A Minsky Meltdown: Lessons for Central Bankers

I’ve read quite a bit of Minsky’s work and I recommend you check out this paper from the San Fran Fed.

About Hyman Minsky (Via Wikipedia)

Hyman Minsky(September 23, 1919, Chicago, Illinois – October 24, 1996), was an American economist and professor of economics at Washington University in St. Louis. His research attempted to provide an understanding and explanation of the characteristics of financial crises. Minsky was sometimes described as a post-Keynesian economist, because, in the Keynesian tradition, he supported some government intervention in financial markets and opposed some of the popular deregulation policies in the 1980s, and argued against the accumulation of debt. His research, nevertheless, endeared him to Wall Street.

Article Introduction (Via Federal Reserve Bank Of San Fran)

Central to Minsky’s view of how financial meltdowns occur, of course, are “asset price bubbles.” This evening I will revisit the ongoing debate over whether central banks should act to counter such bubbles and discuss “lessons learned.” This issue seems especially compelling now that it’s evident that episodes of exuberance, like the ones that led to our bond and house price bubbles, can be time bombs that cause catastrophic damage to the economy when they explode. Indeed, in view of the financial mess we’re living through, I found it fascinating to read Minsky again and reexamine my own views about central bank responses to speculative financial booms.

One of the critical features of Minsky’s world view is that borrowers, lenders, and regulators are lulled into complacency as asset prices rise.  It was not so long ago—though it seems like a lifetime—that many of us were trying to figure out why investors were demanding so little compensation for risk. For example, long-term interest rates were well below what appeared consistent with the expected future path of short-term rates. This phenomenon, which ended abruptly in mid-2007, was famously characterized by then-Chairman Greenspan as a “conundrum.”  Credit spreads too were razor thin. But for Minsky, this behavior of interest rates and loan pricing might not have been so puzzling. He might have pointed out that such a sense of safety on the part of investors is characteristic of financial booms. The incaution that reigned by the middle of this decade had been fed by roughly twenty years of the so-called “great moderation,” when most industrialized economies experienced steady growth and low and stable inflation. Moreover, the world economy had shaken off the effects of the bursting of an earlier asset price bubble—the technology stock boom—with comparatively little damage.

Additional Excerpt (Via Federal Reserve Bank Of San Fran)

The severity of these financial and economic problems creates a very strong case for government and central bank action. I’m encouraged that we are seeing an almost unprecedented outpouring of innovative fiscal and monetary policies aimed at resolving the crisis. Of course, fiscal stimulus played a central role in Minsky’s policy prescriptions for combating economic cycles. Minsky also emphasized the importance of lender-of-last-resort interventions by the Federal Reserve, and this is a tool we have relied on heavily. I believe that Minsky would also approve of the Fed’s current “credit easing” policies. Since the intensification of the financial crisis last fall, the Fed has expanded its balance sheet from around $850 billion to just over $2 trillion and has announced programs that are likely to take it yet higher. In effect, the government is easing the financial fallout resulting from virulent deleveraging throughout the private sector by increasing its own leverage in a partial and temporary offset.

Click Here To Read The San Francisco Fed On The Minsky Meltdown

About Miguel Barbosa

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18. April 2009 by Miguel Barbosa
Categories: Curated Readings, Finance & Investing | Leave a comment

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