Why Minsky Matters (L. Randall Wray)
Hyman Minsky passed away in 1996 having spent his life as somewhat of an outsider in the economics profession, shooting to prominence only after the Global Financial Crisis appeared to substantiate his ideas. His own writings were notoriously dense; Why Minsky Matters is an attempt by his former pupil Larry Randall Wray to summarise those ideas for the general reader. While the financial crisis may have been a moment of vindication, the growing popularity of Modern Monetary Theory (MMT) of which Wray is a leading proponent, certainly claims to build on Minsky's work, and similarities between this book and Stephanie Kelton's The Deficit Myth are abound.
The central insight of Hyman Minsky's work could be said to be the acknowledgement that the economy is a dynamical system, one in which human beings interact with policy and circumstances in ways which alter the effects of those policies and circumstances over time. Centrally, if cause and effect occur in both directions, then predictive, stable equilibrium models cannot exist. John Maynard Keynes' opus The General Theory Of Employment, Interest & Money identified excessive unemployment and inequality as the two ills inherent in capitalism, to these Minsky adds instability.
How this instability manifests can be illustrated simply. When firms borrow to invest in capital, they may borrow an amount which they are able to pay back both the interest and principle, with a certain margin of safety. If this proves to be profitable, and the returns from investment grow revenues and profits, a firm will be emboldened to be less risk averse in borrowing, leaving a lower margin of safety. This borrowing will lead to higher returns in a stable environment, and unexpectedly high profits in a boom, and the process will become self reinforcing, making firms more and more fragile to shocks. By this process, Minsky was able to argue that 'stability is destabilising', and that this is an inherent feature of unfettered capitalism. He classified these stages as 'hedging', then 'speculative', and finally, before a crash, 'ponzi'.
Traders in the 1990s referred to 'The Greenspan Put', the idea that Alan Greenspan (Chairman of the Federal Reserve) would use monetary policy to avert economic downturns, and so betting on growth would always be a good investment. His successor Ben Bernake coined the term 'The Great Moderation' to describe the long period of steady growth and low inflation that took place from the 1980s to 2007, citing central bank independence as the primary cause. Of course both of these led to excessive risk taking and leverage, and eventually catastrophic crash - what has been dubbed a 'Minsky Moment'.
The upshot of Minsky's insight is that every time policy makers intervene to avert damage to an economy, they embolden risk takers to go further next time, in the knowledge that they will be rescued. A significant consideration when buying stocks in a firm is the likelihood of insolvency - but one can hardly imagine any scenario at all in which the U.S. government would allow Goldman Sachs to fail - so why shouldn't it chase higher returns entailing small (but real) existential risk? Equally importantly, allowing Lehmen Brothers to fail in 2008 did untold damage to the world economy, due to the interconnectedness of global finance. Letting the bank fail cost employees their jobs and theoretically sent a message to other banks, but in truth it hurt the public disproportionately. The damage was in fact so great that rather than convince banks to be more prudent, it likely sent the message that such a bank failure was unlikely to be allowed to happen again. This 'prisoner's dilemma' problem has yet to be solved.
Reinforcing Minsky's instability hypothesis is his description of money creation in an economy. Contrary to conventional wisdom, banks do not take on deposits and then loan that money out. In effect, banks create new money by issuing IOUs to depositors and by accepting IOUs from firms and individuals to whom they loan. When there is a shortfall of cash they borrow from the central bank. Anyone can create money, posits Minsky, since an IOU I give to my neighbour represents money that didn't previously exist; if my name is in good enough standing my neighbour can trade the IOU elsewhere on our street. Therefore both money and assets have value in relation to which people will accept them. The central bank is at the top of this hierarchy, then banks, and eventually individuals. The level of acceptability of money in an economy, the 'moneyness' is high when times are good and low during a crisis, causing cascades of instability. Eventually, what Irving Fischer called "debt deflation" sets in - one has to sell assets at any price to meet obligations, causing asset prices to plummet, leading to a fire sale and the destruction of wealth.
Beyond the central thesis of instability were a series of policy recommendations made over a productive fifty year career. Whilst Wray points to significant and under-appreciated work on unemployment and inequality, this work can be seen to fall within a wider framework of Minsky's thought-system. He believed that institutions played a key role in putting "ceilings and floors" on cyclical instability, and that such institutions should be developed further for this purpose. Two key institutions were "Big Government" and "Big Bank" (the central bank). In times of crisis he advocated deficit spending from governments and injections of liquidity from central banks (both of which we saw in 2007-2008).
Surprisingly, Minsky was largely against welfare programmes, believing them to be inflationary, since they distributed money without creating goods; he believed that they didn't help get low-skilled workers into a position to return to work. He was also critical of anti-poverty schemes based on education and training, since they may take years or even decades to have an effect. Instead, Minsky advocated that government become an 'employer of last resort', spending significant government money to provide jobs for any and all who wanted them - citing employment as both the most effective and efficient way to eliminate poverty. I have critiqued government job creation schemes at such scale in my review of The Deficit Myth, and won't repeat those criticisms here, but will say that the argument that such schemes are not inflationary is predicated on the jobs producing things people want to buy. If there exists goods people want to buy that the government can identify but the market hasn't solved, there must of course be a reason. Naturally one can cite externalities and infrastructure projects, but it seems unlikely a scheme that needs to be able to expand from say, 50,000 jobs to 3 million jobs in a few weeks (when a crisis occurs) can be all that productive or useful.
It would be interesting to know how significant a part of Minsky's agenda this programme was. It is front and centre in the book, but the author (and his collaborator Stephanie Kelton) are strongly in favour of a jobs programme, and the MMT agenda does appear to be somewhat foisted on the reader - with much speculation on what 'Minsky would have thought.' One gets the feeling that Wray's Minsky, like Plato's Socrates, may not be identical to the original.
Regarding the issues of instability and moral hazard in finance, there are a number of policy recommendations to avoid future crises. The act of underwriting, that is, serious appraisals of creditworthiness and long term relationships with loanees, is one such recommendation. If banks are 'Too Big To Fail' and know it, essentially they are a public / private partnership. If banks recklessly lend and collateralise the debt in order to get it off their books as they did in the build up to the financial crisis, government has a right to ask what they need the banks for at all. Why not just conduct financial intermediary functions directly?
Relatedly, Minsky warned of the rise in 'shadow banking', financial intermediaries not subject to regulations or capital requirements of traditional banks. Not only did these institutions inject risk into the system, they reduced the profitability of banks, making expensive underwriting less affordable. Indeed, onerous capital requirements themselves hurt profits of banks he argued, making them less not more stable.
Another policy recommendation was that the central bank should lend directly to individual banks rather than in open market operations. This he argued, would allow them to look more closely at the balance sheets of banks, and detect reckless behaviour earlier. An obvious problem with this is the opacity of so much information. Complex derivatives aside, a bubble is often only recognised after the fact. Shares in Apple for the past 20 years have grown by orders of magnitude, and were they to crash would be seen as a bubble; presently they look like a reasonably safe asset. Whilst it may help temper excessively risky behaviour, we should not pretend anyone can truly see what is overpriced at all times.
Overall, Why Minsky Matters is a good introduction to a unique personality in economics. Clear and easy to read, I recommend this short book. Its most significant lesson may be that the subject of economics is structurally flawed. Aside from the abject failure to foresee the financial crisis, the division between schools of thought clearly show a subject purporting to be based on science more prone to articles of faith. That such seemingly sensible observations were rejected not for being false, but for failing to fit neatly within Keynesian, monetarist or neo-classical dogmas reflects poorly on the profession. Both John Maynard Keynes and Frank Knight emphasised that much information concerning dynamic systems was unknowable. This was an insight often forgotten by post war economists, whose mathematisation of the subject had as much to do with physics-envy as the pursuit of truth. Hyman Minsky's literary style and emphasis on instability stemming from complex systems placed him outside of the mainstream conversation - real-world events placed him back there.