Friday, May 22, 2015

Minsky and Keen: for an economic understanding fit for the 21st century?

During his lifetime, Vincent van Gogh (1853–1890) was a marginal figure in the art world, little-known outside of his immediate circle. After his death, he would go on to become one of the most influential and revered figures in 20th century painting.

Hyman Minsky grew up in the US during the Great Depression of the 1930s, and lived until 1996. Like van Gogh, he remained on the margins of his field, macroeconomics, throughout his life. Eschewing mainstream economists' assumptions of dispassionate rationality on the part of lenders and borrowers, Minsky instead proposed a hypothesis of financial instability, based on a distinction between three types of borrowers

  • 'Hedge' borrowers - borrowers who can cover their debts with current cash flows from investments
  • 'Speculative' borrowers - borrowers who can cover the interest payments for their debts, but not the debt itself, with current cash flows from investments
  • 'Ponzi' borrowers - borrowers who can cover neither the interest nor the debt with current cash flows, but must instead rely on their investments increasing in value to enable them to finance the debts

You can read more about Minsky's financial instability hypothesis here (PDF). Hopefully, though Minsky himself was not around to see it, the relevance of his hypothesis in a world reshaped by the financial crisis of 2007-08 is clear from the above!


Steve Keen, an Australian economist who is currently professor of economics at Kingston University, UK, is one of a very select group who predicted the financial crisis before it hit. In the first edition of his book Debunking Economics, published in 2001 and focused on critiquing mainstream economic orthodoxy, Keen wrote that the US was vulnerable to a debt-induced recession (pg254) and predicted the potential of the limits on budget deficits imposed by the Maastricht Treaty to worsen the impact of the recession in the Eurozone (pg212-13).

Keen, informed by his study of Minsky, understood the roles of speculation and private debt in generating instability in a way that other mainstream economists, who failed to anticipate the crisis, did not.

So, what does Professor Keen have to say about the economic policies of the UK government – and, for that matter, the "austerity-lite" proposed by candidates for the post of leader of the opposition – in 2015? 

Well, he doesn't pull any punches in this interview with Chris Menon (everyinvestor.co.uk):
You can't think about the economy and the government's role in the economy like a child might think about a household budget, which is all that's being sold by politicians of both sides...

By focusing on [public debt], and trying to reduce [it], they're likely to first of all push the economy into another slump, but also - if they actually succeeded in holding that level of surplus they're both fantasising about, they'd cause the next financial crisis that way - or, cause a serious decline in economic activity.

They certainly won't cause what they both argue it'll cause, which is sustained economic growth.


If more economists and politicians had listened to Steve Keen in the 2000s, perhaps the financial crisis could have been avoided. Hopefully it's not too late to change course and prevent the next one...

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