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Stabilizing an Unstable Economy
01 Jan 1986-
TL;DR: In his seminal work, Minsky presents his groundbreaking financial theory of investment, one that is startlingly relevant today as mentioned in this paper, explaining why the American economy has experienced periods of debilitating inflation, rising unemployment, and marked slowdowns and why the economy is now undergoing a credit crisis that he foresaw.
Abstract: "Mr. Minsky long argued markets were crisis prone. His 'moment' has arrived." -The Wall Street Journal In his seminal work, Minsky presents his groundbreaking financial theory of investment, one that is startlingly relevant today. He explains why the American economy has experienced periods of debilitating inflation, rising unemployment, and marked slowdowns-and why the economy is now undergoing a credit crisis that he foresaw. Stabilizing an Unstable Economy covers: The natural inclination of complex, capitalist economies toward instability Booms and busts as unavoidable results of high-risk lending practices "Speculative finance" and its effect on investment and asset prices Government's role in bolstering consumption during times of high unemployment The need to increase Federal Reserve oversight of banks Henry Kaufman, president, Henry Kaufman & Company, Inc., places Minsky's prescient ideas in the context of today's financial markets and institutions in a fascinating new preface. Two of Minsky's colleagues, Dimitri B. Papadimitriou, Ph.D. and president, The Levy Economics Institute of Bard College, and L. Randall Wray, Ph.D. and a senior scholar at the Institute, also weigh in on Minsky's present relevance in today's economic scene in a new introduction. A surge of interest in and respect for Hyman Minsky's ideas pervades Wall Street, as top economic thinkers and financial writers have started using the phrase "Minsky moment" to describe America's turbulent economy. There has never been a more appropriate time to read this classic of economic theory.
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TL;DR: In this article, a simple New Keynesian-style model of debt-driven slumps is presented, situations in which an overhang of debt on the part of some agents, who are forced into rapid deleveraging, is depressing aggregate demand.
Abstract: In this paper we present a simple New Keynesian-style model of debt-driven slumps – that is, situations in which an overhang of debt on the part of some agents, who are forced into rapid deleveraging, is depressing aggregate demand. Making some agents debt-constrained is a surprisingly powerful assumption: Fisherian debt deflation, the possibility of a liquidity trap, the paradox of thrift, a Keynesiantype multiplier, and a rationale for expansionary fiscal policy all emerge naturally from the model. We argue that this approach sheds considerable light both on current economic difficulties and on historical episodes, including Japan’s lost decade (now in its 18th year) and the Great Depression itself.
1,249 citations
TL;DR: This paper studied a macroeconomic model in which financial experts borrow from less productive agents and found that the economy is prone to instability and occasionally enters volatile episodes, and that risk sharing within the financial sector reduces many inefficiencies, it can also amlify systemic risks.
Abstract: This paper studies a macroeconomic model in which financial experts borrow from less productive agents. We pursue four sets of results: (i) The economy is prone to instability and occasionally enters volatile episodes. As volatility spikes agents precautionary motive increases depressing prices even further. Log-linear approximations fail to capture these non-linear effects that can cause economies to be significantly depressed for long periods of time. (ii) Endogenous risk during volatile episodes increases asset price correlations. (iii) Financial experts impose a negative externality on each other and on the labor sector by not maintaining adequate capital cushion, and funding structure. (iv) While risk sharing within the financial sector (through securitization and derivatives contracts) reduces many inefficiencies, it can also amlify systemic risks.
1,107 citations
TL;DR: The Financial Instability Hypothesis (FIH) as mentioned in this paper is a model of a capitalist economy that does not rely on exogenous shocks to generate business cycles of varying severity: business cycles are compounded out of the internal dynamics of capitalist economies, and (ii) the system of interventions and regulations that are designed to keep the economy operating within reasonable bounds.
Abstract: The Financial Instability Hypothesis (FIH) has both empirical and theoretical aspects that challenge the classic precepts of Smith and Walras, who implied that the economy can be best understood by assuming that it is constantly an equilibrium-seeking and sustaining system. The theoretical argument of the FIH emerges from the characterization of the economy as a capitalist economy with extensive capital assets and a sophisticated financial system. In spite of the complexity of financial relations, the key determinant of system behavior remains the level of profits: the FIH incorporates a view in which aggregate demand determines profits. Hence, aggregate profits equal aggregate investment plus the government deficit. The FIH, therefore, considers the impact of debt on system behavior and also includes the manner in which debt is validated. Minsky identifies hedge, speculative, and Ponzi finance as distinct income-debt relations for economic units. He asserts that if hedge financing dominates, then the economy may well be an equilibrium-seeking and containing system: conversely, the greater the weight of speculative and Ponzi finance, the greater the likelihood that the economy is a "deviation-amplifying" system. Thus, the FIH suggests that over periods of prolonged prosperity, capitalist economies tend to move from a financial structure dominated by hedge finance (stable) to a structure that increasingly emphasizes speculative and Ponzi finance (unstable). The FIH is a model of a capitalist economy that does not rely on exogenous shocks to generate business cycles of varying severity: business cycles of history are compounded out of (i) the internal dynamics of capitalist economies, and (ii) the system of interventions and regulations that are designed to keep the economy operating within reasonable bounds.
1,088 citations
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TL;DR: In this article, the authors argue that this leverage cycle can be damaging to the economy and should be regulated, and that equilibrium determines leverage, not just interest rates, causing fluctuations in asset prices.
Abstract: Equilibrium determines leverage, not just interest rates. Variations in leverage cause fluctuations in asset prices. This leverage cycle can be damaging to the economy, and should be regulated.
905 citations
760 citations