Theeconomic sector in the world has long been faced with variouschallenges. Countries have adopted different strategies in theireffort to curb the financial problems. The formations of tradingblocs such as the European Union have assisted in ensuring harmonizedtrading across the world. As a result of the trading blocs, there hasbeen a financial crisis that has affected member nations. Forexample, in the United States (U.S.), the global crisis of 2008changed the money and capital market up to a large extent. Thecurrent trends in the markets can well be explained through theinsights and works of the late Hyman Minsky. The explanations posedby Minsky need to be understood through both long-term swings and theconventional medium-term business cycles’ lens (Palley, 2011).Although his theory is an expansion of Keynesian economist, variousaspects have been incorporated into his theory. Keynes theory isbased on the logic behind macroeconomics and microeconomics.
Businesscycle depends on macroeconomics in defining the various features ofthe money and banking market. Various characteristics determine aneconomic cycle. They include expansion, peak, recession, trough andrecovery. The fluctuations in the economic activities are known asthe phases of the cycle. In this case, economic activities involvewages, production, investment, and employment. However, theprosperity and depression are the primary phases in the businesscycle with intermediary being characterized by peak, expansion,trough and recovery (Knell, 2015). Prosperity is characterized byhigh level of actual demand, income, investment, employment, output,and trade. There is also a rising inflation and interest rates. Thehigh level of economic activities during this period translates toincrease in prices and profits. Moreover, there is a steady rise inGross National Product (GNP) because all the resources are fullyemployed in the process (Palley, 2011). Prosperity is also known asboom period. On the other hand, depression is characterized by adecrease in demand, consumption, interest rate, and employmentopportunities. In this case, there is underutilization of resourcesin the economy which directly translates to fall in GNP. As theprices and profits in the market continue falling in the economy,they reach a low point known as trough (McCulley, 2009).
Minskytries to expound on the relationship between financial instabilityand business cycles tried to expand Keynes theory on macroeconomicsthrough the financial instability hypothesis (McCulley, 2009). Minskytheory was solely based on the difference between stabilizing anddestabilizing capitalist debt structures. The theory carries threedistinct relations namely hedge, speculative and Ponzi finance. Hedgefinancing implies the ability to fulfill contractual payment ofobligations by their various cash flows. These mean that there is ahigh likelihood of a unit being hedge finance if they have a greatweight of equity financing (McCulley, 2009). Speculative financeunits are those units which have the ability to meet their respectivepayments obligations on their liabilities though they may beconstrained to repay the principal out of income cash flows. Ponziunits are whereby the various cash flows arising from operations donot meet the repayment of interest and principal. These units cansell their assets or borrow to pay interest (Palley, 2011). Thephases of business cycle such as expansion and peak can relate tohedge financing because the economy is in equilibrium and containingsystem (Knell, 2015). Conversely, when there is a high speculativeand Ponzi finance, it means that the phases of recession and troughare in place.
Thereare two theorems of explaining financial instability theorem in theeconomy and its relationship to the business cycle in place. Thefirst theory states that the economy regime is characterized byfinancing regimes which may either be stable or unstable (McCulley,2009). The economy may only exhibit single cycle at a particulartime. The stable financial regime will mean prosperity while unstablewill mean depression. Alternatively, the second theorem states thatwith the prolonged periods of prosperity, there will reach a timewhen the economy will transit from the stable to the unstable system(McCulley, 2009). For example, when the economy reaches the peak ortrough it will automatically respond by either transitioning to astable or unstable system through recession and depression (Knell2015).
Minskyproposes that the ability to accurately understand the short andlong-term dynamics entailed in a business cycle depends onunderstanding the financial relations to the given theorems (Palley,2011). Moreover, the profit-seeking individuals and corporationscontribute a lot to the evolution of the economic structures. Fromthe above ideologies, one can deduce that financial instabilityhypothesis is concerned about evolutionary economics (Knell, 2015).It is not only about the effective demand in the capital and monetaryeconomy. Minsky is known for his contribution and ability to linkfinancial market vulnerability with speculative investment finance.Minsky argues that capitalists’ economies highly influence businesscycle. There are two price systems in the capitalist economy. One ofthe cost systems is based capital assets value which relies on thepresent value of expected (Knell 2015). The other is based on thelevel of current output. The business cycle occurs because of thecomplex capitalist`s economies. The economic system should have theability to evolve depending on the real calendar time (McCulley,2009). During the prosperity phase, the financial markets are stableas evident by the rising stock prices and interest rates. It impliesthat investors are lured to take more risks. When people make moremoney, they tend to take more risks in the market (Palley, 2011). Ifevery investor takes up the risk, their premiums will shrink whilethe value of collateral steadily goes up. When the peak is reached inthe capitalist economy, inflations and debt deflations will be feltwhich at times may spin out of control (Knell, 2015).
Thehedge, speculative and Ponzi finance determines the strength andweakness of the economy’s financial structure (McCulley, 2009). Inturn, the strengths and weaknesses provide the ranging ups and downspresented in the business cycle. Hedge and Ponzi finance unitsprovide more strength and weakness respectively. Ponzi finance issimilar to depression in that when it becomes prevalent, it oftenresults in the collapse of financial institutions. The 2008 mortgagecrisis was attributed to the persistence of Ponzi finance in theeconomy structure (Knell 2015). The periodic shifts in the stabilityand instability create endogenous business cycles. The internaldynamics of the capitalist economies are responsible for thefluctuations in the economy (McCulley, 2009). The swings from thehedge financing to Ponzi financing is related to depression andrecession. However, the weight of the speculative and Ponzi financeunits will have a positive and adverse effect on the extent ofrecession.
Theworld economy and financial structure have come a long way since theGreat Depression. Most nations have adopted strategies such as thecreation of trading blocs as means to cushion themselves from thefuture economic crisis. Minsky expansion of Keynesian theory hashelped in understanding the dynamics in the financial market.Business cycles components of expansion, peak, recession, trough andrecovery are important in explaining the effects of capitalisteconomies in the financial structure of a country.
Knell,M. (2015). Schumpeter, Minsky and the financial instabilityhypothesis. Journalof Evolutionary Economics, 25(1),293-310.
McCulley,P. (2009). The shadow banking system and Hyman Minsky`s economicjourney.
Palley,T. I. (2011). A theory of Minsky super-cycles and financialcrises. Contributionsto Political Economy,bzr004.