Empirical and Normative Macroeconomic Theory and Monetary/Fiscal Policy in the Twenty-First Century: The Case of Minsky

Abstract

In this second case study about the progress in macroeconomic theory of markets, we try to contribute toward moving the economic discipline beyond its earlier history of divisive schools of economics—moving ahead on a consensus that: (1) Keynes advanced macro-economic theory to include an economic policy concern about employment, (2) Lasik included a concern about inequity, (3) Hayek included a concern about democracy. Now, we add that: (4) Minsky demonstrated that financial markets were inherently unstable and needed proper regulation. Hyman Minsky was a major economist bridging the twentieth and twenty-first centuries, but he did not become famous (an economic “star”) until the 2008 U.S. financial crisis. Minsky argued that financial markets are inherently unstable. In fact, the 2008 financial crisis was a dramatic market instability. Minsky’s prediction about “the instability”; of financial markets was in contradiction to the traditional economic assumption that free markets are always perfect. Furthermore, Minsky emphasized the importance of economic models in empirically validating theory, especially in depicting institutional operations (such as shadow banking). In Minsky’s terms, we show how to construct macroeconomic models that accurately depict reality—illustrating this by modeling the 2008 Global Financial Crisis.