What is this “Financial Instability Hypothesis” by Hyman Minsky really about?

In his publications in the 1950s through the mid 1960s, Minsky gradually developed his analysis of the cycles. First, he argued that institutions, and in particular financial institutions, matter. This was a reaction against the growing dominance of a particular version of Keynesian economics best represented in the ISLM model. At the same time, he examined financial innovation, arguing that normal profit seeking by financial institutions continually subverted attempts by the authorities to constrain money supply growth. This is one of the main reasons why he rejected the LM curve’s presumption of a fixed money supply. With his 1975 book, Minsky provided an alternative analysis of Keynes’s theory. This provides his most detailed presentation of the “financial theory of investment and investment theory of the cycle”. Minsky continually developed his financial instability hypothesis to incorporate the extensions made to his investment theory over the course of the 1960s, 1970s, and 1980s. The Kalecki equation was added; the two-price system was incorporated; and a more complex treatment of sectoral balances was included. Minsky also continued to improve his approach to banks, recognizing the futility of Fed attempts to control the money supply

Minskian Perspective on Instability in Financial Markets

Yesterday, we highlighted the talk that Steve Keen gave at the INET conference as our only post. Today, we present the full and in-depth version including his written analysis via Steve Keen’s DebtWatch website. Steve ends with two innovative solutions to this and future debt crises

Keen: Instability in Financial Markets

Steve Keen’s talk at INET is now up on the web (hat tip BT). His talk is billed as a primer on Hyman Minsky. In it, Steve argues that one cannot model Minsky using a New Keynesian or traditional neoclassical approach because of the reliance of these modelling approaches on the economic equilibrium assumption. Keen sees this assumption as the major flaw that cannot be remedied using standard modelling approaches

Video: Steve Keen on modelling and the Krugman debate

I think this video is worth watching because Keen gets to the heart of the issues with the standard approach to economics. He says that banks, money and debt are front and center in reality as we now see after the crisis. Consequently, they should also be integral in economic models

Alan Blinder gets it

I caught this statement from Alan Blinder in a debate on the New York Times about teaching economics. Clearly, Blinder sees a huge financial crisis and reflexively understands changes must be made

Progress on the monetary policy and banking debate

We seem to be moving forward with this discussion on monetary policy, banking, and reserves. John Carney does a good job of summarising some of the initial forays in this back and forth. I am going to try my hand at framing the discussion here using my own analysis of the comments iteratively, with the assistance of more comments of course. Where there are mistakes, I will fix them accordingly

Endogenous or exogenous money?

I think the real difference between what Nick Rowe is saying and what people like Scott Fullwiler and Steve are saying is that Nick believes over the medium-term, central bank interest rate policy is endogenous. What I think Nick means is that Scott Fullwiler’s view is reasonably clear and straightforward but that it only matters over a short-term time horizon because central bank interest rate policy adjusts endogenously over the medium-term to commercial bank and other economic variables such that it is really endogenous rather than exogenous

Krugman’s Flashing Neon Sign

The debate between Paul Krugman and my friend Steve Keen regarding how banks work (see here, here, here, and here) has caused me to revisit an old quote. Back in the 1990s I would use Krugman’s book, Peddling Prosperity (1995), in my intermediate macroeconomics courses since it provides a good overview of what were then contemporary debates in macroeconomic theory as well as Krugman’s criticisms of various popular views on macroeconomic policy issues from that era. One passage near the very end of the book has always remained in the back of my mind; in it, Krugman critiques a popular view that was and still is highly influential regarding productivity and trade policy. He writes: “So, if you hear someone say something along the lines of ‘America needs higher productivity so that it can compete in today’s global economy,’ never mind who he is or how plausible he sounds. He might as well be wearing a flashing neon sign that reads: ‘I DON’T KNOW WHAT I’M TALKING ABOUT.’” (p. 280; emphasis in original)

In his latest post in this debate (which Keen replied to here), Krugman demonstrates that he has a very good grasp of banking as it is presented in a traditional money and banking textbook. Unfortunately for him, though, there’s virtually nothing in that description of banking that is actually correct. Instead of a persuasive defense of his own views on banking, his post is in essence his own flashing neon sign where he provides undisputable evidence that “I don’t know what I’m talking about.”

Ptolemaic Economics in the Age of Einstein

Paul Krugman’s claim that those who argue banks play an essential role in macroeconomics are “Banking Mystics” has a natural riposte: Neoclassical economists like Krugman who believe that capitalism can be modelled without either money or banks are Barter Mystics (David Graeber, 2011). How on earth can someone believe that the manifest reality that transactions involve money being exchanged for goods can be ignored, and pretend instead that goods are exchanged for goods? How on earth can the institutional reality of banks be ignored by those who claim to be macroeconomists

Ludwig von Mises on Austrian Business Cycle Theory

Yesterday, John Carney at CNBC had a nice little post comparing Hyman Minsky’s Financial Instability Hypothesis with some of the thinking by Friedrich von Hayek behind Austrian Business Cycle Theory. John rightly points to this passage as “a theory about banking as an endogenous destabilizer of the economy.” And this certainly fits with the Minsky view of the world. von Mises takes the view that it is in having “bank notes without gold backing or current accounts which are not entirely backed by gold reserves, the banks are in a position to expand credit considerably”. Nevertheless, whether you believe the genesis of the credit expansion is Federal Reserve interest rate policy, animal spirits, fiat currency or fractional-reserve banking, what should be clear is that it is the lower rate of interest that creates the credit growth. The question is whether this lowering of rates is beneficial over the long-term. Vom Mises argues it is not

On debt’s centrality to modelling complex economic systems

My view as developed in that post is that debt is central to understanding economic systems, and not just because it has a redistributive element in apportioning losses between creditors and debtors when recession forces credit writedowns. More importantly, debt accumulation adds to an economy’s ability to sutain economic growth (and malinvestment) by adding to aggregate demand. The video in this post gets to why this. matters

Why Minsky Matters

My friend Steve Keen recently presented a “primer” on Hyman Minsky. In his piece, Steve criticized the methodology used by Paul Krugman and argued that Krugman could learn a lot from Minsky. In particular Krugman’s equilibrium approach and primitive dynamics was contrasted to Minsky’s rich analysis. Finally, Krugman’s model of debt deflation dynamics left out banks–while banks always played an important role in Minsky’s approach. This post is to help explain why Hyman Minsky matters by quickly summarizing Minsky’s main areas of research. Next week I will post up more on Minsky’s view of “money and banking”