In 2007 the biggest financial crisis after the ‘Great Depression’ of 1939 took place. One theoretical framework explaining financial crises of that kind was envisioned by Hyman P. Minsky (1919-1996) in the latter half of the 20th century and was not considered in this context for a long time. The most prominent part of the theoretical framework, the financial instability hypothesis (FIH), emphasises that “modern capitalist system is prone to bouts of relative instability and financial collapse. When the storm in 2007 broke it was discovered again and the world began to talk about a ‘Minsky moment’. Prominent economics called the theory a required reading and championed it as visionary. Therefore it is no surprise that the book about his FIH was traded at prices over 2000 US$ right after the financial crisis.
Until the year 2007 the economic world followed another school of thought. The so-called neoclassic described a world in which financial crises would only occur if ex-ogenous shocks would disturb the self-regulating power of the markets. In detail this is called the efficient market hypothesis (EMH). In addition means this that financial crises caused by systemically reason are not part of the theoretical model.
On the contrary, Minsky described a cyclical model which tries to implement loan rela-tionships, financial institutions, financial innovations and uncertainty in the analysis of the modern capitalism. An emphasis lays on the financing structure of different eco-nomic players and the role of financial institutions regarding their influence on the real economy. Minsky’s theory is based on the whole economic cycle and really tries to explain how financial crises are actually caused. Additionally other authors see the thoughts of Minsky as an acknowledged theory regarding financial crises in the past. Although all these factors make the theory interesting for the recent crisis and different economics had called the financial crisis a Minsky moment a huge discussion if the theory is really applicable came up. Further if the theory is really applicable the next question would be which consequences have been drawn in order to prevent another crisis.
Table of Contents
1 Introduction
1.1 Problem description
1.2 Objective
1.3 Approach
2 Theoretical background of the financial instability hypothesis
2.1 Interpretations of the General Theory by M. Keynes
2.1.1 The “wall street paradigm”
2.1.2 Influence of uncertainty
2.1.3 Portfolio choice and preference for liquidity
2.1.4 Theory of investments
2.2 The financing structure of economic players
2.3 The role of financial institutions
2.3.1 Schumpeter’s theory of economic growth
2.3.2 The theory of endogenous money supply
2.3.3 Financial innovations and Money-Manager Capitalism
3 The financial instability hypothesis
3.1 Expansion phase
3.2 Contraction phase
3.3 Implications for economic policy
3.3.1 Big Government
3.3.2 Big Bank and regulation of the financial markets
3.4 Limitations of economic policy
4 Analysis of the financial crisis of 2007
4.1 The economy until the 1970s
4.2 Evidence for Money Manager Capitalism
4.3 Reasons for the crisis
4.3.1 Political reasons and monetary factors
4.3.2 Financial innovations and wrong incentives
4.3.3 Ponzi finance and a downward spiral
4.4 Consequences
5 Conclusion
Research Objectives and Themes
This academic paper provides a critical analysis of the financial crisis of 2007 by applying Hyman P. Minsky's "Financial Instability Hypothesis" (FIH). It aims to determine whether the endogenous instability of the economic system can be proven and evaluates the theoretical framework's applicability to the modern economic context, including the transition to "Money-Manager Capitalism."
- The Financial Instability Hypothesis and Minsky’s cycle.
- Keynesian foundations: Uncertainty, liquidity preference, and investment theory.
- Financing structures: Hedge, speculative, and Ponzi finance.
- Economic policy implications: The role of "Big Government" and "Big Bank."
- Analysis of the 2007 crisis: Financial innovations, securitization, and deregulation.
Excerpt from the Book
2.1.2 Influence of uncertainty
In his argumentation Minsky explains another element of the General Theory which he considers as one of the most important achievements of Keynes. Minsky sees the implementation of fundamental uncertainty into economic models as one of the central parts of the theory. Therefore he argues that: “Keynes without uncertainty is something like Hamlet without the Prince”. In the contrary neoclassical theories the decision making process is based on all possible, thinkable alternatives evaluated by the present values weighted according to occurrence possibilities. The central statement of Keynes considering this is that investors act under fundamental uncertainty because of the fact that they are not able to measure profits correctly by using probability calculation. The result of an investment depends on future events which cannot be foreseen.
Further he describes events which cannot be evaluated without a scientific basis on which to form any calculable probability e.g. the rate of interest twenty years hence or the obsolescence of a new innovation. Minsky states out that this uncertainty plays an exceptional role regarding two points. First the financing structure of economic players and second the transactions in financial markets.
Summary of Chapters
1 Introduction: Introduces the 2007 financial crisis, contrasts Minsky's FIH with neoclassical theory, and defines the paper's scope.
2 Theoretical background of the financial instability hypothesis: Details Minsky's interpretation of Keynes, uncertainty, investment theory, and the role of financial institutions in economic growth.
3 The financial instability hypothesis: Describes the expansion and contraction phases of an economy, the three financing structures, and the implications for economic policy.
4 Analysis of the financial crisis of 2007: Applies Minsky’s framework to the 2007 crisis, focusing on deregulation, financial innovations, and the role of Ponzi finance.
5 Conclusion: Summarizes findings on the applicability of Minsky's theory to the 2007 crisis while acknowledging necessary theoretical adjustments.
Keywords
Financial Instability Hypothesis, Minsky, Financial Crisis 2007, Keynes, Money-Manager Capitalism, Hedge Finance, Speculative Finance, Ponzi Finance, Securitization, Uncertainty, Liquidity Preference, Economic Policy, Deregulation, Endogenous Instability, Asset Bubbles.
Frequently Asked Questions
What is the core subject of this paper?
This paper focuses on explaining the 2007 financial crisis through the lens of Hyman P. Minsky's "Financial Instability Hypothesis."
What are the primary thematic fields covered?
The paper covers macroeconomic theory, financial market stability, the evolution of capitalism, and the role of financial institutions in economic cycles.
What is the primary objective of the research?
The goal is to prove whether the 2007 crisis was the result of endogenous instability within the economic system as described by Minsky.
Which scientific methodology is utilized?
The paper employs a qualitative analysis of existing economic theories and literature, specifically applying Minsky’s cyclical models and financing structures to historical data.
What does the main body discuss?
The main body examines the theoretical background of the FIH, identifies different financing structures (Hedge, Speculative, Ponzi), and analyzes the real-world evolution of the 2007 crisis.
Which keywords characterize the work?
Key terms include Financial Instability Hypothesis, Ponzi Finance, Money-Manager Capitalism, Endogenous Instability, and Securitization.
How did Minsky define the 'Ponzi' financing structure?
Minsky defined Ponzi finance as a structure where an economic unit cannot meet its debt obligations (interest or principal) from its net cash flows, making it highly dependent on rising asset prices or new inflows of capital.
What is the significance of the 'Big Government' and 'Big Bank' concepts?
These concepts refer to Minsky’s policy recommendations: Big Government provides stability through fiscal policy, and Big Bank (the central bank) acts as a lender-of-last-resort to prevent debt deflation during crises.
- Arbeit zitieren
- Tim Borneck (Autor:in), 2015, The financial crisis. A crititcal analysis of its causes and consequences, München, GRIN Verlag, https://www.grin.com/document/320269
