The limits of limits

It's four years old, but I am fascinated by Thomas Palley's The Limits of Minsky’s Financial Instability Hypothesis as an Explanation of the Crisis. Minsky makes a good point, Palley says, but "his theory only provides a partial and incomplete account of the current crisis."

I'm still reading, but according to Palley, Tim Geithner and Larry Summers -- the Treasury Secretary and the President's chief economic counselor when the piece was written -- Geithner and Summers' view, Palley says, was that "financial excess was the only problem, and normal growth will return once that problem is remedied." Palley disagrees, and pushes the "roots of the crisis" back to the late 1970s, early '80s:

By giving free rein to the Minsky mechanisms of financial innovation, financial deregulation, regulatory escape, and increased appetite for financial risk, policymakers (like former Federal Reserve Chairman Alan Greenspan) extended the life of the neoliberal model. The sting in the tail was that this made the crisis deeper and more abrupt when financial markets eventually reached their limits. Without financial innovation and financial deregulation the neoliberal model would have got stuck in stagnation a decade earlier, but it would have been stagnation without the pyrotechnics of financial crisis.

When Palley goes back in time to the root of the crisis, he finds people doing what Minsky said they'd be doing. So I haven't figured out why Palley says Minsky's theory provides only a partial explanation. But like I said, I'm still reading.


"The sting in the tail", Palley says, was that the long duration of the policy made the crisis worse "when financial markets eventually reached their limits." Sure: Preventing small forest fires makes the big ones bigger. But I have trouble with the words "reaching the limits".

Palley doesn't say it, but to me the word "limits" implies we might somehow be able to calculate those limits, and that way avoid a crisis the next time. This brings to mind a calculation by Richard Vague, recently referenced by Steve Keen:

This recovery is starting from an unprecedented level of private debt: whereas the last post-recession recovery in America began from a debt level of 115 per cent of GDP, this one is commencing from 155 per cent (see Figure 2). If it only reaches the level of the previous peak (177 per cent) in the next five years, it will have fulfilled Richard Vague’s empirical rule of thumb for the cause of an economic crisis (a private debt to GDP ratio above 150 per cent, and an 18 per cent increase in that ratio over 5 or less years).

I think it conveys the wrong idea to say a crisis occurs when markets reach their limits. It implies there is a number, 18 or 5 or maybe 42, a magic number that when you reach it all hell breaks loose.


I didn't read Minsky, so maybe I have this wrong. (If you think I'm wrong, quote Minsky to me. Don't quote somebody else.) But here's what I'm pretty sure Minsky said: Financial instability increases.

Until what Thomas Palley calls Minsky's "thwarting institutions" are restored, instability increases. As instability increases, the economy becomes increasingly more fragile. Eventually, the weight of a feather is enough to bring it down. An analogy that comes to mind: a bicycle going slower and slower, wobbling and righting itself once, wobbling again, then falling over in a sudden crash.

If the bicycle kept going fast enough, it might have stayed upright. If the economy didn't grow increasingly fragile, it might have withstood the shock that brought it down. It's not like there's a limit-line on the pavement and the bicycle will fall when it reaches the limit.

I think a shock that would scarcely be noticed in a strong economy is enough to topple a weak one. You don't calculate the "limits" at which an economy comes crashing down. You figure out what's making the economy weak, and you calculate how best to strengthen it.