So for my Advanced Composition class, we have to write a paper, but it can be about whatever we want. So I started refuting Hyman Minsky's "Stabilizing an Unstable Economy." This is just a rough, rough draft, and a set up somewhat of a straw man. I'll edit the paper later today.
I still have to write a conclusion and make a better refutation of his argument about the end of a bubble.
In any case, I thought some might find it interesting, so I'll post what I have so far here:
Normal 0 false false false EN-US X-NONE X-NONE MicrosoftInternetExplorer4
In his book, “Stabilizing an Unstable Economy,” the post-Keynesian economist Hyman P. Minsky puts forth a hypothesis that attempts to explain why business cycles occur, how to better prevent them from occurring, and how to avoid a severe recession. Minsky tries to defend the Keynesian view that recessions and financial crises are essentially the fault of markets, not governments, and that government is needed to stabilize the economy. However, Minsky fails in his book to provide a rational theoretical or empirical model to explain business cycles that does not commit post hoc analysis, while his policy prescriptions are extremely short sighted and simply promote worse business cycles in the future.
Minsky’s explanation of the business cycle, dubbed the “Financial Instability Hypothesis,” is quite straightforward. In it, he divides borrowers into three groups: hedge borrowers, speculative borrowers, and Ponzi borrowers. Hedge borrowers are borrowers who can pay back their loans from their cash flows, speculative borrowers can only pay back the interest but not the entire loan, while Ponzi borrowers rely solely on the appreciation of their assets (i.e. stocks and real estate) to pay back their debt. Minsky attempts to explain the business cycle by pointing out how during recessions, loans are only made to “hedge borrowers,” but as the economy gets better and cash flows improve, the appreciation of assets makes it profitable to lend to speculative and eventually Ponzi borrowers. Eventually, according to the Financial Instability Hypothesis, this error is “somehow” discovered and the financial industry collapses. This is where the FIH first runs into problems: it fails to explain why assets would no longer appreciate and why, therefore, speculative and Ponzi borrowers wouldn’t be able to pay back their debts.
To prove that markets are at fault for financial, and therefore economy-wide, instability, Minsky needs to show what forces cause assets to fall in value and therefore make payment of debts impossible for speculative and Ponzi borrowers. An obvious explanation is that inflation eats away at the so-called “natural rate of interest” of capital, and that therefore demand falls for those goods, which then leads to lessened cash flows for certain businesses, which in turn causes speculative and Ponzi borrowers on the margin to go bankrupt, causing a financial-wide panic. Minsky assumes that inflation is actually created by the market, though his claim is false simply because inflation is the direct result of an increase in the amount of circulating money, and only government can coin or print money.
This leads us to the real culprit that Minsky fails to identify: the Federal Reserve System, the only bank allowed to print money in the United States. The Federal Reserve, or “Fed” as it is known for short, is in charge of creating money and lending that money out to banks and other financial institutions. This first causes an appreciation of assets closely linked to loans: products like housing, cars, and machinery. This, in turn, causes the appreciation of financial assets like debt-based securities. However, as inflation catches up, it becomes less and less profitable for businessmen to purchase machinery and for consumers to purchase housing and cars. The result is a fall in demand which causes prices in these goods and their financial contemporaries to plummet. Thus, we can see that Minsky’s blame on the free market system is misplaced.
Nevertheless, Minsky continues and tries to provide a method to stabilize and economy that is in the midst of a financial panic. He proposes a multiple step program: first, government must have a guaranteed employment program to provide a “floor” for consumption spending, second, the expansion of the guaranteed employment program must be financed via debt (so that that debt may be securitized and traded) but not taxes, and third, the Federal Reserve, together with the FDIC, must take aggressive action to prevent banks from failing by refinancing them with their “lender of last resort” powers. Minsky lists several examples when similar techniques have been used successfully to stabilize the economy.
Though this program might temporarily stabilize an economy, it actually destabilizes the economy in the long run. Firstly, his proposal that government deficit spend and thereby provide secure debt that maybe securitized and traded runs into a simple problem: such an action would needlessly raise interest rates, making it harder for businesses to obtain the credit necessary to operate. Thus, deficit spending would actually slow the revival of the private sectors of the economy after a financial crisis. Post-Keynesians like Minsky, though, might argue that the Federal Reserve may simply lower interest rates and therefore make borrowing affordable for businesses as well as government. But this again ignores the longer term impact of such a policy. More credit expansion certainly means more inflation, and since entrepreneurs are never certain about inflation and the returns on their investments, lower Federal Reserve interest rates might simply mean another business cycle in the future. This same critique applies to Minsky’s argument that the Federal Reserve and the FDIC must use their lender-of-last resort powers to refinance failing financial institutions. The money that must be used to essentially bail out these financial institutions can only be created by the Fed, which in turn leads to more inflation. This, though it might temporarily save the economy from collapse, makes entrepreneurs even more uncertain of inflation in the future and how it will eat away at their profits from capital investments – or the natural rate of interest. This inherent uncertainty is bound to create another boom-bust business cycle as profits from some investments actually become negative in real (or inflation-adjusted) terms.
Political Atheists Blog
Very informative and conclusive. However, I didn't quite get one point:
Firstly, his proposal that government deficit spend and thereby provide secure debt that maybe securitized and traded runs into a simple problem: such an action would needlessly raise interest rates, making it harder for businesses to obtain the credit necessary to operate.
Deficit spending = higher demand for credit = higher interest rates. That or the government has to print money, which has other negative side effects (inflation).
Duh, that should've been obvious. Thanks for helping me along.
BTW, I also forgot to add that Minsky says that these bubbles end because the demand for credit pushes interest rates up, which starts makes asset prices fall. However, he ignores that if this were true a bubble could never have started because prices would tend towards equilibrium. Instead, these bubbles are the result of credit expansion.