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Overview of Minskyâs Main Contributions
The lessons I learned from [Paul] Douglas are that any formal analytical toolâsuch as the Cobb-Douglas production functionâexplains 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.
âMinsky, 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.
âMinsky, 19922
Although this book is not a biography of Minsky, we begin with a short introduction to his life.3
Hyman Minsky (1919â1996) 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, âcommitted the cardinal sin of a dissertation advisorâhe diedâ 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 childrenâone 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 1969â1970, 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 lecturedâappearing to ignore themâbut 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 instituteâs 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 instituteâs efforts to influence policy formation. For example, he formulated a proposal to develop a national system of community development banksâand 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 VeblenâCommons 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 âfinancial Keynesianâ as a description of his work and felt close to the American institutionalists.
Minskyâs politics were idiosyncratically leftist. On one hand, he was active in leftistâeven self-described radicalâpolitical 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 CobbâDouglas 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 âusâ versus âthem.â 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 âto move the disciplineââat least a little.
He loved to shock his more left-wing students by railing against the welfare stateâsometimes sounding like President Reagan. (I found out later what he had against welfareâit 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 Chicagoâs âfree-marketâ branch of economics and Lange in the socialist campâor worse, a communist.
However, in Minskyâs views, each of them was offering a (different) way to make markets âwork.â 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 Yorkâpresumably 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 radicalâeven if he, himself, occasionally did!
His biggest influences were the Chicago schoolâs 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 Harvardâs Joseph Schumpeter. The way he saw it, âthe 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.â4 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 Knightâand these reinforce his claim that economics at Chicago in those days was taught as âpart 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,â which he claimed to be âvastly 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.â5
Although he served as Alvin Hansenâs teaching assistant at Harvard, he later remarked that the âmechanisticâ 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 âKeynesiansââPaul Samuelson, Robert Solow, and James Tobin6âwho Joan Robinson called âbastard Keynesiansâ (she said that we know the mother was neoclassical economics, but the father is unknownâcertainly not Keynes).
Since Harvard was known to be âKeynesianâ at the time, while the University of Chicago came to be known as the home of Milton Friedmanâs âmonetarism,â it is surprising that Minsky took away more from his early training at Chicago. However, as he insisted, Minskyâs Chicago was nothing like todayâs 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 Chicagoâs 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 Samuelsonâs famous linear-accelerator model and added institutional âceilings and floors.â 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 Samuelsonâs model. However, Minsky argued that a variety of institutionsâsome private, some publicâconstrain 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.
Minskyâs approach to banking drew heavily on Jack Gurley and E. S. Shaw,7 while adapting Schumpeterâs 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 Reserveâs 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 KennedyâJohnson 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 âThe Reconstitution of the Financial System,â which led to the creation of the âMinsky Conference,â 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
Minskyâs 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 âemployer of last resortâ 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 âeveryone can create money; the problem is to get it accepted.â10 Money is really just an IOU denominated in the money of account, but there is a hierarchy of moniesâsome are more widely accepted than othersâwith 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 âacceptingâ 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 bankâs reserves. Furthermore, â(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.â11 In other words, the âmoney supplyâ 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 âfed fundsâ market in the United Statesâthe 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 reservesâno 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 âmoney creationâ 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)âforcing 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 windowâforcing 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 âbooksâ (show the Fed their assets) when they wanted to borrow reserves.
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