No. 330 - The problem of increasing fragility in the “financial instability hypothesis” from a Kaleckian perspective

The paper offers a critical assessment of the central proposition of the ¡§financial instability hypothesis¡¨, i.e. that phases of expansion and investment growth are harbingers of increasing instability that can endogenously generate a financial crisis. As a preliminary, it is necessary to overcome the confusion, found in post-Keynesian literature on financial instability, between fragility generated by the leverage ratio (sensitivity to profit declines) and that generated by a temporary imbalance between the duration of the financing requirement determined by investment and the duration of debt (sensitivity to interest rate increases). This perspective undermines Lavoie¡¦s criticism that the postulate of increasing fragility during expansions is erroneous inasmuch as individual entrepreneurs¡¦ desire to increase their own leverage ratios will be thwarted ƒ{ owing to the well-known Kaleckian principle of the ¡§widow¡¦s cruse¡¨ ƒ{ by the profits their own investments generate at aggregate level. While Lavoie¡¦s criticism correctly show the non-generality of Minsky¡¦s arguments, it focuses only on leverage ratios, a narrow segment of the broader concept of financial fragility. In addition, it overlooks the relationship between the growth rate of the marginal efficiency of capital and the rate of accumulation of equity capital during euphoric expansions: during the span of time needed for investments to affect aggregate profits, the curve of the marginal efficiency of capital can shift upwards, debt can increase, and there is no guarantee that debt will grow more slowly than equity. In reality, a weakness of the ¡§financial instability hypothesis¡¨ is that it treats as general characteristics of expansions some signs of euphoria (e.g. the marginal efficiency of capital outstripping the accumulation of equity) that instead are seen only occasionally.