I was one of the many economists who had barely heard of Hyman Minsky, still less read any of his work, before the financial crisis. One of the many who, seeking to understand, quickly devoured his [amazon_link id=”0071592997″ target=”_blank” ]Stabilizing an Unstable Economy[/amazon_link]. And found it pretty sensible. Macro isn’t my field, but there didn’t seem to be anything in that book a sensible mainstream macro person should have objected to. Should being the operative word. Because of course everyday, mainstream DSGE models in use in 2008 ruled out the very possibility of a crisis, whereas Minsky believed in their inevitability in some shape.
[amazon_image id=”0071592997″ link=”true” target=”_blank” size=”medium” ]Stabilizing an Unstable Economy[/amazon_image]
This week I’ve been reading Randall Wray’s [amazon_link id=”0691159122″ target=”_blank” ]Why Minsky Matters[/amazon_link], which is a useful and accessible overview of both what Minsky said and – as the title puts it – why it matters. I recommend the book (perhaps particularly to mainstream macro people!).
[amazon_image id=”0691159122″ link=”true” target=”_blank” size=”medium” ]Why Minsky Matters: An Introduction to the Work of a Maverick Economist[/amazon_image]
The first chapter gives an overview of Minsky’s arguments. The second chapter was to me the most interesting. It’s called ‘The Road Not taken’ and sets out the broad mainstream approach against which Minsky developed his arguments. This is the neoclassical synthesis, whose foundations were laid by John Hicks and Alvin ‘Secular Stagnation’ Hansen in the early years after Keynes’s death, then by both ‘Keynesians’ like Patinkin and Tobin and ‘Monetarists’ such as Friedman. Wray argues that these camps disagreed largely over parameter values, and that they essentially bowdlerised Keynes by ignoring his emphasis on investment, finance and uncertainty.
Debates about what Keynes ‘really’ meant in [amazon_link id=”1502423588″ target=”_blank” ]The General Theory[/amazon_link] are not all that interesting – and by the by a good reason for emphasising the importance of maths as well as words in economics. The mathematical notation is a way of enforcing logical consistency and expressing arguments with precision; the words can then explain more clearly, and introduce reality while keeping it rooted in logica and clarity. Anyway, what’s interesting about the chapter is its brief account of how finance vanished from macro, to our great cost.
[amazon_image id=”1502423588″ link=”true” target=”_blank” size=”medium” ]The General Theory of Employment, Interest, and Money (Classic John Maynard Keynes)[/amazon_image]
The later chapters of Wray’s primer set out Minsky’s views on specific issues, starting with his now-famous financial instability hypothesis: that market forces must be constrained in finance to prevent instability, but the consequent stability is itself destabilizing. The final chapter ends with some thoughts about how to proceed in the face of this paradox – in Wray’s view, tougher regulation especially of the shadow banking sector, and a smaller financial sector overall focusing on industrial investment. I agree, not least because the [amazon_link id=”0691169853″ target=”_blank” ]contribution of the sector to GDP is overstated[/amazon_link] (as Sir Charles Bean also pointed out in his recent interim report on economic statistics), and its contribution to economic welfare might well be a net negative.
This seems like common sense. I don’t entirely understand the unwillingness of the political classes to address the finance problem (despite the lobbying and campaign contributions) – will it really take another crisis? The reluctance of people who did pre-2008 macro to ditch their human capital is entirely understandable, and I’m constantly told that anyway there has nevertheless been a lot of change in macroeconomics. Still (and to repeat, this is not my field) I’d be interested to know what proper macroeconomists think about Minsky now. If Minsky is still, as the book jacket claims, a maverick shunned by the mainstream – why?
I was taught about Minsky (and read some of his work) back in 1970. He has always been important to the more radical Keynesians (the Post-Keynesians). He has also always been important to economic historians viz. Kindleberger whose classic book “Manias, Crashes and Panics” relies considerably on Minsky’s ideas. More recently, Paul Krugman, Martin Wolf and George Magnus have all (positively) used his ideas in their commentaries.
The main reasons why his key idea has not penetrated mainstream macro-economics are I think:
(i) It’s entirely dependent on uncertainty and subjective changes in risk perceptions as a result of new information. No-one has yet been able to express this in formal mathematical terms in a way that is modellable; and
(ii) The theory is essentially a long-run theory. It seems to explain well how the recovery of WW1 and the 1920s boom in the 1929 Crash and the 1930s Depression – and similarly for the 1970s to the 2000s and the 2008 crash and Great Recession. But, I doubt whether either Minsky or his supporters would suggest the theory is very helpful for 2-5 year ahead forecasts.
As you suggest, a Minsky perspective may well be useful in thinking about the role of finance and the scope of financial regulation. A Minsky perspective may also be useful in thinking about the validity and reasonableness of macro-models and forecasts – but, not I think to produce them.
Further to my previous comment, there is one important exception to the inability of modern mainstream economist to use Minsky-like ideas.
That exception is Raghuram Rajan’s famous 2005 paper “Has Financial Development Made the World Riskier?” – to which his answer was Yes. (See https://www.imf.org/external/np/speeches/2005/082705.htm for a carefully worded speech Rajan gave in 2005.) However, the paper received a very hostile reception in 2005 even though it was being lauded by 2008. (See http://www.wsj.com/articles/SB123086154114948151)
Rajan was not alone. Before end- 2007, Reinhart and Rogoff were predicting a major US recession based on their econometrics of past financial crises and Roubini had even earlier acquired his nickname of ‘Dr Doom’ for his highly pessimistic forecasts. Interestingly, all three were senior IMF economists.
The problem, though, is that although Rajan and Reinhart & Rogoff could say that their work indicated some serious risks of a major new financial crisis and recession, they could not say HOW BIG it was likely to be let alone WHEN it was likely to occur.
That’s very similar to the problem of modelling exchange rates and other market-sensitive financial variables. Economists can usually estimate quite well whether an exchange rate is some way from its equilibrium rate (PPP, FEER or whatever), but they cannot effectively say when any major change will happen or how quickly it will take place.
Note that this is not just a problem in economics Seismologists can well identify fault lines at risk of a major earthquake but they cannot effectively predict where on the fault line it will happen, let alone when.
Going back to Minsky, that means having his ideas as a set of tools with which to judge the coherence of projections but not of much use for making other than qualitative judgements on potential risks – as Rajan did in 2005.
That’s very interesting. Tony Yates’s response to this post on Twitter was that it’s impossible to handle Minsky formally so it isn’t a useful model. I disagreed there with his apparent view that economists should only consider what they can model formally. You offer a third perspective. Here’s a selection of his tweets:
t0nyyates: @diane1859 …Perhaps, but that’ debatable. second: Minsky’s informal hypothesis is just that. hardly proven, nor even checked logically.
t0nyyates: @diane1859 Stability may be, in fact, stabilising. Who knows. Studying formally is not an easy task.
t0nyyates: @diane1859 what are you suggesting us macro lot do then. we can’t earn a living by remarking briefly ‘that Minsky guy might have a point’.
There’s a lot that economists have to consider, much of which is capable of being handled formally and much, besides Minsky-like arguments, that is not.. See Dani Rodrik’s excellent new book.
I’m a great – and increasing – believer in lessons from economic history.
The very best economists barely reach the level of mediocre scientists. That economists can’t figure out how to mathematically model Minsky is not surprising. Better to turn the problem over to physicists or applied mathematicians.
It doesn’t sound like you’ve spent much time in an econ department. Many critics would say economics is too much like maths/physics in its use of maths…
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I’m not sure what to think of your comment to the effect that what Keynes meant in The General Theory is uninteresting, as this is essentially a rejection of Keynes’ work altogether. His most consequential theory touching on investment, saving and consumption (that of uncertainty) cannot be expressed in a mathematical model.
Is it really wise to suggest something probably isn’t worth considering if it won’t conform to a preferred methodology?
I don’t say it’s uninteresting and on the contrary say read it. What I say is that conducting debate in terms of what Keynes *really* meant – ie trying to claim his true meaning as authority for one’s own argument – is uninteresting.