Mainstream economics versus Minsky
Asad Zaman
The following blog item by Asad Zaiman [1] is an extract from a longer article by the same author [2]: Krugman fails to understand Minsky.
On the one hand, Minsky has been transformed from an eclectic outcast to a darling of the mainstream after the crisis. On the other hand, Krugman and others have failed to appreciate the central insights of Minsky, just as they did with Keynes. While Keynes had completely rejected mainstream theories on solid grounds, Hicks and Samuelson constructed a neoclassical synthesis which conceded the short-run to Keynes on the basis of short run wage rigidities, but kept the fundamentals of mainstream theories intact.
Similarly, today mainstream economists like Krugman admit to being at fault in not predicting the GFC, but blame it on external factors, rather than on central weaknesses in mainstream theories.
Three external factors which account for the failure of economists to “see it coming” are:
-
-
- The GFC was a black swan event. A period of stability led to underestimation of risks and a discounting of the probabilities of crisis.
- The Fed kept interest rates low for too long. This allowed massive levels of credit creation, which led to bubbles.
- The rise of the shadow banking industry went unnoticed. The unregulated financial sector created a crisis by making high leverage gambles, using derivatives as insurance.
-
Accordingly, mainstream economists have proposed three solutions, none of which require any re-thinking traditional macroeconomics:
- We should pay more attention to the possibility of black swan events, and allow for distributions with fat tails in our stock market models.
- We should pay more attention to monetary policy.
- We should do more regulation of shadow banking (macro-prudential regulations).
In fact, this analysis fails to understand the central insights of Minsky. The mainstream, deluded by theories of intermediation, does not understand the central role of private sector credit
creation in generating crises. Even more important, Minsky attacks the central religious belief in “equilibrium”. While Krugman believes that market forces are stabilizing, Minsky promotes the heresy that “equilibria” are inherently unstable. In modern financial economies, the very stability of the equilibria generates the forces which de-stabilize the economy. Very briefly, stability encourages risk taking behaviour, which increases until a crisis occurs.
This viewpoint is truly deeply heretical because it attacks the founding pillars (optimization/equilibrium) of the main- stream orthodoxy.
Source: WEA Pedagogy Blog, 23 Mar 19
