Economies do not move in straight lines

chaotic cycleRichard Goodwin was an American economist, a self-described ‘wayward Marxist’ who taught at Harvard and Cambridge as well as at Siena. One of his best-known papers was a mathematical model of Marx’s description in Capital of the macroeconomic relationship between wages, growth and unemployment, which generates an endogenous growth cycle: that is, it shows how economies can grow over time with fluctuations of output, employment and the other variables in the model generated from within the system, rather than being dependent on external or exogenous ‘shocks’.

Goodwin’s growth cycle model famously draws on the Lotka-Volterra predator-prey model from biology. This describes the dynamics of two interrelated animal populations: the predator and the prey. Starting from, say, a relatively large initial level of the predator population, this could cause the numbers of prey to fall as they are consumed. As the numbers of prey diminish, there is less food for the predator population, whose numbers also then begin to diminish. Falling numbers of the predator population then allow the prey numbers to recover so that they begin to provide a more plentiful food supply for the predators, whose numbers then begin to rise once again. This generates two interdependent fluctuating population cycles, which are not reliant on external or exogenous factors or shocks. Continue reading

Minskyan processes and the coronavirus shock

The Levy Institute has a brief paper here by Michalis Nikiforos on how the shock of the coronavirus pandemic has hit already fragile economies, making the likely eventual economic outcomes particularly damaging. His main focus is the US, but the analysis can be applied to other advanced economies.

The abstract of the paper is below:

The spread of the new coronavirus (COVID-19) is a major shock for the US and global economies. Research Scholar Michalis Nikiforos explains that we cannot fully understand the economic implications of the pandemic without reference to two Minskyan processes at play in the US economy: the growing divergence of stock market prices from output prices, and the increasing fragility in corporate balance sheets.

The pandemic did not arrive in the context of an otherwise healthy US economy—the demand and supply dimensions of the shock have aggravated an inevitable adjustment process. Using a Minskyan framework, we can understand how the current economic weakness can be perpetuated through feedback effects between flows of demand and supply and their balance sheet impacts.

In the paper’s conclusion, he outlines the necessary policy response including, importantly, that:

“unlike the response to the 2007-9 crisis, the assistance provided to large corporations come with strings attached – so that they do not return to the same old (destabilizing) practices once the emergency has passed.”

This was written before the $2 trillion US support package passed through Congress. It seems as if the author’s hope has not been fulfilled.

Prospects and Challenges for the US economy

Here is the latest Strategic Analysis paper from the Levy Economics Institute of Bard College on the prospects and challenges for the US economy over the next few years. The Levy Institute is officially nonpartisan, but much of its output is in the post-Keynesian tradition, and influenced by luminaries such as Hyman Minsky and Wynne Godley.

Minsky and Godley were instrumental in highlighting the interdependence of the real and financial sectors of the capitalist economy and the role of the latter in contributing to its periodic instability.

The post-Keynesian or ‘left Keynesian’ tradition is a broad church, but is generally critical of capitalism while suggesting policies which attempt to mitigate its defects, in particular the presence of unemployment, inequality and instability. It emphasises the importance of aggregate demand and macroeconomic categories and relationships.

The Levy Institute publishes a short Strategic Analysis on the US economy like this one every year. It is accessible while being based on a stock-flow consistent macroeconomic model that Godley spent the final years of his life helping to build.

The paper highlights the risks to the US over the next few years of an overvalued stock market, overstretched and fragile corporate sector balance sheets, an overvalued dollar, a slowing global economy and the US administration’s erratic trade policy. It is well worth a read.

Hyman Minsky explains his financial instability hypothesis

In this rare video, Hyman Minsky explains his financial instability hypothesis. The video dates from 1987, but Minsky was prescient in originating a theory that characterises capitalist economies with developed financial systems as inherently unstable and requiring the intervention of ‘Big Government’ (counter-cyclical fiscal policy) and a ‘Big Bank’ (the central bank acting as lender of last resort). His FIH has become much more widely known since the advent of the 2008 financial crisis.

Minsky was influenced by his teacher at Harvard, Joseph Schumpeter, as well as by John Maynard Keynes and Michal Kalecki. His work falls under the post-Keynesian tradition, emphasising the role of finance and the importance of effective demand in the economy, with the former a major cause of instability in the form of booms and busts. His thinking also incorporated ideas on institutions such as households, firms, banks, and governments, and explored how their balance sheets of assets and liabilities evolve over business cycles.

Marx, Keynes, Hayek and Minsky on economic crises: room for agreement?

At first glance, it would seem fanciful that the theories of Karl Marx and Friedrich Hayek could be drawn on together to explain economic crises, or cycles, booms and busts. Certainly, the two men’s politics could not have been more different: Marx predicted (and hoped for) either the collapse or the overthrow of capitalism and its replacement by socialism and communism. Hayek thought that most kinds of state intervention in the market were the thin end of the authoritarian wedge.

The ideas of John Maynard Keynes and Hyman Minsky are more compatible, and both have many disciples in the post-Keynesian school. Minsky developed Keynes’ theory of investment and its role in instability under capitalism. For Keynes and Minsky then, capitalism is inherently unstable, money and finance play a large role in this instability and it is the job of government to save the system from itself.

On economic policy, these four influential thinkers part ways. Marx offered little theory of policy; Hayek, like others in the Austrian school, rejected it as damaging and favoured a laissez-faire approach; Keynes and Minsky were interventionists. Continue reading

“America First”, Fiscal Policy and Financial Stability: a report on the US economy

What does the future hold for the US economy, given its current trajectory and recent changes in government policy?

The Levy Economics Institute of Bard College, of which distinguished former associates include post-Keynesians Hyman Minsky and Wynne Godley, has just published its Strategic Analysis report on the medium-term prospects for the US.

Godley is recognised as having predicted a severe recession in the US some years before it began in 2008, due to the unsustainable build-up in private sector debt, particularly among households.

Minsky is also well known for his ‘financial instability hypothesis’ and its implication that ‘stability is destabilising’ in the financial sector of capitalist economies: periods of stable economic growth can create fragile balance sheets in the private sector, which often lead to stagnation or crisis. Continue reading

Minsky on stagflation and the limits to state intervention

MinskyCanItHappenAgainGovernment can be a major force for promoting progressive economic and social development. History tells us that this is rarely sustained indefinitely: the political pendulum swings back and forth, and development proceeds unevenly across space and time.

I was reminded of some of the potential limits to state intervention by the quote below from Hyman Minsky in his collection of essays Can “It” Happen Again? , published in 1982. “It” refers to the Great Depression of the 1930s. His Financial Instability Hypothesis argued that ‘stability is destabilising’: periods of successful economic performance tend to encourage an increasingly risky financial structure, leading eventually to a financial crisis. This outcome could take decades to occur, but it seems that he was proved right by the crisis and recession of 2008-9. Continue reading

In brief: the economics of Hyman Minsky

MinskyAs the 2008 financial crisis broke, the term ‘Minsky moment’ became widely used by commentators and financiers (it was originally coined in 1998), as the work of this relatively obscure economist came into fashion. Since then, his major works have been reprinted, and his ideas widely cited, especially among those critical of the financialization of recent decades.

Once again, from Michael Hudson‘s heterodox ‘dictionary’ of economics J is for Junk Economics (p.154-5): Continue reading

Hyman Minsky on the aim of policy – via econblog101

Minsky

Economist Hyman Minsky, whose Financial Instability Hypothesis built on the work of Keynes

I am currently writing up an article on what Minsky added to Keynes an onwards to whether this is an up to date theoretical framework ready for use in the 21st century. In a nutshell, Keynes explained that output, inflation and unemployment are driven by changes in investment, which is itself driven by changes in […]

via Hyman Minsky on the aim of policy — econoblog101

Why Minsky Matters by L. Randall Wray – book review

why-minsky-matters-coverI 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.