Ponzi borrowers’, wouldn’t real economic shocks be sufficient to deliver the “disturbances” consistent with macroeconomic resilience? Unfortunately, the assumption that nominal income stabilisation has no real impact is too simplistic. Macroeconomic stabilisation is one of the key drivers of the process of financialisation through which it transmits financial fragility throughout the real economy and hampers the process of exploratory innovation and creative destruction.
Financialisation is a term with many definitions. Since my focus is on financialisation in the corporate domain (rather than in the household sector), Greta Krippner’s definition of financialisation as a ““pattern of accumulation in which profit making occurs increasingly through financial channels rather than through trade and commodity production” is closest to the mark. But from a resilience perspective, it is more accurate to define financialisation as a “pattern of accumulation in which risk-taking occurs increasingly through financial channels rather than through trade and commodity production”.
In the long run, creating any source of stability in a capitalist economy incentivises economic agents to realign themselves to exploit that source of security and thereby reduce risk. Similar to how banks adaptation to the intervention strategies preferred by central banks by taking on more “macro” risks, macro-stabilisation incentivises real economy firms to shed idiosyncratic micro-risks and take on financial risks instead. Suppressing nominal volatility encourages economic agents to shed real risks and take on nominal risks. In the presence of the Greenspan/Bernanke put, a strategy focused on “macro” asset price risks and leverage outcompetes strategies focused on “risky” innovation. Just as banks that exploit the guarantees offered by central banks outcompete those that don’t, real economy firms that realign themselves to become more bank-like outcompete those that choose not to.
The poster child for this dynamic is the transformation of General Electric during the Jack Welch Era, when “GE’s no-growth, blue-chip industrial businesses were run for profits and to maintain the AAA credit rating which was then used to expand GE Capital.” Again, the financialised strategy outcompetes all others and drives out “real economy” firms. As Doug Rushkoff observed, “the closer to the creation of value you get under this scheme, the farther you are from the money”. General Electric’s strategy is an excellent example of how financialisation is not just a matter of levering up the balance sheet. It could just as easily be focused on aggressively extending leverage to one’s clients, a strategy that is just as adept at delivering low-risk profits in an environment where the central bank is focused on avoiding even the smallest snap-back in an elastic, over-extended monetary system. When central bankers are focused on preventing significant pullbacks in equity prices (the Greenspan/Bernanke put), then real-economy firms are incentivised to take on more systematic risk and reduce their idiosyncratic risk exposure.
Some Post-Keynesian and Marxian economists also claim that this process of financialisation is responsible for the reluctance of corporates to invest in innovation. As Bill Lazonick puts it, “the financialization of corporate resource allocation undermines investment in innovation”. This ‘investment deficit’ has in turn led to the secular downturn in productivity growth across the Western world since the 1970s, a phenomenon that Tyler Cowen has coined as ‘The Great Stagnation’. This thesis, appealing though it is, is too simplistic. The increased market-sensitivity combined with the macro-stabilisation commitment encourages low-risk process innovation and discourages uncertain and exploratory product innovation. The collapse in high-risk, exploratory innovation is exacerbated by the rise in the influence of special interests that accompanies any extended period of stability, a dynamic that I discussed in an earlier post.
The easiest way to explain the above dynamic is to take a slightly provocative example. Let us assume that the Fed decides to make the ‘Bernanke Put’ more explicit by either managing a floor on equity prices or buying a significant amoubt of equities outright. The initial result may be positive but in the long run, firms will simply align their risk profile to that of the broader market. The end result will be a homogenous corporate sector free of any disruptive innovation – a state of perfect equilibrium but also a state of rigor mortis.