Stabilizing an Unstable Economy - Hardcover

MINSKY

Hardcover

ISBN 10: 0071592997 ISBN 13: 9780071592994

Publisher: McGraw Hill, 2008

Synopsis

“Mr. Minsky long argued markets were crisis prone. His 'moment' has arrived.” -The Wall Street Journal

In his seminal work, Minsky presents his groundbreaking financial theory of investment, one that is startlingly relevant today. He explains why the American economy has experienced periods of debilitating inflation, rising unemployment, and marked slowdowns-and why the economy is now undergoing a credit crisis that he foresaw. Stabilizing an Unstable Economy covers:

• The natural inclination of complex, capitalist economies toward instability
• Booms and busts as unavoidable results of high-risk lending practices
• “Speculative finance” and its effect on investment and asset prices
• Government's role in bolstering consumption during times of high unemployment
• The need to increase Federal Reserve oversight of banks

Henry Kaufman, president, Henry Kaufman & Company, Inc., places Minsky's prescient ideas in the context of today's financial markets and institutions in a fascinating new preface. Two of Minsky's colleagues, Dimitri B. Papadimitriou, Ph.D. and president, The Levy Economics Institute of Bard College, and L. Randall Wray, Ph.D. and a senior scholar at the Institute, also weigh in on Minsky's present relevance in today's economic scene in a new introduction.

A surge of interest in and respect for Hyman Minsky's ideas pervades Wall Street, as top economic thinkers and financial writers have started using the phrase “Minsky moment” to describe America's turbulent economy. There has never been a more appropriate time to read this classic of economic theory.

About this title

About the Author

Hyman P. Minsky, Ph.D., was an American economist who studied under Joseph Schumpeter and Wassily Leontief. He taught economics at Washington University, University of California--Berkeley, Brown University, and Harvard University. Minsky joined the Jerome Levy Economics Institute of Bard College as a distinguished scholar in 1990, where he continued his research and writing until a few months before his death in October, 1996. His two seminal books were Stabilizing an Unstable Economy and John Maynard Keynes.

From the Back Cover

Praise for the prescient work of Hyman P. Minsky

“Twenty-five years ago, when most economists were extolling the virtues of financial deregulation and innovation, a maverick named Hyman P. Minsky maintained a more negative view of Wall Street; in fact, he noted that bankers, traders, and other financiers periodically played the role of arsonists, setting the entire economy ablaze.”
--John Cassidy, The New Yorker

“The journey from subprime mortgages to a major credit crisis, a weak economy and broken business models in finance could all have been foreseen through Hyman Minsky’s perspectives. His work remains essential to understanding the ground beneath us and the path ahead.”
—-George Magnus, Senior Economic Adviser, UBS Investment Bank

“It is time to revive an old issue: Just how inherently unstable are economies? But instead of getting much guidance these days from contemporary economists, we need to turn to some of the giants from the past. The work of Hyman Minsky . . . is especially on the mark.”
--Jeff Madrick, The New York Times

“Hyman Minsky's work has never been more valuable. His financial instability hypothesis, complete with hedge, speculative and ponzi units, has played out to a T in the U.S. property and mortgage markets over the last half decade.”
--Paul McCulley, Managing Director, PIMCO

“As it happens, Minsky is enjoying something of a revival. Two of his books, John Maynard Keynes, and Stabilizing an Unstable Economy were just republished by McGraw-Hill, and his contention that stability is inherently unstable seems more relevant than ever in the aftermath of the period of low market volatility that ended in the current crisis.

"In the latter of those books, published in 1986, Minsky wrote, 'If the institutions responsible for the lender-of-last resort function stand aside and allow market forces to operate, then the decline in asset values relative to current output prices will be larger than with intervention; investment and debt financed consumption will fall by larger amounts; and the decline in income, employment and profits will be greater.' In other words, without government bailouts, there can be a downward spiral.”
--The New York Times

Excerpt. © Reprinted by permission. All rights reserved.

Stabilizing an Unstable Economy

By Hyman P. Minsky

The McGraw-Hill Companies, Inc.

Copyright © 2008 Hyman Minsky
All right reserved.
ISBN: 978-0-07-159299-4

Contents

Chapter One

ECONOMIC PROCESSES, BEHAVIOR, AND POLICY

As we approach the last decade of the twentieth century, our economic world is in apparent disarray. After two secure decades of tranquil progress following World War II, in the late 1960s the order of the day became turbulence—both domestic and international. Bursts of accelerating inflation, higher chronic and higher cyclical unemployment, bankruptcies, crunching interest rates, and crises in energy, transportation, food supply, welfare, the cities, and banking were mixed with periods of troubled expansions. The economic and social policy synthesis that served us so well after World War II broke down in the mid-1960s. What is needed now is a new approach, a policy synthesis fundamentally different from the mix that results when today's accepted theory is applied to today's economic system.

Although vital problems like personal safety, honesty, and integrity transcend pure economic concerns, my focus is upon stabilizing the economy. Perhaps naively, a premise in what follows is that if the economy provides basic security and a sense of personal worth for all—because work is available for all—many social problems will recede to manageable proportions.

In an era when performance failures demonstrate the need for economic reform, any successful program of change must be rooted in an understanding of how economic processes function within the existing institutions. That understanding is what economic theory is supposed to provide. Even as institutions and usages are not ordained by nature, neither is economic theory. Economic theory is the product of creative imagination; its concepts and constructs are the result of human thought. There is no such thing, per se, as national income, aside from a theory of how to combine elements in the economy into this special number; demand curves do not confront sellers—customers do; the way in which money and finance affect the behavior of the system can be perceived only within a theory that allows money and finance to affect what happens.

Unfortunately, the economic theory that is taught in colleges and graduate schools—the equipment of students and practitioners of economics over the past thirty years and the intellectual basis of economic policy in capitalist democracies—is seriously flawed. The conclusions based on the models derived from standard theoretical economics cannot be applied to the formulation of policy for our type of economy. Established economic theory, especially the highly mathematical theory largely developed after World War II, can demonstrate that an abstractly defined exchange mechanism will lead to a coherent, if not an optimum, result. However, this mathematical result is proven for models that abstract from corporate boardrooms and Wall Street. The model does not deal with time, money, uncertainty, financing of ownership of capital assets, and investment. If, on the other hand, the factors from which theory abstracts are important and relevant, if financial relations and organizations significantly influence the course of events, then the established economic theory does not furnish an underpinning for the proposition that coherence results from the type of decentralized market economies that exist. In fact, the Wall Streets of the world are important; they generate destabilizing forces, and from time to time the financial processes of our economy lead to serious threats of financial and economic instability, that is, the behavior of the economy becomes incoherent.

In the mid-1960s, after behaving well for some twenty years, the economy began to behave in a manner that cast serious doubts on the validity of the standard theory. Beginning with the credit crunch in 1966, we experienced a sequence of financial near crises (the others occurred in 1970, 1974–75, 1979–80, and 1982–83), each one growing progressively more severe. Officials and pundits alike responded to these cycles by calling for a rejection of the macroeconomic theory derived from the work of John Maynard Keynes and a return to the presumably tried and true analysis of classical microeconomic theory. In truth, however, the economy is now behaving in the way that Keynes's theory holds that a capitalist economy with a fragile financial structure and a big government is expected to behave. The error is in current economic theory, which grossly misinterprets Keynes's work.

A theory that denies what is happening can happen, sees unfavorable events as the work of evil outside forces (such as the oil crisis) rather than as the result of characteristics of the economic mechanism, may satisfy the politicians' need for a villain or scapegoat, but such a theory offers no useful guide to a solution of the problem. The existing standard body of economic theory—the so-called neoclassical synthesis, which takes on both a monetarist and an establishment Keynesian garb—may be an elegant logical structure, but it fails to explain how a financial crisis can emerge out of the normal functioning of the economy and why the economy of one period may be susceptible to crisis while that of another is not.

The economic instability so evident since the late 1960s is the result of the fragile financial system that emerged from cumulative changes in financial relations and institutions over the years following World War II. The unintended and often unnoticed changes in financial relations, and the speculative finance induced by the successful functioning of the economy, have made the rules for monetary and fiscal policy based on the experience of the 1950s and the early 1960s invalid. No set of monetary and fiscal manipulations by themselves can reestablish and sustain the relative tranquility of the 1950s and early 1960s. Fundamental institutional changes similar in scope to the basic reforms of the first six years of the Roosevelt presidency are necessary if we are to recapture such relative tranquility. If reform is to be successful it needs to be enlightened by a theoretical vision that enables us to understand the causes of the instability that is now so evident.

For a new era of serious reform to enjoy more than transitory success it should be based on the understanding of why a decentralized market mechanism—the free market of the conservatives—is an efficient way of handling the many details of economic life, and how the financial institutions of capitalism, especially in the context of production processes that use capital intensive techniques, are inherently disruptive. Thus, while admiring the properties of free markets we must accept that the domain of effective and desirable free markets is restricted. We must develop economic institutions that constrain and control liability structures, particularly of financial institutions and of production processes that require massive capital investments. Paradoxically, capitalism is flawed precisely because it cannot readily assimilate production processes that use large-scale capital assets.

It may also be maintained that capitalist societies are inequitable and inefficient. But the flaws of poverty, corruption, uneven distribution of amenities and private power, and monopoly-induced inefficiency (which can be summarized in the assertion that capitalism is unfair) are not inconsistent with the survival of a capitalist economic system. Distasteful as inequality and inefficiency may be, there is no scientific law or historical evidence that says that, to survive, an economic order must meet some standard of equity and efficiency (fairness). A capitalist economy cannot be maintained, however, if it oscillates between threats of an imminent collapse of asset values and employment and threats of accelerating inflation and rampant speculation, especially if the threats are sometimes realized. If the market mechanism is to function well, we must arrange to constrain the uncertainty due to business cycles so that the expectations that guide investment can reflect a vision of tranquil progress.

The Reagan administration and its program, largely enacted in 1981, may have been a response to a vision that something was seriously wrong with the economy, but it was based on a misdiagnosis of what was wrong and on a theory of how the economy functioned that is inconsistent with the basic institutions of capitalism. The financial fragility that led to the instability so evident since the 1960s was ignored. The deregulation drive and the successful effort to bring the inflation rate down by large-scale and protracted monetary constraint and unemployment exacerbated the financial instability that was so evident in 1967, 1970, 1974–75, and 1979–80. Lender-of-last-resort interventions, which had papered over the problems of the fragile financial structure in the intermittent crises of the late 1960s and 1970s, became virtually everyday events in the 1980s. The crisis of midyear 1982—which saw the Penn Square Bank of Oklahoma City fail and the collapse of the Mexican peso—seems to have ushered in a regime of permanent financial turbulence. In 1984–85 we witnessed lender-of-last-resort interventions to manage the reorganization of the Continental Illinois Bank of Chicago, the refinancing of Argentina, the collapse of state-insured thrift institutions in Ohio and Maryland, and a virtual epidemic of bank failures in the farm states. Containing instability is a major task of economic policy in the 1980s; this is far different from the tasks of economic policy in the 1950s and 1960s.

The protracted unemployment and bankruptcies and near bankruptcies of firms and banks radically transformed the labor force from being income-oriented to being job-security oriented. Job security is no longer being guaranteed by government macroeconomic policy; the only guarantee that labor now enjoys seems to be the right to make concessionary wage settlements. These concessions by workers mean that the cost push part of the business cycle is attenuated—but it also means that consumer demand due to increasing wage income will be less buoyant during an expansion. If anything, the Reagan reforms made prospects for instability worse—but like many things in the economy and politics the full effect of the reforms will not be felt for some time. Even as a deficit-aided strong recovery leads to an apparent success for Reaganomics, the foundations for another round of inflation, crises, and serious recession are being laid.

Economic systems are not natural systems. An economy is a social organization created either through legislation or by an evolutionary process of invention and innovation. Policy can change both the details and the overall character of the economy, and the shaping of economic policy involves both a definition of goals and an awareness that actual economic processes depend on economic and social institutions.

Thus, economic policy must be concerned with the design of institutions as well as operations within a set of institutions. Institutions are both legislated and the result of evolutionary processes. Once legislated, institutions take on a life of their own and evolve in response to market processes. We cannot, in a dynamic world, expect to resolve the problems of institutional organization for all time. On the other hand, we cannot always be engaged in radically changing institutions. Once an institutional arrangement embodies the day's best perception of processes and goals, it should be allowed a run of time in which details are permitted to evolve and policy is restricted to operations within the institutional structure. Only as the inadequate performance of an economic and social order becomes evident and serious does it become necessary to engage in thorough- going institutional reform. Such a time has arrived.

The major contours of our present institutional setup were put in place during the Roosevelt reform era, particularly in the second New Deal, which was completed by 1936. This structure was a response to the failures of the emergency legislation of 1933 to foster a quick recovery and to the spate of Supreme Court rulings invalidating various portions of the first New Deal that had been enacted during the one hundred days of 1933. But while our institutional setup was composed largely during the early Roosevelt years, our understanding of how the economy functions was radically changed by John Maynard Keynes, whose General Theory of Employment, Interest and Money was published in 1936.

There are various schools of Keynesians—conservative, liberal, and radical. There are some who believe that Keynes was simply wrong, others who believe that he merely refined existing economic theory, and still others who believe that he quite correctly broke sharply with previous ideas. But regardless of the view of what Keynes is all about, it must be agreed that, to the extent that our institutional arrangements were, in the main, set prior to 1936, our basic institutional arrangements were not enlightened by perceptions drawn from the Keynesian revolution in economic analysis. All that we can possibly have are Keynesian operations within a legislated economic structure that reflects a pre-Keynesian understanding of the economy.

Although the full force of Keynes's insights into the workings of a capitalist economy has not been absorbed into the ruling economic theory and policy analysis, enough of his message—that our economic destiny is controllable—has come through to make conscious management of the economy an avowed aim of governments in the post–World War II era. The Employment Act of 1946, which set up the Council of Economic Advisers and the Joint Congressional Economic Committee, constitutes a commitment to attempt such management.

Once the proposition that economic policy can shape the course of events is accepted, then answers to "Who will benefit?" and "What production processes will be fostered?" by policy come to the fore. Furthermore, once we admit that institutions are man-made and at least in part the product of conscious decision, we must also face the effects of institutional arrangements on social results. An appeal to an abstract market mechanism as the determinant of "for whom" and "what kind" is not permissible; what exists are specific, historical market mechanisms.

Economic policy must reflect an ideological vision; it must be inspired by the ideals of a good society. And it is evident that we are faced with a failure of vision, with a crisis in the aims and objectives that economic policy should serve. In 1926, Keynes defined the political problem as a need

to combine three things: economic efficiency, social justice, and individual liberty. The first needs criticism, precaution, and technical knowledge; the second, an unselfish and enthusiastic spirit that loves the ordinary man; the third, tolerance, breadth, appreciation of the excellencies of variety and independence, which prefers, above everything, to give unhindered opportunity to the exceptional and to the aspiring.

We need to bring the institutions that foster this triad of efficiency, justice, and liberty up to date.

Given the vast increase in productive ability in the past fifty years, we can if need be compromise on the goal of economic efficiency. We—in the United States at least—are rich. This means we can afford to relinquish some output to achieve social justice and individual liberty. This objective may be well served by an economic order involving interventions that affect the results of decentralized market processes. Since huge centers of private power and differences in wealth compromise the goals of efficiency, justice, and liberty, a policy that is willing to forgo some of the presumed advantages of giant firms and vast financial organizations (advantages that may not in fact exist) seems highly desirable. In the light of recent experience, when the difficulties encountered by giant corporations and financial institutions are central to the instability that plagues the economy, the very largest concentrations of private power should, in the interest of efficiency as well as stability, be reduced to more manageable dimensions.

Social justice rests on individual dignity and independence from both private and political power centers. Dignity and independence are best served by an economic order in which income is received either by right or through a fair exchange. Compensation for work performed should be the major source of income for all. Permanent dependence on expanding systems of transfer payments that have not been earned is demeaning to the recipient and destructive of the social fabric. Social justice and individual liberty demand interventions to create an economy of opportunity in which everyone, except the severely handicapped, earns his or her way through the exchange of income for work. Full employment is a social as well as an economic good.

It would be naive to assume that all stated social and economic goals are mutually consistent. Emphasis on one objective may decrease the ability to achieve other goals, so priorities must be set. I tend to favor personal freedom and democratic rights; the safeguarding of so-called property rights—even if property rights lead to the narrow economic efficiency of orthodox theory—is not to my mind equal to the extension of individual liberty and the promotion of social justice. These beliefs affect my policy positions.

Although this book is mainly concerned with economic theory and some interpretive economic history, its aim is to draw up an agenda for the reform of our malfunctioning economy. Effective reforms must be consistent with the processes of the economy and not violate the character of the people. Without an understanding of the economic process, and without a passionate, even irrational commitment to democratic ideals, an agenda for change, in response to a perceived need for change, can become the instrument of demagogues who play on fears and frustrations and offer panaceas and empty slogans.

The proposals for reform to be advanced will necessarily be painted with a broad brush. Details will have to be refined by Congress, by an administration, and, let us hope, by the debate of an enlightened public willing to think hard about the direction the economy is to take.

The major flaw of our type of economy is that it is unstable. 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. But incoherence need not be fully realized because institutions and policy can contain the thrust to instability. We can, so to speak, stabilize instability.

(Continues...)

Excerpted from Stabilizing an Unstable Economyby Hyman P. Minsky Copyright © 2008 by Hyman Minsky. Excerpted by permission of The McGraw-Hill Companies, Inc.. All rights reserved. No part of this excerpt may be reproduced or reprinted without permission in writing from the publisher.
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Edition details

• Publisher: McGraw Hill
• Publication date: 2008
• ISBN 10: 0071592997
• ISBN 13: 9780071592994
• Binding: Hardcover
• Language: English
• Edition number: 1
• Number of pages: 432