Sunday, April 25, 2010

Minsky as the Glue of an Austrian-Keynesian Synthesis?

Washington is buzzing about financial reform, and so Hyman Minsky has been on the table (well, the 19th Annual Minsky Conference helped with that too). Minsky was a Keynesian economist (usually classified as "post-Keynesian" because of his hostility to the neoclassical synthesis) that taught at Brown, Berkley, and the Washington University in St. Louis. His primary contribution was the idea of "financial fragility" - the fundamental instability of financial markets. He attributed this fragility to the division of borrowers into three groups: hedge borrowers (who can pay off principal and interest out of the cash flow from their investments), speculative borrowers (who can pay off the interest of the debt out of cash flow but must roll over the debt), and Ponzi borrowers (who can only pay off the debt from capital gains, not cash flow). Credit grows the economy, and as the economy grows more Ponzi borrowers are attracted to the market (they see asset values appreciating, which is essential to their strategy for paying debt). If asset values stop appreciating, Ponzi borrowers default and credit is restricted for hedge and speculative borrowers. If the shock is large enough, the Ponzi borrowers can bring down the system. It's a familair sort of story - it sounds a lot like animal spirits, accelerator-multiplier stories, and lots of other Keynesian dynamics. This one just depends on asset values and debt financing strategies.

And I had always associated it with Keynesians until this morning when I saw a post by Arnold Kling (a libertarian economist blogging at Econlog) that seemed to be suggesting that Krugman (in a post lauding Minsky, no less) positioned himself against Minsky. I think Kling's concern was that Krugman suggested that regulation might help fix the "financial fragility" problem. It's an odd thing for Kling to juxtapose with Minsky, since Minsky thought essentially the same thing!

But it did make me think about Minsky's relationship with more libertarian economists. There's actually quite a bit of common ground with Austrian credit cycles. Frank Shostak blogged on Minsky at the Mises Institute blog in 2007. His response was typical of Austrian answers to this sort of question - he argued that Minsky "described" the crisis but did not provide an explanation for why it started. What Shostak really means, of course, is that Minsky didn't provide the explanation that Shostak wanted him to provide. Minsky's system works on its own. Simple intertemporal choice theory gives us the reason for why debt financing emerges. Once you have debt financing, all you need is borrowers with different motivations and repayment strategies (Minsky's hedge, speculative, and Ponzi borrowers), and the system runs on its own: boom and bust, boom and bust. Debt and agent heterogeneity is all it takes. I'm not sure why Shostak can't see this, but regardless - he wanted Minsky to say that central banking was the source of the crisis, which Minsky did not say.

I'm starting to stray outside of territory that I'm familiar with, but it seems to me that a more Rothbardian take on the credit cycle is much more easily reconciled with Minsky. Rothbard recognized that it was the credit system itself, and not central banking in particular (although he of course had major critiques of central banking too) that introduced the business cycle. Rothbard of course took this more or less reasonable concern and went off the deep end with it. He alternatively advocated full reserve banking (!!!!!), and free banking (where banks would issue their own currency, and there would be no bank regulation or central banking). I can't imagine the cognitive dissonance that came with advocating both of those courses of action - one of the most restrictive forms of bank regulation one could think of on the one hand, and complete deregulation on the other. But they do seem to come from a common source for Rothbard: the acknowledgement of a fundamental cyclicality of the credit market.

So can Minsky - with his Keynesian explanation of credit cycles - offer an opportunity for the Austrian-Keynesian synthesis that I've written about in previous posts? My previous thinking on the issue has focused on: (1.) general framing: the shared concern about uncertainty, decentralized knowledge, and time, and (2.) the macroeconomy: a "Garrison-Modigiliani" synthesis of sorts.

But Minsky may offer another point of connection. I've previously remarked that Brad DeLong offers an important olive branch when he highlights the relevance of Austrian theory to pre-Depression business cycles. Of course, Austrian economists are often the type of people that simply don't know how to take a compliment. Because DeLong also critiqued a few of their points, they've generally interpreted his olive branch as a hostile attack! But Minsky goes beyond what Brad DeLong has conceded, and offers the possibility that Austrian (or at least Rothbardian) ideas on the credit cycle may be relevant after the Depression as well as before.

I think there's a lot that needs to be reevaluated before any of this happens - not the least of which being the Austrian's central bank fetish. That, of course, is a problem. Many Austrians think that their critique of central banking is what Austrian economics is. I actually disagree, and I think that's really selling the Austrian school short. The value added from Austrian economics, in my opinion, is the combination of the credit cycle with the temporalized capital structure, and the dynamics that that introduces. Their views on central banking, epistemology, and methodology (not to mention their views on Keynesianism) hinder the Austrian project.

I know this is still all very general, just like my last post on this sort of synthesis. I don't know what to say except for (1.) I have more specific ideas in my head that I am more hesistant to post explicitly, and (2.) I do intend to write them up at some point - but perhaps in the somewhat more distant future.

In closing, I found several interesting Minsky links:

- First, the Levy Economics Institute at Bard College is ground zero for Minskyesque economics today, and it offers a lot of interesting post-Keynesian perspectives.

- They have recently made Minsky's papers available online

- The New Yorker has an interesting piece on Minsky here.

- The Economist describes the proceedings of the Minsky conference (including a lot of what Krugman had to say) here.

- The Economist also describes the Fed's (probably somewhat self-serving) advocacy of Minsky here.


  1. You will remember I posted here a while ago on my thoughts about the similarities between Keynesianism (in particular the 'post-Keynesian' brand) and the Austrian school. I must say it is laudable that you have examined not only the Keynesian theories but also the ostensibly opposing ABCT as well.

    I believe Robert Murphy pointed to the Austrian emphasis on financial instability originating in credit markets, and not necessarily, as some of its less informed advocates belive, with the central banks (this was in his response to Australian Keynesian economist John Quiggin's amateurish 'takedown' of the Austrian school). if there was some mythical central bank that somehow managed to coordinate the supply of credit in such a way as to be perfectly in sync with that Wicksellian idea of the 'natural' rate of interest, perhaps the Austrians would have no choice but to begrudgingly accept such a proposal. But when has this ever been the case? Most central banks are either pumping up the money supply, or erroneously pursuing a 'stable price level' policy. Very few would care to find the so-called natural rate of interest. Which is why Austrians argue that this would better be approximated under a free-banking regime.

  2. As for the alleged cognitive dissonance in Rothbard's advocacy of both 100 percent reserve banking and free banking, the general theory is (and this has also been explicitly stated by Shostak) is that banks would be so risk averse under free banking that they would maintain nearly a 100 percent reserve ratio anyway. But then again, as I'm sure you are aware, many Austrians see no real problem with fractional reserve.

    I certainly do not agree with Rothbard's thesis (although I am, I must say, something of an anti-Rothbard Austrian economist). Australia in the 1800s had almost completely free banking, and although reserve ratios were quite healthy, they did not come close to approaching full reserve banking. And the system was still prone to crises, as the 1890s banking crisis demonstrated. But then again, I would argue that government and central bank involvement only makes things worse.

  3. Anyway, what I was going to say is that I would think at a fundamental level, Keynesianism and Austrian econ are incompatible. In Minsky's model (if I understand it correctly) the recession/depression comes about through a collapse in demand, i.e. it is still a "demand-side" theory. Austrian econ is, in a sense, "supply-side", and too firmly rooted in the ideas of the great classical economists for agreement to be reached on this fundamental level.

    In another post, you mention that there is nothing in Austrian econ that refutes Keynesian economics, and to a certain extent I agree. But that is because the basis for dismissing Keynesian ideas could easily be accomplished using the classical economists' toolbox. The classical definition of Say's law (i.e. not Keynes' crude AS=AD definition) and the emphasis it places on production and savings (not consumption) in increasing economic growth are enough to deal a mortal blow to Keynesianism. Even Hayek and Hazlitt's critiques of Keynesianism are based on arguments already well established by the classical economists. In fact, the best critic of Keynes, as far as I'm concerned, is James Ahiakpor, who is most definitely not an Austrian.

  4. Sebastian - great thoughts, and thank you for commenting. I would agree with you and Murphy that Austrian economics provides a general theory of a credit cycle, rather than simply a central bank theory of a credit cycle. However, I think I would pivot your emphasis a little on the "less informed advocates", and I'd also give Quiggin a bit of a reprieve. Although Murphy is right, I think the point is that the "less informed" facet is the tendancy to downplay natural credit cycles, NOT the critique of central banking. In otherwords, "less informed advocates" have committed an error of omission by neglecting credit cycles. There is nothing uninformed about their critique of central banking as far as ABCT is concerned. Such a critique runs throughout ABCT. I guess I'm simply saying that you can't just whitewash ABCT by calling it a credit cycle theory - the central banking critique is absolutely central to it, even if it doesn't encompass all of ABCT.

    I would also disagree with you on your point that in theory Austrians could support central banking. The whole basis of the Austrian critique of government is the "calculation problem". This is especially evident in Hayek, but you see it in Mises and others as well. The whole point is that a central bank can't perfectly target an ideal Wicksellian interest rate. I would emphasize that Keynesians generally agree with Austrians on this knowledge problem. I think there's a lot of misunderstanding and assumptions that we don't agree. The Keynesian argument isn't that monetary or fiscal authorities are better than private actors. The point is that macroeconomic dynamics present certain situations in which monetary and fiscal authorities can improve macroeconomic outcomes, even if they can't target perfectly.

  5. I agree with your assessment of Rothbard and I want to clarify that I do see him as being idiosyncratic in a lot of respects. I don't take him to be the voice of the Austrian school - but he is an important voice within the Austrian school. Critiquing him is a valid critique of the Austrian school in that sense. Similarly, I don't agree with everything that Lawrence Klein or JK Galbraith or Krugman or Stiglitz say - but they are important voices in Keynesianism, so I can't simply disown them. I have to say "sure, that's a valid critique of those guys and I disagree with those guys on these issues too, but that doesn't constitute a refutation of Keynesian theory". That seems to be your take on Rothbard too, and I think it's the right one.

    Are you particularly familiar with Australian monetary policy? I seem to remember hearing enthusiastic praise for Australian monetary policy (ie - relative to American) over the last several decades, but I'm not really familiar with the history there. As for what central banking did in Australia - some quick googling on my part suggests that the central bank was fairly restricted in its open market operations until about mid-century. So I think we need to be careful about comparing apples to oranges here. Not all central banks are created equal! If the Australian central bank had its hands tied on open market operations for much of its early existence, I have no doubt that it might not have improved things very much. Keynesians don't advocate the mere existence of a central bank - they want a central bank that can guarantee liquidity and stabilize domestic prices.

  6. On Minsky - I honestly haven't read much of Minsky himself, and I need to. I've read what others have written about him. I think it's "demand driven" in Keynes's "animal spirits" sense, but it doesn't seem to me to be demand-driven in the "effective demand"/AD sense. So I'm not quite sure the contradiction is a stark as you suggest. There's nothing un-Keynesian about supply side factors, anyway. I don't think the primary problem is that Keynesians look at demand and Austrians look at supply. I think it's that Keynesians accept the disjointedness of supply decisions and demand decisions and therefore are more receptive to the prospect of a "general glut".

    RE: "The classical definition of Say's law (i.e. not Keynes' crude AS=AD definition) and the emphasis it places on production and savings (not consumption) in increasing economic growth are enough to deal a mortal blow to Keynesianism."

    I have no idea what you could possibly mean by this. I'm not sure where this "consumptionist" meme got started with Keynesianism. Investment spending is as good for Keynesians as consumption is. Indeed - it is the erratic behavior of investment that is the source of all the problems in the Keynesian system, not a deficiency in consumption! Remember - for the Keynesian the concern is inadequate _demand_, not inadequate _consumption_.

    These are great thoughts, Sebastian - thanks so much for sharing them. Before I close, I want to emphasize the point of this post, and of the earlier Keynesian-Austrian synthesis post I wrote. It's not simply to "examine" ABCT, or to demonstrate that ABCT doesn't refute Keynesianism. If anything I've failed at examining them - I still feel like I have a lot to learn about ABCT. My point isn't to examine and refute, but to acknowledge ABCT. I like quite a bit of it, and I also dislike quite a bit of it. For me, this series of blog posts (and an article I'm currently working on) isn't an exercise in examination - it is really an exercise in synthesis. Keynesian ideas are "mainstream", but I think often fundamentally misunderstood or caricatured. Austrian ideas are out of the mainstream - and some of the more eccentric Austrian ideas keep it that way. I also get the sense that Austrians LIKE that distinction and insularity. I don't see that as a good thing. I'd like to see a more explicit consideration and incorporation of Austrian ideas.

  7. I think that the answer coming from the Austrian school is laughable: blaming the centralized banking while at the same time today they would be in favor of the bail-out. Centralized banking is stabilizing the system.

    Adam Smith was much closer to truth, and the truth is that the moment the credit pyramid collapses the system has been fixed by the forces of the market ("invisible hand").

    The only thing that the centralized banking and the help from the state do is to postpone the crisis. Practically it means that whatever bad would have happened over a course of 20 years happens in a short span of 5 years. The real problem is the borrowing itself. It is intrinsic to any economical system which is based on credit.


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