Theories of Financial Disturbance
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Theories of Financial Disturbance

An Examination of Critical Theories of Finance from Adam Smith to the Present Day

Jan Toporowski

Theories of Financial Disturbance examines how the operations of market-driven finance may initiate and transmit disturbances to the economy at large, by looking in detail at how various economists envisaged such disturbances occurring.
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Chapter 10: The Principle of Increasing Risk II: Michal Kalecki

Jan Toporowski


Kalecki rapidly took up and extended the essential concept of financial risk that Breit had put forward. The first version of Kalecki’s ‘Principle of Increasing Risk’ appeared in English in 1937.1 In his hands this analysis became a theory of investment, an explanation for the size of firms, and a reason why increasing the supply of credit in financial markets would not increase investment, as suggested by the equilibrium loanable funds theory.2 Along the way he echoed (unconsciously) Fisher in criticising Pigou’s real balance effect. 1. RISK IN CORPORATE FINANCE Kalecki suggested that a constant prospective return on investment is more realistic than the decreasing returns favoured by most economists. Given such a return, and the current rate of interest with increasing risk margins, the amount of investment that a firm can undertake is limited by the amount of its savings. A similar risk constraint would apply to funds raised from the stock market, through a rising cost of funds on bond issues. In the case of shares, existing shareholders would resist the watering-down of their stock by additional stock issues, and corporations would be faced with rising costs of selling more than an ‘optimum size of issue’. In the 1954 version of this paper, Kalecki dropped the static analysis of investment decisions based on internal savings, and turned his principle of increasing risk into a theory of the size of the firm under the revised title of ‘Entrepreneurial Capital and Investment’.3 He argued in general terms that ‘the expansion...

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