Induced investment and business cycles

James Ensor, Masks and Death


Commentary on Hyman Minsky's Book

Induction investment and business cycles is the title of the doctoral thesis defended at the Harvard University by Hyman Minsky (1919-1996), the most influential financier theorist in the heterodox current in the second half of the 1883th century. It would be guided by Joseph Schumpeter (1950-1906), considered one of the first theorists to consider technological innovations as the engine of capitalist development. Because of his death, the thesis was completed under the supervision of Wassily Leontief (1999-XNUMX), noted for research on how changes in a single sector of the economy affect others.

The original theme of his thesis was to explore the relationships between the corporate market structure and banks. The project was defined to be a macroeconomic investigation, involving the operation of joint forces of markets and aggregate demand and showing how demand volatility leads to economic fluctuations, ie business cycle.

However, the thesis starts from a microeconomic analysis of the behavior of companies, covering the various decision-making processes regarding cash inflows and outflows, market structure, expansion, vulnerability and survival. It discards, at first, the centralized model, where the State is consolidated as the main agent, being called “from top to bottom” [top-down].

It adopts, then, another model, whose focus fits in the implementing agents and their power of discretion in the execution (or not) of public policies and, for this reason, it is called “bottom-up” [bottom-up] Hyman Minsky describes his objective as formulating a model of specific product markets, which will lay the foundation for the aggregated analysis, allowing him to consider a range of public policies relevant to the elaboration of a business cycle theory.

In terms of methods of economic analysis, I would say that he started from methodological individualism by focusing on iteration (repetition) in microeconomic decisions, but their interactions provoke macroeconomic results in uncertain dynamic configurations. By concluding with the presentation of the mechanisms of systemic transmission, it allows for methodological holism, that is, the analysts' vision of the whole.

For Hyman Minsky, the dominant factor in economic life is the interdependence of all institutional units and/or economic agents. In my reading, it is the interconnections of personal, corporate, public, banking and international finance, which allow the emergence of a complex system, whose intellectual challenge is for economists-financiers to decipher and ponder its key components.

But he initially abstracts from the State and the rest of the world. As was customary, before the external opening in the face of the globalization of trade, it worked with a closed economy. He revised conventional models to accurately describe the trajectory of the economy as a whole and provide fiscal policy alternatives in coping with “secular stagnation” or “ongoing inflation”.

At the microeconomic level of a company, it placed its investment as resulting from changes in internal and aggregate income. However, it still suffered from a “psychologism, the childhood illness of psychologists” (sum of psychologists and economists) when announcing the structure of its balance sheet and income accounts (profit and loss) to reflect “the psychological attitude towards taking of risk”.

Methodological individualism has led to this exacerbation of the psychological “expectations” of decision makers in the recent history of economic thought. After all, how many make collective decisions approved by committees, boards and boards of directors? Their heterogeneous behaviors can be reduced to an expectation, binary type: “optimistic” or “pessimistic”. Less less…

“Induced” investment demand is a function of investment decisions altered by market changes, associated with changes in aggregate income. By extension, any investment changes would cause business cycles.

The changes in its phases (or conjunctures) include both changes in the market structure and the new context resulting from the incipient interaction of non-homogeneous firms. They would be able to lead to a change in investment.

The “accelerator model”, in economics, considers investment dependent on changes in production (income) and/or on changes in consumption and the capital-output ratio. The Minskyan model of the business cycle establishes the accelerator coefficient to be pro-cyclical.

This model helps to understand how initial shocks to the economy, whether positive or negative, can propagate and amplify through interactions between multipliers and accelerators. It combines these two concepts: an autonomous increase in investment spending leads to an increase in production, depleting productive capacity, leads to more investment (accelerator effect), and so on, with the multiplier effect amplifying the cycle of expansion in spending. On the contrary, a decrease in autonomous spending can also lead to a cycle of contraction.

Empirically, this multiplier model receives, among others, the following criticisms:

(i) excessive simplifications: they do not reflect the real complexity of the economy, such as the assumption that all expenditure increases result in linear increases in production; (ii) failure to observe long-term effects: the model tends to focus on short-term effects, neglecting the long-term dynamics that influence the economy's response to spending shocks; (iii) price and wage rigidity: the model assumes instantaneous adjustments in prices and wages, however, many are rigid and do not adjust quickly to changes in demand; (iv) budget deficit effect: increase in government spending leads to concerns about public debt and fiscal sustainability, affecting investor confidence.

(v) Dependence on circumstances above the trajectory: the multiplier effects may vary depending on the macroeconomic context, the phase of the economic cycle and the composition of expenditures, making the impact of the multiplier imprecise; (vi) propensities to consume and expectations: if they are pessimistic, the multiplier effects can be attenuated by the way consumers, companies and government interpret and respond to spending shocks; (vii) leakage via imports: part of the expenses can be destined to other countries in the form of imports, thus reducing the multiplier impact on the domestic economy; (viii) limitations in open economies: multiplier effects are affected by external factors, such as exchange rates and trade flows, modifying the relationship between spending and production.

Therefore, the Keynesian multiplier model has limitations and must be interpreted with care, considering real-world complexities and multiple variables over future time. In the 1950s, Hyman Minsky focused on the cost structure of the firm, operating through wages as they change due to fluctuations in employment and the degree of investment activity.

However, Hyman Minsky becomes avant-garde by highlighting: previously created capital positions must be funded. A company's willingness and ability to absorb losses incurred by its liabilities depend on current and future cash flows and balance sheet positions. These are a function of past, present and future demand.

As market structure changes over time, so too do a company's financing conditions, dictated by its particular balance sheet structure. It determines the degree of your vulnerability and, ultimately, your survival.

Funds for investment can be obtained from three sources: equity, earnings retained in reserves and credit. Along with their uses, they describe the balance sheet structure (liabilities and assets) of the company.

Usual economic theory ignores corporate finance and assumes a single principle of behavior for all companies: profit maximization. Now, in an economy of bank debt, minimizing losses is more sustainable...

What distinguishes Hyman Minsky's treatment of the business cycle from traditional theory is the determination of the investment accelerator coefficient not only by the stylized facts of the income-demand interaction, but also by the effects of a firm's financing conditions. This distinction is undoubtedly the origin of the originality of Hyman Minsky's thinking when raising his famous “financial fragility hypothesis”.

*Fernando Nogueira da Costa He is a full professor at the Institute of Economics at Unicamp. Author, among other books, of Brazil of banks (EDUSP).


Hyman Minsky. Induction investment and business cycles. Cheltenham, Edward Elgar Publishing, 2005, 288 pages (

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