Cyclical Theories of Financial Crises
The purpose of this chapter is to set out the main theories and concepts that have been developed to explain the phenomenon of financial crises. No attempt has been made to be exhaustive; rather, the emphasis is on the major theoretical viewpoints of writers who approach financial crises from the perspective of the business cycle.
Theorists of the late nineteenth and early twentieth centuries have been included, as mentioned in the Introduction. The assumption is that at least some basic processes involved in financial crises are due to the fundamental workings of an industrialized capitalist economy. Also, much of the work on financial crises that has taken place recently has proceeded without specific reference to the insights of the theorists who wrote during the time when financial crises were more severe. This book hopes to remedy that defect to some extent by investigating the ideas of those earlier theorists. More contemporary theorists, of course, are also discussed.
An analysis of financial crises was developed in 1904 by Thorstein Veblen, the founder of the institutionalist approach within economics. His theory of financial crises is based upon the effects of movements in the rate of profit upon the extension of credit. 1
Veblen stresses the central role of profits. For him, profit considerations dominate business decisions, and the degree to which profits are realized can affect the overall economy: "Times are good or bad according as the process of business yields an adequate or inadequate rate of profits." He distinguishes between two types of credit: (1) "deferred payments in the purchase and sale of goods" (what today we would call trade credit) and (2) "loans or debt—notes, stock shares, interest-bearing securities, deposits, call loans, etc." 2 His view is that