Financial Instability

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Financial Instability The hypothesis of financial instability was developed by economist Hyman Minksy. He argued that financial crisis are endemic in capitalism because periods of economic prosperity encouraged borrowers and lender to be be progressively reckless.
Financial Instability could be summed up as: Success breads excess which leads to crisis or Economic stability itself breads instability. Since the credit crisis, many have looked back at the Great Moderation (prolonged period of economic growth during 1990s and 2000s) had examined how it contributed to complacency and risk-taking. How economies go from stability to instability? Traditionally, bank lending is secured against assets. The lending is hedged against default. For example, banks lend mortgages if people can raise a deposit and can maintain mortgage payments to repay both the capital and interest.
Minksy Moment The Minsky moment refers to the point where the financial system moves from stability to instability. It is that point where over-indebted borrowers start to sell off their assets to meet other repayment demands. This causes a fall in asset prices and loss of confidence. Implications of Financial Instability Hypothesis Minsky argued that because capitalism was prone to this instability, it was necessary to use government regulation to prevent financial bubbles.
Financial Instability and Credit Crunch The work of Hyman Minsky was largely ignored by main stream economics in the 1970s and 1980s. Instead there was widespread support for financial deregulation. But, the credit crisis of 2007 onwards understandably created renewed interest in his work. The model seemed to offer considerable explanation for elements of the credit crisis. Limitations of Financial Instability Hypothesis Government regulation of financial markets is often more difficult in practise than theory. Financial firms have ways of avoiding government regulation.
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