Financial Fragility Hypothesis Research Articles

Financial Fragility and Public Social Spending: Unraveling the Endogenous Nexus

This article provides both stylized facts and estimations of the endogenous nexus of the financial fragility hypothesis (FFH) with public social spending (PSS) for a paradigmatic Eurozone member country. The sample period 1995–2022 includes three major economic crises, the global financial crisis 2007–2009, the European debt crisis 2010–2015 and the COVID-19 pandemic one in 2020–2022. Within the context of the financialization literature, this paper is founded, for the first time, as far as we know, on the “financial fragility hypothesis”, combining the effects of both Minsky’s “financial instability”, as it has been extended for open economies, and the “Eurozone fragility one”. Similar to the relevant literature, the findings show that the PSS is associated, in a long-term steady state (cointegration), with the financial fragility process, starting, firstly, from the hedge-financing structure with high profitability of firms, when PSS decreases; secondly, to hyper-speculative financing with risky options, supported by bank credit and openness, indebtedness or discretionary fiscal policy, when PSS rises; thirdly, to the hyper-speculative or even Ponzi financing structures with over-indebtedness (leverage) from the global capital market, inflated asset prices and internationalized fragility, when PSS also rises, and so on. Our conclusion validates Minsky’s famous saying, “stability breeds instability”, also in the architecturally incomplete Eurozone. Policy implications are straightforward and discussed.

Impact of banking sector competition on emerging market banks’ safety and soundness – A study on Indian Banks

The literature is unsettled on the simultaneous existence of Competition-Stability and Competition-Fragility phenomena in the banking system. Our study has extended the debate where we have incorporated accounting-based information along with 2-SLS system equation modeling to further explore linkages between competition, systemic risk, and stability prevailing in the Indian banking system. The study revealed that for Indian banks competition and systemic risk are inversely related. Systemic risk build-up occurs during the business growth cycle, and it spillovers onto the banking system during the economic down-cycle. The article finds that while a healthy competition would support the overall stability of banks, a fierce competition exerts competitive pressure on the banking system, and hence it negatively contributes to the bank’s stability. It has supported the financial fragility hypothesis and envisages that increased capital restricts competition, and aggressive loan creation increases fragility.

Analysis of the Financial Fragility Hypothesis Applied of Brazilian States by Means of Structural Equations

Studies of financial instability were undertaken by Hyman Minsky, his analyses resulted in the Financial Fragility Hypothesis. Such phenomena can also be studied and analysed from the point of view of governments’ financial positions. In this context, the aim of this study was to analyse the effects of public debt interest and charges on financial fragility in relation to Brazilian states’ public debt. For this purpose, structural equation modelling was used as the empirical procedure. The effects of the structural model’s constructs explained 90.2% of the Public Sector Financial Position, specifically, in this study, the Brazilian states’ financial position. The Gaussian Copula technique was used to assess the model's endogeneity problems, which were not found. The results show that financial fragility in Brazilian states is caused by excessive current spending but is aggravated by interest and amortization costs that exceed the Current Revenue/Current Expenditure balance.

Analysis of the Financial Fragility Hypothesis Applied of Brazilian States by Means of Structural Equations

Analysis of the Financial Fragility Hypothesis Applied of Brazilian States by Means of Structural Equations

Role of bank competition in determining liquidity creation: evidence from GCC countries

ABSTRACT This study aims to investigate the impact of banking-sector concentration on the banks’ liquidity creation in GCC countries over the period from 2012 to 2018 by using a dynamic GMM panel procedure. The results suggest that increased bank competition reduces banks’ liquidity creation across the GCC countries. The study’s findings are in line with the ‘financial fragility hypothesis” according to which banks to reduce their lending activities when competition is high in the market. The evidence suggests that the banking industry is different from others, and pro-competitive policies in the banking industry can reduce liquidity provision by banks. In the context of policy implications, a concentrated banking system discourages capital provision to firms; hence, regulators have to take appropriate measures to resolve the problem of a reduced supply of capital. Government must regulate the banking sector by keeping in view their long-run goal as competition is a double-edged sword in banking.

Income inequality and household debt as a factor of financial fragility in the Spanish economy

Abstract After the last major financial crisis, there was much discussion about the idea that the increase in income inequality during the expansionary phase could have forced middle- and low-income groups to increasingly resort to indebtedness to finance their consumption. This debt-led consumption would have stimulated economic growth, but would also explain why it was not sustainable since families would have become more financially fragile. This approach, which we refer to as the ‘income inequality and debt-financed consumption as a cause of financial fragility hypothesis’, is based on empirical studies that mostly consider the US economy. In this article, we examine whether, as some of the literature suggests, this assumption is sufficient to explain the expansion and subsequent recession in the Spanish economy.

The financial fragility hypothesis and the debt crisis in Italy in the 2010s

The financial fragility hypothesis and the debt crisis in Italy in the 2010s

Investment cycle of the Brazilian economy: a panel cointegration analysis of industrial firms based on Minsky’s financial instability hypothesis—2007–2017

The aim of this paper is to argue that one of the impacts of the 2008 international financial crisis and the European crisis in the Brazilian economy was in the investment rate. Our interpretation is that the impact of the international crises made the balance sheet of non-financial firms more fragile, mainly the industrial firms, and the economic measures implemented to sustain profit margins from 2011 onwards were not enough to counterbalance the deceleration in the aggregate demand and the rise in financial costs. To investigate the evolution of the financial fragility of industrial firms , following Minsky’s financial fragility hypothesis , we propose an econometric model using a cointegration panel. We develop the analysis in two stages using instrumental variables to estimate the rate of investment and the share of financial receipts in total receipts. Among the instrumental variables, the share of wages in value-added, the domestic interest rate, the exchange rate, and the world income were statistically significant. We conclude that the deterioration of the capacity of industrial firms to generate enough internal funds to face debt commitments can be explained by the deceleration of the aggregate demand, expressed by investment rate and the deceleration of the world income, and the increase in the weight of the wage share in total value-added.

The non-financial private firms’ sector of Portugal in 2001–2017: The financial fragility hypothesis-based analysis

The article attempts to analyze the debt crisis in Portugal — as an essential component of the Great Recession in this country — using the financial fragility hypothesis developed by H. P. Minsky. Using a sample of 42 leading Portuguese non-financial private companies, the paper analyzes how the financing regimes used by these companies changed from 2001 to 2017. Before and at the height of the Great Recession, the share of firms with hedge financing mode was decreasing, while the share of firms with fragile financing regimes was increasing. Special attention is paid to how the Portuguese authorities applied austerity policies to deal with the debt crisis, and how they subsequently departed from the principles of this policy. The paper demonstrates that it was precisely after departing from the austerity doctrine that Portuguese non-financial private firms largely managed to get rid of financial fragility.

Political risk and bank stability in the Middle East and North Africa region

This paper examines the relationship between political risk and bank stability in the Middle East and North Africa (MENA) region. We find that political risk is adversely associated with bank stability, generally supporting the financial fragility hypothesis. The analysis suggests that political risk differentially influences the level of stability of conventional and Islamic banks. Political risk has a less detrimental effect on the riskiness of Islamic banks compared with conventional banks. Our analysis also suggests that Islamic banks in the Gulf Cooperative Council (GCC) sub-region are less exposed to political risk compared with those operating in the non-GCC countries (other countries in the MENA region outside of the GCC sub-region).

Public Sector Financial Fragility Index: an analysis of the Brazilian federal government from 2000 to 2016

This article adapts the Public Sector Financial Fragility Index to exam the Brazilian federal government financial posture over 2000–2016. This Index enables examining public finances based on Minsky’s financial fragility hypothesis. The paper undertakes three analyses: one explores the federal government financial fragility using the borrowing requirements data, which is the standard series to assess public finances. The second analysis makes use of the budget execution data, comprising all governmental cash flows, including the financial revenues and expenses but excluding credit operations, which are new debt borrowed by the government; this new debt is considered in the third analysis. The outcomes show that, in its borrowing requirements, the Brazilian government was Speculative over 2000–2013, and Ponzi from 2014 to 2016. Applying the Index to the budget execution data, Brazil was Speculative throughout the period. Considering the budget execution added with credit operations, Brazil was mostly Hedge, although artificially, because built on new debt and not on government revenues. Parallelly, the Index enables analyzing the type of the Brazilian fiscal policy, if pro or countercyclical: it was chiefly procyclical, maintaining Speculative and Ponzi postures whilst the GDP grew, a diverse behavior in relation to the Post Keynesian proposition.

Analysis of factors make Turkish economy fragile by LOGIT and PROBIT models (1990.01-2018:05)

Abstract. The globalization movements that started towards the end of the 20th century influenced many areas of the economy. As a result of the globalization, despite the persistence of the political borders, countries have established borderless relationships in the economic arena. On the other hand, along with globalization, financial crises have become more frequent in the world economy. In particular, the fact that the 2008 Global Crisis reached serious dimensions made it necessary to take measures to stabilize the markets and to evaluate the factors that would shake the market and make the market fragile. Financial fragility is a concept that is often concurrently used with the concepts of financial instability and financial crisis. Financial fragility is a hypothesis which was developed by Hyman Minsky and is different from both concepts and also is interactively affected by instability and crises. In this study, unlike other studies with reference to Minsky's financial fragility hypothesis, we aimed to identify the factors that make fragile the financial markets in Turkey. Logit and probit models were studied with the data of 1990:01-2018:05 period. With reference to the study results, the increase in ratios of the volume of bank loans and M2 occur reserves increases the possibility of future crises. Besides, it is found at the end of the study that a decrease in the composite leading indicators index and in M2 in the BIST 100 index will strengthen the probability of a crisis. Keywords. Financial fragility, Minsky hypothesis, Logit model, Probit model. JEL. G00, C12, B23.

Currency crisis and external fragility: a Minskyan interpretation applied to the Brazilian economy between 1999 and 2013

Abstract: This work has two goals. The first one is to develop an interpretation for open economies founded on Minsky’s financial fragility hypothesis about the process of a currency crisis and its determinants. The deterioration of an economy’s external financial structure is identified as the reason for the increase of its crisis susceptibility. With this approach, we create external fragility indexes intending to measure an economy’s crisis susceptibility. Our second objective is to evaluate the Brazilian external fragility between 1999 and 2013using the index and the interpretation previously developed. The results suggest that Brazilian’s external fragility suffered a gradual and significant decrease and tends to follow stable trend in the coming years.

Inside Money in a Kaldor-Kalecki-Steindl Fiscal Policy Model: The Unit of Account, Inflation, Leverage, and Financial Fragility

We hope to model financial fragility and money in a way that captures much of what is crucial in Hyman Minsky’s financial fragility hypothesis. This approach to modeling Minsky may be unique in the formal Minskyan literature. Namely, we adopt a model in which a psychological variable we call financial prudence (P) declines over time following a financial crash, driving a cyclical buildup of leverage in household balance sheets. High leverage or a low safe-asset ratio in turn induces high financial fragility (FF). In turn, the pathways of FF and capacity utilization (u) determine the probabilistic risk of a crash in any time interval. When they occur, these crashes entail discrete downward jumps in stock prices and financial sector assets and liabilities. To the endogenous government liabilities in Hannsgen (2014), we add common stock and bank loans and deposits. In two alternative versions of the wage-price module in the model (wage-Phillips curve and chartalist, respectively), the rate of wage inflation depends on either unemployment or the wage-setting policies of the government sector. At any given time t, goods prices also depend on endogenous markup and labor productivity variables. Goods inflation affects aggregate demand through its impact on the value of assets and debts. Bank rates depend on an endogenous markup of their own. Furthermore, in light of the limited carbon budget of humankind over a 50-year horizon, goods production in this model consumes fossil fuels and generates greenhouse gases.The government produces at a rate given by a reaction function that pulls government activity toward levels prescribed by a fiscal policy rule. Subcategories of government spending affect the pace of technical progress and prudence in lending practices. The intended ultimate purpose of the model is to examine the effects of fiscal policy reaction functions, including one with dual unemployment rate and public production targets, testing their effects on numerically computed solution pathways. Analytical results in the penultimate section show that (1) the model has no equilibrium (steady state) for reasons related to Minsky’s argument that modern capitalist economies possess a property that he called “the instability of stability,” and (2) solution pathways exist and are unique, given vectors of initial conditions and parameter values and realizations of the Poisson model of financial crises.

Participation in Assets as a Solution to the Debt Crises

Last global financial crisis, as well as liquidity trap in Japan, the theory of debt deflation, the financial fragility hypothesis, the theory of balance sheet recession testifies imperfections of financial relations based on debt financing. It forces to reconsider principles of functioning of the financial system and search new approaches to solving debt crises. In article some theories of debt crises are shown, and it is argued that the participation in assets that provides coupling of debts with assets will allow solving of debt crises.

Will the Recovery Continue? Four Fragile Markets, Four Years Later

This public policy brief analyzes the current economic climate in light of recent data and commentary. The authors’ approach rests upon a Keynesian framework in which departures from full employment can persist even in the long run. Moreover, monetary policy matters in our view, but fiscal policy and finance are more central to the problem of stabilizing a modern economy. In keeping with Wynne Godley’s stock-flow consistent approach to macroeconomics, levels of debt and financial imbalances play a central role in our analysis through good times and bad. Problems with private-sector debt are a subtle and important matter, which we interpret through the lens of Hyman P. Minsky’s financial fragility hypothesis. In this public policy brief, we find that as of early spring 2011, the economic recovery is still alive, but numerous dangers lie both ahead and behind: ill-conceived calls for fiscal austerity in Washington and other capitals; concerns about monetary laxity that unfortunately persist in the face of low long-term interest rates and inflation in almost every major economy; undercapitalized banks that have yet to deal with the many low-quality assets that remain on their books; a dysfunctional public-finance system in the European Union; commodity prices that are in many cases rising at double-digit annual rates; and high rates of short- and long-term unemployment. Fortunately, in spite of these nagging issues, consumer spending and the export sector have been showing some signs of improved health. Nevertheless, our analysis suggests that the current situation requires increased fiscal deficits and additional long-maturity asset purchases by the Federal Reserve.

Usando el "Minsky’s Cushions of Safety” para analizar la Crisis del Mercado Hipotecario en los Estados Unidos

Mientras la inestabilidad financiera ocupa nuevamente un lugar central en el debate de la economía mundial, la prensa financiera ha señalado la hipótesis de la fragilidad financiera de Minsky, para esclarecer las causas de la crisis actual. Sin embargo, aunque muchos elementos de la visión de Minsky son relevantes en la crisis financiera de Estados Unidos, un componente principal de su hipótesis, el declinante margen, o colchón de seguridad en las transacciones financieras, se ha manifestado en una forma distinta a la que propuso Minsky. En el sistema bancario tradicional, el análisis de Minsky propone que bajo condiciones de expansión, las expectativas optimistas acerca de la habilidad de alcanzar obligaciones futuras causan que los bancos bajan sus márgenes de seguridad. Sin embargo, operando bajo el modelo de “originar y distribuir” de años recientes, los procesos de evaluación crediticia fueron transferidos de los bancos a las agencias calificadoras. Éstas también bajaron sus colchones de seguridad, pero no debido al desempeño crediticio histórico, sino por la asignación errónea de precios en el modelo de originar y distribuir. Así, mientras la crisis actual tiene todos los atributos de una esquema Ponzi y amenaza con convertirse en un plena devaluación de deuda, no es el resultado del tradicional proceso endógeno de Minsky en el cual los reducidos márgenes de seguridad llevan a la fragilidad.

Minsky's ‘Cushions of Safety', Systemic Risk and the Crisis in the Subprime Mortgage Market

The current crisis in the financial systems of developed countries is often explained in terms of Hyman P. Minsky’s financial fragility hypothesis. Minsky was an economist at the Levy Institute and the foremost expert on credit crunches. His hypothesis was that the structure of a capitalist economy becomes more fragile over a period of prosperity; that is, endogenous processes breed financial and economic instability. In this brief, Senior Scholar Jan Kregel explains how the current crisis differs from the traditional Minsky hypothesis. He reviews Minsky’s concept of a margin or “cushion” of safety, financial fragility, and debt deflation. He concludes that, while the current subprime mortgage crisis involves both Ponzi financing and declining margins of safety, these conditions are not the result of endogenous processes. Rather, the crisis is the result of insufficient margins of safety based on how credit worthiness is assessed (the undervaluation and mispricing of risk) in the new “originate and distribute” financial system.

Liquidez internacional e ciclo reflexo: algumas observações para a América Latina

International liquidity and reflex cycle: some observations to Latin America. The international financial instability of the 1990 has been analysed in several occasions on Minskyan perspectives. The paper is based on this theoretical approach and intends to demonstrate that the financial fragility hypothesis is very useful to the analysis of the cycle in peripheral economies, which real performance is associated to the availability of international liquidity. The analysis is based on three Latin American countries: Brazil, Argentina and Mexico.

The Minskyan System, Part II: Dynamics of the Minskyan Analysis and the Financial Fragility Hypothesis

This is the second part of a three-part analysis of the Minskyan framework. It studies in detail the dynamics at the root of the endogenous financial weakening of capitalist economic systems. This part combines the properties presented in part I with other important concepts, such as the paradox of leverage and conventional expectations, to explain the Financial Instability Hypothesis. It is demonstrated that the signs of fragility are not always visible and that financial weakening can take many different (even though well-defined) routes. This is used to draw some conclusion about the appropriate way to test for this hypothesis and the limit of data.