Amplification of Debt
Updated: Sep 25, 2019
Minsky proposed theories linking financial market fragility, in the normal life cycle of an economy, with speculative investment bubbles endogenous to financial markets. Minsky stated 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, even to companies that can afford loans, and the economy subsequently contracts.
This slow movement of the financial system from stability to fragility, followed by crisis, is something for which Minsky is best known, and the phrase "Minsky moment" refers to this aspect of Minsky's academic work.
Minsky's model of the credit system, which he dubbed the "financial instability hypothesis" (FIH), incorporated many ideas already circulated by John Stuart Mill, Alfred Marshall, Knut Wicksell and Irving Fisher. "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 cycles."
Disagreeing with many mainstream economists of the day, he argued that these swings, and the booms and busts that can accompany them, are inevitable in a so-called free market economy – unless government steps in to control them, through regulation, central bank action and other tools. Such mechanisms did in fact come into existence in response to crises such as the Panic of 1907 and the Great Depression. Minsky opposed the deregulation that characterized the 1980s.
All the above can be found on Wikipedia. For me, Irving Fisher and Hyman Minsky understood the role debt plays in an economy. The Great Financial Crises proved his theory correct, while McCulley, Bernanke and the Federal Reserve economists proved academically inept.
For me, Fisher and Minsky focused on debt. Debt created the death of over levered enterprises. And each death begat another.
Now for the great failing of the debt hypothesis!!!