Stabilizing an unstable financial system

Norberto Montani Martins and Gabriel Porto

Chapter 10 in Central Banking, Monetary Policy and Financial In/Stability, 2025, pp 179-203 from Edward Elgar Publishing

Abstract: The present chapter argues that financial and macroeconomic instability are inextricably linked in both theory and practice. Contributions from Hyman Minsky, such as the Wall Street Paradigm, survival constraints, and Financial Instability Hypothesis, are used to explain why central banks must perform a stabilizing role if monetary economies are to operate within reasonable boundaries. The practical side of the discussion is addressed by an analysis of the response by the US Federal Reserve to the financial turmoil caused by the Covid-19 pandemic. Conclusions are twofold. First, the Minskyian approach that is proposed here is demonstrably useful to interpret recent events, while remaining agnostic in terms of the most divisive contributions from the author (such as the two-price system and associated investment function). This approach effectively revealed how large-scale asset purchases (LSAP) can be deployed to halt debt-deflation processes and, thus, explained why these instruments constitute an important part of the central banks’ toolbox for dealing with financial instability. Second, the Federal Reserve's response to the Covid-19 pandemic partially followed a Minskyian rationale: economic relief was swift, incisive and went beyond traditional financial markets and institutions. Nevertheless, there are still important criticisms to be made, in terms of the apparent lack of legislative measures to remove the fragilities that required broader central bank interventions in the first place; and questions about whether fiscal measures would be more adequate to promote the financial stability of households, medium and small businesses and municipalities.

Keywords: Financial instability hypothesis; Large-scale asset purchases; Covid-19 crisis (search for similar items in EconPapers)
Date: 2025
ISBN: 9781035302147
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