By Laura Elisa Leal, M.B.A. & Edson Timana, M.A.
The old saying that “history tends to repeat itself” is a well suited phrase for studying economic theories and institutions. Economic history, at least in the United States, demonstrates that fluctuations are a normal aspect of the boom-bust cycle. Everyone expects these fluctuations to happen and these corrections are vital to sustaining an open market system. When these market corrections occur (think 1929 or 2008), they can significantly impact prices, production levels, interest rates and the stock market. At times, these fluctuations become so severe and prolonged that people are compelled to do a close-up review of market structures and the instability that seems to be deeply rooted in both financial and investment paradigms. One would think that US markets would tend to shield themselves from such instability—that certain gates or walls (taken in the form of regulations, policies, and institutional intervention) could be strategically placed so as to minimize damage to US financial markets and increase the overall feeling of economic well-being.
In our more recent experience with financial/economic instability, we realized that economic growth (marked notably by increases in real GDP) can be terribly undermined by irrational valuation of assets and greater leniency towards leveraged borrowing, thus leading to what is commonly regarded as a balance sheet recession. The dangers of this type of recession is debt-deflation and systemic failure which ultimately leads to the trade-off of financial/economic destabilization…and once the pieces are picked up is doomed to be repeated yet again.
Hyman Minsky (1919-1996) was a keen observer of this recurring phenomenon. His observations on boom-bust business cycles laid the groundwork for his Financial Instability Hypothesis, thereby asserting a fresh perspective for explaining persistent destabilization forces found at both the business and macroeconomic levels. For decades, he asserted that “[t]he conclusions based on the models derived from standard theoretical economics cannot be applied to the formulation of policy for our type of economy…the model does not deal with time, money, uncertainty, financing of ownership of capital assets, and investments”(Minsky,1986).
To describe Minsky’s ideas more succinctly, macroeconomic stabilization would require that economic agents (primarily banks and government) be viewed as “cash inflow-outflow entities, facing solvency and liquidity survival constraints” and that these agents should exercise greater discretion when faced with the temptation of “financing long lived capital assets with short-term debt and rolling the debt at maturity into another short-term debt” (Mehrling, 2015). This affirms Minsky’s distrust of speculative and Ponzi financing and its destructive effects on the domestic economy and global markets. This is not to state, however, that all financing mechanisms should be constrained, but rather that short term financing should be used sparingly to finance long term projects due to the volatile nature of current financial markets (for instance, political events such as the Brexit vote or the use of negative interest rates in Europe/Japan clearly affirm that liquidity/credit is a global problem and that partially explains why there is a greater rate of volatility and market distortions).
In summary, Minsky believed that market destabilization could be mitigated by implementing the following recommendations:
1) Better cash flow examination procedures…in other words, there should be greater transparency between the Federal Reserve, member banks and fringe banks.
2) Extending access to the Federal Reserve’s discount window to primary securities dealers and important financial intermediaries
3) Carefully examining all financial institutions, and in particular those financial institutions that can be characterized as fringe banks such as real estate investment trusts, finance companies, government bond dealers, commercial paper houses and any other institution engaged in position making…the Federal Reserve must be aware of how these fringe banks finance their own operations and the extent to which commercial banks provide both the ‘normal’ finance and the ‘fall back’ financing for fringe bank institutions” (Kregel, 2010).
Minsky’s ideas about destabilizing market forces and how to address them open up readers into an intriguing world of finance, price theory and monetary/fiscal policies. Although his viewpoints are not altogether orthodox, Minsky’s work does in fact support some key underpinnings found in neoclassical Keynesian theory and at best, helps to explain how financial markets and economics leave their mark on political, social and legal institutions throughout the world. The aforementioned Minsky reforms could serve as reliable “monetary stabilizers” and thereby help economies to “normalize” and attain their target rates in both inflation and employment.
References
Kregel, J. (2010). Minsky Moments and Minsky’s Proposals for Regulation of an Unstable Financial System. Presented at 19th Annual Hyman P. Minsky Conference, Bard College. Mehrling, P.G. (2015, 30 September). Minsky’s Financial Instability Hypothesis and Modern Economics. [Weblog]. Retrieved 9 June, 2016], from: http://www.perrymehrling.com/ Minsky, H. P. (1986). Stabilizing an Unstable Economy. New York, NY: McGraw Hill Professional.
This is easy to agree with for me! More transparency seems like a great thing. In a marketplace more volatile than ever before, transparency is a great thing. “balance sheet recession” is a cool term, it seems like the recession happens on paper before any real-world effects are seen. financial institutions can get carried away with different types of lending, like I saw in the movie The Big Short. I definitely would like to hear more about the second point. Maybe it’s just me, but this doesn’t sound super unorthodox. And no, I don’t think the answer to market volatility is more regulations. Irrational over-valuing has much more to do with eventual crashes than a lack of regulations, in my opinion. I would like to read more about Minsky in the future.
The saying “history tends to repeat itself,” might describe most situation not exactly repeating itself but since we cannot really know what is actually happening most of it is prediction of what has happened before and since economy is not always the same and it switches up unexpectedly like one might be able to see that business is not its brightest but one can’t be sure if it’s just of a couple of day or how long it will stay low or if it go back up or if it’s just with that type of business or if all business are low until it actually happens. Even if we do go through the same mistakes, maybe we should try fixing it by another way because even though it worked the first time it might not work the second time since how we live today is more advanced to how it used to be back then.
It is quite interesting how Minsky’s ideas manage to stay relevant till this day, this article gives a sense that he knew that market corrections were something to analyze. It is important to read more about him due to the fact that his ideas might help us in the future. Minsky’s theories are definitely somewhat different but they give a new and interest perspective to look at the economy and the problems the United States have to dealt with. In my opinion he is right, the best way to reduce the market destabilization is through carefully reviewing and analyzing certain financial institutions.
Do I agree with Robert Schiller? Very much so. I genuinely enjoyed his take and explanation of this subject, Honestly, I have never really considered these aspects of economics before, but it seems quite obvious to me now. The economy relies on its people and the diversity of its people. In a free market economy, it is completely depending upon the people and their thoughts and actions. We also know that their actions can be affected by many factors, such as politics, war, etc.
There is a saying in the Bible that says “What has been will be again, what has been done will be done again; there is nothing new under the sun” Ecclesiastes 1:9. This also seems to apply to economics, There will always be fluctuations in the market. History shows us that fluctuations are normal. Fluctuations can be severe causing instability and fear. Other times, fluctuations can be minimal causing a temporary feeling of security. Everyone expects fluctuations and honestly they keep people interested in studying the economy. Hyman Minsky’s observations on the fluctuations in business cycles led him to his Financial Instability Hypothesis. He believed that “short term financing should be used sparingly to finance long term projects.” I agree with his concern of liquidity issues arising from this type of financing. I also agree that steps can be taken to help the economy to remain stable. One of the most important steps is communication. If the Federal Reserve, member banks, and fringe banks communicate, it will serve as monetary stabilizers.
A lot of history as time goes by has been repeatdly and it has been proven, and if failed to alter or change we will have almost the same result throughout the years of our previously experienced.
As Mr. Minsky speaks i agree with everything he talks about. Things need to be change so that we will have different, better results in our society. Is kinda of a way of saying if you need someone or don’t, you have to change every year to make it better and have better results. You don’t want to face the same results, you want something that benefits you. Thinking about our economic system people tend to get very comfortable with the situations and stop worrying about the things that are going on around us because they are afraid to change things, they believe it will get worse. Until our leaders changes things, it will continue to be cayose and our economy will continue to be at its worse. This is why we need to make a change, even if we think its not gonna work for some of us, we need to improve or we will stay the same.
As Mr. Minsky speaks i agree with everything he talks about. Things need to be change so that we will have different, better results in our society. Everyone expects fluctuations and honestly they keep people interested in studying the economy. Hyman Minsky’s observations on the fluctuations in business cycles led him to his Financial Instability Hypothesis. He believed that “short term financing should be used sparingly to finance long term projects.” I agree with his concern of liquidity issues arising from this type of financing. In a free market economy, it is completely depending upon the people and their thoughts and actions. We also know that their actions can be affected by many factors, such as politics, war, etc.