IFIM Tute 8

1)What are the three sectoral balances on the financial system?

Foreign balance Sector (Imports – exports) - Change in the NFA(FB)

Government balance (taxes – Spending(G)) - Change in the NFA(GS)

Private balance (savings – investments) - Change in the(NFA(DP))

S-I - this is the change in the Net Financial assets of the domestic private sector (NFA(DP))

FB + GB + PB = 0
Sources - Y= C + I + G
Uses Y = C + T + S

2) If there was only one country in the world, and the private sector of that country
wished to net save, or in other words to accumulate net financial assets, but the
The government was determined to avoid running a budget deficit, what would be the result?

One of these sectors would have to be in deficit, to allow the other to be in surplus.

- The economy would contract, until either the government ran a deficit to allow the private
sector to net save, or the private sector was too poor to net save.

- Everyone saving causing the economy to contract and incomes to fall is what John Maynard
Keynes called ‘the paradox of thrift’

GB + PV = 0
S-I = G-T
Net Financial assets
Not possible

3) What are hedge, speculative and Ponzi balance sheets?

● A borrower using with a hedge balance sheet expects to be able to pay back its interest and
principal obligations out of income. There should be no need to roll over debt. This is a
robust balance sheet.

● A borrower with a speculative balance sheet expects to be able to pay the interest, but not
repay the principal from income. The borrower needs to roll over maturing debt or rely on
capital gains. This exposes the borrower to the risk that they may be unable to roll-over their
existing loans when they mature.

● A borrower with a Ponzi balance sheet cannot even the interest on its existing debts,
without taking on even more debt to do so. They must borrow more to pay its existing
repayments and increase their debts over time, or rely even more on capital gains. Ponzi
balance sheets are the most risky of all, and unless the borrower is rescued by capital gains
or unexpected increases in income, they are unsustainable and must lead to insolvency.
4) What did Minsky mean when he said, ‘stability breeds instability’?

- People relax when system has been stable for a long time

During good economic times, those who take on the most leverage make the highest
returns. So those with hedge balance sheets do badly, compared with those who have
more speculative balance sheets. Leveraging up to invest in shares, property and other
speculative assets pays off.

This encourages people to take on more debt, and transforms the financial system from a robust
state, with many hedge balance sheets, few speculative ones and hardly any Ponzi ones, into a
fragile financial system, with fewer hedge balance sheet, more speculative ones, and an increasing
number of Ponzi balance sheets

5) What is a ‘Minsky Moment’?

A financial crisis so severe that even cutting interest rates to zero, doing quantitative
easing, and running fiscal deficits as large as politicians feel able to accept, is unable to
prevent a prolonged economic slump.

The fragile balance sheets described above create a set of circumstances where a ‘Minsky
Moment’, like 1929 or 2008, becomes possible.
1).What do you notice about the private sector financial balance? Is the private sector
normally in surplus or deficit? Were private sector deficits more common or less common before the 1980s than
since that decade?

- The private sector is normally in surplus

- Private deficits were less common before 1980

2). What do you notice about the government balance, since 1945?
Has the UK government run fiscal deficits or fiscal surpluses?

- The government has nearly always run fiscal deficits

3)For the majority of the nineteenth century (1801-1900), the UK was on the gold standard, and the UK
government approximately balanced its budget. What was the typical private-sector financial balance
during that century? How was the private sector financial balance made possible, given the government was
balancing its budget? Who was doing the deficit spending?
- The typical balance of the private sector was around 7-9%

4)There are four spikes on the chart– the most recent of these relates to Covid- 19. What were the events
which caused the previous three spikes? The UK had gone through a ruinous economic depression during the
The 1930s. How do you suppose it was possible for the UK Government to pay for the financial
costs of the 1939-45 war?

- Napoleonic wars
- World War 1 (1914-1918)
- The great depression (1929 - 1933)
- World War 2 (1939-1945)
- Covid 19

- Uk had to borrow to finance the war, and by the end of the war Britain’s debt exceeded
200% of GDP
- - The US provided major source of funds