A Minsky Moment
The Wall Street Journal has a front-page story regarding Hyman Minsky, whom it labels an obscure economist. The label, obscure, gives the impression of a crank ignoring the collective wisdom of the economics profession. In fact, Minsky’s obscurity owed more to the willful ideological stubbornness of the discipline that wanted to believe in market efficiency.
The article does not really give much detail about Minsky’s work, except to sum it up: “When times are good, investors take on risk; the longer times stay good, the more risk they take on, until they’ve taken on too much. Eventually, they reach a point where the cash generated by their assets no longer is sufficient to pay off the mountains of debt they took on to acquire them. Losses on such speculative assets prompt lenders to call in their loans. “This is likely to lead to a collapse of asset values,” Mr. Minsky wrote.”
Minsky was much more subtle, but this thumbnail sketch shows an enormous gap between conventional economics and Minsky. After all, academic economics teaches that markets are efficient. Milton Friedman insisted that Darwinian forces would eliminate inefficient speculators. The remaining speculators would serve to stabilize the market.
Minsky had a small number of economists who understood his message, but almost none of them had any influence within the profession.
One point that would have made Minsky more relevant today would have been the understanding that profit rates tend to decline, at least in the course of the business cycle. As profits fall, investors look to keep earning the same returns. Consequently, they turn to increasingly speculative ventures that promise to earn comparable returns, even though these ventures are more risky. As long as the optimistic expectations are met, investors pour more money into them, and possibly into even more risky investments in hope of a little bit higher rates of profit.
These temporary profits can lead to more spending, reinforcing the confidence of speculators. Eventually, these speculations become increasingly foolhardy. Financial crisis occurs. Everybody learns a lesson, then quickly forgets it; temporary reforms are put into place, then weakened; and soon the game starts all over until finally a subsequent crisis becomes catastrophic.
Lahart, Justin. 2007. “In Time of Tumult, Obscure Economist Gains Currency: Mr. Minsky Long Argued Markets Were Crisis Prone.” Wall Street Journal (18 August): p. A 1.