Minskynomics

Profits can’t be sustained in a competitive market environment and there are few environments more competitive than recessions. Lower wages, lower prices, results in still lower wages and prices. Embrace deflation, the position of Hoover’s treasury secretary. What doesn’t get deflated though is debt, and increasing the amount of debt that must be defaulted is a step away from the solution. That was why Hoover strove to maintain the price structure. He saw no way to deal with debt that was written in terms of gold other than default.

One aspect of an extreme hedge finance stage such as the one we are in is that it can lead to the complete liquidation of firms that might have been able to restructure reasonably if they had been given some degree of reasonable financial support. The current wave of liquidations of well known firms is probably such a case. One can say, “the market works, they lost, close them down,” but it may be that they are being faced with an overly harsh financial situation and could survive, and there is little doubt that having widespread such liquidations aggravates the downturn that has now gone fully global, and according to the IMF as of yesteray, is now the worst since WW II.

Yes, Arnold and Bryan and David, there are multiplier effects, and they work on the downside as well as the upside.

Greg,

Well, Minsky is about a bit more than merely changes in risk perception and tastes, and I think went beyond both Keynes and Hayek in the details of his discussion of how the cycles of financial development work. Sure, one can find some of this in “pre-Keynesian” thinkers, including Hayek to some degree, as well as earlier ones including John Stuart Mill, and even Adam Smith and Cantillon to some extent. But, Minsky made real advances, despite his goofiness on some things, as Arnold notes. He was the source for the excellent discussion in Kindleberger’s _Manias, Panics, and Crashes_, and they do not call it “the Minsky Moment” for nothing, and we have just had one, I would say on September 17, 2008, if not some subsidiary ones at some other points recently.

Hayek was wise, but I do not think he is fully up to explaining all this. The big difference between him and Minsky is that he largely attributed all of the changes to badly managed monetary policy, whereas Minsky saw it as more of a process endogenous to the financial system itself, indeed feeding into the tendency for a credit loosening. Yes, the Fed’s lowering of interest rates goosed this bubble up in 2003 in particular. But it started earlier than that, and probably would have gone up and gotten sour, even if the Fed had held the line back then, more than the Fed’s actions involved in it.