Narrow banking and a “monetary production economy”
Indeed, for Minsky and Schumpeter, such a “narrow banking” system could not be considered a modern “capitalist” system; it would be akin to what John Maynard Keynes defined as a “real wage,” as opposed to a “monetary production,” economy. In a monetary economy, it is the role of the financial sector to ensure the financing of the acquisition and control of capital assets by increasing the liquidity of the liabilities of the business sector.
But more important, such a system would create an additional problem for what is now called “macroprudential” regulation. In a narrow banking system the liabilities of the financial system would be composed of
(1) investment fund shares representing household savings and business profits used to finance real investments;
(2) deposits held by households and businesses in the narrow banks backed by government debt or currency and coin; and
(3) government-issued coin and currency held by households and firms.
In such a system it is evident that total private saving would exceed investment by the private sector’s holdings of narrow bank deposits and government currency, creating a tendency toward deflation or recession. Price and/or output stability would require an exogenous addition to demand to offset this imbalance, such as might be provided by government expenditures financed by the issue of either currency or government bonds, if such issues were held as reserves for the narrow banks or the direct discounting of business sector liabilities.
Alternatively, the central bank could engage in the direct financing of public or private sector investment expenditures. The “macroprudential” stability of the financial system would then require the application of what Abba Lerner (1943) called “functional finance.” The size of the deficit creating the additional government means of payment required for macroprudential stability would be determined by the private sector holdings of narrow bank deposits and currency, adjusted for the current account position.
Thus, what Minsky believed was the major factor stabilizing the postwar Glass-Steagall system—the existence of a “Big Government” deficit providing a floor under private sector incomes—would become even more important in a narrow banking system holding company structure than it was under Glass-Steagall. Indeed, Minsky’s use of the Keynes-Kalecki profits equation was meant to show that it is primarily the generation of corporate income resulting from investment expenditures that allows current profits to cover the cash flows associated with the liabilities issued to finance investment. It is the level of business investment and government net expenditure that generates the cash flow that validates the corporate liabilities and produces the real source of financial stability in the system.
In the absence of a large government sector to support incomes, liabilities used to finance investment could not be validated in a narrow bank holding company structure. But, even more important, it would be impossible in such a system for banks to act as the handmaiden to innovation and creative destruction by providing entrepreneurs the purchasing power necessary for them to appropriate the assets required for their innovative investments. In the absence of private sector “liquidity” creation, the central bank would have to provide financing for private sector investment trust liabilities, or a government development bank could finance innovation through the issue of debt monetized by the central bank.
To meet the requirements of the “two masters,” such a system would have to combine Keynes’s idea of the “socialisation of investment”3 with the “socialisation” of the transactions-and-payments system. This suggests that in order to satisfy Minksy’s “two masters,” the real problem that must be solved lies in the way that regulation governs the provision of liquidity in the financial system.
The “two masters” are Siamese twins.
In the modern capitalist system that Minsky analyzed in his financial fragility hypothesis, two different types of financial institutions provide the liquidity required for the financing of Schumpeterian creative destruction. The control of real assets by productive enterprises can be financed through the issue by a
financial institution of liabilities that can be used as a means of payment in lieu of the coin and currency issued by the government. This is what is commonly known as “deposit creation,” and it has traditionally been provided by what in the Glass-Steagall regulatory system were called “commercial” banks.
Alternatively, productive enterprises can issue securities through the services of financial institutions that provide liquidity by acting as primary and secondary market makers offering to buy and sell the securities at announced bid-ask spreads and in standard amounts. These have traditionally been known as “investment,” or merchant, banks.
Minsky considered deposit creation the basic activity of banks. He defined it as the “acceptance function”:
“Banking is not money lending; to lend, a money lender must have money. The fundamental banking activity is accepting, that is, guaranteeing that some party is creditworthy. A bank, by accepting a debt instrument, agrees to make specified payments if the debtor will not or cannot. . . . A bank loan is equivalent to a bank’s buying a note that it has accepted” (Minsky 2008 , 256).
Thus, for Minsky the basic activity of a bank is not the safekeeping of depositors’ coin and currency, nor is it the investment of depositors’ funds because of an informational advantage. Rather, a bank’s basic activity is the creation of its own liabilities, which are used to acquire the liabilities of productive enterprises that it has “accepted”—that is, whose payment it has guaranteed. A narrow bank on this definition is not a bank, but simply a safe house or piggy bank for government issues of coin and currency. It is for this reason that Minsky eventually gave up his support for narrow banking and sought other alternatives to replace Glass-Steagall. The proposal has no more to recommend it today than it did in the 1990s.
1. In Wallace’s analysis the returns on short- and long-term investments are known. Minsky’s proposal would provide for a government guarantee to support the mark-to-market value of the assets.
2. In addition, there are theoretical difficulties in formulating the correspondence of real and money rates (see Myrdal 1965 ) or neutral money (see Sraffa 1932).
3. This is a proposal from the General Theory that is more fully worked out in Keynes’s memoranda on postwar recovery policy. See Kregel (1985).
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About the Author
Jan Kregel is a senior scholar at the Levy Economics Institute of Bard College and director of its Monetary Policy and Financial Structure program. He also holds the position of professor of development finance at Tallinn University of Technology. In 2009, Kregel served as Rapporteur of the President of the UN General Assembly’s Commission on Reform of the International Financial System. He previously directed the Policy Analysis and Development Branch of the UN Financing for Development Office and was deputy secretary of the UN Committee of Experts on International Cooperation in Tax Matters. He is a former professor of political economy at the Università degli Studi di Bologna and a past professor of international economics at Johns Hopkins University’s Paul Nitze School of Advanced International Studies, where he was also associate director of its Bologna Center from 1987 to 1990. Kregel has published extensively, contributing over 200 articles to edited volumes and scholarly journals, including the Economic Journal, American Economic Review, Journal of Economic Literature, Journal of Post Keynesian Economics, Economie Appliquée, and Giornale degli Economisti. His major works include a series of books on economic theory, among them, Rate of Profit, Distribution and Growth: Two Views, 1971; The Theory of Economic Growth, 1972; Theory of Capital, 1976; and Origini e sviluppo dei mercati finanziari, 1996. His most recent book is Ragnar Nurkse: Trade and Development (with R. Kattel and E. S. Reinert), 2009.
Kregel studied under Joan Robinson and Nicholas Kaldor at the University of Cambridge, and received his Ph.D. from Rutgers University under the chairmanship of Paul Davidson. He is a life fellow of the Royal Economic Society (UK) and an elected member of the Società Italiana degli Economisti. In 2010, he was awarded the prestigious Veblen-Commons Award by the Association for Evolutionary Economics for his many contributions to the economics field.