Minsky in the News

The Financial Times has been running a series for some time on “Capitalism in Crisis.” In yesterday’s paper Martin Wolf provided a summary of the discussion and proposed “Seven ways to fix the system’s flaws.” The first and most important task, he notes, is to manage macro instability. In this regard, he pays homage to the late Hyman Minsky and notes that

… his masterpiece, Stabilizing an Unstable Economy, provided incomparably the best account of why this theory (of a stable capitalist economy) is wrong. Periods of stability and prosperity sow the seeds of their downfall. The leveraging of returns, principally by borrowing, is then viewed as a certain route to wealth. Those engaged in the financial system create – and profit greatly from – such leverage. When people underestimate perils, as they do in good times, leverage explodes.

What is the answer to macro instability? According to Martin Wolf, the first answer is to recognize that crisis is inherent in free-market capitalism. Second, macroprudential policies matter, including restrictions on leverage and better capital buffers in banks. And finally, governments, including central banks, have a role to play in stabilizing the economy after a crisis.

As for the financial system, Wolf wants “to protect finance from the economy and the economy from finance” by building bigger shock absorbers in the form of better capital buffers and less leverage. There should be no more “too big to fail.”

Wolf notes at the end of his article the close links between wealth and politics, but his suggestion to partially fund political parties and elections will not solve this problem, even though it may represent a good start. The crisis has shown that the links between finance and politics are deeply entrenched both in the US and Europe, and unless deep structural reforms are enforced, the problem of TBTF is not likely to go away.

The increased recognition of Minsky’s outstanding theories is indeed welcome, especially by Martin Wolf (who also has become somewhat of a Godley follower in his analysis of the current global crisis). But whereas his diagnosis of the global financial crisis is largely in line with Minsky’s financial instability hypothesis, his policy advice falls short of what Minsky would have prescribed.

Hyman Minsky wanted forceful central bank intervention to protect markets in a crisis, but also vigorous government deficit spending to enable firms and household to repay debt.  He was also skeptical of the current panacea of increasing the ratio of bank equity to bank assets, as this would hurt bank profitability. Instead he suggested “a tighter regulatory regime” as a way of getting around the tendency of banks to risk their capital on new adventures after every crisis.

If lender-of-last resort interactions are not accompanied by regulations and reforms that restrict financial market practices, then the intervention sets the stage for the financing of an inflationary expansion, once the “animal spirits” of business people and bankers have recovered from the transitory shock of the crisis.

Unless banks were dramatically cut down to size, “we can expect intervention by the Federal reserve to continue to take place when individual giant banks are in difficulty.” (My note: this was written in 1985!).

Minsky noted in this ’85 article that “…as long as the Federal Reserve fears disaster, the odds are with the giant (financial) institutions forcing the Federal Reserve to intervene to support their operations and refinance them when the crisis threatens.”