The Slump Goes On: Why?

Bernanke_ben-071609_jpg_230x778_q85 Robin Wells and Paul Krugman in the NYRB:

If the fundamental problem lay with a crisis of confidence in the banking system, why hasn’t a restoration of banking confidence brought a return to strong economic growth? The likely answer is that banks were only part of the problem. It’s curious that only one of the three books surveyed here so much as mentions the work of the late Hyman Minsky, a heterodox, long-neglected economist whose moment has come—in more ways than one. However, Roubini and Mihm give a good overview of Minsky’s views—and Richard Koo, whether he knows it or not, is very much a Minskyite.

Minsky’s theory, in brief, was that eras of financial stability set the stage for future crisis, because they encourage a wide variety of economic actors to take on ever-larger quantities of debt and engage in ever-more-risky speculation. As long as asset prices keep rising, driven by debt-fueled purchases, all looks well. But sooner or later the music stops: there is a “Minsky moment” when all the players realize (or are forced by creditors to realize) that asset prices won’t rise forever, and that borrowers have taken on too much debt.

But isn’t this new prudence a good thing? No. When one individual tries to pay down debt, that’s all well and good—but when everyone tries to do it at the same time, the consequences can all too easily be destructive for everyone involved. The process of destruction is easiest to see in the financial sector, where everyone’s attempt to pay off debt by selling assets all at the same time can lead to a vicious circle of plunging prices and rising distress. But the problem isn’t necessarily restricted to finance.