Paul Krugman reviews Martin Wolf's The Shifts and the Shocks: What We’ve Learned—and Have Still to Learn—from the Financial Crisis, in The New York Review of Books:
The Shifts and the Shocks opens with a long quotation from the late Hyman Minsky, a heterodox economist who had little influence on mainstream economists and policymakers during his lifetime, but whose analysis is now central to the Standard Model. Minsky’s ideas have been cited by monetary officials including Janet Yellen, by business economists like Pimco’s Paul McCulley, and by many academics, myself included. You could say that we are all Minskyites now.
What did Minsky bring to economics? In part, he argued that conventional views of financial crisis were too narrowly focused on the specific issue of bank runs. In Minsky’s vision, excessive leverage—too much reliance on borrowed money—creates a risk of crisis whoever the borrower. Banks, which in effect borrow money short-term from their depositors but invest in assets that can’t easily be converted to cash, may be especially vulnerable. But business and household debt also expose the economy to the possibility of a self-reinforcing downward spiral.
Minsky was not, of course, the first to make this observation; during the Great Depression the great American economist Irving Fisher, in a paper that reads remarkably well to this day, argued that the economy was suffering from “debt deflation,” in which borrowers of all kinds were trying to pay down their debts at the same time, which led to plunging prices of assets and a severe economic slump, which made their debts even less supportable and led to further pullbacks.
What Minsky added, however, was the notion that deflation as a result of excessive debt is fated to happen every once in a while, that periodic financial crises are a more or less unavoidable feature of capitalism. According to his “financial instability hypothesis,” eras of economic stability carry within themselves the seeds of their own down- fall. If there hasn’t been a financial crisis for many years, both borrowers and lenders will become complacent, underestimating the risks of high levels of debt.