The Economics Book

298

T

he instability of economic

systems has been debated

throughout the history of

economic thought. The view of

classical economists, following in

the tradition started by Adam Smith,

is that an economy is always driven

toward a stable equilibrium. There

will always be disturbances that

create booms and slumps—a

pattern that is sometimes called

the business cycle—but ultimately

the tendency is toward stability

with a fully employed economy.

The Great Depression of 1929

led some economists to examine

business cycles in more detail. In

1933, US economist Irving Fisher

described how a boom can turn to

bust through instabilities caused

by excessive debts and falling prices.

Three years later John Maynard

Keynes (p.161) questioned the idea

that the economy is self-righting. In

his General Theory, he developed

the idea that an economy could

settle into a depression from which

it had little hope of escaping.

These works were the genesis of

understanding the unstable nature

of modern economies. In 1992,

Hyman Minsky looked at the

problem again in his paper “The

Financial Instability Hypothesis.”

The paper suggested that the

modern capitalist economy contains

the seeds of its own destruction.

In Keynes’s view the modern

capitalist economy was different

from the economy that had existed

in the 18th century. The major

difference was the role played by

money and financial institutions.

In 1803, the French economist

Jean-Baptiste Say (p.75) gave a

classical interpretation of the

economy as essentially a refined

barter system, in which people

produce goods that they exchange

for money, which is used to

exchange for the goods they want.

The real exchange is good for good:

money is just a lubricant. Keynes

argued that money does more than

this: it allows transactions to occur

over time. A firm could borrow

money today to build a factory,

which it hopes will generate profit

that can be used to pay back the

loan and the interest in the future.

Minsky pointed out that it is not

FINANCIAL CRISES

Pictured here after his arrest in 1910,

Charles Ponzi ran investment scams in

the US promising unrealistic returns.

Minsky compared capitalist booms to

Ponzi schemes, doomed to collapse.

IN CONTEXT

FOCUS

Banking and finance

KEY THINKER

Hyman Minsky (1919 –96)

BEFORE

1933 American economist

Irving Fisher shows how

debt can cause depression.

1936 British economist

John Maynard Keynes claims

the financial markets have a

larger role in the functioning

of the economy than was

previously thought.

AFTER

2007 Lebanese-American

risk theorist Nassim Nicholas

Taleb publishes The Black

Swan, which criticizes the

risk-management procedures

of financial markets.

2009 Paul McCulley, former

managing director of a large

US investment fund, coins the

term “Minsky moment” for

the point at which booms bust.

House prices in the

US climbed steeply

from the late 1990s

until 2007 as banks

increasingly granted

mortgages to people

without the income to

pay the money back.

(^197519791983198719911995199920032007)
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