Stabilizing an Unstable Economy—Part 3

(Part 1 🙵 2)

The theories of Hyman Minsky have attracted a lot of attention because of the financial component he imparted to Keynesianism. Unlike other economic descriptions of the economy, Minsky's writings have paid great attention to the market for credit and income-bearing securities.   Arguably, his analysis is attractive because he
(a) connects his hypotheses with a major body of practical knowledge about money markets;
(b) explains his ideas in ways that don't require extraordinary specialized expertise;
(c) limns his description of the economic world with recognizable developments.
Most people who read Minsky can see the historical landmarks that he describes: the stream of new tools for leverage, the cycles of financial instability, the tendency for tools for controlling the economy to become less effective over time, even as authorities become more sure of themselves.

In addition, he discusses shortcomings of the other schools of economics.

MINSKY VS NEOCLASSICISM: ASSET MARKETS

The neoclassical model that had come to dominate economics, he argues (Minsky 1986, p.114), ignores money and idealizes an economy of efficient barter ("abstract exchange").  Economic models have arbitrary divisions between representative models and firms, and money has no role to play.  "Using an artificial construction of trading relations, the theory demonstrates that a decentralized market economy achieves a coherent result."  The reactions of the system to external changes are predictable (p.116), and interventions are not required.

Minsky observes that, when a system is shown (in this case, through mathematical analogies) to be coherent, then incoherence needs to be explained.  Factors outside the model must be the cause of extraordinary shocks, such as a purblind state—or technology shocks.  If the model is properly specified, then shocks will not arise from within the system.

He mentions that neoclassical research papers often identify scapegoats, such as the monetary authorities, labor unions, and political events.¹ It logically follows that, "If the pricing mechanism of a decentralized capitalist economy can lead to coherent results only if proper policy or institutions rule, then intervention is necessary even though the market mechanism can be relied upon to take care of details" (p.117). Indeed, this can be seen in the endless demands by economists in the wake of the GFC for the government to "align incentives" for financial markets.  To be clear, a fundamental proposition of economic thought is that markets are spontaneous and respond effectively, if not instantaneously, to real world conditions.  If the climate naturally changes, then supposedly the markets will adapt successfully to the new conditions. But if the government does something incorrect (according to the theory) then all hell breaks loose.
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Stabilizing an Unstable Economy—Part 2

(Part 1 🙵 3)

It would probably strike most people that the financial instability hypothesis (FISH) is hardly much of a hypothesis.  You can improve your situation by doing more of B, so you do.  Soon, everyone else is doing B as well, requiring you do even more B, until eventually you wind up doing an insane amount of B just to stay in business.  At some point, it all blows up and everyone is upset. In this case, the thing consists of borrowing money until you're literally borrowing more just to cover the interest payments.

However, the FISH is not the whole book.  Minsky seems well aware of the fact that it's senseless to scold the business managers, who do the borrowing, and it's not a whole lot more sensible to scold the financiers, who at the end of the day are motivated by the need to be competitive with other financial managers or institutions.  He does do an excellent job of critiquing bank supervision ("Institutional Dynamics," pp.249-282), mainly outlining what he knows.  The downside, of course, is that there have been over 28 years since he wrote this, and those 28 years have witnessed cataclysmic changes to the financial sector.  It's not just massive deregulation; the structure of the industry has experienced deliberate reconstruction by executives who engineered a regulatory revolution, and then there was the (mostly unexpected) wave of upstart non-bank financial firms like Countrywide.¹ The Global Financial Crisis will probably leave its own mark on the practice of banking.

Minsky's book is mostly about banking as a macroeconomic force. After an introductory chapter I'd advise most readers to skip (vague generalities), he starts off on an exploration of the 1973-1975 recession (Minsky 1986, pp.17ff)  .  This began as a mild downturn before the financial system exploded and the economy fell off a cliff.  Between September 1974 and March 1975, unemployment shot upward, production plummeted, and banks began to fail.² Minsky naturally projects this forward another two quarters and compares it to what actually happened.  "Price-deflated GNP shifted from a 9.2 percent annual rate of decline in the first quarter of 1975 to a 3.3 percent annual rate of increase in the second quarter of 1975, and a larger 11.9 percent rise in the third quarter."

This was indeed an amazing turnaround, but not unique.  Something similar had happened in 1966 and 1970.

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Stabilizing an Unstable Economy—Part 1

Hyman P. Minsky, Stabilizing an Unstable Economy, McGraw Hill (2008/1986) link updated 

Minsky's general hypothesis of economic instability has recently received a lot of favorable attention. The Global Financial Crisis triggered a lot of interest in a theory of economic crises that actually included some role for the financial sector, which mainstream economics mostly lacks.¹ Minsky was a heterodox economist who rejected the IS-LM interpretation of Keynes's General Theory of Employment, Money, and Interest in favor of an alternative model based on verbal (i.e., non-mathematical) models.²

This post is mainly a discussion of Minsky's most frequently-cited work, Stabilizing an Unstable Economy, which was originally published in 1986 and republished in 2008 by a bunch of admirers.

The usual summary of the Minsky analysis is that business cycles through three phases of borrowing, always in the same order (Minsky 2008, p.78):

Hedge Finance—Borrower (presumably a going concern) makes payments of both interest and principle out of current revenue. In effect, financing serves practical function of dividing one big purchase into many smaller payments.  Cash receipts of the borrower exceed cash payments on the loan in each time period.

Speculative Finance—Borrower needs to borrow (more) to repay debt (especially principle; p.48).   Minsky implies (p.225) that distinction between speculative and non-fraudulent Ponzi finance is that speculative financing involves payments of interest (and probably some principle, at least some of the time).

Ponzi Finance—Borrower needs to borrow to pay interest as well as principle (p.70). In effect, the borrow is running a Ponzi scheme in which current payouts to investors and creditors come from a rapidly-growing debt load.

The idea is that, in periods of virtuous growth, speculators are confined to markets, as "bubbles on a steady stream of enterprise" (Keynes, 1936, p.159).  In some cases, they're needful for the making of markets—a risky vocation.  But at other times, speculation becomes the enterprise, and this drives the development of the productive capacity of a nation into terrible plans—plans that are not easily reversed.
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