Hyman Minsky’s “financial instability hypothesis” employs the key concept of fin
ID: 1194150 • Letter: H
Question
Hyman Minsky’s “financial instability hypothesis” employs the key concept of financial “fragility.” What does it mean to describe a financial environment as “fragile”? In the short-run, during a period of economic growth, Minsky argues that modern capitalism has an inherent tendency to become more financially fragile–explain why, and clarify what then typically results, in Minsky’s view. Finally, on what grounds does Minsky also claim that, in the
long-run (over the course of several cycles), “stability is destabilizing”?
Explanation / Answer
Meaning of Financial Environment as fragile: Minsky proposed theories linking financial market fragility, in the normal life cycle of an economy, with speculativeinvestment bubbles endogenous to financial markets. Minsky claimed that in prosperous times, when corporate cash flow rises beyond what is needed to pay off debt, a speculative euphoria develops, and soon thereafter debts exceed what borrowers can pay off from their incoming revenues, which in turn produces a financial crisis. As a result of such speculative borrowing bubbles, banks and lenders tighten credit availability, even to companies that can afford loans, and the economy subsequently contracts.
This slow movement of the financial system from stability to fragility, followed by crisis, is something for which Minsky is best known, and the phrase "Minsky moment" refers to this aspect of Minsky's academic work.
In the short-run, during a period of economic growth, Minsky argues that modern capitalism has an inherent tendency to become more financially fragile–explain why, and clarify what then typically results, in Minsky’s view.
Finally, on what grounds does Minsky also claim that, in the long-run (over the course of several cycles), “stability is destabilizing”?
While there is a natural tendency toward increasing financial fragility in a Minsykan system, this does not mean that stabilisation policy is ineffective. Minsky stresses the role of active stabilisation policies in preventing financial crises, crediting the increasing importance of transfer payments since World War II with the relative stability enjoyed by the US until recently. He argues that when confidence starts to fail, the scale of any contraction is reduced as increased government spending (whether a result of automatic stabilisers or discretionary policy) supports the profitability of businesses, helping them to meet their debt-servicing obligations. This view provides direct support for the use of fiscal stimuli during recessions.
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