Alternative title: Ignore Minsky at Your Own Risk


Thomas Donlan in Barron’s discusses the asymmetric policy approaches of the Fed. It turns out that Policymakers ought to respond as aggressively to sharply rising markets as they do to rapidly falling ones. That failure is one of the factors in allowing bubbles to form and markets to get out of hand.


“IN 2007, WHEN TROUBLES BEGAN TO SURFACE in housing, most analysts argued that the problem would be contained. Inflation was low, they said, and the Federal Reserve could keep the problem from worsening by lowering interest rates. As late as last July, a large majority of economic forecasters believed the U.S. would avoid the recession that had already begun.

It is easy to blame incompetent bankers, but a major part of the blame for today’s global crisis belongs to incompetent theories. Economic orthodoxy ties boom and bust cycles to external shocks and inflation dynamics and in so doing treats financial markets as a sideshow. To such economists, shocks cannot be anticipated. Central bankers must respond forcefully if a bolt from the blue arrives…

Goldilocks growth on Main Street invites destabilizing activities on Wall Street. This was the longstanding thesis of the late renegade economist Hyman Minsky. His work was largely ignored by mainstream economists throughout his life. Much of the carnage unfolding today can be laid at the doorstep of central bankers who still ignore Minsky…

Asset bubbles swell when risk appetites are high and credit spreads are narrow. Had the Fed considered spreads in its policies for 2004 and 2005, its tightening might have been much more aggressive. Home prices might have cracked much earlier. And today’s recession might have been much milder…

Central bankers, as we can all see at the moment, are always at the ready to respond to violent increases in credit spreads. When stock and corporate bond markets go into free fall, policy makers ease aggressively, pointing out that investors need to be cleansed of primal fears.

But what about rising markets? For the past 25 years, policy-makers were willing to say they knew better than falling markets but they refused to respond to markets that were rapidly rising. This asymmetry played a major role in the creation of a succession of asset bubbles. And much of today’s crisis stems from this asymmetric response.

Good stuff, Thomas.


On the Other Hand
Barron’s JANUARY 3, 2009

Category: Federal Reserve, Markets, Politics, Psychology, Real Estate

Please use the comments to demonstrate your own ignorance, unfamiliarity with empirical data and lack of respect for scientific knowledge. Be sure to create straw men and argue against things I have neither said nor implied. If you could repeat previously discredited memes or steer the conversation into irrelevant, off topic discussions, it would be appreciated. Lastly, kindly forgo all civility in your discourse . . . you are, after all, anonymous.

28 Responses to “Why Don’t Policymakers Respond to Rising Markets ?”

  1. Steve Barry says:

    An even better title: “The Greenspan Put Flaw.”

    Great article, until he wrote: “It is easy (sic) lay blame on a few key policymakers. Former Federal Reserve Chairman Alan Greenspan is generally perceived to have been asleep at the switch. But only a few short years ago he was idolized as the “Maestro.” Greenspan was at the helm when policy blunders were committed. But he was simply following a script that was approved by a majority of the mainstream economics community.”

    Which is it?…was he “at the helm” or was he “following” the community. Can’t really see it both ways. In my book, a “maestro” is by definition a forceful leader and he must take the blame, along with his $8 Million book advance.

    Final question..who wrote this piece? Online it says Donlan…in the print edition, it says Robert J. Barbera ( I assume guest writing on Donlan’s usual commentary page)…They should also error check an article before printing (See sic above)…very sloppy.

  2. gogreen says:

    What I don’t get is why no one took steps. Everyone knew there was a bubble…they talked about it all the time. And everyone was just waiting for it to burst.

    Now we have the MAJOR fall out.

    At least comedians are making money on the whole thing:

  3. Winston Munn says:

    What has been termed the great moderation and caused Chairman Bernanke to boast as root cause the superior skills of modern central bankers appears simply to have been Minsky’s growth of instability cloaked in the arrogance of ideological faithfulness.

    Bernanke’s words now seem hollow, distant, a lingering echo bouncing from Fisher’s permanent high plateau.

  4. RW says:

    Article doesn’t read like a Donlan screed – a different author is likely the correct call.

  5. wally says:

    At least the question is starting to be considered; it is well past time and the price of the delay appears to have been rather high.
    Maybe next time we can avoid this.

  6. Marcus Aurelius says:

    2008 was exceedingly Minsky.

  7. danm says:

    It used to be that the world worked at a slower speed. Today, rare are those who know how to pace themselves. Everything is unstable including family life. It’s hard to be consistent and well balanced.

    It does not help that we admire people who accomplish things at ever younger ages. Life exectancy might be 80 but by 13, kids today have done everything that took me 20-30 years to experience! I feel sad for kids today as I wonder how many “midlife” crisis they will have to go through.

    Go around and ask the average Joe what living withing your means implies. I’m sure you’ll get many different answers. I really don’t know how we’ll be able to get us out of this hole we’re created for ourselves.

  8. Tom K says:

    A better question: Why Do Policymakers Respond to Falling Markets ?

  9. Steve Barry says:

    Even better question…can’t the free market set interest rates?

  10. Lee_in_DC says:

    It’s opinion polls, stupid. Why would any policymaker want to mess with a good thing, especially when they have other agendas they need political and popular support for? How much influence do administrations really have over the Federal Reserve?

  11. PrahaPartizan says:

    What’s the mystery? The central bank head is more than ready to respond to “rising” markets when the President and/or Presidential candidate from the party different than the one to which the central bank head belongs needs a rising market. That’s what happened in 2000 when Greenspan pulled the trigger every month pumping economic bullets into Gore’s 2000 Presidential aspirations. Talk about an economic hit man! Greenspan even reloaded a few times.

    Could Greenspan do the same thing leading up to the 2004 or 2008 elections when his actions might have made a difference? Get real. We’re talking politics here. Greenspan cooperated with the Rovian philosophy of politicizing every element of the government, bar none. They just didn’t expect it to detonate in their faces before they left office.

  12. Theodore D. says:

    @Steve Barry,

    I’ve been reading the Austrians alot lately and they seem to argue for that, as well as the abolishment of the FED. I have been trying to understand why Deflation is bad and I can’t come up with a legitimate answer. Doesn’t deflation increase the purchasing power of the dollar, incentivizing saving? With the Fed Fund rate near 0 banks should lend more because of cheap $ – but supposedly they are not lending so they are building up reserves. With the amount these banks were levered this inflow of cash borrowed from the Fed should bring them back to a safer levered rate. If banks are no longer lending under a minsky idea to either ponzi borrowers, or speculative borrowers (or even Hedge borrowers) then their should be a contraction in the economy which some will say is proof of deflation but the increase in the money supply is actually increased but just held in reserve. So with the Fed Fund rate so low more money is being printed but not loaned so there should be a contraction in the real economy (With some arguing that this is deflation) with actual inflation.

    If we want to incentivize savings shouldn’t the rate be raised? Wouldn’t this increase the purchasing power of the dollar? Sure there would be less lending but didn’t speculative borrowing contribute to the housing bubble? Also aren’t we seeing business contraction because there are actually bad/redundant businesses? IE GM, Half the retail industry, Circuit City. Don’t we want deflation? The economy would wipe out all the shitty businesses and then come back stronger. But we are seeing the Gov. save bad businesses hurting us in the long run. Isn’t increased inflation (caused by low fed fund rate) the worst thing possible right now?

  13. Steve Barry says:

    @ Theodore: You ask “Isn’t increased inflation (caused by low fed fund rate) the worst thing possible right now?”

    My answer is a resounding NO. When you are drowning in debt, you need inflation. Deflation will kill you , because your debt stays fixed, while dollars become more valuable. For example: You owe $1 Million on a house…with inflation, your salary rises, but the million is constant…it is easier to pay the loan back and you are doing it with less valuable dollars.

    With deflation, you still owe the million, but your salary is not rising, perhaps dropping as you get laid off and go work in McDonalds. You have to pay the loan back in more valuable dollars in the future. Unfortunately, with our levels of debt, it would take Weimar Republic type inflation to inflate our way out of it.

  14. RW says:

    Deflation’s a pretty bad deal even if the debt level is not screaming like it is now because debt simply isn’t attractive for any reason — why use credit to leverage investment, add to a business, etc. when it will cost you more to pay it off down the road to the point it may even entirely offset the gain you expect by adding capital in the first place — so the cash hording starts, business expansion begins to dry up, unemployment rises, and the positive feedback loops of a contractionary economic cycle accelerate.

    Reading detailed accounts of economic depressions make it pretty clear that anything but the worst hyper-inflationary eras — of the Weimar Republic or Zimbabwe ilk — would be preferable (certainly not preferred given any druthers of course).

    Preaching Calvinistic self-reliance, a restricted monetary base and citing the Austrians has developed a certain cachet these days but anyone serious about pursuing the policies implied might want to carefully think through their own vulnerabilities first; the price of virtue can come very high in a world with fewer jobs, less money and no legitimate social claim for assistance from anyone including government.

  15. danm says:

    Actually, you don’t get much focus on production in either scenario, inflation or deflation.

  16. Theodore D. says:

    Gentlemen thank you for your insights. Given I owe 150k and don’t have a job (grad student) I should argue for inflation in the short run for self serving purposes. But I don’t see how that helps anyone in the mid-to long run. The question inflation begs is what causes it. Well it seems as though printing more money and making it easier to get from the banks is the principle cause. So the banks should lend out more money? To whom? Isn’t that what banks have been doing by lowering their lending standards and giving it out to everyone? If this practice has been going on for year and the avg. person has a rising debt level aren’t we just exacerbating the debt problem by giving people cheap money?

    There are three components as I see it: Personal, commercial, and public.

    Personnel: We are up to our ears in debt. Check out the avg. indebtedness of a U.S. citizen. It has gone up every year for the past 12 years. Increasing inflation by giving loans in practice means rolling over your credit card debt onto a new card. Is this an advisable solution?

    Commercial: 1. people are in debt and aren’t going to buy as much anymore. We have consumed beyond our means and our debts are due. Are you arguing to loan ppl more money to keep the economy rolling? 2. Some of our businesses need to go into bancruptcy. GM couldn’t be profitable during the autoboom in the country, Circuit City was redundant, Retail outlets are about to start failing soon enough. Do we keep throwing good money at bad companies? At what point do we stop giving public $ to companies that were not successful?

    Public: If we just keep printing money and lowering the value of the dollar at what point do we run the risk of having foreign countries abandon the $ as the currency of choice? While that may be unlikely in the short run, they will probably stop loaning to us so that we can buy the goods they produce.

    While I would personally benefit from Weimarish hyper inflation, I don’t see how inflation helps anyone other than those in debt. Deflation stops incentizing people from accumulating debt and benefits those who weren’t stupid with their money and wanted to actually save. What have you been reading in the news non-stop businesses that have great expansion ideas that aren’t able to get credit or everyone in there mother getting loans, most of which are undeserved?

    IMHO you can’t separate inflation from lending so how can you advocate for one but not the other?

  17. algernon says:

    If we had market-produced money instead of fiat or faith-based money produced by a gov’t bureaucracy, then the rise in investment demand (whether for stocks or houses) would increase interest rates naturally to choke off the developement of a bubble. It is unlikely that a bureaucracy like the Fed will ever be able to mimic a market interest rate.

    The interest rate should result from the interplay of the supply of savings & the demand for loans. When the Fed via fractional reserve banking can lend money that no one has ever saved, booms & busts are the natural result of an unnatural interest rate.

  18. Pravin says:

    The confusion about deflation/inflation stems from the basic difference in the definition of inflation by the Austrians and the Keynesians. If inflation is defined as an increase in money supply and deflation as the reduction of money supply (base money),then you are in the Austrian camp.If you use falling prices to signify deflation then it is a Keynesian perspective (which is flawed,IMO).
    We love falling prices in daily life.Falling memory chip prices,PC prices,TV prices -all brought about by productivity gains is widely welcomed and nobody seems to complain.Only when financial assets fall do people seem to crib.In a situation where the base money supply is stable,we will have falling prices by default,as productivity gains are passed on to consumers.Savings is incentivized and every gets more bang for their buck .Borrowers(prudent ones) gain because of overall fall in prices.Their debt is now more in real terms,but it is more than made up for by falling prices for the rest of the goods and services he needs to purchase.So,to a prudent borrower,it is not a bad thing. It is definitely bad for a person who blows the money mindlessly in consumption. i.e prudent borrowing is incentivized and those who will be able to have ROI greater than the cost of borrowing (includes education loans) will benefit.

    Since there are a lot of savers,there will be a lot of people ready to lend and this in turn reduced interest rates.So the interest rates will always be on the lower side -and this will be low not because some Fed mandated it artificially.

    If the monetary authority insists on tinkering with rates and money supply,as the Austrians show,there will be malinvestments and booms and bust cycles.

    Minsky makes a lot of sense,but I think he may only be explaining the symptoms rather than the cause.The Austrian explanation is much more easier to grasp(KISS principle?)

  19. Theodore D. says:

    Just a little quip – Donlan writes “The U.S. has been in recession for much of this year” – oh wow all 3 days of it?

  20. Economics 101 says:

    @RW : the price of virtue can come very high in a world with fewer jobs, less money and no legitimate social claim for assistance from anyone including government.

    Hello all,

    Well this view, as many others, is interesting. How about this. That may be just what is neccessary…. rather than creating false economies for people to exist within. Also, we could use the principle of population to explain where we are today. For example, as the Industrial Revolution allowed us to expand the production possibilities frontier….. the mass production and mass distribution system became larger and more efficient. In this, population would be allowed to increase from an increase in food production and distribution capability overall in an economy (whether you take a national or global perspective is irrelevant.) An example of this would be America with efficient production and distribution vs. Ethiopia (Had enough food however the means to distribute food were poor and thus starvation occured.) If the Rev. Malthus is correct, and a increasing food supply is not available through means of production then even the U.S. efficient distribution system would fail and population would suffer as a result. Perhaps we should be more cautious on how we construct a successful economy because if we create an artificial means (unsustainable debt (margin financing) or (leverage)) of supporting an increase in population (jobs, businesses, lives, homes, etc.) that cannot be sustained then the population that exists within will suffer until the level of sustainability would be reached. Essentially, you could look at us (humans) in Malthus’s perspective and see stages. Stage I: pre-agriculture, Stage II: agriculture (with horse and plow), Stage III: industrial agriculture (which might be unsustainable unless a technological breakthrough can take us to Stage IV ??????). Apply this methodology…… if you have eyes you will see that balance and harmony must be achieved rather than false pursuits. True sustainability is 1=1 or for every input there is one output. Extrapolate that.

    On the lighter side of things, I am stiil going to public school. (When are people going to realize that these Harvard, Yale, and Chicago grads with their orthodox thought process is not an education?) Heterodox is where its at. LOL. Anyway, I start this term Tuesday. I am still studying Business, Finance, and Political Economy (Why? I don’t know….it is not like there are many jobs in this deflationary spiral.) There are some great thinkers on this blog. I love the excellent commentary.

    Thanks all,

    Economics 101

  21. Theodore D. says:

    Malthus leads to scary conclusions be wary.

  22. Blissex says:

    «If we had market-produced money instead of fiat or faith-based money produced by a gov’t bureaucracy, then the rise in investment demand (whether for stocks or houses) would increase»

    The USA tried this, it is called “wildcat banking” and in effect what increases is fraud. A good argument can be made that in the past 10-15 years the USA has in effect reverted to wildcat banking as the effective abolition of reserve requirements and the creation of new unregulated financial instruments has allowed banks and other business to create their own money, of which curiously there seems to be always overproduction :-).

    «interest rates naturally to choke off the developement of a bubble. It is unlikely that a bureaucracy like the Fed will ever be able to mimic a market interest rate.»

    The problem is that interest rates really cannot determined by “the market”. They are exogenous. Unless one makes something else an exeogenous policy instrument.

    The reason why there must be an exogenous instrument in the economy is that something must express a link between paste present and future.

    The unwise people who argue for gold as currency are just arguing that the exogenous instrument should be the physical production of gold, and that is a rather arbitrary and bad link between present and future.

  23. Pravin says:

    There is nothing ‘arbitrary’ about gold as a choice. It is the outcome of 6000 years of civilization and has been the default choice across cultures and geographies for millenia.It is paper/fiat money which is a recent arrival .The natural choices of generations of human beings is not arbitrary at all.Or you can choose barter and its accompanying inefficiencies. A lack of understanding of economic history causes people to assume it is some goldbug fantasy.

  24. danm says:

    Apply this methodology…… if you have eyes you will see that balance and harmony must be achieved rather than false pursuits
    There will never be harmony in North America.

    If you got to Virginia and learn the history of the first settlers, you will discover that everything North Americans do has been unsustainable from the very beginning.

    First of all, even the natives who lived in symbiosis with nature, could not practice a sustainable lifestyle. They would colonize an area for a hundred years (maybe more) then would have to move on to another area as the land became unproductive. I guess the speed of the process depended on the population growth.

    Before the settlers arrived, there were no domesticable animals in NA, thus no horse power and not many fruit trees. Once you are made aware of this, it’s easy to understand why the natives never managed to get as “civilized” as the Europeans.

    When the Europeans arrived, they razed the land and produced some of the most energy sucking crops you can think of: tobacco. It’s obvious that they needed more and more land. They introduced animals and horsepower by importing horses and animals from Europe. They also imported the honey bee from Europe, so I’m not surprised to hear that the bee colonies are disappearing! And I guess they also imported the fruit trees that the bees would pollinate.

    From the very beginning, we jeopardized the entire environmental landscape of our continent and never thought ntwice about it. Our way of life is totally unsustainable and we’ve done so much damage, I don’t believe we can reverse it. We might be able to slow it down but it won’t be our efforts, it’ll be because we are forced to.

    IMO Malthus was right, he just got the timing wrong.

  25. danm says:

    thus no horse power and not many fruit trees: of European taste.

  26. Thisson says:

    The ratio of money to goods has to be fixed through some exogenous mechanism, but it doesn’t need to be interest rates OR precious metals. In modern times, Oil might be a better base for currency than gold or silver. We could rely on “Petrodollars” for currency.

  27. algernon says:


    Exogenous is a academic construct. I’m talking about reality.

    Free people in the long run don’t gravitate to wildcat banking. They evolve rules to regulate the inherent dangers of fractional reserve banking. We were doing this over the period of 1865 to 1913, a period of unparalleled economic growth & little inflation. Unfortunately the evolution was killed off by Progressives with the Fed.

    Without the Fed, the Depression would not have been Great, the Stagflation of the 70s wouldn’t have occurred, nor the Dotcom or Housing bubbles. For the 50 years before the Fed, the value of the $ was fairly stable. Since the Fed, the $ has lost ~98% of its 1913 value.

    Free people interacting voluntariy produce good results. We don’t have free markets & look at the results.

  28. jus7tme says:

    Well, a big Duh! is in order.

    One has to understand what Central Banking and Policymaking is really FOR.

    Answer: maximizing asset inflation, so as to benefit the banks and the financial elite, all the while paying lip service to low consumer goods inflation.

    That is why the Central Bank never tries to deflate a bubble. It is quite simple, really.