of Financial Capitalism
The late Hyman Minsky (1919–1996) was a
leading authority on monetary
theory and financial institutions. For much of Minsky’s career,
economics paid little attention to the role of the financial system in
macroeconomic theory. But in recent years, there has been an
of new research, both theoretical and empirical, much of which
his remarkable insights.
Following is a digest of a paper* by Papadimitriou and
Wray, that briefly
outlines Minsky’s views on modern capitalist systems.
Capitalism is constantly evolving. We can identify
stages in its evolution going back to the early 1600s. Today,
is quite different from what it was just 30 years ago, and it may now
in the process of evolving into a new stage through
The one constant throughout is the profit-seeking motive in money terms
that leads to continual innovation, especially in finance. Firms
spend money to earn more money.
Financial institutions play a critical but delicate
role, since they
are themselves profit-seeking enterprises. They not only supply
funds, but may have a direct stake in the potential profits of the
Banks increase the money supply whenever they share the belief of the
that positions in assets or financed activity will generate sufficient
cash flows. Money is thus created as a result of normal economic
The Key Role of Firms
A modern economy is ultimately dependent on the
viability of its firms,
all of which are owned by the household sector, and which provide the
source of household income as wages. The
focus should therefore be on firms, not households, and on investment
its finance, not on consumption and saving out of household income flows.
This is in sharp contrast to the exposition found in textbooks, which
with households and their consumption versus saving decision, with
determining investment and therefore growth.
Two Price Model
Minsky’s analysis involves two sets of prices. One
of the prices of current output -- consumption, investment,
and export goods and services. The other set is the prices of assets--
capital assets used by firms in production and financial instruments
firms issue to gain control of fixed and working capital. The
set of prices is critical in determining how much investment will be
The two sets of prices reflect what happens in two different sets of
and thus will vary independently. This is in marked contrast to the
price system of the consumption versus investment model typically used
Spending on investment depends on the demand price of
(what firms are willing to pay) relative to supply prices (what
require to produce them). For capital assets to be produced and
generate profits, demand prices must exceed supply prices by enough to
cover the risks. The resulting investment will then validate
investment. Investment today determines whether investment
was a good idea. But investment today depends on expectations
the future regarding demand and supply prices of investment
Whether there will be aggregate profits to distribute depends on
The Role of Profits
Capitalism involves the acquisition of expensive assets
necessitate financing of positions in those assets. A firm must
sufficient market power to assure lenders that it will earn enough to
its financial liabilities. Thus a goal of every firm is to gain
power in order to control its markup. The ability to set price is
critical in determining who gets credit.
At the micro level, each firm must be able to obtain a
markup over labor
costs. However at the macro level there won’t be any profit
there is spending in excess of aggregate wages in the consumption
Aggregate profit of firms is equal to the sum of investment plus
out of profits, plus the government’s deficit, plus the trade surplus,
less saving out of wages.
In the simple case with no government deficit, no trade
no saving out of wages, capitalist profit equals investment plus
consumption. As long as the price is set high enough that workers
cannot buy all the output, capitalists can get the rest so
long as they spend. The amount of surplus available at
the aggregate level depends on the aggregate markup. It is
spending on investment that generates the profit, and validates the
capital. Neither thriftiness nor technology has anything to do
Financial Positions of a
Minsky defines three financial positions of increasing
Over a protracted period of good times, economies tend to move from a
structure dominated by hedge financing to a structure with increasing
and Ponzi financing. The shift toward speculative positions
intentionally and more or less inevitably because of the way in which
in a boom enhances expectations. However the shift from
toward Ponzi finance is usually unintentional.
- Hedge finance: income flows are expected to
meet financial obligations
in every period.
- Speculative finance: the firm must roll over
debt because income
flows are expected to only cover interest costs.
- Ponzi finance: income flows won’t even cover
interest cost, so the
firm must borrow more or sell off assets simply to service its
Business cycles are endogenously generated, and are not
due to shocks.
In large part they are due to the interplay between the two price
and the way the financial system naturally evolves toward
Exogenous effects can precipitate a crisis, but only when the system
already evolved to a fragile position.
Conventional wisdom argues that the economy is naturally
the invisible hand guiding the economy to equilibrium. Rather
treating institutions as contributing to stability, orthodoxy views
as barriers to achieving equilibrium. Minsky argues that
and interventions thwart the inherent instability of financial
by interrupting the endogenous process and restarting the economy under
more favorable conditions.
As Minsky observed, capitalism is inherently
unstable. As each
crisis is successfully contained, it encourages greater speculation and
risk taking in borrowing and lending. Financial innovation makes
it easier to finance various schemes. To a large extent,
and lenders operate on the basis of trial and error. If a
is rewarded, it will be repeated. Thus stable periods naturally
to optimism, to booms, and to increasing fragility.
A financial crisis can lead to asset price deflation and
of debt. A debt deflation, once started, is very difficult to
It may not end until balance sheets are largely purged of bad debts, at
great loss in financial wealth to the creditors as well as the economy
Big Government and Big
Before World War II, government spending was no more
than 3% of GNP.
Whenever the economy faltered, there was little countercyclical deficit
spending to offset the loss in private spending. The era was
by several depressions. Government has since grown to more than
of GNP. Its spending effectively sets ceilings and floors on
of current output, helping to constrain the natural tendency of
demand toward boom and bust cycles. It is notable that there has
been no depression in the Big Government era.
Government deficits may not be sufficient to prevent a
If one occurs on a large enough scale, asset prices can become so
that revenue from sales of assets does not permit servicing of
Defaults can spread and bring down more creditors. Minsky argues
that the prevention of such a financial crisis is the primary purpose
the central bank and not, as orthodoxy assumes, control of the money
or inflation. To reduce the moral hazard effects, any lender of
resort activity must be accompanied by Big Bank supervision of balance
* Working Paper No. 275, Minsky's Analysis
of Financial Capitalism, by Dimitri B. Papadimitriou and L.
Wray, of Jerome Levy Economics Institute, July 1999.