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The Economics of Instability: An Abstract of an Excerpt

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  • Frank Veneroso

Abstract

The dominant postwar tradition in economics assumes the utility maximization of economic agents drives markets toward stable equilibrium positions. In such a world there should be no endogenous asset bubbles and untenable levels of private indebtedness. But there are. There is a competing alternative view that assumes an endogenous behavioral propensity for markets to embark on disequilibrium paths. Sometimes these departures are dangerously far reaching. Three great interwar economists set out most of the economic theory that explains this natural tendency for markets to propagate financial fragility: Joseph Schumpeter, Irving Fisher, and John Maynard Keynes. In the postwar period, Hyman Minsky carried this tradition forward. Early on he set out a "financial instability hypothesis" based on the thinking of these three predecessors. Later on, he introduced two additional dynamic processes that intensify financial market disequilibria: principal-agent distortions and mounting moral hazard. The emergence of a behavioral finance literature has provided empirical support to the theory of endogenous financial instability. Work by Vernon Smith explains further how disequilibrium paths go to asset bubble extremes. The following paper provides a compressed account of this tradition of endogenous financial market instability.

Suggested Citation

  • Frank Veneroso, 2018. "The Economics of Instability: An Abstract of an Excerpt," Economics Working Paper Archive wp_903, Levy Economics Institute.
    • Handle: RePEc:lev:wrkpap:wp_903
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    References listed on IDEAS

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    1. Gjerstad,Steven D. & Smith,Vernon L., 2014. "Rethinking Housing Bubbles," Cambridge Books, Cambridge University Press, number 9780521198097.
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    More about this item

    Keywords

    Financial Instability; Joseph Schumpeter; Irving Fisher; John Maynard Keynes; Hyman Minsky; Financial Markets; Macroeconomics;
    All these keywords.

    JEL classification:

    • D53 - Microeconomics - - General Equilibrium and Disequilibrium - - - Financial Markets
    • E44 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Financial Markets and the Macroeconomy

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