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'''Introduction'''
'''Introduction''': Minsky, Marxist and Berkeley
Minsky, Marxist and Mathematics


The financial crisis in 2008 is often compared to the Great Depression and was considered the most serious recession by many economists. In our senior seminar final project, we plan to explore the theories provided by different schools of economists such as Marxist and Minsky. Following the theories, we will also examine the empirical evidence from the Great Depression and the recession in the 70s as well as the current financial crisis. The Marxists think recessions are imbedded in the capitalism system and business cycles are the direct result of profit maximizing actions in the market. Carl Marx developed the major theory of business cycle, which draws heavily from J.S. Mill. As a post Keynesian economist, Minsky explained the fragility of the financial system is a feature of a Capitalist system. In particular, an integrated international financial market only increases the instability of individual economy. In addition to the theories presented by Marxist and Minksy, we also plan to explore the mathematical approach to the global financial crisis by examining methods and theoretical models (coordination games, herding and learning models) that are largely derived from major international economic theories such as Obstfeld’s Model of the Financial Crisis.  
On September 15, 2008, the bankruptcy of the United States investment bank Lehman Brothers and the collapse of AIG, the world's largest insurance company, triggered the 2008 Global Financial Crisis. The end result was a global recession, which cost the world tens of trillions of dollars and rendered 30 million people unemployed. In addition, the crisis doubled the national debt of the United States. In our senior seminar final project, we plan to explore the relevant theories provided by economists Karl Marx, Hyman Minsky and George Berkeley on the financial crisis.  


[[File:Bad economics.gif|thumbnail|right|]]
Following the Marx and Minsky theories, we will examine the empirical evidence from the Great Depression and the recession in the 70s as well as the current financial crisis. The Marxists think recessions are imbedded in the capitalism system and business cycles are the direct result of profit maximizing actions in the market. Karl Marx developed the major theory of business cycle, which draws heavily from J.S. Mill. As a post Keynesian economist, Minsky explained the fragility of the financial system is a feature of a Capitalist system. In particular, an integrated international financial market only increases the instability of individual economy.  


[[File:Econ.jpg]]
Within the Berkeley approach, we will examine human motivation, Berkeley's functions of a bank, regulatory monitoring, separation of powers, transparency, elimination of conflicts of interest, speculation and economic crisis and artificial appetites. Furthermore, we will apply these sections of analysis to Wall Street. 


[[File:Inside-Job.jpg|right|frame|The Inside Job (2010)]]


== Section I ==
== Section I Marxist==


'''Minsky'''
[[File:Karl MARX.jpg|right|frame|Karl Marx (May 5, 1818 –  March 18, 1883)]]


Marx argues that profit of firms in a Capitalist market has a tendency to fall as competition increases. As a result, firms experience a boom-bust cycle, which could become a economic recession. In other words, recessions are part of business cycles.
Inspired by Mill and Ricardo, Marx argues that profits of firms in a Capitalist market have a tendency to fall as competition increases. As a result, firms will experience a boom-bust cycle, which could become an economic recession. The primary assumptions Marx make includes labor exploitation, falling profit rates and finally the innate crises of Capitalism.


== Section II ==
'''Ricardo and Mill’s Inspiration'''


'''Marxist'''
The Marxist theory follows the tradition of Ricardo and J.S.Mill. The Ricardian theory of distribution explains that “wages and profits vary inversely, prices were determined by labor costs, and long-run wages will fall to subsistence levels” (126, Skousen). The initial idea that is later developed into the labor exploitation and surplus theory. Mill expands the labor theory to a discussion of Socialism which inspired Marx’s ideas. Ricardo and Mill were the first intellectuals to employ the concept of classes to analyze economies. This class view of society greatly influenced Marx’s economics theories. In particular, Mill questioned the legitimacy of private ownership and advocates three types of socialism: Utopian Socialism, Revolutionary Socialism and Fascist Socialism (128, Skousen). Marx continued the tradition of Revolutionary socialism by calling for violent abolishment of private ownership.


Minsky’s idea concerns the fragility of the financial system at the national level and the international level. He explains the tendency of firms in both financial and non-financial sectors to take greater risks in liabilities as the business expands. Governments and central banks therefore must play a supervising role and act as “lender of the last resort”. Following Keynes’s countercyclical theory, Minsky strong advocates government regulation in times of financial crisis. Empirical data from the Great Depression shows that the Depression was a direct result of the risky lending in the early 20s, while the New Deal serves as an example of successful government intervention. In the 70s, similar conclusion can be drawn from the recession in 1975. At the international level, the interdependence of economies largely increases the instability of the international financial system because of international lending activities.
'''Labor Exploitation'''


== Section III: George Berkeley ==
According to Marx, the value of products are determined by the amount of hours workers spend to produce and machines are forms of working hours stored in metals (Buchholz,130). He also insists that labor is the only determinant of product value. In an ideal system, the prices of products should always be equivalent to the labor wages. However, in a Capitalist society, owners of the firms make profits by deriving “surplus values” from workers who live on small wages (Buchholz, 131). This process is called labor exploitation by Marx. In order to demonstrate the surplus value, he invented a formula: P=s/(v+c) in which P is profit, s is surplus value, v is variable capital and c is constant capital (152,Buchholz). According to this formula, profit derived from production is directly related to surplus value, or exploitation. He also comments on women and child labor as an extreme example of exploiting surplus value.


'''Falling Profits and Accumulation of Capital'''


[[File:George Berkeley.jpg|right|frame]]
He further explains the technology advancement such as replacements of machinery in a way benefit the exploiters, as they will need fewer workers for the same production process. However, according to the surplus formula, P=s/(v+c), an increase in machinery will drive down profits. Big firms stay in business due to their larger scale of production whereas small businesses fail. More workers will become unemployed from small firms. In addition, competitions among producers will coerce producers to substitute workers for newer equipment and result in larger unemployment rate. A direct consequence of such unemployment is that people now have less purchasing power for more goods produced due to the lack of substantial income. Economic instability thus results from the surpluses of output.
 
'''The Crisis Cycle'''


-      George Berkeley had already developed a sophisticated analysis of financial crises by the 1730s.  
The natural tendency of expansion in output is the real driving force to economic downturns. Thus Marxist believes crises are buried in the root of Capitalism.  
-     His policy recommendations still have much to teach us today as we come to grips with the current financial crisis.  
“lowering costs, falling profits monopolistic power, under consumption, massive unemployment of the proletariat class---all these conditions lead to more extensive and more destructive crises and depressions for the capitalistic system.” (153, Skousen)
- Berkeley’s work: combines his insights about human sociality and his knowledge of real-world banking successes and failures with his concern for the public.  
Unaware of profit-seeking activities will lead to economic downturns, firms will continue to fall into the same cycle as they expand. Crisis cycles will inevitably occur as the Capitalistic system functions. A credit cycle occurs in accordance with the business cycle. Businesses expansions increase credit demand. In a capitalist system, this will allow temporary increase in services and producst sold. As a result, the economy will experience a boom. However, as the debts will eventually have to be paid back, artificial surplus values added could become a potential credit crisis (1,Mandel).  
- Berkley’s theory on human behavior and his theories of economic development: consistent framework for understanding 18th century style financial crises that provides concrete policy conclusions.  
- Berkeley’s multi-faceted argument draws on three main works: The Querist, The Ruin of Britain and National Bank plan.


'''Marxist Solution'''


'''Berkeley's Approach to Money, Credit, and Debit'''
The solution Marx proposes is to overthrow the capitalist government by revolutions. The working class should redistribute means of production to workers. The problem of overproduction will then be solved because workers make more sensible production decisions than firm owners. Marx also calls for an international alliance of workers. In the long term, economic crisis will not happen again if working class rules the world.


Berkeley worked along the lines of the Theory of the Second Best (argued that his beloved country of Ireland ought to make the best of a difficult situation). He judged policy in terms of the Greatest Happiness of the Majority: the wellbeing of all of the people not just a select few. To promote economic prosperity, the majority ought to be made better off. “Power refers to actions and action follows appetite or will. Fashion creates appetite and the prevailing will of a nation is the fashion. The current of industry and commerce is determined by the prevailing will. Power is the ability to take action to express the appetite and will.” Money is a circulating medium based on credit: “all circulation…is like a circulation of credit, whatever medium (metal or paper) is employed…” (Query #426).”The true idea of money is that of a ticket or counter” (Query #23) What is real wealth then? It is not the token money but rather it is the “power to command the industry of others”, that is “real wealth” and money is merely “tickets or tokens for conveying and recording such power” (Query #35). A country is made wealthy by “the industry of its inhabitants…they prove to inexhaustible funds of real wealth…” (Query # 40) Land itself is not wealth. (Query #38) It is the” industry of the people” that makes wealth possible (Query #38). A number of queries emphasize that it takes human labor and industry to generate wealth. Money is seen as an aid to and not a substitute for human effort.
== Section II: Minsky ==


[[File:The Querist.jpg|right|frame]]
[[File:Hyman Minsky.jpg|right|frame|Hyman Minsky (September 23, 1919 – October 24, 1996)]]


[[File:The Querist.jpg|right|frame]]
Section II Minsky’s Theory
'''
'''Human Motivation'''
Minsky’s idea concerns the fragility of the financial system at the national level and the international level. He explains the tendency of firms in both financial and non-financial sectors to take greater risks in liabilities as businesses expand. At the international level, the interdependence of economies largely increases the instability of the international financial system because of international lending activities. Governments and central banks therefore must play a supervising role and act as “lender of the last resort”. Following Keynes’s countercyclical theory, Minsky strongly advocates government regulation in times of financial crisis. Empirical data shows an example of successful government intervention in 1970s. Similar conclusion can be drawn from the  current crisis.


Berkeley realizes that the human actor must be involved and so he attempts to set incentives and to separate functions as to minimize malfeasance. He does not rest his economic arguments on the assumption of benevolent agents. Thus, he proposes that the government and legislature is the ultimate overseer of the bank. However, Berkeley sees human agents as flawed. Hence, he provides checks and balances in his bank plan and seeks the improvement of politicians (a number of queries calling for those with influence and power to improve themselves). Within his writings, there are numerous examples of the fallible human actor and his instruction on their self-improvement (he was a Bishop after all). He sees market failure with private banks and calls for government action to avert market failure. Berkeley is also not blinded by the actions of self-interested and fallible politicians who ultimately oversee the bank which final authority emanates. Thus, he suggests checks and balances to try to get the incentives right, believing that the human actors will need the disciplining effects of an open and transparent system of governance.
'''Minsky’s approach to domestic fragility'''


'''Functions of Banks and Commonly Accepted Aspects of Regulation'''
Minsky’s theory includes two aspects: the increasingly fragile nature of the financial system and the importance of authorities to counter the fragility. In chapter nine of his Stabilizing the Unstable Economy, he pointed out the main reason for different economic behaviors are “financial practices and the structure of financial commitments change” (197,Minsky). He also compares the post-war economic stability, a result of financial conservation and the instability in the 1970s and 1980s, a direct consequence of profit-seeking activities in the economy. The profit-driven economy will also impact the financial structure through merge, acquisition and other restructuring activities. The financial market, driven by profits, is open to innovative financial activities such as inventions of financial products, techniques and strategies. A successful financial activity, as he points out, will inevitably be imitated by the market without considering the risks. The financial market will be thus run by the most risk-taking groups. To counter risky financial activities, Minsky thinks that the central banks and governments should play a critical role in overseeing financial activities.


Berkeley’s writings demonstrate an awareness of what have become the commonly recognized economic functions of banks (a testament to how far ahead he was compared to the time period in which he lived in). For Berkeley, banks receive deposits and ought to create loans to promote industry. Hence, banks act as financial intermediaries helping to channel savings from borrowers by moving funds from “lenders” (the depositors of the bank) to borrowers. Berkeley’s public bank would help coordinate lending with sound borrowers and would encourage “manufacturers of several kinds, which are not likely to be set on foot and carried on to perfection without great stock, public encouragement, general regulations and the concurrence of many hands”. (Query 226) Banks issue banknotes, hold deposits, and lend out reserves in excess of the combined legal and desired level of reserves. Banks deposits would count as part of the money supply. Depositors could write checks against their account. Hence, banks play an important role in the creation and contraction of the money supply. Given their role in the credit creation process, Berkeley’s banks play an integral role in the collection and payments system. From Berkeley’s perspective, his proposed bank is merely a well thought out extension of this principle (economy would rise to credit endogenously) that arises naturally out of economic relations when a surplus beyond subsistence exists. As Berkeley argues, his public bank will be better able to enforce agreements and vet good and bad risks. Back by the power of the state and with legislative oversight, a public bank would be better able to reduce the problems of asymmetric information (adverse selection and moral hazard) which might otherwise mean that fewer loans would take place.
'''The Instability of the International Financial System'''


'''Berkeley's Rules of Sound Banking to Avert Financial Crisis'''
Minsky is particularly concerned with internationalization of the financial market. On one hand, he states the inevitability of integration because of the increasing economic interdependence among countries. On the other hand, Minsky is critical about this tendency of a connected international financial system. A domestic economy will be affected by foreign originated shocks. As lending decisions are made by domestic executives with limited access to foreign borrowers’ credit history, international transactions might be riskier than domestic financial activities. Moreover, the domestic economy experiences more “disturbances and mistakes that have their origin in foreign but connected systems.”(150, Pollin) The integrated instability is also dependent upon relative sizes of economies. For example, the international system will be sensitive the U.S. domestic economic activities than a smaller country.


1.) Restrictions on Entry. Not just anyone should own or operate a bank: “too much power in the hands of private men…gives handle to monopolies, stock jobbing, and destructive schemes.” (Query 216)
'''Empirical evidence'''


2.) Disclosure and Transparency to help prevent fraud: subscriptions, shares, dividends, and stock jobbing. The opacity (transparency) of financial activities has played a role in the current financial crisis. “The secrecy of private banks” is “the very thing that renders them so hazardous” (Query 45”) Policy goal ought to be promotion of industry.  
Minsky is a strong advocate for Big Government in times of instability. In his Stabilizing an Unstable Economy, he drew the economic data from the 1973-1975 recession to illustrate the effectiveness of government intervention which eventually prevented another Great Depression. The 1973-75 recession underwent two phases: the first four quarters of mild economic downturn and the drastic drop in the last two quarters (Minskky, 15). During the first phase, uncertainty made it more difficult to make decisions in the short term. In particular, businesses shifted investment preferences to “large immediate financial gains that can be made by being right on the swings over the more lasting and secure gains”(Minsky,17).  The change in investment behaviors in turn aggravated the recession in the following period.  


3.) Regulatory Monitoring: “Those things that are subject to the most general inspection are the least subject to abuse.” (Query 56) Proper regulation and supervision allowing for regular and routine inspection by the state.  
To counter the recession, the government increased federal deficits to “affected income, sustained private financial commitments and improved the composition of portfolios” (Minsky,19). In addition to aggressive fiscal policy, the Fed also acted as lender of last resort to encourage refinancing activities. The Big Government actions were perceived to be effective in various aspects such as the income and employment effect, budget effect and portfolio effect during the recession. Being the most direct influence, the increase in government spending on goods and services; budget effect creates more sectoral surplus; the portfolio effect reflects the financial instruments change in both the private and public sectors.  


4.) Banks and Investment firms ought not to be overseeing their own regulation. Through vigorous lobbying, the financial industry has played a large role in the helping to reduce regulation: “But, whether a private interest be not generally supported or pursued with more zeal than a public.” (Query 28)
'''The Minsky Moment and Reform'''


5.) Structure to ensure that private interests are aligned with the public interest.  
According to Paul McCulley, an economist and fund manager at Pacific Investment Management Co. the world's largest bond-fund manager "we are in the midst of a Minsky moment, bordering on a Minsky meltdown." (Lahart,Wall Street Journal) A Minsky moment refers to a time when borrowers have to sell of their good debts to pay off excessive loans, which often follows by cash flow problems. The current crisis starting from 2007 is described as such a moment. Although Minsky did not live to see it happen, he proposed a constructive reform to the current financial system.
According to traditional economic theories, financial risks can be reduced by pooling among large integrated financial institutions (11, Bard Levy Institute of Economics working paper). The mainstream financial reform is based on two ideas: regulations should help financial institutions better manage their risks and the means to force them into bankruptcy (11, Bard Levy Institute of Economics working paper). In contrast to the traditional effort to prevent risk-taking activities, Minky thinks crisis is imbedded in the operations of the financial system and it is therefore impossible to prevent financial disruption. Reforms should focus on the operations. Instead of “too big to fail”, he is in favor of allowing banks to fail without public assistance. In other words, banks will naturally reconstitute into bigger banks to retain good liabilities. He also mentioned a structural change in the profit-generating model for many financial institutions. In particular, instead of limiting financial rewards from risk-taking activities, Minsky advocates a shift from short-term profit seeking of financial products to profit generation from long-term assets and commission fees (12, Bard Levy Institute of Economics working paper). Financial institutions thus will not have the incentives to take excessive risks but maintain financial stability for their long-term benefit. Minsky proposed a fundamental solution to alter the fatality of the current financial system by changing the motivations of financial institutions. In the long term, banks will be more responsible for their lending activities.


6.) Policy should enhance actual and perceived security to provide for stability. Not only the physical makeup, construction and layout of the bank.
== Section III: George Berkeley ==
 
7.) Restrictions on Assets and Activities: There should be a wall of separation between Banks and firms that engage in risky investments (Query 106). “A means of idleness and gaming, instead of a motive and help to industry” (Query 229), circulating without industry (Query 250), “subscriptions, shares, dividends, and stock jobbing” (Query 246)
 
8.) Separation of Powers: separate powers for directors, auditing inspectors and governing bodies that have oversight over the bank managers and the directors of the bank. (Query 111) Separate bodies choose directors (Query 230), are not part of the legislature which would help to oversee the bank. Directors would “be subject to the audit and visitation of a standing committee of both houses” (Query 231) To prevent conflicts of interest and power to be accrued the “committee of inspectors should…be changes every two years, one-half going out, and the another coming in by ballot” (Query 232).


9.) Adequate Ready Cash Reserves on Hand to promote stability in banking system and lessen risk of default.
This section can now be found on the moodle course


10.) Deposit Insurance and lender of last resort (LOLR): Berkeley’s public bank had the full backing of the legislature and the public.
'''References'''


11.) Money need not have intrinsic value or be “a commodity, a standard, a measure, or a pledge” (Query #23). Indeed, “the true idea of money…is that of a ticker or counter” (Query #23).  
Buchholz, Todd G. New Ideas from Dead Economists. N.p.: A Plume Book, n.d. Print.  


12.) Berkeley warned about “permitting all persons to take out what bills they pleased, upon the mortgage of lands” (Query #215).
Dymski, Gary, and Robert Pollin. New Perspectives in Monetary Macroeconomics. N.p.: The University of Michigan Press., n.d. Print.  


13.) Conducting monetary policy is another important aspect of banking. Banks play such an important role in the money supply creation process. Berkeley also recognized this important role with his emphasis on preventing inflation from becoming too great. KEPP INFLATION IN CHECK. Berkeley cautioned that there must exist limits on the creation of notes and he suggests some guides to policy making, pointing to inflation and asset price inflation especially of land prices and mortgages. Emphasized that policy makers ought to keep an eye on land prices and to avoid the formation of bubbles. Making the prevention of asset bubbles a policy goal and explicitly pointing to relevant asset prices (land for his day). He sees a monetary goal allowing for slow increase in prices over time, keeping an eye on inflation and the rise in the price of lands. Monetary Policy is a trial and error procedure where “the quantum of notes ought…to bear proportion to the public demand” (Query 245). “Too small a proportion of money would…hurt the landed man, and too great a proportion the monied man” (Query 245). In these queries, Berkeley points to the crises that came about because of failure to limit the number of notes issued.  
Mandel, Ernest. "Karl Marx." Marx's Theory of Crises. N.p., n.d. Web. 8 May 2011. <http://www.marxists.org/archive/mandel/19xx/marx/ch09.htm>.  


14.) Monetary policy ought to help meet the financing needs of business (Query 134) and to provide for stable prices.
"MINSKY ON THE REREGULATION AND RESTRUCTURING OF THE FINANCIAL SYSTEM." Levy Economics Institute. N.p., n.d. Web. 8 May 2011. <http://www.levyinstitute.org/>.  


== Section IV ==
Minsky, Hyman P. Stabilizing a Unstable Economy. New Haven: Yale University Press, n.d. Print.


'''International Economics (Krugman)'''
Skouse Mark. The Making of Modern Economics: the Lives and Ideas of the Great Thinkers. 2nd ed. Armonk : n.p., n.d. Print.

Latest revision as of 19:27, 8 May 2011

Introduction: Minsky, Marxist and Berkeley

On September 15, 2008, the bankruptcy of the United States investment bank Lehman Brothers and the collapse of AIG, the world's largest insurance company, triggered the 2008 Global Financial Crisis. The end result was a global recession, which cost the world tens of trillions of dollars and rendered 30 million people unemployed. In addition, the crisis doubled the national debt of the United States. In our senior seminar final project, we plan to explore the relevant theories provided by economists Karl Marx, Hyman Minsky and George Berkeley on the financial crisis.

Following the Marx and Minsky theories, we will examine the empirical evidence from the Great Depression and the recession in the 70s as well as the current financial crisis. The Marxists think recessions are imbedded in the capitalism system and business cycles are the direct result of profit maximizing actions in the market. Karl Marx developed the major theory of business cycle, which draws heavily from J.S. Mill. As a post Keynesian economist, Minsky explained the fragility of the financial system is a feature of a Capitalist system. In particular, an integrated international financial market only increases the instability of individual economy.

Within the Berkeley approach, we will examine human motivation, Berkeley's functions of a bank, regulatory monitoring, separation of powers, transparency, elimination of conflicts of interest, speculation and economic crisis and artificial appetites. Furthermore, we will apply these sections of analysis to Wall Street.

The Inside Job (2010)

Section I Marxist

Karl Marx (May 5, 1818 – March 18, 1883)

Inspired by Mill and Ricardo, Marx argues that profits of firms in a Capitalist market have a tendency to fall as competition increases. As a result, firms will experience a boom-bust cycle, which could become an economic recession. The primary assumptions Marx make includes labor exploitation, falling profit rates and finally the innate crises of Capitalism.

Ricardo and Mill’s Inspiration

The Marxist theory follows the tradition of Ricardo and J.S.Mill. The Ricardian theory of distribution explains that “wages and profits vary inversely, prices were determined by labor costs, and long-run wages will fall to subsistence levels” (126, Skousen). The initial idea that is later developed into the labor exploitation and surplus theory. Mill expands the labor theory to a discussion of Socialism which inspired Marx’s ideas. Ricardo and Mill were the first intellectuals to employ the concept of classes to analyze economies. This class view of society greatly influenced Marx’s economics theories. In particular, Mill questioned the legitimacy of private ownership and advocates three types of socialism: Utopian Socialism, Revolutionary Socialism and Fascist Socialism (128, Skousen). Marx continued the tradition of Revolutionary socialism by calling for violent abolishment of private ownership.

Labor Exploitation

According to Marx, the value of products are determined by the amount of hours workers spend to produce and machines are forms of working hours stored in metals (Buchholz,130). He also insists that labor is the only determinant of product value. In an ideal system, the prices of products should always be equivalent to the labor wages. However, in a Capitalist society, owners of the firms make profits by deriving “surplus values” from workers who live on small wages (Buchholz, 131). This process is called labor exploitation by Marx. In order to demonstrate the surplus value, he invented a formula: P=s/(v+c) in which P is profit, s is surplus value, v is variable capital and c is constant capital (152,Buchholz). According to this formula, profit derived from production is directly related to surplus value, or exploitation. He also comments on women and child labor as an extreme example of exploiting surplus value.

Falling Profits and Accumulation of Capital

He further explains the technology advancement such as replacements of machinery in a way benefit the exploiters, as they will need fewer workers for the same production process. However, according to the surplus formula, P=s/(v+c), an increase in machinery will drive down profits. Big firms stay in business due to their larger scale of production whereas small businesses fail. More workers will become unemployed from small firms. In addition, competitions among producers will coerce producers to substitute workers for newer equipment and result in larger unemployment rate. A direct consequence of such unemployment is that people now have less purchasing power for more goods produced due to the lack of substantial income. Economic instability thus results from the surpluses of output.

The Crisis Cycle

The natural tendency of expansion in output is the real driving force to economic downturns. Thus Marxist believes crises are buried in the root of Capitalism. “lowering costs, falling profits monopolistic power, under consumption, massive unemployment of the proletariat class---all these conditions lead to more extensive and more destructive crises and depressions for the capitalistic system.” (153, Skousen) Unaware of profit-seeking activities will lead to economic downturns, firms will continue to fall into the same cycle as they expand. Crisis cycles will inevitably occur as the Capitalistic system functions. A credit cycle occurs in accordance with the business cycle. Businesses expansions increase credit demand. In a capitalist system, this will allow temporary increase in services and producst sold. As a result, the economy will experience a boom. However, as the debts will eventually have to be paid back, artificial surplus values added could become a potential credit crisis (1,Mandel).

Marxist Solution

The solution Marx proposes is to overthrow the capitalist government by revolutions. The working class should redistribute means of production to workers. The problem of overproduction will then be solved because workers make more sensible production decisions than firm owners. Marx also calls for an international alliance of workers. In the long term, economic crisis will not happen again if working class rules the world.

Section II: Minsky

Hyman Minsky (September 23, 1919 – October 24, 1996)

Section II Minsky’s Theory

Minsky’s idea concerns the fragility of the financial system at the national level and the international level. He explains the tendency of firms in both financial and non-financial sectors to take greater risks in liabilities as businesses expand. At the international level, the interdependence of economies largely increases the instability of the international financial system because of international lending activities. Governments and central banks therefore must play a supervising role and act as “lender of the last resort”. Following Keynes’s countercyclical theory, Minsky strongly advocates government regulation in times of financial crisis. Empirical data shows an example of successful government intervention in 1970s. Similar conclusion can be drawn from the current crisis.

Minsky’s approach to domestic fragility

Minsky’s theory includes two aspects: the increasingly fragile nature of the financial system and the importance of authorities to counter the fragility. In chapter nine of his Stabilizing the Unstable Economy, he pointed out the main reason for different economic behaviors are “financial practices and the structure of financial commitments change” (197,Minsky). He also compares the post-war economic stability, a result of financial conservation and the instability in the 1970s and 1980s, a direct consequence of profit-seeking activities in the economy. The profit-driven economy will also impact the financial structure through merge, acquisition and other restructuring activities. The financial market, driven by profits, is open to innovative financial activities such as inventions of financial products, techniques and strategies. A successful financial activity, as he points out, will inevitably be imitated by the market without considering the risks. The financial market will be thus run by the most risk-taking groups. To counter risky financial activities, Minsky thinks that the central banks and governments should play a critical role in overseeing financial activities.

The Instability of the International Financial System

Minsky is particularly concerned with internationalization of the financial market. On one hand, he states the inevitability of integration because of the increasing economic interdependence among countries. On the other hand, Minsky is critical about this tendency of a connected international financial system. A domestic economy will be affected by foreign originated shocks. As lending decisions are made by domestic executives with limited access to foreign borrowers’ credit history, international transactions might be riskier than domestic financial activities. Moreover, the domestic economy experiences more “disturbances and mistakes that have their origin in foreign but connected systems.”(150, Pollin) The integrated instability is also dependent upon relative sizes of economies. For example, the international system will be sensitive the U.S. domestic economic activities than a smaller country.

Empirical evidence

Minsky is a strong advocate for Big Government in times of instability. In his Stabilizing an Unstable Economy, he drew the economic data from the 1973-1975 recession to illustrate the effectiveness of government intervention which eventually prevented another Great Depression. The 1973-75 recession underwent two phases: the first four quarters of mild economic downturn and the drastic drop in the last two quarters (Minskky, 15). During the first phase, uncertainty made it more difficult to make decisions in the short term. In particular, businesses shifted investment preferences to “large immediate financial gains that can be made by being right on the swings over the more lasting and secure gains”(Minsky,17). The change in investment behaviors in turn aggravated the recession in the following period.

To counter the recession, the government increased federal deficits to “affected income, sustained private financial commitments and improved the composition of portfolios” (Minsky,19). In addition to aggressive fiscal policy, the Fed also acted as lender of last resort to encourage refinancing activities. The Big Government actions were perceived to be effective in various aspects such as the income and employment effect, budget effect and portfolio effect during the recession. Being the most direct influence, the increase in government spending on goods and services; budget effect creates more sectoral surplus; the portfolio effect reflects the financial instruments change in both the private and public sectors.

The Minsky Moment and Reform

According to Paul McCulley, an economist and fund manager at Pacific Investment Management Co. the world's largest bond-fund manager "we are in the midst of a Minsky moment, bordering on a Minsky meltdown." (Lahart,Wall Street Journal) A Minsky moment refers to a time when borrowers have to sell of their good debts to pay off excessive loans, which often follows by cash flow problems. The current crisis starting from 2007 is described as such a moment. Although Minsky did not live to see it happen, he proposed a constructive reform to the current financial system. According to traditional economic theories, financial risks can be reduced by pooling among large integrated financial institutions (11, Bard Levy Institute of Economics working paper). The mainstream financial reform is based on two ideas: regulations should help financial institutions better manage their risks and the means to force them into bankruptcy (11, Bard Levy Institute of Economics working paper). In contrast to the traditional effort to prevent risk-taking activities, Minky thinks crisis is imbedded in the operations of the financial system and it is therefore impossible to prevent financial disruption. Reforms should focus on the operations. Instead of “too big to fail”, he is in favor of allowing banks to fail without public assistance. In other words, banks will naturally reconstitute into bigger banks to retain good liabilities. He also mentioned a structural change in the profit-generating model for many financial institutions. In particular, instead of limiting financial rewards from risk-taking activities, Minsky advocates a shift from short-term profit seeking of financial products to profit generation from long-term assets and commission fees (12, Bard Levy Institute of Economics working paper). Financial institutions thus will not have the incentives to take excessive risks but maintain financial stability for their long-term benefit. Minsky proposed a fundamental solution to alter the fatality of the current financial system by changing the motivations of financial institutions. In the long term, banks will be more responsible for their lending activities.

Section III: George Berkeley

This section can now be found on the moodle course

References

Buchholz, Todd G. New Ideas from Dead Economists. N.p.: A Plume Book, n.d. Print.

Dymski, Gary, and Robert Pollin. New Perspectives in Monetary Macroeconomics. N.p.: The University of Michigan Press., n.d. Print.

Mandel, Ernest. "Karl Marx." Marx's Theory of Crises. N.p., n.d. Web. 8 May 2011. <http://www.marxists.org/archive/mandel/19xx/marx/ch09.htm>.

"MINSKY ON THE REREGULATION AND RESTRUCTURING OF THE FINANCIAL SYSTEM." Levy Economics Institute. N.p., n.d. Web. 8 May 2011. <http://www.levyinstitute.org/>.

Minsky, Hyman P. Stabilizing a Unstable Economy. New Haven: Yale University Press, n.d. Print.

Skouse Mark. The Making of Modern Economics: the Lives and Ideas of the Great Thinkers. 2nd ed. Armonk : n.p., n.d. Print.

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