On a recent blogpost that I wrote there was some confusion in the comments section regarding Hyman Minsky’s theories and their relationship to the phenomenon of rising asset prices. I have seen this confusion made many times before — even by some otherwise good Post-Keynesian economists — but I think that it is time to finally clear it up once and for all.
The confusion runs something like this: “Hyman Minsky’s theory of rising asset prices is that debt drives asset prices. If we want an explanation for rising asset prices we simply look at the levels of debt in the economy. This is tied to the fact that Minsky was a proponent of Post-Keynesian endogenous money theory and this theory states that private banks create money which, if this creation process is allowed to spiral out of control, will lead to rising asset prices.”
Okay, before I go into what Minsky actually wrote in this regard I think I should make one crystal clear comment: the above argument is a monetarist argument. In Post-Keynesian endogenous money theory money = debt. So, if we say that debt is the cause of rising asset prices we are effectively saying that money is the cause of rising asset prices. That is a monetarist conception of how price levels in markets operate.
Monetarists maintain that rising prices — whether they be asset prices or the prices of goods and services — are due to increases in the money supply; and since saying that increases in the level of debt leads to rising prices is just another way of saying that increases in the level of money leads to rising prices, this is an absolutely identical argument to the monetarist one. All we have done is changed the words.
Post-Keynesian endogenous money theory never posits debt as the cause of anything. Rather it is decisions by economic agents that cause increases in the price levels of any given market. The debt that follows from these decisions is merely a residual.
We can see this clearly in the original statements of endogenous money theory. For example, in Basil Moore’s seminal paper Unpacking the Post-Keynesian Black Box: Bank Lending and the Money Supply he writes,
The behavior of the money wage rates, both as a component of companies’ demand for working capital finance and as determinants of disposable personal income, plays a central role in determining private demand for bank credit. (p555)
In that paper what Moore was describing as the ‘black box’ was the causal element that leads to increases in money lending and, hence, increases in the money supply. Through extensive empirical investigation he finds that the inflation of the 1970s was mainly caused by rising money wages.
As we can see for Moore an increase in bank lending does not truly cause anything. Rather it is the phenomenon that must be explained through reference to a causal variable. In the case of the 1970s inflation this causal variable was money wages. If Moore were to explain the inflation of the 1970s by saying that it was caused by an increase in bank lending he would be making an identical argument to the monetarists except that rather than saying that the ‘money supply’ caused rising prices he would say ‘bank credit’; but since the two things are two sides of the same coin (change in bank lending = change in money supply) he would be saying the same thing in different words.
The exact same holds true in asset markets. If Minsky had been saying that the cause of rising asset prices was changes in bank credit he may as well have been saying that the cause of rising asset prices was changes in the money supply. The arguments are the same; only the words are different.
Okay, so all that said, what was Minsky’s argument? How did he explain rising asset prices? Well, he deals with this in a section of his book Stabilizing an Unstable Economy entitled ‘Quasi-Rents and Capital Asset Prices’. This section can be found on pages 200-205 in that book. In this section he argues that capital asset prices are dependent on (that is, caused by) two things: expected cash-flows and perceived liquidity. Minsky writes,
In a world with a wide variety of financial markets and in which capital assets can be sold piecemeal or as collected in firms, all financial and capital assets have two cash-flow attributes. One is the money that will accrue as the contract is fulfilled or as the capital asset is used in production; the second is the cash that can be received if the asset is sold or pledged. The ability of an asset to yield cash when needed and with slight variation in the amount is called its liquidity.
The price, PK , of any capital asset depends upon the cash flows that ownership is expected to yield and the liquidity embodied in the asset. The cash flows a capital asset will yield depend upon the state of a market and the economy, while the liquidity embodied in an asset depends upon the ease and the assuredness with which it can be transformed into money. The price of a financial asset such as a bond or even a savings account depends upon the same considerations as the price of a capital asset: the cash flow and the breadth, depth, and resilience of the market in which it can be negotiated. (p202)
Note that nowhere does Minsky mention debt is discussing how asset prices are determined. It is true that when assets are purchased debt is often incurred but this is only a residual of a decision taken by investors with respect to expected cash-flows and perceived liquidity**. Debt is not the explanatory or causal variable in Minsky’s theories of asset prices. And that is because Minsky is not a monetarist but rather a Keynesian.
Minsky’s theory, as he always insisted, built on Keynes’ theory of financial markets as laid out in the General Theory and the Treatise on Money. For Keynes too it was these two variables that caused asset prices to rise or fall. The money that was used to purchase them — whether debt financed or not — was a residual; an important residual, as Ponzi debts might lead to asset price deflations, but still a residual. In these theories debt does not cause anything any more than money causes anything — indeed, the two entities are actually two sides of the same coin.
** Note that with a given state of expected cash-flows and perceived liquidity the rate of interest (which is chosen by how much reserve cash the central bank wishes to release to the banking system) will determine the price of assets. But in Minsky’s theories, as in Keynes’, we cannot expect a static state of expectations and thus the rate of interest will be of secondary importance to the determination of asset prices; the key driver is, as in Keynes, the animal spirits of investors or the state of confidence.