Why Minsky Matters by L. Randall Wray – book review

I wrote this review of L. Randall Wray’s Why Minsky Matters for the Rethinking Economics project back in January. RE have changed their website and my review can no longer be found there, so I thought I would post it here. Minsky didn’t have all the answers, but his Financial Instability Hypothesis remains highly relevant, and his prescience regarding the inevitability of major financial and economic crises was remarkable:

The effects of the 2008 Global Financial Crisis (GFC) are still with us. As I write, forecasts for the growth of the capitalist world economy are being progressively downgraded. One economist whose ideas gained a new lease of life from the GFC’s inception is the late Hyman Minsky. Indeed, as the crisis began to unfold, some commentators initially dubbed it a ‘Minsky moment’.

To sum up Minsky’s most influential contributions to economics in his own words: ‘stability is destabilizing’. Simply put, the financial system under capitalism tends to make the economy unstable and periods of relatively stable growth encourage increased risk-taking in the private sector. Over time, the system becomes more and more fragile, leading eventually to a serious crisis. Minsky died in 1996, but reflecting upon the economic turbulence of the 1930s in his writings, he asked if ‘it’ (another Great Depression) could happen again. Unfortunately, it seems as if he has been proven correct, although to date the GFC has been less severe overall than in the 1930s in terms of lost output and jobs, while the effect on individual countries has been uneven. At least initially, government interventions across the world prevented ‘it’ from happening again, although the recovery since then has been weak.

L Randall Wray has written an excellent account of Minsky’s main contributions to economic thought, aimed at the intelligent and interested reader. Note that there are no diagrams and no equations! This is not a biography, but an attempt to make Minsky’s ideas accessible to a wider audience and for this the author should be highly praised. Wray is a former student and colleague of Minsky and is therefore well placed to write such a book. He is a proponent of Modern Monetary Theory, a development of some of the radical parts of Keynesian thought, and this comes across in some chapters, particularly in the discussions on the nature of money. However this does not detract from the book’s thoroughness, relevance and readability.

Following the introduction, Wray gives a brief biography of Minsky, and an outline of his main areas of research. The author then discusses the evolution of macroeconomic theory since Keynes wrote his magnum opus, The General Theory, in the 1930s. In the view of Minsky, Keynes’s most important ideas were ignored and the less radical ones absorbed into mainstream thought. This became the neoclassical synthesis, which dominated economics and policy-making until the stagflation of the 1970s discredited it. The rise of free-market thinking followed, in the form of monetarism, new classical economics, rational expectations and real business cycle theory. Then in the years leading up to the GFC, the ‘new neoclassical synthesis’ became influential. This introduced imperfections such as sticky prices into theories of otherwise perfectly functioning markets.

As a member of the heterodox post-Keynesian school, Minsky sought to clarify and extend the ideas of Keynes regarding the impact of finance on the economy. In his early career, he had been influenced by American institutionalism, and wrote his PhD under Schumpeter. From the latter he adopted an evolutionary approach to capitalism, applying this to the financial system. It is here that innovation produces gradually increased risk-taking and debt accumulation by the private sector. This tends to become unsustainable, destabilizing investment and from there the whole economy. These ideas became known as the Financial Instability Hypothesis. For Minsky, the business cycle is endogenous, created within the system, rather than by exogenous shocks as in new classical theory. Fluctuations in GDP are driven by changes in investment, which in turn are driven by the behaviour of the financial system. Every so often, financial fragility will increase to such an extent that it leads to a major crash. In this way, Minsky could be said to have predicted the GFC years before it happened.

Wray devotes a chapter to Minsky’s work on Money and Banking, essential for understanding his ideas more fully. This includes the theory that growth in the money supply is driven by the credit creation of the banking system, and therefore cannot be directly controlled by the Central Bank as in mainstream theory.

Also well described is Minsky’s view that the modern capitalist economy is best viewed as a financial system, and should be analysed using balance sheets of assets and liabilities, which interact with flows of income (wages, profits, interest and so on). According to Minsky this is applicable not just to banks, but to firms, households and governments, indeed to the whole system. Mainstream economics tends to ignore balance sheets, and is therefore less able to explain and predict inherent instability.

Less well known are Minsky’s ideas on reducing poverty and inequality under capitalism. Surprisingly he was critical of the welfare state, and believed that public job creation at a reasonable wage would be far more effective in improving social outcomes.

A whole chapter is given over to the causes and evolution of the GFC in a Minskyian framework. Tellingly, Minsky had predicted the rise of securitization, which played such a key role in the crisis, as far back as 1987.

In the book’s conclusion, Wray outlines Minsky’s ideas on how to reform the capitalist economy to deliver ‘stability, democracy, security and equality’. This puts him very much in the spirit of Keynes, who to the end of his life, championed policies to prevent the kind of economic disaster which he felt had played a role in the rise of political extremism in the 1930s. Given recent events, these are surely worthy aims, though some critics, particularly on the right, may argue with Minsky’s policy proposals.

Minsky’s influence has grown in recent years, particularly among heterodox economists willing to incorporate balance sheets into their analysis. Notable academics in this vein include Steve Keen and Michael Pettis, as well as the late Wynne Godley who, like Wray and Minsky himself, was associated with the Levy Economics Institute. Both Keen and Godley predicted a major recession in the advanced economies some years before the advent of the GFC, although they were largely ignored by the mainstream.

Hyman Minsky was a mixture of pessimist and optimist regarding capitalism. His central idea, that stability is destabilizing, highlights the flawed nature of the system, with its chronic unemployment, inequality and cyclical behaviour. On the other hand, he thought that with the right policy interventions we can surely do better. This provides an encouraging end to an important book which deserves a wide readership at a challenging time for the world economy.