Why Minsky Matters

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L. Randall Wray. Why Minsky Matters: An Introduction to the Work of a Maverick Economist. Princeton: Princeton University Press, 2016.

This book is an introduction to one of the most important critics of mainstream economics in the twentieth century. Although he did not live to see the 2007 global financial crisis, Minsky’s understanding of the economy led him to anticipate how it would unfold. His work is getting a lot of attention now that the crisis has generated some reassessment of economic theory, as crises usually do. Minsky’s ideas are part of the foundation for the emerging Modern Monetary Theory, now well represented not only by the author of this book, but also by Stephanie Kelton, whose The Deficit Myth I reviewed recently.

Hyman Minsky (1919-1996) studied mathematics at the University of Chicago and economics at Harvard. He taught at Berkeley from 1957 to 1965 and at Washington University in St. Louis from 1965 to 1990. After retiring from teaching, he was associated with the Levy Economics Institute at Bard College, a nonprofit research and policy organization specializing in alternatives to mainstream economics. Wray, who was once Minsky’s teaching assistant, calls Minsky “the smartest guy in the room, in every room.”

L. Randall Wray is a Professor of Economics at Bard College and Senior Scholar at the Levy Economics Institute.

The nature of the economy

Minsky’s disagreements with mainstream neoclassical economics were fundamental. He objected to its portrayal of a free-market economy as a self-stabilizing machine seeking equilibrium. Market forces supposedly move the economy toward a state in which supply equals demand, everything that is produced can be sold, and resources are allocated most efficiently. Deviations from equilibrium come from exogenous (externally caused) shocks, such as a global shortage of some commodity or excess spending by government. The economy is something like a climate-control system regulated by a thermostat. During the so-called “Great Moderation,” the 25 years preceding the financial crisis, many economists came to think of the central bank as the thermostat, raising or lowering the interest rate if the economy was either too hot (high inflation) or too cold (high unemployment). Some economists even proposed making such decisions more automatic by devising a rigid rule to govern them.

By the way, I have been noticing how scientists in a variety of disciplines have been challenging mechanistic models lately: biologists who say that an organism is more than a molecular copying machine, or neuroscientists who say that a brain is more than a computing machine. Sociologists have long questioned whether the machine metaphor is very useful for understanding societies and their institutions, which are creators of new culture and organized behavior. Minsky’s work is in the tradition of institutional economists like Thorstein Veblen, who was a sociologist as well as an economist. Minsky praised the University of Chicago for teaching economics as “part of the study of society…vastly superior to the usual practice of teaching economics in isolation in a specialized course.” That was before the ideas of Austrian economists and Milton Friedman came to dominate the Economics Department.

Minsky rejected the assumption that the economy is naturally stabilizing. He argued that market forces generate instability endogenously (internally). In fact, he said that “stability is destabilizing,” since a period of stable growth tends to alter expectations, policies and behaviors in ways that undermine stability itself. For example, confidence in continued profits can breed overconfidence and riskier behavior. Minsky saw this happening in a big way in the 1980s and 90s.

Society needs a variety of institutions to constrain instability and keep the economy working in the service of societal goals. That means especially the whole government, not just the central bank. Minsky said that “the institutions established through public policy play a vital role in determining what form capitalism takes; and…laissez faire is a prescription for economic disaster.”

Although he held an undergraduate degree in mathematics as well as a doctorate in economics, Minsky was skeptical of formal mathematical models that were devoid of historical and institutional context. He said “to be useful, analytical tools have to be embedded in an understanding of the institutions, traditions and legalities of the market.” Wray makes a similar criticism in his own macroeconomics textbook (coauthored with William Mitchell and Martin Watts):

Over the past half century mainstream macroeconomics has become increasingly devoid of relevance to our understanding of how modern monetary economies operate. In part this is due [to] an increased emphasis on mathematical models underpinned by simplistic assumptions that reduce human behaviour to that of a ‘rational agent’ who maximizes simple goals in at worst a ‘risky’ economic environment.

A revolutionary Keynesian

Minsky considered himself a follower of John Maynard Keynes, having been a teaching assistant to Keynesian Alvin Hansen at Harvard. However, he was disappointed in how Hansen, Paul Samuelson and others had integrated Keynesian ideas into the mainstream “neoclassical synthesis.” Minsky regarded Keynes as a revolutionary thinker whose revolution had been aborted. Mainstream economists acknowledged that government fiscal policy could be useful in combating recessions, but they did not take seriously enough his analysis of why recessions kept happening. Rather than moving toward an equilibrium where resources are optimally allocated, an economy could get stuck at a low level of utilization where producers lack the confidence to spend on production, and workers lack the income to spend on consumption. Minsky took chronically high unemployment as a sign that capitalism wasn’t working very well.

After the stagflation of the 1970s, the monetary school led by Milton Friedman discredited Keynesian fiscal policy as it was then practiced and minimized the role of government in the economy. At a time when Keynes was largely out of fashion, Minsky preserved and elaborated on Keynes’s analysis of investment cycles. Calling himself a “financial Keynesian,” he added the idea that the financial system amplifies those cycles, endogenously producing dangerous swings between financial booms and busts.

The following posts will start with Minsky’s theory of investment cycles and financial cycles, and then go on to discuss his take on the history of capitalism and his proposals for making it work better.


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