Why Minsky Matters

An Introduction to the Work of a Maverick Economist

L Randall Wray

• Publisher: Princeton University Press
• Year: 2015
• ISBN:
  9781400873494
• Topic: Économie
• Subtopic: Histoire économique

Perhaps no economist was more vindicated by the global financial crisis than Hyman P. Minsky (1919–96). Although a handful of economists raised alarms as early as 2000, Minsky's warnings began a half-century earlier, with writings that set out a compelling theory of financial instability. Yet even today he remains largely outside mainstream economics; few people have a good grasp of his writings, and fewer still understand their full importance. Why Minsky Matters makes the maverick economist's critically valuable insights accessible to general readers for the first time. L. Randall Wray shows that by understanding Minsky we will not only see the next crisis coming but we might be able to act quickly enough to prevent it.As Wray explains, Minsky's most important idea is that "stability is destabilizing": to the degree that the economy achieves what looks to be robust and stable growth, it is setting up the conditions in which a crash becomes ever more likely. Before the financial crisis, mainstream economists pointed to much evidence that the economy was more stable, but their predictions were completely wrong because they disregarded Minsky's insight. Wray also introduces Minsky's significant work on money and banking, poverty and unemployment, and the evolution of capitalism, as well as his proposals for reforming the financial system and promoting economic stability.A much-needed introduction to an economist whose ideas are more relevant than ever, Why Minsky Matters is essential reading for anyone who wants to understand why economic crises are becoming more frequent and severe—and what we can do about it.

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Overview of Minsky’s Main Contributions

The lessons I learned from [Paul] Douglas are that any formal analytical tool—such as the Cobb-Douglas production function—explains but little of what happens in the world, and that to be useful, analytical tools have to be embedded in an understanding of the institutions, traditions and legalities of the market.

—Minsky, 1988, p. 174¹

A capitalist economy can be described by a set of interrelated balance sheets and income statements. The liabilities of the balance sheet are commitments to make payments either on demand, when a contingency occurs or at specified dates.

—Minsky, 1992²

Although this book is not a biography of Minsky, we begin with a short introduction to his life.³

Hyman Minsky (1919–1996) studied mathematics as an undergraduate at the University of Chicago, graduating in 1941 with a major in math and a minor in economics. He was offered a fellowship to remain and study for a graduate degree in economics. However, he left for Harvard after only one semester to join a research group in postwar planning, working with Professor Wassily Leontief. He had planned to return to Chicago to resume studies, but Harvard offered a more generous fellowship to stay. That was short-lived, as he was drafted by the U.S. Army after only one semester. He was discharged in Berlin in 1946 but accepted a six-month civilian assignment in the Manpower Division of the Office of Military Government. He later said that his appreciation for the importance of specific institutions and historical circumstances grew out of that assignment.

Minsky received graduate fellowship offers from both Chicago and Harvard, but he chose Harvard because several of the professors he preferred to work with at Chicago would be absent. In 1949, he took his first permanent academic position at Brown University; like many Ph.D. candidates, he had to finish his dissertation while teaching. He was writing it under the direction of Harvard Professor Joseph Schumpeter, who, Minsky joked, “committed the cardinal sin of a dissertation advisor—he died” before Minsky could finish. Professor Leontief volunteered to fill in, even though the topic was outside his area of interest. Minsky finished in 1954. While at Brown, he married Esther De Pardo in 1955 and they had two children—one is a professor of art history, and the other is a producer for progressive radio programs.

He temporarily left Brown for a visiting position at the University of California at Berkeley, which led to a permanent position in 1957. He had a leave to work at the National Bureau of Economic Research in 1960 but remained at Berkeley until 1965. While there, he published articles in many of the top economics journals; his research included multiplier-accelerator models, central banking and money markets, employment and growth, and financial crises.

By the mid-1960s, the student movement was gearing up. While Minsky was a leftist who supported the goals, he did not always approve of the methods. He used to say that one of the reasons he left Berkeley for Washington University in St. Louis was to get some peace and quiet. In truth, there were two other reasons: a generous salary and the opportunity to be associated with Mark Twain Bank in St. Louis. That association helped to develop his understanding of financial institutions, instruments, and practices.

In 1969–1970, Minsky spent a sabbatical year at Cambridge University, UK, where he was able to engage influential economists like Joan Robinson and Frank Hahn and begin a close friendship with Jan Kregel (who wrote his dissertation with Robinson). Some years later, Kregel helped to create the Trieste Summer School of Advanced Economic Studies, held annually in the late summer on the coast of northern Italy; Minsky gave lectures there and debated fellow post-Keynesian economists, such as Paul Davidson and Pierangelo Garegnani. He would often sit in the middle of the audience and read a newspaper while others lectured—appearing to ignore them—but then launch penetrating questions in the discussion that followed.

When he retired from teaching in 1990, he moved to the Levy Economics Institute at Bard College as a distinguished scholar, where he remained until his death in 1996. At the Levy Institute, he established two of the institute’s ongoing research programs: Monetary Policy and Financial Structure, and the State of the U.S. and World Economies; he was also a driving force behind the institute’s efforts to influence policy formation. For example, he formulated a proposal to develop a national system of community development banks—and some of the ideas were incorporated into a bill signed by President Clinton to fund a (smaller) program.

He was a recipient in 1996 of the Veblen–Commons Award, given by the Association for Evolutionary Economics in recognition of exemplary standards of scholarship, teaching, public service, and research in the field of evolutionary institutional economics. Though he is commonly identified as a post-Keynesian, he preferred “financial Keynesian” as a description of his work and felt close to the American institutionalists.

Minsky’s politics were idiosyncratically leftist. On one hand, he was active in leftist—even self-described radical—political activities as a student. His parents were Mensheviks, Russian refugees who met in America at a party to celebrate the 100th birthday of Karl Marx, sponsored by the Socialist Party of the United States. During the years in Berkeley, he participated in political groups that were on the left wing of the Democratic Party. His politics played a role in his decisions to leave both Brown and Berkeley as he had angered top administrators at both universities sufficiently that further promotion was endangered.

On the other hand, as a student in Chicago he became a close friend of Paul Douglas (of Cobb–Douglas production function fame and future U.S. Senator), who saw him as a safe opponent of Leninism. He befriended many bankers and Wall Street traders, including Leon Levy and Henry Kaufman. Many of his closest friends in academic economics were mainstream and not particularly liberal (in the American sense). He had no desire to partition the discipline into “us” versus “them.” In the last months of his life, he asked his colleagues at the Levy Institute to reach out to the mainstream, telling all of us that the time was right “to move the discipline”—at least a little.

He loved to shock his more left-wing students by railing against the welfare state—sometimes sounding like President Reagan. (I found out later what he had against welfare—it is discussed in chapter 5.)

He rarely taught or even talked about Marx and infrequently mentioned him in his writing. He could be fairly scathing in his criticism of work done by many economists on the left. As discussed below, his two most important influences during his studies at the University of Chicago were Henry Simons and Oscar Lange. This adds to the confusion about his politics, as most economists today would include Simons in Chicago’s “free-market” branch of economics and Lange in the socialist camp—or worse, a communist.

However, in Minsky’s views, each of them was offering a (different) way to make markets “work.” Minsky would later report that it broke his heart when Lange left Chicago to work for the new Communist government in Poland. While Minsky credited Lange as a major influence, Minsky avoided him later in the 1940s when Lange came to New York—presumably because of his association with the communist government. It is safe to say that few of his fellow economists would have labeled his politics as radical—even if he, himself, occasionally did!

His biggest influences were the Chicago school’s institutionalist tradition (especially Henry Simons and Paul Douglas, but he also worked with those outside the camp, including Lange, Jacob Viner, and Frank Knight) and Harvard’s Joseph Schumpeter. The way he saw it, “the socialism of Lange had more in common with the capitalism of Simons than with the socialism of Stalin, and the capitalism of Simons had more in common with the socialism of Lange than with the capitalism of Hitler.”⁴ He also noted that among the senior faculty at Chicago, only Lange and possibly Douglas were sympathetic to the work of Keynes.

Minsky left copious bound class notes from courses he had with Lange and Knight—and these reinforce his claim that economics at Chicago in those days was taught as “part of the study of society, where economic history, political science, sociology, anthropology and economics were part of an integrated sequence aimed at understanding modern society,” which he claimed to be “vastly superior to the usual practice of teaching economics in isolation in a specialized course. If I had my way the standard American course in economics would be introduced in the context of social sciences and history. The current American way of teaching economics leads to American economists who are well-trained but poorly educated.”⁵

Although he served as Alvin Hansen’s teaching assistant at Harvard, he later remarked that the “mechanistic” approach of mainstream Keynesians did not appeal to him. J. M. Keynes clearly influenced Minsky, but he did not have much affinity with the postwar American “Keynesians”—Paul Samuelson, Robert Solow, and James Tobin⁶—who Joan Robinson called “bastard Keynesians” (she said that we know the mother was neoclassical economics, but the father is unknown—certainly not Keynes).

Since Harvard was known to be “Keynesian” at the time, while the University of Chicago came to be known as the home of Milton Friedman’s “monetarism,” it is surprising that Minsky took away more from his early training at Chicago. However, as he insisted, Minsky’s Chicago was nothing like today’s bastion of free-market ideology. What he learned at Chicago was an appreciation for the need to develop a detailed understanding of real-world institutions and behavior, as well as of economic history. His notes from courses reveal that Chicago’s economics was a far cry from the esoteric mathematical models taught today to graduate students.

From his earliest work, Minsky was interested in studying the dynamic, evolutionary change of an economy operating with institutional constraints. Indeed, in one of his first papers, he took Paul Samuelson’s famous linear-accelerator model and added institutional “ceilings and floors.” We address this work in more detail later, but the basic idea is that the modern capitalist economy is naturally unstable, with forces that cause it to move from boom to bust.

That is what Minsky borrowed from Samuelson’s model. However, Minsky argued that a variety of institutions—some private, some public—constrain that instability. This is what he learned from the institutionalist tradition at Chicago. Combining the two, Minsky could explain that although there is a natural cyclical tendency in modern economies, runaway inflations and depressions are rare events because instability is attenuated by institutional constraints.

Minsky’s approach to banking drew heavily on Jack Gurley and E. S. Shaw,⁷ while adapting Schumpeter’s theory of innovation to analysis of the financial sector. During the 1960s, he was involved in major studies of monetary policy formation and banking regulation, doing research for the Federal Reserve’s Board of Governors and for the California state banking commission. Later, he served on the board of a Missouri bank holding company, which helped him to keep a finger on the pulse of finance. He also became a close friend to Martin Mayer, the most astute historian of American postwar financial institutions.

While at Berkeley, Minsky worked closely with labor economists to develop policy to reduce unemployment and poverty. Indeed, Minsky proposed an alternative to the Kennedy–Johnson War on Poverty, arguing that to be successful, an anti-poverty program would need to focus on job creation. Minsky integrated this proposal into his policy recommendations to promote economic stability.

All of this experience provided a deep understanding of real-world institutions and practices that influenced his writing and thinking. After he moved to the Levy Institute, he used Wall Street connections to establish a long-running research project titled “The Reconstitution of the Financial System,” which led to the creation of the “Minsky Conference,” held every year in April.⁸ In recent years, his work on unemployment and poverty was also recovered, leading to a revival of interest in direct job creation as an important component of policy to promote full employment and economic stability.⁹

Minsky’s Main Areas of Research

Minsky is best known for his development of the Financial Instability Hypothesis (FIH), but it was by no means his only contribution. This section also examines his work in three other areas: his analysis of money and banking; his “employer of last resort” proposal; and his views on the longer term evolution of the economy. Here we provide only a brief overview of his main research areas; in the chapters that follow, we go into more detail.

Money and Financial Institutions

Following Gurley and Shaw, Minsky took a broad approach to money creation, arguing that “everyone can create money; the problem is to get it accepted.”¹⁰ Money is really just an IOU denominated in the money of account, but there is a hierarchy of monies—some are more widely accepted than others—with the monetary IOUs issued by the treasury and the central bank sitting at the top of the money pyramid.

Minsky saw banking as essentially the business of “accepting” IOUs, making payments on behalf of customers, and holding their liabilities. Banks make payments in their own IOUs, which are then cleared using the central bank’s reserves. Furthermore, “(b)ecause bankers live in the same expectational climate as businessmen, profit-seeking bankers will find ways of accommodating their customers; this behavior by bankers reinforces dis-equilibrating pressures. Symmetrically, the processes that decrease the prices of capital assets will also decrease the willingness of bankers to finance business.”¹¹ In other words, the “money supply” expands and contracts as bankers accommodate the demands of their customers in a procyclical manner: when business is good, loans are easy to get; when prospects are bad, banks do not want to lend.

In one of his first publications,¹² Minsky analyzed the development of the “fed funds” market in the United States—the interbank market where banks lend reserves to one another to meet clearing drains as well as legally required reserve ratios. At the time, this was a relatively new financial innovation. Most people thought that the quantity of reserves constrains bank lending, since they would need to accumulate reserves before lending in order to be sure they would not be caught short.

Minsky, however, argued that banks use the fed funds market to economize on reserves—no bank would need to hold any extra reserves (called excess reserves) since they could lend them at interest to other banks that needed them. This would make it difficult for the Federal Reserve (Fed) to influence lending activity or “money creation” by trying to constrain reserves. According to Minsky, bank lending would not be determined by the quantity of reserves they held, but rather by the willingness of banks to lend, and of their customers to borrow. If they then needed reserves for clearing or to meet legal reserve requirements, they would simply go to the fed funds market and borrow them.

The implication is that if the central bank wants to influence bank lending, it must affect the decision of banks to lend and borrowers to borrow. For example, it can raise required underwriting standards (in which banks determine creditworthiness of borrowers)—forcing banks to require more collateral and better credit histories. Central banks can also raise interest rates to try to reduce lending; they do not really use the quantity of reserves to do so. Instead, they operate with interest rate targets, not reserve quantity targets.

Stemming from his research conducted for the Fed in the 1960s, Minsky came to the conclusion that reserves should be provided mostly at the discount window—forcing banks to borrow them directly from the central bank, rather than obtaining them from other banks or through open market purchases by the central bank. Minsky favored pushing banks to the discount window and forcing them to open their “books” (show the Fed their assets) when they wanted to borrow reserves.

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