Does Minsky’s ‘financial instability hypothesis’ provide a useful explanation of the global financial crisis? Does it suggest possible policy action to respond to or prevent crisis?
The striking expansion of international finance and increased interdependence has risen the role of volatility in financial system and following the threats of a financial crisis.
This paper seeks to provide Minsky’s explanation of current crisis. It addresses the question “to what extent Minsky’s ‘financial instability hypothesis’ provide a useful analysis of global financial crisis and its measurement, and does it provide useful measurements?”
This paper agrees on Minsky’s idea that financial regulation is necessary to ensure economic stability, and argues his insights are helpful in understanding nature of financial crisis although it does not explain completely and adequately.
In addition to this introduction section, this paper includes six sections. The first section provides a changing finance environment in modern era which suits Minsky’s theory and offers a practical elements and background. The second and third explores Minsky’s financial instability hypothesis to explain the fragility and instability of financial system which building on the income-debt analysis in financial behaviour system. The second part analysis the income-debt flow As the invest expansion behaviour develops, optimistic expectation increase, the attitudes about proper level of debt and risk change, then financial system becomes increasingly fragile (Minsky, 1992). The third part gives a second look at Minsky’s income-debt relations to explain why financial crisis still occur under normal operations due to its inherent irrational expectations, actors’ inability to repay the future money in cash flows, not unusual events, and the development of financial fragility. The forth illustrates some limitation of Minsky’s ‘financial instability hypothesis’ in explaining financial crisis. The fifth section is Minsky’s measurements to financial crisis including a big bank and a big government. The final is a brief conclusion.
Section 1: Structural elements: a first look at Minsky’s ‘Financial instability hypothesis’
Financial innovation in two decades: the new financing market Three key developments in financial markets over the past two decades have gradually dismantled the gaps within financial markets and have raised its efficiency. But they have also greatly raised the potential for financial instability and following the threats of crisis (Edey, 1996).
Firstly, the process of globalization of financial service industries and the increased volume of the international capital flows have led in a striking increase of international financial transactions. The modern financial market provide both across borders and across market sectors in financial shocks business. For evidence, at the end of 1994, the stock of cross-border bank assets had increased more than 4.5 times comparing its situation in 1983. Further, the assets have rise from 20% of the GDP of OECD countries in 1980 to 35% in 1994. However, the effects of globalization process in financial markets are evidently beyond the scope of this article (Edey, 1996).
Secondly, widespread functional integration of banking and securities business has led to the operation combination between financial conglomerates and traditional banks and non-bank business, therefore leading a fusion of commercial and investment banking. The increasing tendency for the fusion is highly resulted from the deregulation policies in major financial centres including London, the United States and Japan. The motivation of the deregulation in those countries is that financial institutions, commercial business and government believe it is profitable through the integration (Edey, 1996).
Thirdly, financial innovation, particularly in the derivative products, has produced a new financial market which did not exist two decades...
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Wolfson, M.H., 2002, “Minsky’s Theory of Financial Crises in a Global Context, Journal of Economic Issues”, Vol 34, No.2, pp 393-400
Working Paper Online:
Minsky, H. P., 1992, “The Financial Instability Hypothesis,” May 1992, Working Paper no. 74, New York: Levy Economics Institute of Bard College, accessible on 10th May, 2013
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