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.

Minsky (1975, p.120) observes that success in enterprise leads to accumulation of capital assets and increased access to credit, well in excess of the increase in ability to pay.  At the same time, borrowing is key to the potential earnings of an enterprise.  When confidence is high, and interest rates are low, entrepreneurs borrow and expand their enterprise; they can borrow more cheaply than before (because their credit rating is better) and increased leverage means greater return on their equity.

The transition to speculative finance by whole enterprises is probably inevitable. Minsky often suggests that his ambition is to head off financial booms entirely, and elsewhere suggests that this is a (destructive) trait inherent to capitalism (Minsky, 1986, p.113).³  One point he may or may not have mentioned is that a business manager may be under great pressure to push the expansion of debt to the very maximum, in the desperate bid to win the commanding heights of a particular sector.  If one understands that the first firm to implement 5G across one's service area will be the winner, then one will do so... whatever it takes.  If the alternative is to lose one's job at the head of a major firm, then one will go do likewise.

Once a firm is engaged in speculative borrowing, then it's not much of a jump to Ponzi borrowing. This just means the borrower has taken on so much leverage that it has to continually borrow more to make payments on the interest, while rolling over the principle.⁴  Ponzi borrowing is often the whole business model for a lot of start-ups, and there's little reason for a business enterprise facing an existential struggle with a competitor to not engage in Ponzi borrowing. Whether or not this will be the prevailing mode of business borrowing depends, evidently, on options available to the firm; if regulations permit creative financing to sustain enormous amounts of leverage, then many businesses will eventually migrate to a permanently expanding-debt position.

(Part 2)

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NOTES:

1. See, for example, John Cassidy, "The Minsky Moment," The New Yorker (February 2008)


2. Minsky's criticism is motivated by the IS-LM failing to capture the role of uncertainty in portfolio decisions and investment behavior (Minsky, 1975, p.38).  Full disclosure: I was much more impressed with John Maynard Keynes than with Stabilizing an Unstable Economy.


3. Judging by Keynes (1937, pp.217-218), this seems like an innate feature not only of capitalism, but of any system in which time moves one direction. In Keynes (1936, p.135), he expounds on "the marginal efficiency of capital": the rate of time-discount that makes expected future returns on a capital investment exactly equal to its supply price. A small increase in the interest rate available to the firm can have a devastating n-order effect on the value of the investment.


4. Minsky (1986, p.79) acknowledges that banks often engage in Ponzi finance, albeit not in so many words. 

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SOURCES 🙵 ADDITIONAL READING:

• Hyman P. Minsky, John Maynard Keynes, Columbia University Press (1975)


• Basil J. Moore, Horizontalists and Verticalists: The Macroeconomics of Credit Money, Cambridge University Press (1988); this is a very dense volume outlining his theory of endogenous, or horizontal, money. Another source is his paper, "Unpacking the Post Keynesian Black Box: Bank Lending and the Money Supply" (PDF), Journal of Post Keynesian Economics V.4, pp.537-556 (1983).


• John Maynard Keynes, "The General Theory of Employment" (PDF), Quarterly Journal of Economics, 51 (1937). For people who have difficulty making much sense out of the 1936 book General Theory of Employment, Interest, and Money (links will lead to the Marxist.org text, although it lacks page numbers), his short 1937 paper is very worthwhile as a succinct explanation. In fact, it's extremely engaging and unusual for a formal paper in economics.