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posted on 11 March 2016

Minsky Thought Banking Should Be Restructured - In 1994

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Joe Bongiovanni sent me the link to a working paper by Hyman Minsky, Financial Instability and the Decline (?) of Banking: Public Policy Implications (Working Paper No. 127, The Jerome Levy Economics Institute of Bard College, 1994) after reading the GEI News article Minsky in New York.

Minsky was concerned in the early 1990s that what he thought were the two roles of banking in a capitalist society were being performed to a decreasing extent by organizations that were chartered as banks.

hyman.minsky.380x280

The two primary functions of banking he describes as

  • supplying the means of payments; and

  • channeling resources into the capital development of the economy.

Minsky argued that this separation of banking from the real economy would diminish the role of central banks in influencing the economy in the traditional manner through monetary policy. Given this loss of influence through the traditional tools of "changing the availability or cost of financing". He felt that the variable remaining would be management of "uncertainty".

He argued that the changes in banking required regulation to be rethought:

The decrease in the weight of banks in financing the capital development of the economy tends to increase the significance of the Securities and Exchange Commission relative to that of the Federal Reserve System. That some major organizations that are chartered as commercial banks operate more like investment banks is an issue bond rating firms are facing, even as our regulatory structure for banks remains frozen and unchanging. The policy problem that emerges from the decline in the relative importance of institutions chartered as banks is whether the existing institutional structure of regulation and supervision of financial institutions needs to be changed in a serious way.

Minsky criticized the orthodox neo-classical (mainstream) economic theory. He said these theories dealt with money as an economic "neutral" in economic systems existing in equilibrium conditions rather than what he considered in his financial instability hypothesis (see further reading below) in which "the economy is viewed as a set of interacting, interdependent processes that generate the path of the pertinent economic variables through real time". Most of the time the progression of the economy through time progressed "often tranquil" but occasionally the "interacting processes generates turbulent conditions as well as incoherent behavior". His summary:

This theory holds that periods of incoherent behavior occur as a natural outcome of the interactions between flows of income, payment flows due to financial commitments and the prices of assets as determined in markets. These interactions reflect the essential characteristic of a capitalist economy, that it is simultaneously an income generating system and a financial system.

Minsky saw over-indebtedness of the private sector as a key element in the creation of conditions of instability. He drew extensively on the work of John Maynard Keynes and Irving Fisher in formulating his theory, but felt that what he saw as new technology driven environments for banking indicated that the very structure of the institution should be reevaluated. He wrote:

In the past, serious changes were the result of serious public inquiries. I suggest that enough is amiss in our financial and banking structures that it is time to go back to the drawing board and determine what the monetary, financial, and financing arrangements should be in the 21st century. A late 20th century National Monetary Commission should be on the public policy agenda.

In view of what has happened since 1994, the call for a "National Monetary Commission" was more than prescient. Of course, one major financial crisis later there has still been no such commission. Nor does one seem likely. Some will point to the Dodd Frank Act of 2010, but this, we maintain, was no reform of banking. It still has the same structure with minor tinkering around the margins which opponents have been systematically trimming away.

Further Reading:

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