Schumpeter, Minsky and the financial instability hypothesis

Abstract

Hyman Minsky pioneered the idea of the financial instability hypothesis to explain how swings between robustness and fragility in financial markets generate business cycles in the economic system. Yet few economists have recognized that this elemental idea originates not only from the financial theory of investment and investment theory of business cycles put forward by John Maynard Keynes, but also in the credit view of money and finance advocated by Joseph Schumpeter. Nevertheless, Minsky described Schumpeter’s business cycle theory as ‘banal’ because it relied on the real economy as Walras represents. The reason was that money was endogenous in Schumpeter’s earlier view, as it emerged out of the credit system, which allowed for a discussion of the relationship between production and finance. This essay will focus on how Minsky related some ideas from Schumpeter’s Theory of Economic Development with those in Keynes’ General Theory Money and finance provide a link between Keynes’ view of the investment decision as a determinant of output and employment with Schumpeter’s view of the investment decision as a determinant of innovation and economic growth.