John Maynard Keynes (Hyman Minsky)

John Maynard Keynes’ General Theory Of Employment, Interest and Money, published in 1936 marked an epoch in the history of economics. At a time when capitalism was failing great swaths of the populations of Europe and America, and communist and facist alternative systems circled overhead, Keynes proffered a road to prosperity that promised to keep democracy intact. As with any paradigmatic shift in intellectual thinking, major new ideas do not come out fully formed, rather they evolve as a response to critics and contributors over time. A series of chance events prevented Keynes himself from being fully involved in this process, argues Hyman Minsky, and as a result some of his ideas have been misinterpreted or lost.

Hyman Minsky’s John Maynard Keynes (and his later work An Unstable Economy) is a kind of exposition of Minsky’s ideas, which are built on the foundation of his interpretation of Keynes. This is reminiscent of Schopenhauer’s philosophy, built as it was on Kant, and a critique of where Kant went wrong. As with Schopenhauer, Minsky is the enfant terrible of his profession; where Schopenhauer called Hegel a ‘clumsy charlatan’, Minsky refers to post Keynesian interpretations absent of uncertainty as like ‘Hamlet without the Prince’ (we could take this analogy further with Adam Smith as Plato, but we won’t).

Just 12 months after the publication of The General Theory, Keynes had a heart attack, and took a full year to fully recover. As a result he only gave one full rebuttal to the academic critiques of his magnum opus. The General Theory is primarily concerned with an economy in slump, one with under-utilised resources; the onset of World War II brought Keynes back into government, working on the quite different problem of how to utilise all available resources with maximum effectiveness for war. After the war, with U.S. and British economies rebuilding, and with a stable financial system flooded with risk-free government bonds, there were no serious slumps until 1966, a full 20 years after Keynes’ death. The upshot of this was, according to Minsky, a mistaken interpretation of Keynes’ central idea; an acceptance of the principle that governments must intervene to avoid economic downturn, but an implicit rejection of the central tenet of Keynes’ economic theory. The period after World War II saw the mathematisation of economics - a process criticised by many as scientism - which meant the need for certainties in models, achieved by underpinning models with certain necessary assumptions. Such assumptions imagined away much of the uncertainty Keynes explicitly identified, and, according to Minsky, undermined his entire schema in the process. 

Minsky begins the book by outlining the three main ways in which economists have taken Keynes’ ideas and managed to integrate them into standard economic theory, along with his criticisms of these syntheses. He follows with his own interpretation and development of Keynes, and finishes with some wider thoughts on policy implications for his theory. 

These three interpretations of Keynes were an assessment of the consumption function to the exclusion of the rest of the book, the IS-LM framework, published by John Hicks as a way to formalise Keynesianism in the classical format, and versions of this that factor in the labour market. The IS-LM framework is a graphical way to show equilibrium between the money markets and goods markets. All three of these have, says Minsky, the potential for unlimited complexity, with very little sophistication. 

In simple terms, Keynes spent the 1920s arguing against the gold standard, because higher interest rates and a stronger currency (making exports more expensive) caused unemployment. The argument Keynes’ opponents made was that wages would adjust downwards with a stronger pound, and a deflation would have the same stimulating effect on the economy as a devaluation of the economy (lower wages and prices reduce the cost of exports abroad, at a fixed exchange rate). The ‘post-Keynesian’ models showed this again to be the case. That short of financial impediments, or restrictions on wage flexibility (unions, unemployment benefits, minimum wages), economies would self adjust to major contractions. Keynes was arguing that this wasn’t the case in the 1920s and 1930s because it very obviously and clearly was not the case. Unemployment was high and persistent, and The Great Depression was not short lived. So the new formalism relegated Keynesianism to a special case, as opposed to a new doctrine, much to the dismay of Minsky.

Beyond the anecdotal evidence that wages simply hadn’t adjusted in a timely manner (to use Keynes’ parlance, wages are sticky), Minsky points out further flaws in the idea that impediments to wage flexibility were the cause of persistent unemployment. As wages and prices fall, debt (which is issued in nominal form) gets more expensive. This discourages investment, for what company will want to take a loan and invest it, in the knowledge that the real debt will increase over time by an indeterminate amount. Moreover, if debt is going to get more expensive over time, entrepreneurs will borrow less, shrinking the money supply. In more extreme situations, if prices are falling and expected to fall, people are incentivised to hold more cash (they have increased ‘liquidity preference’), reducing consumption; so both consumption and investment can fall as a result of a deflation, contrary to classical and some post-Keynesian doctrines. Thus, whilst classical synthesis models saw wage inflexibility as the cause of the failure of an economy to reach equilibrium in time, Keynes argued that changes in an economy lead to disequilibrium - and wage flexibility can actually contribute to that. 

The crux of Minsky’s interpretation of Keynes in contradistinction from mainstream post-Keynesians is the inclusion of uncertainty into his model. As ever, economics is a study of human behaviour, at its core unpredictable, which is unfortunate for those determined to make economics a formal science in the mould of physics. Keynes states that aggregate demand consists of consumption and investment (setting aside for now government spending and imports / exports). If consumption is relatively stable, investment decisions are critical to whether an economy reaches full employment. But Keynes was very clear that investment decisions are subject to subjective decisions of individual investors; their current optimism or pessimism about the future. Less visible than confidence in investment (especially in the form of the stock market), is the subjective assessment of lender’s risk and borrower’s risk, not shown in contracts. If banks feel negatively about the future, they won’t necessarily just lend at a higher interest rate, they will refuse loans; the converse is true of firms taking loans for investment. Minsky states that whilst collapse in investor confidence or the state of credit can cause a slump, both must recover for an economy to return to full employment. 

In his infamous chapter 12 on investment and uncertainty, Keynes posits that liquid markets in investment (stock exchanges) are necessary to encourage people to invest - only because I know I can sell tomorrow without affecting the price will I buy today. But of course, this liquidity is only an illusion - if we all decide to sell tomorrow, it will dramatically affect the price. Thus, whilst real prices are rigid or sticky, prices in finance can change instantaneously with the public mood. Minsky introduced finance into Keynes’ schema, to show that capitalism is inherently unstable. Not only can (as Keynes acknowledged) downward spirals in investment lead to slumps - when assets are sold to meet obligations but prices collapse leading to more sales - but upward cycles are also unstable. 

The degree to which a firm decides to use debt relative to its own funds to invest is partially dependent on confidence. If asset prices are rising, then not only do paper gains look like investments were smart decisions (leading to more risk taking), but firms' balance sheets will appear healthy. In this instance, banks will also feel confident, and eager to lend as much as they can. The restriction on bank lending will be reserve requirements, and Minsky argues that banks will circumvent these as much as they can. This can be achieved by various forms of financial manipulation and rule-bending, all of which effectively increase the money supply. By this route, money creation is endogenous. An important way in which banks can increase their lending and effectively ‘create money’, is collateralised debt. By creating tradable versions of debt, a bank no longer needs to be prudent in its lending (as it ceases to warehouse the risk on its books), and a ‘safe’ tradable security is created and held by pension funds and the like. It is a matter for another essay, but the 2008 financial crisis was dubbed by many to be a ‘Minsky Moment’ because of its correlation to his description of the cyclical nature of economies driven by finance. 

When the above ‘reciprocating stimulus’ is broken by an event that shakes confidence, asset prices fall, debts cannot be paid, and bankruptcies ensue. The pessimism and fear stemming from such a series of events becomes self perpetuating, the money supply shrinks as banks refuse to borrow and firms refuse to lend, asset prices fall and liquidity dries up. Thus Minsky’s famous phrase ‘stability is destabilising’. The longer we go with growth but without wild exuberance, the weaker the argument becomes against higher risk taking, the more risk is accepted as safe. Until...

Keynes’ General Theory showed that, despite classical theories, an economy could come to equilibrium below full employment. Minsky argued that there was no such equilibrium, that instability reigns in capitalism, and that economies are cyclical. He sees it as an error by Keynes to not have broached the subject of business cycles explicitly in The General Theory, when he was clearly interested in them in his previous Treatise On Money. I would suggest that perhaps Keynes avoided the discussion of ‘cycles’, because those who argued against his policy prescriptions for solving unemployment saw economies as self correcting, and prescribed that we wait for this mechanism. Such arguments frustrated Keynes, and so perhaps to muddy the waters with talk of cycles was best avoided. This however, is merely speculation. 

In A Brief History Of Time, Stephen Hawking remarked that every formula included in a book will half its readership. Were this the case, John Maynard Keynes could have outsold the King James Bible, had Minsky been of a more literary persuasion. It has been often remarked that had Minsky formalised his work mathematically he would not have been such an outsider in mainstream economics. Therefore it is regrettable that he was neither a mathematical whizz in the guise of Paul Samuelson or Paul Romer, nor a great writer in the tradition of Adam Smith or Keynes himself. For the ideas in this book, presented as a gross simplification here, are not difficult to follow and could have been extrapolated without the constant slipping in and out of algebra. This is a short book with immense insight and original thinking, but one that requires a thorough reading of The General Theory as a prerequisite. Minsky’s prescriptions for socialised investment and job creation as the upshot of his ideas are not the only conclusions one can draw from the acknowledgement of instability and uncertainty in economic life. The Austrian School also emphasises such uncertainty in markets (albeit at a micro level) and concludes exactly the opposite policies regarding government intervention are the solution. 

Hyman Minsky’s resurgence after the 2008 financial crisis is testament to the superiority of simple truths over complex and mathematically beautiful falsehoods. The disadvantage one has of pointing out patterns in social sciences that occur over longer periods of time than human lifespans is in not being around to say ‘I told you so’. Minsky told us so.