Longer Waves in Financial Relations: Financial Factors in the More Severe Depressions II

Article excerpt

Moses Abramowitz, testifying in 1939 before the path-breaking hearings chaired by Senator Paul Douglas on "Employment, Growth and Price Levels," said "it is not yet known whether they (the long swings) are the result of some stable mechanism inherent in the structure of the U.S. economy, or whether they are set in motion by the episodic occurrence of wars, financial panics or unsystematic disturbances" [U.S. Congress 1959, 12].

In reading these hearings for a review article [Minsky 1961], I took exception to Abramowitz's casual identification of financial panics as exogenous, episodic elements in the generation of the cycles of experience. In a 1963 presentation to the American Economics Association, I argued that there is a mechanism in capitalist economies that has generated the longer swings in economic experience. This mechanism centers around the need for firms to finance investment spending and positions in capital assets externally and the cumulative changes in financial variables that result over the long swing expansions and contractions.(1)

The model that underlaid my 1963 paper is still attractive, even though it was based on the simple Hansen-Samuelson interaction between the accelerator and the consumption propensity. Let us suppose that the investment and consumption interactions combine to form a process that, if unconstrained, leads to an explosive expansion or decline of prices, output, or employment. But, in fact, the usual outcome is that an explosive increase or decrease does not happen. Containing factors enter that constrain what happens to what is economically possible or politically palatable.

As reasonable values of the parameters of the endogenous interactions lead to an explosive endogenous process, and as explosive expansions and contractions rarely occur, then constraints by devices such as the relative inelasticity of finance or an inelastic labor supply need to be imposed and be effective in generating what actually happens [Ferri and Minsky 1992]. The relative inelasticity of finance can lead to a decrease in the rate of increase of investment and an increase in the carrying costs of both inherited short-term debt and new long-term debt. An inelastic labor supply can lead to wage increases that absorb an increased proportion of gross revenues. These reactions constrict the cash flows that are available to fulfill payment commitments on inherited debts and may well trigger liquidity and solvency crises.

In this way of looking at the economy, the "parts" of the economic process that are ignored as the "formal model" is set up enter the argument by setting floors and ceilings, which can thwart the full realization of an endogenously determined explosive expansion or contraction. What happens is constrained to be consistent with those economic conditions that were set aside as the formal intertemporal model was set up.(2)

The model is one that combines processes that endogenously generate explosive expansions or contractions and constraints, which are determined by policy and institutional elements that were left out of the formal model. The mathematical interpretation of such a model is that when constraints or policy interventions become effective, the endogenous process is stopped and restarted with initial conditions that reflect the constraints and the interventions. The results of the interactions between endogenous processes, represented by a formal model, and constraints and interventions that are due to institutional characteristics that had been placed in a Marshallian-type bag of caeterus paribus when the formal model was set up, are contained cycles, if the constraints and interventions hold.(3)

Questions concerning what determines the "constraints" and "interventions" and what limits there are on the efficacy of the "constraints" and "interventions" are opened by this approach. The constraints and interventions are embodied in legislated institutions and usages that reflect the interpretation of what went wrong with the economy that ruled when the legislation was enacted. …