Developing Countries in the Global
Financial Crisis: A Minskyan Account
Annina Kaltenbrunner
Lecturer in the Economics of Globalisation &
The International Economy
Leeds University Business School
Motivation
1,800
17
1,600
15
1,400
13
1,200
11
1,000
9
800
7
600
5
400
3
200
0
1
Brazilian Real
Mexican Peso
Turkish Lira
South African Rand
Polish Zloty
Korean Won (RHS)
Outline
 Neoclassical Models of Financial (Foreign Exchange) Crisis
 Post Keynesian Theories of Financial Crisis
 Keynes: Chapter 12 of the General Theory
 Hyman Minsky: The Financial Instability Hypothesis
> Policy Implications and Open Economy Applications
 Developing Countries (Brazil) in the Global Financial Crisis
(September 2008)
Neoclassical Models
Overview
 First Generation Models (Krugman 1979)
 Rational speculators attack central bank in face of fundamental
disequilibria (current account and/or fiscal deficit)
 Second Generation Models (Obstfeld, 1996)
 Self fulfilling expectations about deteriorating fundamentals –
Government “Trade-off ”
 Third (Asian) Generation Models (e.g. McKinnon and Pill,
1996; Radelet and Sachs, 1998; Chang and Velasco, 2002)
 Concern about external repayment capacity
 Net short-term external debt (“original sin”)
Neoclassical Models
Assumptions
 Efficient markets
 Underlying “real” fundamentals run the show (dichotomy
between monetary and real)
 Heterodox approaches to Asian crisis (foreign currency debt)
 Rational agents
 First Generation: No doubt
 Third Generation/Asymmetric information: Constrained
information (moral hazard and adverse selection)
 (Behavioural Finance: Heterogeneous)
Neoclassical Models
Policy Recommendations
 Fix Fundamentals
 Current account, fiscal balance, inflation etc.
 Reduce net foreign currency debt
 Develop domestic financial markets
 Accumulate foreign exchange reserves
 Asymmetric Information: Transparency
 Further reduce State involvement in financial markets (e.g.
“rule-bound”, flexible exchange rates)
 Further open capital account (macroeconomic discipline,
liquidity for domestic financial market etc.)
Post Keynesian Theories of Financial
Markets/Financial Crisis
 Monetary Production Economy
 Creative agency/expectations
 Fundamental Uncertainty (non-ergodicity)
 “Rationality” pointless
 Inter-subjective nature of price formation
John Maynard Keynes
General Theory: Chapter 12
 What determines Investment?
 Rate of interest and the schedule of the marginal efficiency of
capital
 Rate of Interest (GT: Chapters 13-17)
 Reward for parting with the security provided by money in a
world of fundamental uncertainty and historical time >>
money as “secure abode of purchasing power” and medium of
contractual settlement (Paul Davidson)
 Marginal Efficiency of Capital
 Relation between the supply-price of capital asset and its
prospective yield
Chapter 12
Prospective Yield
“The considerations upon which expectations of prospective
yields are based are partly existing facts which we assume to
be known more or less for certain, and partly future
events which can only be forecasted with more or less
confidence”….
”We may sum up the state of psychological expectation
which covers the latter as being the state of long-term
expectation...”
Chapter 12
Speculation
 Conventions and State of Confidence
 Conventions: “Assuming that the existing state of affairs will continue
indefinitely, expect in so far as we have specific reasons to expect a
change”
 Speculation vs. Enterprise
 Stock Market (Secondary Market)
 “It is as though a farmer, having tapped his barometer after breakfast, could
decide to remove his capital from the farming business between 10 and 11 in
the morning and reconsider whether he should return to it later in the week”
 Precariousness of Conventions
 Musical Chair/Beauty Contest
 Displaces enterprise
Chapter 12
Speculation
“Speculators may do no harm as bubbles on a steady
stream of enterprise. But the position is serious
when enterprise becomes a bubble on a whirlpool
of speculation. When the capital development of a
country becomes a by-product of the activities of a
casino, the job is likely to be ill-done”.
Chapter 12
Summary and Policy Implications
 Swings in asset prices detached from “fundamentals” inherent
feature of capitalist economies
 Worse in more liquid markets
 Negative implications for investment and capital formation
 Animal Spirit: spontaneous urge to action rather than inaction
 Policy Implications:




Stabilizing conventions?
Investment permanent and indissoluble >> Illiquidity?
“Force” socially beneficial investment
State investment
Chapter 12
Applications and Extension
 Keynes: stock market
 Paul Davidson, John T. Harvey: foreign exchange market
 Sheila Dow: financial markets in general
 Alves et al. (among others): Asian financial crisis
 But: Keynes not a theory of financial crisis >>> Minsky
Hyman Minsky
The Financial Instability Hypothesis
 “John Maynard Keynes” (1975); “Stabilizing an Unstable Economy”
(1986)
 Missing link in General Theory is finance (credit) – liability side of
balance sheets
 Theory of inherent and endogenous fragility of financial markets
and capitalist economies
 Balance sheet/Wall Street view of capitalist economies
 Financial fragility and instability due to changing cash flow
configurations over the business cycle (profits vs. debt payments)
>Financial Instability Hypothesis
The Financial Instability Hypothesis
Building Blocs
1. (Subjective) Expectations change over course of the cycle: stability
breeds instability

Rising investment > higher profits and rising asset prices >
feedback to investment > boom/euphoria
2. Increasingly fragile financial structures - match between cash flow
commitments (debt service and principal) and cash income
(investment yields)
Hedge: income meets interest rates and principal
Speculative: income meets interest rates but not principal
Ponzi: income does not cover interest rates
>> Margin of safety falls
>> Increased vulnerability to changing (financial) market conditions



The Financial Instability Hypothesis
Building Blocs
3. Endogenous “shock” (rise in interest rate) which turns fragility
into instability
 Central bank raises interest rate to cool economy
 Banks raise interest rate reacting to high demand for external
finance
4. Debt deflation (Fisher (1933))
 Rising interest rates > higher borrowing costs, falling net-worth,
lower credit ratings > inability to meet cash flow requirements
 Falling profits and asset prices
 Defaults > banking crisis
The Financial Instability Hypothesis
Summary and Policy Implications
 Financial instability and crisis inherent feature of capitalist
economies with “mature” financial markets
 Financial crisis not due to misaligned fundamentals but
increasingly fragile financial structures – balance sheets and
cash flow requirements
Policy Implications:
 Big Government > stabilize firm profits
 Big Bank > stabilize asset prices
 Regulate Finance
The Financial Instability Hypothesis
Applications and Extensions
 Capitalist firm > banks, households, states
 Open economy/Emerging Markets
 Exogenous shock?
 Exchange rate > “super-speculative” units (Arestis and
Glickman, 2002)
Developing Countries in the Global
Financial Crisis
1,800
17
1,600
15
1,400
13
1,200
11
1,000
9
800
7
600
5
400
3
200
0
1
Brazilian Real
Mexican Peso
Turkish Lira
South African Rand
Polish Zloty
Korean Won (RHS)
Neoclassical Models
Fundamentals and Foreign Currency Debt
Table 1: Domestic Economic Fundamentals
Current Account (%GDP)
Primary Fiscal Surplus (%GDP)
Public Sector Net Debt (%GDP)
Inflation Index (CPI-IPCA)
FX Reserves/Total External Debt (%)
FX Reserves/Short-term External Debt
(%)
Dec06
1.3
3.8
45.9
3.1
49.7
211.7
Jun07
0.8
3.6
45.0
3.7
76.9
216.3
Dec07
0.1
3.9
43.9
4.5
93.3
289.9
Jun08
-1.0
3.9
41.8
6.1
97.7
312.2
Sources: BCB Economic Indicators and Brazilian Treasury
Sep08
-1.7
4.1
40.9
6.2
98.2
296.8
Dec08
-2.2
3.6
38.5
5.9
104.3
349.8
Jun09
-1.2
3.0
41.2
4.8
104.7
349.7
Dec09
-1.3
2.6
42.1
4.3
120.6
455.2
Jun10
-2.1
2.9
40.0
4.6
110.7
367.6
Dec10
-2.1
3.0
39.2
5.9
112.4
371.4
Jun11
-2.0
3.0
38.6
6.7
115.1
437.7
Sep11
-2.1
3.1
36.3
7.3
117.3
474.9
Post Keynesian/Minskyan Account
Unprecedented Amount of Capital Flows
80,000
Emergence
of the
Eurozone
Crisis
Emergence
of the Global
Financial
Crisis
60,000
40,000
20,000
-
Deepening
of the
Eurozone
Crisis
(20,000)
(40,000)
Global
Crisis hit
EME
(60,000)
Current Account
Portfolio Flows
Banking Flows
Post Keynesian/Minskyan Account
In complex, very short-term domestic currency assets
45
40
35
30
25
20
15
10
5
0
Derivatives - US$ Futures
Derivatives - DI Futures
Stock Exchange
Domestic Public Debt
Post Keynesian/Minskyan Account
Which created Balance Sheet Vulnerabilities
150,000
100%
100,000
90%
80%
50,000
70%
0
60%
-50,000
50%
-100,000
40%
-150,000
30%
-200,000
20%
-250,000
10%
-300,000
0%
Share of Local Currency Claims (RHS)
International Investment Position (IIP) Short-Term
Funding Gap
International Investment Position (IIP) Strongly Short-Term
Post Keynesian/Minskyan Account
The Crisis
 “Shock” (rising interest rates and increased risk aversion in




developing financial markets)
Rising funding costs for international banks
Speculative and Ponzi Units need to make position
Do so in overexposed and liquid assets > Brazil
Falling asset prices and exchange rate depreciation
exacerbate financing difficulties > Stampede and exchange
rate depreciation by 60% unrelated to Brazilian fundamentals
Conclusions
 Neoclassical vs. Post Keynesian: Different Ontological
assumptions of how financial markets (economic dynamics
generally) work
 Neoclassical: stable underlying fundamentals which will be
aligned with expectations as long as frictions are removed
(government, noise traders etc.)
 Post Keynesian: Symbiotic relationship between real and
finance; no underlying fundamentals; inherent fragility of
financial markets and economic systems
>>> State and Government Control