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www.routledge.co m an infor mabusiness
Rnancial Dynamics
and Business Cycles
Financial Dynamics
and Business Cycles
New Perspectives
Edited by
Willi Semmler
~l Routledge
m~ Taylor & Francis Group
LONDON AND NEW YORK
First published 1989 by M.E. Sharpe.Inc
Published 2016 by Routledge
2 Park Square, Milton Park, Abingdon, Oxon 0X14 4RN
711 Third Avenue, New York, NY 10017, USA
Routledge is an imprint of the Taylor & Francis Group, an informa business
Copyright © 1989 by Taylor & Francis. All rights reserved.
No part of this book may be reprinted or reproduced or utilised in any form or by
any electronic, mechanical, or other means, now known or hereafter invented,
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Notices
No responsibility is assumed by the publisher for any injury and/or damage to
persons or property as a matter of products liability, negligence or otherwise, or
from any use of operation of any methods, products, instructions or ideas contained
in the material herein.
Practitioners and researchers must always rely on their own experience and
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used only for identification and explanation without intent to infringe.
Library of Congress Cataloging-in-Publication Data
Financial dynamics and business cycles : new perspectives / edited by
Willi Semmler.
p. cm.
Bibliography: p.
ISBN 0-87332-531-1
1. Business cycles—Mathematical models. 2. Economic stabiliza
tion—Mathematical models. 3. Debts, External—Mathematical models.
I. Semmler, Willi.
HB3722.F56 1989 88-30857
338.5'42'0724-dc 19 CIP
ISBN 13: 978-0-87332-531-8 (hbk)
Contents
Foreword
Hyman P. Minsky vii
Introduction
Willi Semmler xi
I
Basic Models on Nonlinear Dynamics and Financial Instability
A Minsky Crisis
Lance Taylor and Stephen 0 'Connell 3
Finance, Instability, and Cycles
Michael Woodford 18
Debt-Financing of Firms, Stability, and Cycles in a
Dynamical Macroeconomic Growth Model
Reiner Franke and Willi Semmler 38
Accumulation, Finance, and Effective Demand
in Marx, Keynes, and Kalecki
Anwar Shaikh 65
The Real and Financial Determinants of Stability:
The Law of the Tendency Toward
Increasing Instability
Gerard Dumenil and Dominique Uvy 87
II
Stabilization Policy in Nonlinear Dynamical Models
with Money and Finance
Comparative Monetary and Fiscal Policy Dynamics
Richard H. Day 119
Monetary Stabilization Policy in a Keynes-Goodwin
Model of the Growth Cycle
Toichiro Asada 145
Qualitative Effects of Monetary Policy
in "Rich" Dynamic Systems
Peter S. Albin 168
Debt Commitments and Aggregate Demand:
A Critique of the Neoclassical Synthesis and Policy
Steven Fauari and John Caskey 188
III
Empirical Evidence on Debt and Financial Instability
The Cyclical Behavior of Corporate Financial Ratios
and Minsky's Financial Instability Hypothesis
Christopher J. Niggle 203
Theories of Financial Crises
Martin H. Wolfson 221
The Political Economy of the External Debt and Growth:
The Case of Peru
Felix Jimenez and Edward J. Nell 228
Foreword
Hyman P. Minsky
As the 55th anniversary of the bank holiday of March 1933 approached, financial
instability was a main topic in the financial press. Daily reports appeared of
international debt crises, of the covert bankruptcy of deposit insurance, and of the
near bankruptcy of one great financial institution after another.
The great stock market crash of October 19 and 20, 1987, demonstrated that
extreme instability can happen. It is generally asserted that the consequences of
October 19th and 20th would have been disastrous if the Federal Reserve and
Treasury interventions had not set things right. As a result of these interventions,
subsequent asset prices and financing terms were different from what uncon-
strained markets would have generated. However, the various and assorted state-
ments in the financial press, even by exalted economists, are not clear on what
caused the free fall of the 19th and 20th, and on how the interventions that took
place led to more normal behavior of the economy and various financial markets.
In 1933, financial markets in the United States and throughout the capitalist
world collapsed. The bank holiday of March 1933 remains an extreme example of
a policy intervention that dominates market processes. But in the nice, polite, but
largely apologetic economics of the time, breakdowns such as occurred during
the period from October 1929 to March 1933 were not supposed to happen. This
position of the orthodox theory of the early 1930s is quite surprising, as financial
breakdowns had occurred with regularity ever since modern capitalism emerged,
with its expensive, long-lasting capital assets, markets in which activity and
positions in capital are financed, and entrepreneurial banks riding high on a crest
of new technology.
In the light of historical experience, the past 55 years are the anomaly. During
this time span, no financial or economic collapse has taken place which comes
close to the magnitude of either the great collapse of 1929-1933 or even that of
1907. However, the orthodox economic theory of today, like the apologetic
economics of the 1920s, does not offer a lucid account of why the economy is now
vii
viii HYMAN P. MINSKY
so much more stable than in the past. Why are income, employment, and price
level repercussions of the so-evident financial instability now contained?
In the early 1930s a race was on among the eminent economists of the day to
explain the great collapse as a normal result of interactions among the monetary,
production, and portfolio management spheres of the economy. The announced
aim of Keynes's research program was to develop a theory of a monetary produc-
tion economy that was rich enough to encompass a smoothly expanding economy,
a constrained cyclical economy, and an economy that from time to time collapses
into depressions or explodes into accelerating inflation. In the verbal exposition
of The General Theory, endogenously determined changes in liquidity preference
could lead to rapid movements in the relative prices of different types of assets
and of assets and output. In turn, these changes can lead to rapid and large
movements in output and employment.
In this exposition, it was quite clear that the properties of a capitalist economy
with banks and bankers of various sorts and debts denominated in money were
being examined. If the structure of indebtedness was sufficiently binding in such
an economy, then normal market reactions to excess supply could increase, not
decrease, the excess supply. Specifically, in a financially complex economy, wage
flexibility in response to unemployment could make things worse.
The General Theory carried the day as an explanation of why a capitalist
economy can work as well as the American economy did in the 1920s and as
miserably as it did in 1929-1933. In winning the day, The General Theory beat
out serious efforts by von Hayek, Myrdal, and Schumpeter, who also attempted to
integrate money with the financing of production.
The popular semi-mathematical statements of The General Theory, most par-
ticularly the successful IS/LM version of Hicks, transformed what was essential-
ly a complex nonlinear system of the verbal exposition, which showed that the
economy had various modes of possible behavior, into a nice, polite interdepen-
dent equilibrium system. In the hands of Patinkin, the Hicks version of Keynes's
theory was transformed into a system that sought and sustained equilibrium:
Keynes's theory was stood on its head. The dynamics of the macroeconomics that
emerged out of the Hicks-Patinkin tradition of interpreting Keynes was retro-
grade when compared to the various operational equilibria (market, short-period,
and long-period) of the Marshallian tradition in which Keynes worked. The
reason for this retrogression is that the mathematical exposition of The General
Theory in terms of a multi-market equilibrium was cut to the mathematical
competence of the economists of the day, which, to put it kindly, was limited.
Poor and largely irrelevant economics does no harm when the economy be-
haves so as to generate a largely smooth trajectory. In the first decades after World
War II, the financial structure was so robust that, in truth, money and financial
relations mattered very little. Quite by accident, the fiscal structure of the United
States during this period was such that modest, largely built-in deficits and
surpluses were sufficient to stabilize the economy. In the era of financial tranquil-
FOREWORD ix
ity, the basic message of Keynes-that the proper subject of economics is a
monetary production economy and that once in a while the normal functioning of
such an economy leads to deep and serious depressions-was lost.
In the 1980s, financial turbulence reappeared. The Federal Reserve no longer
could assume that playing around with the money supply was sufficient to stabi-
lize the economy. The lender oflast resort function became the dominant determi-
nant of the time and extent of Federal Reserve intervention. In the turbulent world
of the 1980s, the lack of relevance of the formal models, such as rational expecta-
tions that had achieved prominence in the 1970s, became evident. Fanciful
schemes to develop business cycle models on the basis of either no or poorly
conceived monetary relations emerged in the 1980s. The irrelevance of these
models became evident as financial turbulence and intervention to constrain the
effects of this turbulence became common.
Even as financial instability emerged as a dominant observation, the combina-
tion of the ability to simulate complex dynamical behavior and greater mathemat-
ical sophistication enabled economists, who were not wearing the blinders of
neoclassical orthodoxy, to develop dynamic models that were capable of generat-
ing the complex paths through time that the verbal exposition of The General
Theory encompassed. Mathematical formulations have finally caught up with the
theoretical results based upon a combination of close verbal reasoning of the
repercussions of profit maximization in a monetary production economy and a
close understanding of how capitalist economies behave.
The papers collected in this volume come from various backgrounds and
research paradigms. A common theme runs through these papers that makes the
collection both interesting and important: The authors take seriously the obvious
evidence that capitalist economies progress through time by lurching. Whether a
particular study starts from household utility maximization or from the processes
by which productive structures are reproduced and expanded, the authors are
united in accepting the evidence that financial instability is a significant charac-
teristic of modern capitalism.
If a theory holds that a capitalist economy is best thought of as a complex
interdependent system whose trajectory depends on initial conditions and an
internal dynamics that is capable of endogenously generating periods of incoher-
ence, then the question "Why is incoherence so rare?" moves onto the research
agenda. The obvious answer is that the impact of the institutional structure and
the system of interventions that result from this structure dominates the econo-
my's endogenous dynamics. This dominance can be interpreted as the intermit-
tent imposition of new "initial conditions." Coherence is observed not because
markets yield order, but because institutions and policy interventions dominate
markets. In the view that follows from this argument, though not all chapters in
the volume will agree on it, markets are social devices to adjust details of the
economy once the structures of intervention and regulation are in place that can
abort the full development of chaos.
