A Minsky Moment?

The advent of the recent financial crises resurrected the seminal ideas of Hyman Minsky to the forefront of economic thinking.  In particular, Minsky’s Financial Instability Hypothesis has received considerable attention, elevating him to almost ‘prophetic’ standing.  Notably, it provides a narrative which seemingly mirrors the unfolding of the recent crisis, but perhaps conveniently fills an aching void in the ability of economics to explain what just happened?

Hyman Minsky (1919-1996)

In short, Minsky proposes that crises are an inherent part of capitalism.  He argues that financial institutions - the heart of a capitalist system, are fueled by Keynesian animal spirits which inevitably lead to unsustainable growth mainly through the use of debt.  As the market booms, the allure of profits dispels uncertainty, but eventually the market recognizes the unsustainability of the situation and uncertainty proliferates.  This potentially leads to a financial and broader economic crisis.

Minksy’s hypothesis went further.  He distinguished between 3 borrower types; hedge, speculative and Ponzi, with only hedge borrowers able to meet both the principle and interest payments on their debts.  Minksy proposed that the number of speculative and Ponzi borrowers soars during a speculative bubble with the manifestation of a culture of rolling over debt.  This swells the speculative bubble, but eventually a tipping point is reached (catalyzed perhaps by the collapse of an important financial institution).  At this point those who have borrowed excessively must sell their assets as prices tumble to repay their debts.   We can refer to this critical point as a Minsky Moment.

It is easy to see why economists developed a new-found appreciation of Minksy's ideas given the considerable resonance they had with the recent financial crisis.  For example early in the financial crisis (September 2008), Martin Wolf (CBE) a prominent economic commentator with the Financial Times declared, "What went wrong? The short answer: Minsky was right.......undue faith in unregulated markets proved a snare" (full article here).