Macroeconomics of Speculation

Despite his emphasis on the speculative character of investment decisions, Minsky paid little attention to asset price speculation per se, ignoring asset price bubbles and their macroeconomic effects. That is perhaps because his views were formed during the era of financial regulation, when speculation "could do no harm as bubbles on a steady stream of enterprise." Clearly, times have since changed. Keynes's old warning that the situation is serious when enterprise becomes the bubble on a whirlpool of speculationÓ has begun to ring true again. To deepen our understanding of financial fragility under present-day conditions, the paper builds on Keynes's insights in his General Theory on the stock exchange by going back to his Treatise, where asset price expectations and speculation play an integral part in his analysis of the business cycle. More specifically, it develops the macroeconomic implications of some of his arguments that have mainly been eclipsed by his GT. These can be summarized in three related propositions: (1) asset price expectations systematically exhibit self-sustained biases in one direction or another over the business cycle; (2) once an asset price bubble emerges no automatic mechanism exists to check the deviation of prices from their true values; and, (3) mean reversion in asset prices over time plays itself out through a rise in inactive money balances in the banking system, which Keynes called the bear position, as more and more people begin to think that asset prices have reached levels that are unreasonable. This early picture of how financial variables interact with output determination over the business cycle is contrasted with Keynes's better known analysis in the GT, which, it is argued, does not lend itself as readily to analyzing asset price misalignments.