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Minsky’s Financial Instability Hypothesis and Modern Economics. Hyman Philip Minsky (b. 23 September 1919, d. 24 October 1996) was best known for his Financial Instability Hypothesis of the business cycle, which emphasized the dynamics of business investment finance as a recurring cause of anna, macroeconomic instability (Minsky 1972, 1980). During a boom, the outline, expansion of debt-financed investment spending causes initial “robust” financial structures to anna akhmatova essay, evolve into essay competitions 2013, “fragile” financial structures, and it is akhmatova requiem essay, this evolution that ultimately brings the expansion to an end. In the subsequent contraction, typically some fragile financial structures collapse while others are refinanced into more robust financial structures, thereby creating the preconditions for renewed expansion. A central reason for policy intervention in this boom-bust process, Minsky emphasized, is the ever-present danger that the contraction will get out of control and spread into resume, a system-wide debt-deflation. In this way, a normal business recession can become instead a deep and long-lasting depression, such as happened in 1929-1933 when debt deflation brought down the US banking system and ushered in a depression that did not end until World War II, notwithstanding all the attempts of Roosevelt’s New Deal.
Wartime public spending and wartime public debt finally did succeed in recreating the robust financial preconditions for renewed economic expansion in the immediate postwar decades. But over time, once private debt had a chance to build up for a while, robust financial structures again evolved into fragile structures, and instability returned starting in about 1966. Unfortunately, the anna requiem, return of instability coincided also with the worldwide, ascendancy of a new interventionist orthodoxy in requiem economic theory which, extrapolating from the essay competitions 2013, entirely unusual circumstances of the immediate postwar, attributed business fluctuations not to changing financial structures but rather simply to fluctuations in aggregate demand. According to this new orthodoxy, incipient downturns could and should be countered by anna akhmatova requiem, appropriate government fiscal and journals publish lyric essays, monetary policies. Government spending could maintain aggregate demand directly, and/or tax cuts and subsidies could stimulate private consumption and investment indirectly, so as to maintain aggregate income near the level of full employment. In the short run, this policy orthodoxy achieved its stated goal, but in the longer run it acted to anna akhmatova essay, block the natural process of restoring robust finance, with the consequence that an increasingly fragile financial structure served as an journals that publish, increasing obstacle to anna akhmatova, capital investment and hence also to robust economic performance.
Because of government intervention there was no debt deflation and no great depression, but rather stagnation and inflation during the decade of the 1970s. Six Pillars! Finally, the akhmatova requiem, extraordinary tight monetary policy of 1979-1982 under Paul Volcker turned the tide and created the financial precondition for renewed expansion in the decade to follow (Minsky 1986). However, the subsequent expansion was different from the immediate postwar, because the financial preconditions were different. What followed after Volcker was a new kind of institutional arrangement that Minsky called “money manager capitalism”, driven by a new breed of lead resume, institutional investors in akhmatova essay pension funds, insurance companies, and mutual funds. Unlike the immediate postwar, long-term capital development of the nation was off the table, replaced instead by the pursuit of of character essay, short-run financial portfolio returns.
In effect, tight monetary policy had succeeded in creating a parallel banking system, focused more on real estate and housing speculation than on increasing business productivity. Minsky viewed the financial crisis of 1987 as a first crisis of anna essay, this new system. He did not however live to see the global financial crisis of 2007-2009, which the press dubbed a “Minsky Moment”. Minsky got his start in economics at the University of Chicago, where he enrolled in 2008 September 1937 in the middle of the Great Depression. There is no reason to requiem essay, doubt Minsky’s own assessment that two Chicago professors, Oscar Lange and Henry Simons, were the most significant early influences on his thought (Minsky 1985). The inspiration to study economics came from of character essay, Lange, who was at that time working out a synthesis of Marx and neoclassical economics that he called market socialism. Akhmatova! Henry Simons was the essay competitions, source of Minsky’s lifelong interest in finance, as well as the anna akhmatova requiem, idea that the fundamental flaw of modern capitalism stemmed from its banking and financial structure. Minsky took the lesson that capitalism could be stable if, first, large-scale capital investment were owned and financed publically rather than privately and, second, smaller scale private business were financed with equity rather than debt. After a three-year interruption for war service (Papadimitriou 1992), Minsky continued his education at Harvard University where he fell in with the young Keynesians who gathered around Alvin Hansen. However it was Joseph Schumpeter, not Hansen, who was the more important influence.
A “conservative Marxist”, as Minsky would later characterize his mentor, Schumpeter’s earliest work on the Theory of Economic Development (1912) had emphasized the importance of money creation by lead resume, the banking system as the crucial source of entrepreneurial finance. Banks can and requiem essay, do lend by creating deposits, which serve as purchasing power that entrepreneurs use to acquire the real resources they need in order to make their future plans into present realities. This mechanism, according to Schumpeter, is the source of the dynamism of capitalism, just as it is also, according to Simons, the source of capitalism’s instability. Minsky’s 1954 PhD thesis “Induced investment and business cycles” represents his attempt to insert his concerns about sat essay question 2008, finance into the then-standard Hansen-Samuelson accelerator-multiplier model, which has no finance in it. Viewed in retrospect, the more fundamental contribution Minsky made in his thesis was to conceive of ordinary business firms as akin to banks, insofar as they can be seen fundamentally as cash inflow-outflow operations that confront both solvency and requiem, liquidity “survival constraints” (1954, p. 157-162). Worldwide Essay Competitions! From this point of view, the natural accounting structure for the economic system is akhmatova requiem essay, not the National Income and Product Accounts, which served as the empirical basis for the Hansen-Samuelson model, but rather the newer Flow of Funds accounts developed by American institutionalist Morris Copeland (1952). In effect, Minsky’s mature Financial Instability Hypothesis would build on this alternative empirical basis, though Minsky goes beyond the Flow of Funds accounts to emphasize the time-dated pattern of cash commitments embedded in the structure of essay competitions, outstanding debts of various kinds (Minsky 1964). A final, but crucial, early formative influence was Minsky’s experience as a participant observer at a major Wall Street brokerage house, where he learned about requiem essay, new developments in the Federal Funds market and the use of repurchase agreements (Minsky 1957). Sat Essay 2008! He concluded from that experience that the goal of using monetary policy for anna akhmatova essay, aggregate stabilization was probably illusory on on the family, account of the attendant financial innovation. The central bank could try to limit the supply of public bank reserves, as a way of holding back expansion, but the akhmatova essay, result would only lead resume be to encourage banks to anna akhmatova requiem, develop their own private mechanisms for economizing on scarce reserves.
The Fed Funds market and the repo market were already doing that as early as 1957. In later years, non-reservable bank certificates of deposit, and eventually a parallel system of non-bank finance, would go even further (Minsky 1966). With each additional step the link between policy tools and macroeconomic outcomes became further attenuated (Minsky 1969, 1980). The Financial Instability Hypothesis. At the very center of Minsky’s conception of what makes a financial structure robust or fragile is the essay competitions 2013, relationship between the anna akhmatova, time pattern of cash commitments and the time pattern of expected cash flows. A firm with cash flows greater than cash commitments for every future period is said to be engaged in “hedge” finance, because the unit can meet its commitments from its own resources. So-called “speculative” financial structures expect cash flows greater than interest payments on outstanding debt, but also anticipate the essay, need to refinance the anna requiem essay, principle at maturity. That makes the firm vulnerable in the event that refinance turns out to family, be unexpectedly expensive or even unavailable. So-called “Ponzi” financial structures are even more vulnerable since they anticipate cash flows insufficient even to anna, cover interest payments, so refinance depends on capital gains in lead teller resume the underlying investment as well as general financial conditions. The core idea of the Financial Instability Hypothesis is that there is a built-in tendency for the system to shift over time from robust “hedge” financial structures to fragile “speculative” and akhmatova requiem, “Ponzi” financial structures. A central driver of this tendency is the outline for a, apparent cheapness of short term finance relative to long term finance, a consequence of liquidity preference which means that wealth holders are willing to accept a lower yield on assets that are more readily (or imminently) turned into current cash.
Thus it is always tempting to finance long-lived capital assets with short-term debt, planning to roll over the debt at maturity into another short-term debt. That temptation pushes firms from hedge to speculative finance. The temptation is always there, but in the immediate aftermath of a contraction that has visibly involved the collapse of fragile financial structures, both borrowers and requiem essay, lenders are able to resist the temptation. Liquidity risk is on their minds. Competitions 2013! Thus, it is only gradually over time that robust financial structures give way to fragile financial structures, as evidence accumulates that giving in to temptation is once again a profitable strategy, for anna akhmatova, both borrowers and lenders. Eventually it seems to be safe, and margins of safety begin to erode in the pursuit of higher expected gain. In Minsky’s mature work, a key mechanism leading to sat essay question 2008, this erosion is the positive feedback between investment spending and business profits, which Minsky took from the work of Kalecki (1971).
When investment spending is strong, aggregate demand and hence aggregate business profits are also strong so that business cash flows exceed expectations, proving more than sufficient to meet existing cash commitments. Thus the lesson is learned that previous caution was excessive, and anna requiem, thus the road is opened for teller resume, a shift to more fragile finance. And of anna akhmatova, course the same mechanism works the opposite way on the way down, as lower investment leads to lower profit than expected and of character essay, hence greater than expected difficulty in meeting cash commitments. Minsky’s discovery of Kalecki, probably during his sabbatical year 1969-70 at St. Requiem Essay! Johns College in Cambridge, England, was crucial also for shifting Minsky’s view of Keynes. Back at Harvard, the Keynes that Minsky had learned was supposed to be about a liquidity preference theory of six pillars essay, money demand, which interacted with an requiem, exogenously fixed money supply to teller resume, set the rate of interest.
There was nothing much in anna akhmatova requiem that Keynes for Minsky, with his Simons-Schumpeter vision of integral role of elastic bank finance for business investment, a commercial loan model of the (endogenous) money supply rather than Keynes open market operations (exogenous) money model. By contrast, although Kalecki’s Marxism was not the conservative type favored by Schumpeter, it was a familiar frame and it was through that frame that Minsky found his way to essay, Keynes. In his subsequent book John Maynard Keynes (1975), Minsky finally embraced Keynes in words that could apply equally to anna akhmatova, himself: “The knowledgeable view of the operation of finance that Keynes possessed was not readily available to academic economists, and spanish family, those knowledgeable about finance did not have the skeptical, aloof attitude toward capitalist enterprise necessary to understand and appreciate the basically critical attitude that permeated Keynes’s work” (p. 130). In the end, Minsky came to think of his own financial instability hypothesis as a completion of Keynes’ work by filling in the details of the financial system, the “logical hole” (p. 63) that Keynes left out in his own academic formulations. Reading Keynes with his new understanding that Keynes, like himself, was always looking at the world through the lens of banking—the “Wall Street” or “City” view–led Minsky to formulate what he called his “two-price theory of investment”. Contra the quantity theory of money, monetary conditions do not drive the price of output; but they do drive the price of capital assets. The kind of liquidity-stretching innovations that banks use to overcome central bank constraint (as Minsky 1957) not only enable them to anna akhmatova, provide the investment finance demanded by their business clients, but also operate directly to stimulate that demand through their effect on the price of existing capital assets. Sat Essay Question! Specifically, creation of requiem, private liquidity to satisfy demand for liquidity preference lowers the question, premium required to hold illiquid capital assets, and hence drives up their price.
Subsequently, a widening gap between the requiem essay, price of existing capital assets and the current output price of new capital assets provides incentive to lead teller, add new capital assets to the old, which is investment. Anna Essay! This “Keynesian” asset price mechanism offers yet another path leading from robust finance to fragile finance. Minsky’s Simons-Schumpeter-Kalecki-Keynes view of the world put him at odds with the postwar monetary Walrasian orthodoxy of worldwide competitions, Patinkin-Tobin-Modigliani. Whereas orthodoxy emphasized the use of monetary policy to “control” aggregate fluctuation, Minsky always emphasized instead the “support” function as lender of last resort in a crisis and market maker in normal times. Regular engagement with market participants through the discount window would, Minsky thought, allow the akhmatova, central bank to shift the balance a bit toward hedge finance by favoring robust structures in its collateral policy. Toward that end, he urged widening access to worldwide, the discount window in normal times to requiem essay, include a broader cross-section. This divergence from orthodoxy on spanish essay, policy reflects a deeper methodological divergence.
Whereas postwar economic orthodoxy characteristically operated within an intellectual frame of market equilibrium, even intertemporal market equilibrium, with abstract individual agents making rational intertemporal allocation decisions, Minsky characteristically operated closer to anna akhmatova, the lived reality that actual agents confront, namely an open-ended future that is substantial uncertain (not just risky) and a present choice set that is substantially constrained by survival constraints of various kinds. Minsky’s agents are not irrational, but rather more like Schumpeter’s constructive entrepreneurs who imagine a possible future and then use their cash inflow-outflow interface with the economic system to acquire resources in an attempt to make that imagined future a present reality. In a world like this, it matters a lot which agents get the chance to make that attempt; it matters for the capital development of the nation. Minsky’s financial instability hypothesis was designed to essay family, explain the essay, times he was living in, not so much the post-Volcker era of sat essay question 2008, money manager capitalism. Anna Essay! At the center of Minsky’s picture is business investment finance not household mortgage finance, bank lending not capital market finance, and his purview is characteristically domestic not global. But the analytical apparatus he developed is more general. The banking view that he took toward business investment is equally applicable to any other economic agent—we are all of us cash inflow-outflow entities, facing solvency and liquidity survival constraints. Similarly applicable is family, Minsky’s emphasis, at the level of the system as a whole, on the shifting match between the time pattern of cash commitments that is embedded in the existing structure of anna requiem essay, debt as compared to lyric, the time pattern of expected cash flow to fulfill those commitments.
Copeland, Morris A. 1952. A Study of Money-flows in the United States. New York: National Bureau of essay, Economic Research. Kalecki, M. 1971. Selected Essays on the Dynamics of the Capitalist Economy (1933-1970). Cambridge, UK: Cambridge University Press. Minsky, Hyman P. Six Pillars! 1954. “Induced investment and business cycles.” Unpublished PhD dissertation, Department of Economics, Harvard University. Minsky, Hyman P. 1957. “Central banking and money market changes.” Quarterly Journal of Economics 71 (2): 171-187.
Reprinted as Ch. 7 in Minsky (1982). Minsky, Hyman P. 1964. “Financial Crisis, Financial Systems, and akhmatova, the Performance of the Economy”. Pages 173-380 in question Private Capital Markets. Commission on Money and Credit Research Study. Akhmatova Requiem Essay! Englewood Cliffs, NJ: Prentice Hall. Minsky, Hyman P. Question 2008! 1969. “The New Uses of Monetary Powers.” Nebraska Journal of Economics and Business 8. Reprinted as Ch. Anna Requiem! 8 in Minsky (1982). Minsky, Hyman P. 1972. “Financial Instability revisited: the that, economics of disaster.” In Reappraisal of the Federal Reserve Discount Mechanism, Board of Governors, Federal Reserve System.
Reprinted as Ch. Requiem! 6 in Minsky (1982). Minsky, Hyman P. 1975. John Maynard Keynes. New York: Columbia University Press. Minsky, Hyman P. 1980. “Finance and college admissions essay, Profits: the changing nature of American business cycles.” In The Business Cycle and Public Policy 1929-1980: A Compendium of Papers submitted to the Joint Economic Committee. Congress of the anna requiem essay, United States, 96th Congress, 2nd Session. Washington, DC: Government Printing Office. Reprinted as Ch.
2 in Minsky (1982). Minsky, Hyman P. 1980. “The Federal Reserve: Between a Rock and a Hard Place.” Challenge 23 (May/June), 30-36. Reprinted as Ch. 9 in Minsky 1982. Minsky, Hyman P. 1982.
Can ‘It’ Happen Again? Essays on Instability and Finance. Armonk, NY: ME Sharpe. Minsky, Hyman P. 1985. “Beginnings.” Banca Nazionale del Lavoro Quarterly Review 154: 211-221. Minsky, Hyman P. 1986. 2008! Stabilizing an anna akhmatova requiem, Unstable Economy.
Twentieth Century Fund Report. New Haven and London: Yale University Press. Papadimitriou, D. B. 1992. Journals Publish Lyric! “Minsky on himself.” Pages 13-26 in Essays in Honor of Hyman P. Minsky, edited by S. Anna Akhmatova! Fazzari and D. Worldwide Essay! B. Papadimitriou. Armonk, NY: ME Sharpe. 4 comments on anna, “ Minsky’s Financial Instability Hypothesis and Modern Economics ” Good essay by Mehrling summing up Minsky’s work. For Minsky’s view of monetary policy to work properly (use the discount window, not the for a college essay, open-market desk), you have to have honest and competent discount window administration. Anna! I encountered that at the two Federal Reserve Banks at which I worked, at the times that I worked for them (1974-1994). I’ve been writing about it ever since. If you politicize the publish lyric, discount window, then how can Minsky’s corrective or stabilizing model work? Alas, today we might live in the worst of both worlds: Politicized open-market operations (see, e.g., above-market interest rates paid on reserves and a subsidy rate paid on reverse repos) and a politicized discount window during the crisis (anything involving Section 13(3)).
And we haven’t even discussed foreign exchange swap lines. Perry, this is great; it widens my understanding and appreciation of akhmatova essay, Minsky. Did you mention when in Utah that you are working on a book? Was it on Minsky? Re: Paul Volcker.
“So back to the 70?s, and continuous oil price hikes by a foreign monopolist. Competitions 2013! All nations experienced pretty much the same inflation. And it all ended at about the same time as well when the price of crude fell. The ‘heroes’ were coincidental. In fact, my take is they actually made it worse than it needed to requiem essay, be, but it did ‘get better’ and they of course were in the right place at the right time to get credit for that.” “Next, President Carter’s appointment of journals essays, Paul Volcker to Chair the Fed was a disaster for people in low wage jobs, since Volcker and his successors used wage rises as a criterion for evaluating whether inflation was accelerating. So, during and anna akhmatova essay, after Volcker’s tenure, the Federal Reserve systematically repressed wages by raising its overnight rate targets whenever private sector wages began to family, rise, and cooling the anna akhmatova, economy, a policy that may or may not still be somewhere in the background of the Fed’s toolkit under Janet Yellin. In short, summarizing all of the foregoing, President Carter did not advocate strongly for fiscal policies that would create jobs, and, in addition, he opposed the sat essay question, efforts of akhmatova, many in the Democratic Congress to legislate such programs. This attitude toward fiscal policy was also reflected in six pillars Congress, though to a lesser degree. So, overall it has to be concluded that during the Carter Administration, little was done by the Government to achieve and maintain full employment at a living wage. Why was the Government so opposed to doing what was necessary to achieve living wages and full employment?
Again, it was because a majority of Government decision makers, including President Carter, believed in the gospel of fiscal responsibility and austerity. They were incapable of anna, recognizing that they could spend what was necessary to journals that, accomplish these goals, even though FDR had shown them what was possible during World War II and part of the Great Depression, and even though they had even more policy space than FDR had to deficit spend, due to the shift to a non-convertible fiat currency, with floating exchange rates, and no debts in foreign currencies, completed by President Nixon in 1971.”
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