Week 2 summary of our 'Important Economists' series

In Week 2 of our 'important economists' Twitter series, we covered Louis Bachelier, Joseph Schumpeter, Robert Solow, Hyman Minsk, Irving Fisher, and John Maynard Keynes. Minsky clearly generated the most engagement so here is an introduction to his work.

Hyman Minsky (1919-1996) was an American economist who is best known for his research on financial instability and the causes of economic crises.

Minsky argued that stability in financial markets can lead to instability over time. He proposed a theory known as the "Financial Instability Hypothesis," which suggests that periods of stability and prosperity in the economy tend to encourage risk-taking behavior by market participants. This behavior can eventually lead to a buildup of debt and speculative investment that exceeds the capacity of borrowers to repay.

Minsky argues financial crises are endogenous: periods of stability create a fragile financial structure that is susceptible to a sudden loss of confidence. He identified three types of firms: the hedge firms, which can meet all cash payment liabilities with cash receipts; the speculative firms, which have some liquidity issues in the short-term and may need to refinance some short-term liabilities; and finally, the Ponzi firms, which must borrow to meet current interest payments and continually increase their outstanding debt (Wolfson, 2002).

As debt levels rise, there comes a point where some borrowers become financially fragile. A Minsky moment refers to a sudden and severe collapse in asset prices and the ensuing financial crisis. A Minsky moment occurs when confidence in the economy or a particular asset class collapses. It could be triggered by an external shock, such as a sharp decline in asset prices, a burst of a speculative bubble, or a sudden increase in interest rates. When this happens, investors and lenders start to panic, leading to a widespread decline in asset prices, tightening of credit conditions, and a wave of defaults.

During a Minsky moment, the fragility and instability that have been building up in the financial system become apparent. The crisis reveals the excessive debt burden, weak underwriting practices, and vulnerabilities created during the preceding period of economic stability. It can have severe consequences for the broader economy, including recessions, bankruptcies, and a contraction of credit, as the financial system tries to deleverage and restore stability.

Minsky's work gained renewed attention following the global financial crisis of 2008, as his ideas offered insights into the systemic risks and vulnerabilities in financial markets. His emphasis on the role of debt and financial fragility has influenced subsequent research and policy debates on financial regulation and macroeconomic stability. Today, he is regarded as one of the important figures in the field of financial economics.

Watch this space or Twitter for in-depth summaries of the most important economists!