Missing Minsky

Martin Wolf, at FT.com, wrote on December 24 that Keynes offers us the best way to think about the financial crisis:

We are all Keynesians now. When Barack Obama takes office he will propose a gigantic fiscal stimulus package. Such packages are being offered by many other governments. Even Germany is being dragged, kicking and screaming, into this race. The ghost of John Maynard Keynes, the father of macroeconomics, has returned [and] that of his most interesting disciple, Hyman Minsky.

I first heard Hy Minsky talk in the 1960s. His main message I summarize as follows:

1. Financial systems have a built-in tendency to euphoria. The financial market does not tend toward stability. The opposite is true. Bankers and other financial actors borrow more and more heavily, making the system increasingly vulnerable to panic. Lenders start after a scare by being conservative, hedging their bets. But eventually confidence returns and speculation takes hold again. Then investors get to the Ponzi phase - manic use of credit, a euphoria or bubble.

2. The credit cycle tends to manic, ends with panic. The Ponzi phase continues until some investors exit with their profits, or the central bank raises interest rates to reduce investor euphoria, and then a financial institution runs into difficulty. The failure causes a bankers' panic. Turning points in the five stages of the cycle are called "Minsky moments".

3. The system tends to instability and must be regulated. Fashions in monetary theory have moved from a belief that Keynesian sophisticates could "fine-tune" the economy, to fear that the Fed had lost control of the ability to contain inflation, to a belief that markets work best with minimal interference. Hy rejected all these ideas, preaching consistently about the need for regulation and the importance of leaning against the excesses of what Keynes called the animal spirits of investors.

Born in Chicago, Hy taught at Brown, Berkeley and Washington University (St. Louis). He died 12 years ago in Rhinebeck, 77 years old, near Bard College's Levy Institute, which has a special interest in business cycles and treated Hy as a star in his last six years. Hy didn't live to see how closely this year's meltdowns would follow his predicted scenario, with the Lehman failure being one of several clear Minsky moments.

Former Fed Governor Laurence Meyer, who spoke in New York City last week, has said of Minsky: "Few have influenced my thinking about economics more than Hy." If Hy had been listened to more than he was, we would have seen less deregulation and permissiveness - Ninja mortgages, lax SEC oversight, highly leveraged instruments and institutions, Treasury deficits - during the credit runup. Fed Chairman Alan Greenspan and then-Governor Ben Bernanke were anxious not to "pop the bubble" because (citing the Milton Friedman-Anna Schwartz history) that's the mistake the Fed made in 1928. The Fed was concerned not to stifle financial innovation, arguing that it is ready with new weapons in the event of an asset-destroying credit freeze.

This last theory is now being tested. The stakes are high, beyond an academic debate. Any sensible person should be rooting for the outgoing and incoming Fed-Treasury teams to succeed in restoring confidence and the flow of credit.

Comments

[AnnMedlock]

Thanks for the lead to Minsky. Not being an economist myself, I've wondered where the sane voices might be in this madness of Friedman/Rand-isms. May the new Econ team take Minsky to heart. He sounds sane.

[joebhed]

Thanks, John, for restoring Hy Minsky's wisdom to the dialogue of the day.

I find his Foreword to Ronnie J. Phillips' book on 'The Chicago Plan and New Deal Banking Reform'
to be perfectly telling of our times.

"Phillips, in this volume, has recovered part of the memory of those exciting days of the 1930s when the best of abstract thought was wedded to the need to resolve pressing crises. We owe him a debt of gratitude for reminding us that the economists and public figures who participated in the discourse of the 1930s were sophisticated thinkers who were alert to the issues that are now to the fore: the creation of a financial system that is consistent with a full utilization of resources and which provides for the broad-based economic well-being that is a pre-requisite for a strong and viable democracy"

"The economic and political crisis of the '30s made policy-oriented economists aware that narrowly-defined economic efficiency was NOT the ultimate policy objective: a performance of the economy that is consistent with the maintenance of a participatory democracy is the greater good."

"Ronnie Phillips will serve us well if this book leads us to respect the past even as we try to meet the challenges of today."

It would serve us all well to find the Krugmans, Reichs, Kleins, Kuttners and Greiders once again recalling Hy Minsky, and set about to bring forward again the Chicago Plan for Monetary Reform.

[DiogenesOfAlaska]

While it doesn't help much to solve the challenges of the current crisis, it may still be worth keeping in mind for the future that

'a performance of the economy that is consistent with the maintenance of a participatory democracy is' not only 'the greater good'

but is a necessity for the sake of stability itself.

Depending on the performance in unchartered waters of 'new weapons in the event of an asset-destroying credit squeeze' is not an option for the future. Let's hope it works now, but then moderation and counteracting the cycle must be the new name of the game, not blind faith in self-correcting chaos. With hindsight, it was real dumb to have blind faith in self-correcting chaos. Maybe the true challenge in the spirit of your quotes is that voters have been asked in the past few decades all across the G20 whether that's what they want - and have very frequently responded with a resounding yes. Oops!

[joebhed]

hmmmm.
Very good point.
Yes.
Ignorance is bliss.
I am convinced that if voters were to choose between the Chicago Plan and the Federal Reserve Plan, with all of its G20 versions, they would resoundingly choose the people's money system.
So I think that Minsky's comments can be used as a guide to solving the current crisis, given that it is monetarily-economic in nature.
Or, at least I hope so.

[Novista]

Another follower of Minsky is Steve Keen (Australian) who forecast the bubble outcome, in late 2005. Here's a link to his blog.

http://www.debtdeflation.com/blogs/

[beaupritchard]

With that in mind ... the stock market was 3000 points over valued and financed by debt. OK ... I could go with that ... but then what of investors waiting for those highs to return. No ... the market is still over valued propped up by something ... low interest rates(Fed maybe but they can't go any lower) ... I'm thinking we haven't hit bottom yet.

[joebhed]

I had a very early bet on 7500 based on the DOW's fundamentals.
Won a nickel from some good friends.
With the total screw-ups, and the prop-up mechanisms that the FED has put out there, not only ZIRP but mainly poisoned collateralization, I say 6000 MAX.

[moAb]

Prof. Minsky got it right. His book on this topic has been republished:
STABILIZING AN UNSTABLE ECONOMY
Excellent read and au courant to boot. He was a great prof. Had we payed a bit more attention to his teachings.....oh well. We didn't did we?