Minsky: What Do Banks Do? What Should Banks Do?

Abstract Via L. Randall Wray

Before we can reform the financial system, we need to understand what banks do; or, better, what banks should do. This paper will examine the later work of Hyman Minsky at the Levy Institute, on his project titled “Reconstituting the United States’ Financial Structure.” This led to a number of Levy working papers and also to a draft book manuscript that was left uncompleted at his death in 1996. In this paper I focus on Minsky’s papers and manuscripts from 1992 to 1996 and his last major contribution (his Veblen-Commons Award–winning paper). Much of this work was devoted to his thoughts on the role that banks do and should play in the economy. To put it as succinctly as possible, Minsky always insisted that the proper role of the financial system was to promote the “capital development” of the economy. By this he did not simply mean that banks should finance investment in physical capital. Rather, he was concerned with creating a financial structure that would be conducive to economic development to improve living standards, broadly defined. Central to his argument is the understanding of banking that he developed over his career. Just as the financial system changed (and with it, the capitalist economy), Minsky’s views evolved. I will conclude with general recommendations for reform along Minskyan lines.

Excerpted Conclusion

Over past decades the belief that “markets work to promote the public interest” gained in popularity. Minsky questioned: but what if they don’t. Then a system of constraints and interventions can work better. He also believed that we need to make “industry” dominate over “speculation” (recalling Keynes’s famous dichotomy), and not vice versa, or the capital development of the economy will be ill done in two ways: the Smithian/Neoclassical way or the Keynes/aggregate demand way. If investment is misdirected, we not only waste resources, but we get boom and bust. If investment is too low, we not only suffer from unemployment, but also profits are too low to support commitments—leading to default. Further, when profits are low in “industry” then problems arise in the financial sector because commitments cannot be met. In that case, individual profit-seeking behavior leads to incoherent results as financial markets, labor markets, and goods markets all react in a manner that causes wages and prices to fall, generating a debt deflation. The Smithian ideal is that debt deflations are not endogenous, rather they must result from exogenous factors, including too much government regulation and intervention, so the solution is deregulation, downsizing government, tax cuts, and making markets more flexible. The Keynesian view is that the financial structure is transformed over a run of good times from a robust to a fragile state as a result of the natural reaction of agents to the successful operation of the economy. If policymakers understood this, they could formulate policy to attenuate the transformation—and then to deal with a crisis when it occurs.

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30. August 2010 by Miguel Barbosa
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