Hyman Minsky

Prophet of financial doom, iconoclast or economic genius? – Wayne McMillan

Hyman Philip Minsky (Hy to his friends) was born on 23 Sep 1919 in Chicago, Illinois and died on 24 Oct 1996 at New York, of pancreatic cancer. aged 77. He fought a year’s battle with the disease prior to his death, leaving behind a rich macroeconomic legacy for his followers and students.

Minsky was born into a family of Menshevik emigrants from Belarus. His mother – Dora Zakon – was an actively engaged trade unionist, and his father – Sam Minsky – was an active Jewish Socialist in Chicago. There is no doubt that he was exposed to Marxian thought in his childhood and that this influenced his

later thinking. He was a member of the youth division of the American Socialist party while attending secondary school in Chicago. He had a strong interest in formal logic, philosophy and methodology of science, and probability theory. His original intention was to specialise in mathematics and physics, despite his strong interest in social sciences.

In 1937, Minsky graduated from George Washington High School in New York City and entered University of Chicago. In 1941 he received a B.S. degree in mathematics from the University of Chicago and went on to earn the post- graduate degrees of M.P.A. and Ph.D. (in economics) from Harvard University, where his doctorate was supervised by Joseph Schumpeter jointly with Wassily Leontief. His undergraduate studies at the University of Chicago were import- ant in getting him to study economics, even though they were in mathematics. He saw the University of Chicago as an intellectual powerhouse and remained in contact with both past and present students and academics from Chicago. While at Chicago he encountered some original thinkers like Oscar Lange, Paul Douglas, Jacob Viner, Frank Knight and Henry Simons. These people at the time had high status among academic economists. Minsky also attracted the friendship of Gerhard Meyer and Abba Lerner while at Chicago.

In the summer of 1942 he worked on the input/output study of W.W. Leontief at Harvard University, and stayed there as a graduate student. During February 1943 he entered the US Army and served in the Transportation Corps in New York City, Great Britain, France and Germany until late 1945. He then stay- ed in Berlin as a civilian employee in the manpower division of the US Military Government for Germany until

August 1946. In September 1946 he resumed his studies at Harvard, where he became a teaching assistant in the money and banking course run by the well-known Keynesian Alvin Hansen. Strangely, instead of choosing Hansen, he chose the great Austrian economist Joseph Schumpeter as his PhD thesis supervisor. Unfortunately, Schumpeter died in 1950 (before he completed his doctorate in 1954), and he then asked Leontief to be his thesis supervisor.

Minsky’s thesis was centred on the interrelationships among market structure, banking, the determinants of aggregate demand, and business cycle performance.

In their Minsky studies, Papadimitriou and Wray have mentioned that Minsky was never happy with Hansen’s mechanistic and too narrow interpretation of Keynes, so this may explain why he never asked Hansen to supervise him. Hansen seems to have ignored the significance of uncertainty and the role that money and finance play within a complex capitalist system, which is what Minsky believed that Keynes had clearly identified. So Minsky’s thinking was more heavily influenced by Joseph Schumpeter, Oscar Lange and Henry Simons, than by Alvin Hansen. And in those days Simons was more open to the idea of Democratic Socialism which appealed to Minsky. Minsky was closest to Lange who was interested in developing a scientific, socialist market economy. While at the Cowles Commission, he also befriended Kenneth Arrow.

Minsky began his academic career at Carnegie Tech (now Carnegie Mellon University) in the summer of 1947, and worked on the Raymond Goldsmith study of savings in the summer of 1948. Over 1949-57 he was Assistant, then Associate Professor at Brown University, then visiting Associate Professor and Associate Professor at the University of California Berkeley from 1957–65. In 1955 he married Esther De Pardo; they had two children: Diana, born in 1964 and Alan, born in 1965. From 1965 until his retirement he was Professor of Economics at Washington University (at St Louis) and Professor Emeritus there from July 1990. After his retirement he was appointed Distinguished Scholar at Levy Economics Institute, Bard College.

How did Minsky develop his ideas about finance capitalism?

His reading of Marx as a youth taught Minsky that capitalism was inherently unstable, but he recognised that further detailed research was needed to pin- point how financial instability operated. Like Keynes, Minsky was gifted in using and understanding mathematics. He read Keynes’s Treatise on Probability first before studying his General Theory of Employment, Money and Interest. He realised that Keynes thought money and the financial system was central to understanding the operation of capitalist economies. Keynes and Minsky both thought that uncertainty, velocity of the money supply and liquidity preference were very important variables in the money equation for household consumers, lenders and borrowers. Minsky drew from Keynes’s understanding of borrower and lender risk.

Minsky believed Keynes had solved the problem of the non-neutrality of money by recognizing that there are two key price levels in a capitalist economy: (A) the price level of current output and (B) the price level of financial and real assets, and that these two price levels are based upon two quite different relations.

While working at Berkeley, Brown and Washington Universities, Minsky had occasions to interact with the research departments of financial institutions and also with bank managers/economists. He was preoccupied with the idea of the probability of the occurrence of another depression. He undertook research on this at the instigation of the Commission on Money and Credit. He also conduct- ed research sponsored by the Federal Reserve System and also the Federal Deposit Insurance Corporation. One of his influential studies, ‘The Economics of Disaster’, was first prepared as a draft research paper for the Federal Reserve Board of Governors in1966 then revised and submitted it to them in 1970. For almost 20 years Minsky was also associated with the Mark Twain banks in St Louis; he often asserted that these banks were his laboratory.

It is obvious that Minsky was eclectic in his analysis of finance capitalism and had no time for arcane discussions about the history of economic thought. He freely admitted that he stood on the shoulders of giants like Marx, Keynes, Schumpeter and Simons and extracted from their works whatever he could fashion as handy tools to help him in pursuing his understanding on how modern capitalism operated and what public policies would be effective. His greatest debt was to Keynes, therefore he considered himself to be a financial Keynesian, although Post-Keynesians claimed him as one of them.

From Henry Simons he learnt various things about what constitutes successful industrial policy. Simons intimated that an industrial policy that promotes competitive industry, facilitating financing, aiding and abetting the development of a highly trained and productive labour force, is highly desirable.

Schumpeter understood the innovative and destructive forces of capitalism via its institutions. Minsky realised from his discussions with Schumpeter that to fully understand finance capitalism you had to grasp the detailed, sophisticated processes and operations of the system by studying its institutions.

Effectively Minsky was able to use the insights of Marx, Keynes, Schumpeter and Simons to bring together a blend of Post-Keynesian and Institutional economic thinking.

Minsky’s achievements

1. Created substantial theoretical work on financial fragility and the political economy of instability in advanced capitalist economies, using relevant financial empirical evidence.
2. Influenced policy-making of governments and financial communities to a greater extent than academic economists.
3. Raised some basic questions about contemporary economic methodology, particularly the relations between economic theory, mathematical models and statistical estimation.
4. Identified fundamental limitations of contemporary economic modelling technique.
5. Discovered that ‘financially sophisticated economies’ behave as complex and dynamic systems, and that their essential features cannot be captured within a static framework.
6. The endogenous dynamics of the system have the potential to break out into instability. In addition, he discover- ed that policy intervention is essential to containing instability. Intervention may lead to acceptable behaviour for a time, but the risk remains that the system will overcome any particular structure of institutional containment mechanisms.
7. Showed how the development of the federal funds market allowed a given quantity of aggregate banking reserves to support greater deposit expansion, and how repurchase agreements allow- ed a given quantity of demand deposits to support a greater volume of loans.
8. Discovered that when a central bank tightens monetary policy and increases interest rates, this encourages design of new and riskier financial products by banks. Such innovations increase the potential for financial instability. Innovation therefore is a function of profit seeking behaviour. Also demonstrated how innovation allows business activity to expand even in the absence of expansionary monetary policy.
9. Discovered that the Samuelson’s multiplier-accelerator model was valid only if income and production cyclical growth were to occur without affecting behaviour or inducing institutional innovation.
10. Constructed the financial instability hypothesis (FIH). Minsky emphasized that systems are continually evolving, generally toward fragility, so that a “stable” position is temporary. He continually argued that “stability is destabilizing”: The 1st theorem of the financial instability hypothesis is that the economy has financing regimes under which it is stable and financing regimes under which it is unstable. The 2nd theorem is that over periods of prolonged prosper- ity, the economy transits from financial relations that make for a stable system to financial relations that make for an unstable system. Minsky’s FIH is institutionally-specific, applicable only to a capitalist economy embracing complex financing of long-lived capital assets. Financial positions evolve from “hedge” to “speculative”, and finally to “Ponzi”. First as expectations of future returns become increasingly optimistic, and later as expectations are disappointed or financial arrangements are disrupted.
11. Created a finance capitalism reform strategy with four main aims to stabilise the financial aspects of capitalism (see the policy prescriptions).

Minsky’s policy prescriptions

1. The volume of government spending must be large enough to accommodate downfall swings in private investment.
2. Barriers to labour force participation must be removed, to ensure that those who seek a job will be able to obtain one. He advocated a true “full employment” policy: the government would act as the employer of last resort, using a program modelled on the New Deal’s Civilian Conservation Corps or Works Program Administration (WPA). This would guarantee a public sector job to anyone unable to find a private sector job, at an established minimum wage.
3. Spending priorities must be reorder- ed toward employment programs, child allowances, and public infrastructure investment, and away from defence and non-old-age, survivors, disability, and hospital insurance (OASDHI) transfers.
4. The central bank (Fed) must take greater responsibility for regulating financial markets, to guide the evolution of financial institutions by favouring stability-enhancing and discouraging instability-augmenting institutions and practices. The must be greater reliance on prudential supervision of banks. He believed that policies that favoured medium-sized banks would also favour medium sized firms, because bank size determines – to a large extent – the size of customers. Big banks tend to serve big customers, while medium sized banks serve medium sized customers.
5. Minsky also argued that “industrial policy” should not only favour smaller firms, but should also favour employment over capital-intensive production techniques. Smaller firms tend to use more labour-intensive techniques for the simple reason that their ability to finance positions involving long-lived and expensive capital assets is lower. He favoured regulation and government intervention in specific markets wher- ever these would promote competition.

Summary

Minsky was not a prophet of doom, but could see clearly that modern finance capitalism was inherently unstable. He provided policy recommendations for combatting this instability but he wasn’t confident that in the long run this would be sufficient to prevent major collapse. He was a realist and a genuine iconoclastic economist. Minsky’s brilliance lay in his ability to absorb and take what he needed from great economists like Marx, Keynes, Schumpeter and Simons and to fashion new techniques for his analysis. Minsky was no ivory tower academic and was always using the real world of financial institutions as his laboratory to test out his ideas. His real genius embraced his uncanny ability to understand and map out carefully the processes, operations, development and impacts of modern day finance capitalism.

Quotes:

1. “Stability, even of an expansion, is destabilizing in that the more adventuresome financing of investment pays off to the leaders and others follow.” — Wray, L. Randall, Why Minsky Matters: An Introduction to the Work of a Maverick Economist (p. 1) Princeton University Press, 2016. Kindle Edition.

2. “Hy was a bigger than life kind of person, quite a character.” remembers Lawrence Meyer, economist and former Fed governor, who worked with Minsky at Washington University. “He kind of loved to shock people. He took great joy in that, I think.” — https://www.bbc.com/news/magazine-26680993

3. “He was more driven by seeing convent- ional theories as being a delusional thing, a Disneyworld view of the real world,” says Australian economist Prof Steve Keen. “He was much more for getting your hands dirty in the real world. I think Minsky gave us the first sensible overview of capitalism – with warts and all – of what capitalism is about.”– https://www.bbc.com/news/magazine-26680993