Financial Fragility and Investment in the Capitalist Economy The Economic Legacy of Hyman Minsky, Volume II
The Economic Legacy of Hyman Minsky, Volume II
Edited by Riccardo Bellofiore and Piero Ferri
Chapter 8: Financial instability revisited: aggregate fluctuations due to changing financial conditions of heterogeneous firms
8. Financial instability revisited: aggregate ﬂuctuations due to changing ﬁnancial conditions of heterogeneous ﬁrms Domenico Delli Gatti and Mauro Gallegati 1 INTRODUCTION Hyman Minsky’s ﬁnancial instability hypothesis is grounded in a vision of the economy as a system populated by heterogeneous ﬁnancially constrained ﬁrms, which he classiﬁed as hedge, speculative and Ponzi units according to their degree of ﬁnancial fragility. Changes in the ﬁnancial conditions of each and every ﬁrm – that is, changes in their balance-sheet positions – drive economic ﬂuctuations: ‘We can conceive of a scale of ﬁnancial robustness – ﬁnancial fragility which depends upon the mixture of hedge, speculative and Ponzi ﬁnancing outstanding. As the proportion of hedge ﬁnancing decreases the ﬁnancial structure migrates toward fragility’ (Minsky, 1982, p. 33). This approach was already outlined in his Ph.D. dissertation (Minsky, 1954), where ﬁrms are differentiated by ﬁnancial condition and technological level, and is developed further in his mature production.1 Minsky’s characterization of his own work – a ﬁnancial theory of investment and an investment theory of aggregate demand and the business cycle – is grounded in a view of the economy in which agents’ heterogeneity plays a crucial role. In this chapter we emphasize this aspect of Minsky’s theory. We model an economy in an uncertain environment with capital market imperfections due to limited (asymmetric) information.2 Each ﬁrm is characterized by a degree of ﬁnancial fragility, inversely related to the ratio of the equity base to the capital stock – the equity ratio for short – which affects supply and capital accumulation decisions....
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