Net worth ratio, bank lending and financial instability

Abstract

This paper extends a Minsky model by incorporating net worth ratio, which Steindl stressed the importance of in reference to financial markets. We construct a dynamic macroeconomic model comprising discrete equations of both the net worth ratio and interest rate. We investigate what factors bring the instability of the steady state. We show that the effect of asset income on consumption can contribute to economic stability following Lavoie (1995) and Hein (2007). On the other hand, the economy becomes unstable when a bank’s lending reaction is elastic with respect to the net worth ratio of the firm. When the steady state is a saddle point, the monetary policy is likely to shift the economy from an unstable path to a convergence path. It can be said that monetary policy may have a stabilizing effect in the long run, however, in practice, there would be considerable difficulties in accomplishing this.