Hyman Minsky and the Financial Instability Hypothesis

Hyman Minsky and the Financial Instability Hypothesis

Luz A comas

Strayer University

Professor: Michael Hamuicka

Financial Management – FIN 534

05/05/2011

Abstract

The current turmoil on the Stock Market has taken a lot of people by surprise. One person who, were he alive today, wouldn’t be the least bit surprised, is Hyman Minsky, who predicted that events like this would be a regular feature of a deregulated financial system. He developed what he called “The Financial Instability Hypothesis”, and anyone who wants to understand today’s events needs to know about it.

The following is just an introduction to Minsky's ideas. Minsky’s research focused on understanding and explanation of financial crisis.

Minsky claimed that in prosperous times, when corporate cash flow rises beyond what is needed to pay off debt, a speculative euphoria develops, and soon thereafter debts exceed what borrowers can pay off from their incoming revenues, which in turn produces a financial crisis. As a result of such speculative borrowing bubbles, banks and lenders tighten credit availability, like right now, even to companies that can afford loans, and the economy subsequently contracts.

Hyman Minsky and the Financial Instability Hypothesis

Hyman Minsky, Ph.D. (1919 – 1996), was an economist and professor at Washington University in St. Louis, but stayed in New York during last 10 years of his life. A few years ago, almost no one heard of him, until the current credit crisis. With the recent subprime mess, suddenly his theory becomes a lot more pertinent and popular these days.

Minsky's core model is known as "Financial Instability Hypothesis" (FIH), which simply declares stability is inherently destabilizing. "A fundamental characteristic of our economy," Minsky wrote in 1974, "is that the financial system swings between robustness and fragility and these swings are an integral part of the process that generates business...