The Economics of Instability: An Abstract of an Excerpt

Frank Veneroso

Economics Working Paper Archive from Levy Economics Institute

Abstract: The dominant postwar tradition in economics assumes the utility maximization of economic agents drives markets toward stable equilibrium positions. In such a world there should be no endogenous asset bubbles and untenable levels of private indebtedness. But there are. There is a competing alternative view that assumes an endogenous behavioral propensity for markets to embark on disequilibrium paths. Sometimes these departures are dangerously far reaching. Three great interwar economists set out most of the economic theory that explains this natural tendency for markets to propagate financial fragility: Joseph Schumpeter, Irving Fisher, and John Maynard Keynes. In the postwar period, Hyman Minsky carried this tradition forward. Early on he set out a "financial instability hypothesis" based on the thinking of these three predecessors. Later on, he introduced two additional dynamic processes that intensify financial market disequilibria: principal-agent distortions and mounting moral hazard. The emergence of a behavioral finance literature has provided empirical support to the theory of endogenous financial instability. Work by Vernon Smith explains further how disequilibrium paths go to asset bubble extremes. The following paper provides a compressed account of this tradition of endogenous financial market instability.

Keywords: Financial Instability; Joseph Schumpeter; Irving Fisher; John Maynard Keynes; Hyman Minsky; Financial Markets; Macroeconomics (search for similar items in EconPapers)
JEL-codes: D53 E44 (search for similar items in EconPapers)
Date: 2018-04
New Economics Papers: this item is included in nep-his, nep-hme, nep-hpe, nep-mac and nep-pke
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