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Economics
Minsky's Moment
"Stable economies sow the seeds of their own destruction" (Buttonwood, 2009). This is the basic philosophy of Hyman Minsky, an economist of the mid-20th century. Minsky argues that our financial system plays a big role in amplifying the economic cycle. He says that investors, banks, companies and consumers all tend to make the same mistake. They all assume that the future will look a lot like the past. After seeing several years of growth and low inflation, people develop an erroneous confidence that the good times will last for a long time. This encourages people to begin to borrow, banks begin to lend and the riskiness of the whole system begin to rise (Buttonwood, 2009).
Minsky says that the process has three phases. The first phase consists of investors taking on little enough debt that they have no trouble meeting their capital and interest payments. The second phase consists of investors stretching their finances so they can only afford the interest payments. And the third phase is where investors take on debt levels that require rising prices to be financed. It is when the market reaches this point that the system begins to unravel. Once prices start to drop, borrowers start to default on their loans causing prices to fall even further (Buttonwood, 2009).
When this situation happens the Government must step in and take action. When the banking and finance sector hit crisis mode it causes deflationary destruction, because capital is essentially eliminated. Businesses, investors and consumers begin to lose confidence and borrowers find it hard to repay their lenders. When financial times are good, government revenues in the form of taxes on capital gains, bonuses, corporate profits and property sales tend to be strong. But as governments are now discovering, such revenues collapse very quickly when the bubble bursts and things fall apart (Buttonwood, 2009). The financial sector in this country plays a very important role and can make or break depending on the mode that it is in.
References
Buttonwood. (2009). Minsky's moment. Retrieved April 13, 2009, from Economist.com Web
site:
http://www.economist.com/research/articlesBySubject/displaystory.cfm?subjectid=34891
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