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Stabilizing an Unstable Economy

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This classic work of political economy, first published in 1986, has valuable lessons for us today. Minsky studies the recessions of 1975 and 1982, economic theory, institutions, particularly banks, and finally presents an agenda for reform.

Financial traumas have led to ever-worse recessions, in 1970, 1975, 1979-80, 1982, 1987, 2002 and the present. As he notes, "the normal functioning of our economy leads to financial trauma and crises, inflation, currency depreciations, unemployment, and poverty in the midst of what could be virtually universal affluence - in short, .. financially complex capitalism is inherently flawed." Yet he believes, "the collapse of aggregate demand and profits, such as occasionally occurred and often threatened to occur in pre-1933 small government capitalism, is never a clear and present danger in a Big Government capitalism such as has ruled since World War Two." Life is disproving this hope.

What causes these recessions? Minsky writes, "the Wall Streets of the world are important; they generate destabilizing forces. ... This instability is not due to external shocks or to the incompetence or ignorance of policy makers. Instability is due to the internal processes of our type of economy. The dynamics of a capitalist economy which has complex, sophisticated, and evolving financial structures leads to the development of conditions conducive to incoherence - to runaway inflations or deep depressions." Strangely, capitalism can't handle capital: "capitalism is flawed precisely because it cannot readily assimilate productive processes that use large-scale capital assets."

What is to be done? He warns, "Meaningful reforms cannot be put over by an advisory and administrative elite that is itself the architect of the existing situation." Then he stresses, "The emphasis on investment and `economic growth' rather than on employment as a policy objective is a mistake. A full-employment economy is bound to expand, whereas an economy that aims at accelerating growth through devices that induce capital-intensive private investment not only may not grow, but may be increasingly inequitable in its income distribution, inefficient in its choices of techniques and unstable in its overall performance." But, as Minsky acknowledges, capitalism cannot deliver full employment: "Capitalist market mechanisms cannot lead to a sustained, stable-price, full-employment equilibrium."

He proposes, "Public control, if not out-and-out public ownership, of large-scale capital-intensive production units is essential." He suggests nationalising the railroads and the nuclear power industry, as private enterprise runs both so poorly.

He also notes capitalism's other failures: "the market mechanism ... cannot and should not be relied upon for important, big matters such as the distribution of income, the maintenance of economic stability, the capital development of the economy, and the education and training of the young." It seems we can't rely on capitalism for anything.

This is and has really re-emerged as a classic and prophetic book on the endogenous factors that drive instability. Again, the book is referred to a little too late and undoubtedly the same will happen in whatever next bubble next pops. To give a quick overview, most people study economic growth as as function of the economy's factors of production (including human capital) and their dynamics (modern economists are updating methods and ideas but people are still taught the solow growth model as foundational). The "trajectory" of an economy is usually smooth and the stochastic growth drivers/detractors are technology and exogenous shocks, where exogenous are not known from a substance or timing perspective a priori. Minsky explores a form of instability that is not discussed in most growth models, he discusses the instability that is embedded in our economies resulting from the use of currency its fluctuation from being scarce to abundant.

To me his insights as to the dynamics of what drives asset bubbles, in particular, banks propensity to lend as well as agents propensity to borrow against assets as a function of recent history was so spot on it makes you smile were it not so sad that it just happened. Minsky has identified a particularly dangerous form of the animal spirits that Keynes and more recently Schiller have written about, especially in a fiat currency environment in which we are separated from the pricing of money mechanism that the central bank is empowered to control. This book is worth reading for a multitude of reasons. Not only does it make one think about the worlds inherent instability, for which no obvious solution exists, it reminds us that we need to work on policy that tries to generate negative feedback to counteract the positive feedback to take us from hedge finance, to speculative finance, to ponzi finance.

After reading this book, one is not an expert able to give a solution to endogenous money and asset price shock risks, but one can understand the problem much more deeply. Given the dynamics driving the instability isnt stationary and central bank measures often take a long time to filter through (obviousy example being raising rates yet continuation of property speculation) more time needs to be spent on what policy might induce counterbalancing feedback. After reading Minsky one can read policy recommendations and get a more complete sense of the influence and the merit in things like bank capital cushions being used to dampen multiyear volatility. This has always been a must read, but the recent and ongoing crisis is another re-affirmation to add this to ones cart.

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The main theme is that our economic system, corporate capitalism, is essentially unstable because of the existence of the financial industry necessary for financing investment. It is very clear explaining the neoliberal synthesis and demonstrating that is useless to use it as a guide for our economy. It builds and explains which kind of economic theory will fit the real world we are living in.

It explains very well how we arrived at this desperate situation but Hyman Minsky could never imagine how to get out of today's catastrophic disaster when all the possible economic remedies have been used (interest rates near 0, gigantic liquidity injections, without even asking about the existing total debts of the financial institutions,...) because what is lacking is trust in the market and between the market players. In brief liquidity preferences are huge compared with investment ones.

I recommend it to everybody interested to know what to do now and what to avoid in the future.

Unfortunately, economists seem to given more attention after they're deceased and it appears Hyman P. Minsky (1919 -1986) is one in this category as well. As I read this book, originally published in 1986, I was amazed at not only one, but the many, parallels to today his synthesis of economic views, a blend of today's camps including the behavioral, had.

More valuable to you are his comments than mine, so I will quote Minsky as much as possible in this review and highly suggest its reading to fill in the gaps he so well articulates on his own. I decided to read this book because I'm not an economist and heard how his theories may better apply today than ever.

Many years later, the preface to this edition provides an excellent summary of Minsky's work. You do not need to be an expert to follow along. In the Introduction (8), Minsky points out that the institutional arrangements we have today in response to the Great Depression were set up pre-Keynes and with a pre-Keynesian understanding of the economy. ¨The evidence from 1975 indicates that, although the simple Keynesian model in which a large government deficit stabilizes and the helps the economy to expand is valid in a rough and ready way, the relevant economic relations are more complicated than the simple model allows. In particular, because what happens in our economy is so largely determined by financial considerations, economic theory can be relevant only if finance is integrated in the structure of the theory.¨

Minsky discusses Big Government and lender-of-last-resort (Federal Reserve or Fed) which is enlightening is and of itself. The balance of Chapters two and three are devoted to how these two interventions may work in theory. ¨To understand how Big Government stopped the economy's free fall, it is necessary to delve into the different impacts of government deficits on our economy ...¨ (24) He proceeds to define and then discuss three impacts: income and employment effect; budget effect; and portfolio effect. The standard view only incorporates one impact while Minsky argues and expanded view must incorporate all three views. ¨As a result of the 1975 experience, the issues in economic theory and policy that we should have to face are not about the ability of prodigious government deficit spending to halt even a very sharp recession but about the relative efficiency of specific measures and the side and after effects associated with particular policy strategies.¨ (24-25) I would suggest this has not been done effectively in response to the 2007 recession (started in Dec 2007 and has not been declared over as of this review writing (google "nber recession dates" for start and finish dates for this recession) which to date has had a more blind application of Keynesian without much thought as Minsky suggested long ago. Of interest is his discussion how Big Government entitlement programs impart an inflationary bias into the economy. (29)

Minsky's lender-of-last-resort includes a discussion on the lack of understanding of the inflationary side effects affects of intervention (51) and explosive growth of speculative liability structures (52) are as applicable today as to then. ¨Unless a theory can define the conditions in which a phenomenon occurs, it offers no guide to the control or elimination of the phenomenon.¨ He discusses the open market and discount window functions of the Fed and is instructive as to how the FOMC loses its power to affect member bank behavior, thus the Fed is not acting on intimate knowledge of banking practices. (54) Wow! Wasn't that also true this time! Minsky points out five causes of concern that the 1974 Chairman of the Federal Reserve System had appear as relevant today as to then as well: ¨first, the attenuation of the banking systems' base of equity capital; second, greater reliance on funds of a potentially volatile character; third, heavy loan commitments in relation to resources; fourth, some deterioration in the quality of assets; fifth, increased exposure to the larger banks to risks entailed in foreign exchange transactions and other foreign operations.¨

Minsky foresees how regulators (and politicians it seems) in imputing ¨...the difficulties he sees to either a laxness of regulatory zeal or, perhaps, some rather trivial mistake in how the regulatory bodies were organized, rather than to a fundamental behavioral characteristic of our economy.¨ (58) Even today, we see more shuffling of regulatory responsibilities and body creation rather than understand the behavior that causes the problems first in order to develop solutions.

He also points out how real estate was a problem back then as well, as result from explosive speculation. ¨The need for lender-of-last-resort intervention follows from an explosive growth in speculative finance and the way in which speculative finance leads to a crisis-prone situation.¨ (59) ¨Inasmuch as the successful execution of lender-of-last-resort functions extends the domain of the Federal Reserve guarantees to new markets and to new instruments there is an inherent inflationary bias to these operations; by validating the past use of an instrument, an implicit guarantee of its future is extended.¨ (58-59)

¨It is important to emphasize that ... any constraint placed on the Federal Reserve flexibility (e.g. by mandating mechanical rules of behavior) attenuates its power to act. Rules cannot substitute for lender-of-last-resort discretion.¨ Recall, the call by many to constrain the Fed? Minsky suggests otherwise. He also states ¨Certainly the bank examination aspects of the FDIC and the Federal Reserve should be integrated, especially if inputs from bank examinations are to become part of an early warning system for problem banks.¨ (64) This ties in with the idea above where the Fed has lost intimate knowledge of the banking practices.

Minsky discusses how the behavior of many actors need to be considered in a cohesive theory when he states ¨The dynamics of the financial system that lead to institutional change result from profit-seeking activities by businesses, financial institutions, and households as they manage their affairs.¨ (77) The problems that exist in the hierarchical financial system between mainstream banks and fringe banks is also noticed by Minsky years ago where a potential domino effect can cause serious disruptions as a result of the lender-of-last-resort guarantee to the mainstream banks as discussed on page 58. (97)

So far Minsky has laid the groundwork for actor interactions and issues. He then proceeds to theory. ¨In all disciplines theory plays a double role: it is both a lens and a blinder.¨ "It is ironic that an economic theory that purports to be based on Keynes fails because it cannot explain instability. ... Identifying a phenomenon is not enough: we need a theory that makes instability a normal result in our economy and gives us handles to control it." (111) "In what lies ahead, we will develop a theory explaining why our economy fluctuates, showing that the instability and incoherence exhibited from time to time is related to the development of fragile financial structures that occur normally within capitalist economies in the course of financing capital asset ownership and investment. We thus start with a bias in favor of using the market mechanism to the fullest extent possible to achieve social goals, but with recognition that market capitalism is both intrinsically unstable and can lead to distasteful distributions of wealth and power." (112) "The elements of Keynes that are ignored in the neoclassical synthesis deal with the pricing of capital assets and the special properties of economies with capitalistic financial institutions." (114) Minsky goes on to deconstruct both pre-Keynesian and and after-Keynesian constructs and synthesis. Minsky's "financial instability hypothesis" (127) addresses weaknesses he views in the neoclassical model. "In the neoclassical view, speculation, financing conditions, inherited financial obligations, and the fluctuating behavior of aggregate demand have nothing whatsoever to do with savings, investment, and the interest rate determination." (123) "In neoclassical theory, money does not have any significant relation to finance and the financing activity." (124) Minsky addresses the point that Keynes thoughts came out after government programs for reform and recovery were put into place, not the other way around and many may think today. (134) Minsky then develops how cause and effect to lay the ground work for his hypothesis throughout chapters 6 through 9 as he discusses in turn price relations allowing for government, foreign trade, consuming out of profits and saving out of wages, supply prices, taxes and government spending, financing of business spending, investment and finance, capital asset prices, investment, cash flows, and three kinds of financing (hedge, speculative and Ponzi: "The mixture of hedge, speculative, and Ponzi finance in an economy is a major determinant of its stability. (232)). "The main reason why our economy behaves in different ways at different times is that financial practices and structure of financial commitments change." (219) He calls the economy existing always in a transitory state.

Minsky then builds a larger model by discussion Institutional dynamics in Part 4. "Business cycles are `natural' in a investing capitalist economy, but to understand why this is so it is necessary to deal with the financing of investment and positions in capital assets explicitly." (249) He also recognized the distinction between commercial banks and investment banks and that the distinction between the two were breaking down even back in the 80's. (249) "In a capitalist economy money is tied up with the process of creating and controlling capital assets." (250) "Money is created as bankers go about their business of arranging for the financing of trade, investment, and positions in capital assets." (250).

Deposit (commercial banks) are emphasized in Chapter 10. Minsky's observation in the 80's rings as true today as it did then when he says "The narrow view that banking affects the economy only through the money supply led economists and policymakers to virtually ignore the composition of bank portfolios." (252) The rest of Chapter 10 explains how bank portfolio composition works and the economic effect this has.

Chapter 11 in about inflation. "My theory emphasizes the composition of financed demand and the spending of incomes that are allocations of profits as the determinants of the prices of consumption goods. It is compatible with the multiplier analysis in orthodox Keynesian theory" (254) "The determination of employment, wages, and prices starts with the profit calculations of businessmen and bankers. This proposition is in sharp contrast to the views of neoclassical monetarist theory." (255) Milton Friedman is a monetarist that he discusses next with this weakness in that theory in mind. Minsky develops his inflation theory by discussing money wages, price-deflated wages, government as an inflation engine, and trade union roles in inflation.

Part 5 is the culmination of his work where he discusses possible policy implications of his theory through the lens of his financial instability hypothesis. "Even if a program of reform is successful, the success will be transitory." (319) He continually reminds us that a dynamic system will need continual monitoring, adjustment and trade offs in the attempt to keep instability within reasonable bounds. An overarching agenda and approach should be developed to do this. An employment strategy should be developed, financial reform should be carefully crafted so as to not make matter worse.

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Conclusion:
As I mentioned at the beginning, I am not an economist. Minsky's description of the economy as developed through his instability model appears to describe much of how the interactions work, the inherent instability of a capitalist system, and his proposals to manage the instability appear to have merit for consideration. Especially in light of the 2007 recession.

Minsky appears to be an interesting combination of Keynesians who look to mitigate busts, and Austrians who look to prevent artificial booms.

For an easy read which builds a hypothetical economy, using an example of an island and fish on up, to describe economic history through the lens of the Austrian economic model: How an Economy Grows and Why it Crashes by Peter D Schiff and Andrew J Schiff.

For more on Keynes, this work by Hunter Lewis describes what Keynes said and what he didn't say side by side. Where Keynes Went Wrong: And Why World Governments Keep Creating Inflation, Bubbles, and Busts

Review by Larry Frank, author of Wealth Odyssey: The Essential Road Map For Your Financial Journey Where Is It You Are Really Trying To Go With Money?

I just finished reading this book and I have to say that my understanding of the crisis and in the general workings of the economy are vastly improved. The math isn't too hard and Minsky's prose is pretty good. A lot of ground is covered and important points are repeated so understanding of the material is more easily retained. This material should find its way into Introductory Macroeconomics textbooks to replace all the right wing trash. Read this book and you will see for yourself.

"The fundamental propositions of the financial instability hypothesis are:
1. Capitalist market mechanism cannot lead to a sustained, stable-price, full-employment equilibrium.
2. Serious business cycles are due to financial attributes that are essential to capitalism"

Minsky includes a good overview of the neoclassical synthesis and how the Walrasian 'village fair' economy is incompatible with Keynes' General Theory. He also sharply criticizes Hicks and Patinkin for 'bastardizing' Keynes.

Minsky's assertions sound so convincing I'm struck wondering why he was ignored. Whether it was from some serious flaw in his theory that I'm ignorant of or if it was merely political (Minsky is not afraid to point the blame at Monetarists and Reagan). However, Minsky's solutions in section 5 would be considered highly controversial today. In an age of neoliberalism I highly doubt too many politicians would campaign for a new CCC or WPA. Let alone the socialization of key capital intensive industries.

Be warned: Minsky often throws in long chains of causality that a layperson probably would not truely grasp. I recently finished a course in intermediate macroeconomics, basically teaching only the neoclassical theory, and sections 3&4 were still difficult. This is by no means a passive book.

Hopefully the next generation of economists may learn from the current crisis, with the help of men like Minsky, and successfully stabilize an unstable economy.

Minsky provides a more detailed, subtle and nuanced study than the Keynes of the General Theory(GT) ,but not of the A Treatise on Money, of how Wall Street speculators create inflation and deflation through their ability to leverage their debt position once they have obtained bank loans so as to engage in securitization practices,be they the balloon payments- mortgage loans and margin account financing of the 1920's or the sub prime mortgages and derivatives of the late 1970's to 2000's.Minsky follows Keynes in targeting this fundamental point-Allowing Wall Street speculators to dominate Main Street guarantees severe inflationary and deflationary problems as the Wall Street speculators (hedge funds,private equity firms,investment banks and giant ,private, commercial banks )inflate the bubble on the way up and then watch the bubble collapse on the way down.

Unfortunately,Minsky was never able to master Keynes's formal mathematical demonstration in chapters 20 and 21 in the GT of how the use of money for asset demand purposes ,that is speculative practices involving M2,where M=M1+ M2,M is the total demand for money and M1 is the transactions demand for money,will lead to suboptimal macroeconomic outcomes that generate involuntary unemployment.Keynes's mathematical demonstration has been overlooked since 1936.
A second problem is Minsky's complete and total ignorance(this is a common problem when dealing with economists) of the extensive discussions carried out by Adam Smith of the dangers that lurk if the private commercial banks or financiers can make loans to projectors,prodigals and imprudent risk takers.These three categories are equivalent to Keynes's Wall Street speculators and rentiers.Minsky could have tied his work directly to that of the Master, Adam Smith .
I recommend that the book be bought in spite of these two blemishes.Minsky's additional details add to the Smith-Keynes analysis.One could also incorporate Irving Fisher's 1934 work as well within Minsky's framework.

Minsky has done the work outlining the reality of capitalistic systems. Intuitively I knew his points as he made them. This is how our economy really works. Booms and busts are the result of natural human tendencies but are not the preferred nor inevitable outcomes. Humans can also modify their behavior.

Instability is obvious to anyone who has been involved with commodities. The tendency to throw fundamentals to the wind and bet the farm on a bull run is without question a fundamental in and of itself. Minsky has outlined the new economic order that universities should embrace and teach our future generations.

The late professor Hyman P. Minsky wrote this study of economic volatility in 1986, as an era of frequent economic crises was shaking investors' confidence. His treatise remains relevant today. Minsky doesn't mention dot-com bubbles or subprime mortgages, yet he manages to nail contemporary economic reality. As the economist who lent his name to "the Minsky Moment," that point in time when markets tip from prosperity to crisis, he often repeats his concerns about income inequality, seeming to predict the current debate about ever-increasing concentrations of wealth. But in case you consider labeling Minsky as just a tax-and-spend liberal, consider that he frowns on welfare and long-term unemployment benefits. He's no master stylist as a writer, but Minsky's prose is generally clear enough to reward readers who seek his insight. getAbstract recommends this classic analysis to readers seeking a skeptical perspective on free markets.

This was a very interesting read and although I am not a believer in the Keynesian model of economic policy, I tried to keep an open mind. Minsky is a very talented writer and he did a wonderful job of explaining the economic circumstances from about 1929 to 1986. He did explain that the thought of Roosevelt using Keynesian economics was impossible since Keynes' books didn't really affect the world until at least 1937. Well after the depression started. The theory that the economy doesn't get worse in 1975 and even today is Minsky's main points throughout the book. He likes Big Government and the Federal Reserve's proactive management of rates. Interesting, these are exactly what ISN'T popular in today's America. He really does believe that Government is suppose to create demand, increase inflation and then let the Fed keep rates low. Well, it worked a bit and my only problem with the argument is that authors of this persuasion always say it would have been worse if we didn't do it.. How do they know?

Last point is the conclusion of the book. He recommends that we continue the path of big government, fed intervention and still he concludes that reforms are necessary (more govt intervention) but will do no good because it is simply the way the capitalistic world we live in.. an unstable world.

So basically the title of the book is useless, he's contention is there is no way to stabilize an unstable economy