Business cycles and financial crises

The current economic curriculum has  mostly neglected the active role of money and financial institutions and the destabilizing effect that speculative practices have on business cycles.

In truth, these issues have long been neglected by mainstream economists who argue that business cycles and financial crises result from misguided economic policies, particularly over-spending by governments. For instance, Milton Friedman said that financial crises are monetary phenomena that result from central banks’ wrong decisions. At the root of a financial crisis, the central bank is active in increasing the money supply in order to maintain the domestic income level higher than its non-inflationary level. Thus, the solution to end the crisis should be a restrictive monetary policy to stabilize prices and, therefore, the income level. Friedman’s theoretical approach emphasizes the distortions caused by monetary policy on the interest rate equilibrium level (natural rate). Focus is also given on government controls in credit markets which main effect is the reduction of loanable funds. Indeed, mainstream economists argue that financial deregulation is necessary to enhance efficiency in the allocation of funds  towards the non-inflationary income level.

Critical of mainstream economics, Hyman Minsky considered the role of finance in the business cycle and developed the financial instability hypothesis which states that financial crises are inherent to the capitalist economy. From the Keynesain tradition, Minsky considered the capitalist economy as a set of interrelated balance sheets and cash flows among income-producing companies, households and banks.

Minsky adds to our understanding that banks play a crucial role in determining the path of sustainable economic growth since investment decisions are, therefore, affected by available finance. Through the period of boom, entrepreneurs borrow from banks and accumulate debts.  A sentiment of euphoria takes over and entrepreneurs begin to be over-optimistic in their short-term expectations while financial innovations impact upon banks’ assets and  liabilities.

During the expansionary period of the business cycle, investment demand increases, so does the demand for finance and funding. However, as financial fragility grows,  lower levels of loans increase uncertainty and pessimism in the economy. Banks become unwilling to lend money because of higher credit risk since income flows turn out to fall short of debt repayment plans. As investment decisions collapse, through the multiplier process, employment, income and consumption fall leading to a recession. If the financial crisis also leads to a sharp decline in prices, debt deflation can occur, where asset prices fall.

In short, while considering the relevance of investment as the unstable component of aggregate demand, the Minskyan approach also points out how banks’ strategies and a weak financial regulation turn to induce financial fragility. The recent global crisis revealed that current global finance, as a historical set of institutions, behaviours and policies, has  increased the systemic risk with deep negative consequences for real economies and societies. In order to support sustainable economic growth, the economic curriculum should not neglect how current economic processes and social changes have been subordinated to trading private money.


  1. Bank credit money is created as a chequing account, M1. When saved at a bank (M2 minus M1) it is sequestered (not available) and replaced with new bank credit/borrower debt. In the USA, according to the Fed, M2 is typically 4 times M1,
    That means every dollar available to be earned is owed to a bank as principal debt 4 times over.

    During prosperous times the ratio goes as low as 2:1. At the Crash of 2008 it was an unprecedented 5.26:1

    The ROOT cause of financial instability is SAVINGS, an inherent part of the DESIGN of The BANKING SYSTEM and, at an even deeper level, our concept of money as a uniform quantity made valuable by its own scarcity. There is no remedy nor escape until BOTH are radically transformed.


    • Maria Alejandra Madi said:

      Thanks for your comment but I do not agree that “The ROOT cause of financial instability is SAVINGS”. the unserstading of the causes of financial instability depends on the anlysis of banks’ strategies in creating money and financial innovations; investors’ behaviour; central banks’ policies; business performance and households’ debt and income evolution.

      • You don’t agree – yet you cannot (haven’t even tried to) disprove my facts, logic or arithmetic, all derived directly from Fed statistics and rules and corroborated by events as described in the document. That makes you the same as every other economist I have challenged since 2009.

        I did predict the Crash and an ongoing debt crisis with an animated movie watched by millions in 24 languages. I offer both a so-far irrefutable analysis and a non-disruptive and amazing solution but you can’t be bothered to actually try to refute my argument and instead choose to “fuzzy think” yourself into an excuse why you don’t need to. This isn’t a matter of agreeing or disagreeing. I am challenging you to PROVE me wrong with facts logic and math, or do none of these things actually matter to you?

  2. David Chester said:

    Although many economists have described the business cycle, nobody (with one exception) has provided a theoretical explanation as to what their cause is. Until this vital piece of information is broadcast, how we can see the means for making our social system of macroeconomics more stable, so that there is less risk and uncertainty on business dealings?

    The theory that does explain it was produced more than 135 years ago by Henry George in his seminal book “Progress and Poverty in 1879. George showed how land value speculators hold useful and developing land unused, which makes its price of all the sites (used and not) rise dramatically over a few years. Eventually builders and entrepreneurs cannot afford to buy sites for use, the price bubble bursts and the banks who supported this speculation have to be bailed out by the government. Then the cycle begins again.

    But after George’s book was published, the adverse forces, namely the land owners, introduced confusing ideas, by claiming that land and capital goods are the same (John Bates Clark in about 1900). This caused George’s theory to be virtually forgotten–it was was a deliberate attack on social justice. In common with much else to do with this subject, a group of powerful but adverse-to-common-sharing organizations changed to way that Adam Smith first explained the production process (land, labor and durable capital go into production and have as returns, ground-rent, wages and interest and dividends).

    George provided a cure to this unstable economy. His means to eliminate the business cycle was by stopping the speculation in land values, so that it would not be worthwhile to hold unused land. The opportunities which all useful land provides should be returned to the community as a kind of tax (and other kinds of taxation reduced to zero), so that the advantage that the land provides can be shared. Naturally land owning monopolies objected as did the banks, who also gain from this kind of investment. It would be possible to make this change to our regime of taxation, but it should be introduced slowly.

    • Ernesto Vaihinger said:

      Una explicación anterior a Keynes sobre los ciclos económicos reales la aporta J Schumpeter: el impulso inicial del ciclo porque los bancos financian con crédito, sin contrapartida en bienes, a las innovaciones de empresarios. Auge generalizado por decisiones de inversión que se propaga a la demanda total. Luego vendrán las crisis y depresiones propias de ciclo de innovaciones con sus éxitos y fracasos de sucesivos impulsos en el marco de las ondas largas descriptas por Kondratieff (sólo descriptas, pero creer por acto de fe porque se repiten con sus más y menos cada 50 años).
      Esta visión de J Schumpeter es compatible con la movilidad social que rompe la perpetua circulación económica de quienes participan de sus privilegios. Es la principal función del crédito, cuando financia sólo especulaciones con los precios de activos existentes es una patología que debe ser castigada por los bancos centrales.

      • David Chester said:

        Sorry, but I find your explanation to be unsatisfactory. The banks and their money have less effect on the ability for an economy to function, because when money is needed the banks can always led it. If they need, they will set a rate of interest to suit themselves so that the loan will still happen. This does not stop economic activity in the same way as does land speculation, in fact it simply slows it down without so drastic a change as to make cycles. Several theories exist for business cycles (my macroeconomics book lists 7) but none of them work in every case, so either there is no simple explanation or George is right.

      • Maria Alejandra Madi said:

        El abordaje Keynesiano de Minsky fué influenciado por la lectura de Schumpeter. Adaptó el concepto de innovaciones para traer las innovaciones financieras para el debate de los ciclos y de la política monetária. Entretanto, Minsky dejó de lado la importancia del progreso técnico y de los cambios estructurales en la producción.

        Creo que tu sugestión es interesante y podríamos pensar en un abordaje más aplio reunindo Schumpeter y Minsky.


        Maria Alejandra

    • Maria Alejandra Madi said:

      Thanks for your comment. The focus on speculation in business cycles is an interesting one. Nowadays, speculation with financial assets are crucial to understand financial crises. The speculation with commodities is part of the current financial speculation.

  3. David Chester said:

    The Georgist proposal for land value taxation (LVT), that enables our business cycles to become stable, has the following effects which need careful study, before any gradual change in taxation regimes are made. There are 17 Aspects of LVT Affecting Government, Land Owners, Communities and Ethics

    Four Aspects for Government:
    1. LVT, adds to the national income as do other taxation systems, but it replaces them.
    2. The cost of collecting the LVT is less than for all of the production-related taxes–tax avoidance becomes impossible because the sites are visible to all.
    3. Consumers pay less for their purchases due to lower production costs (see below). This creates greater satisfaction with the management of national affairs.
    4. The national economy stabilizes—it no longer experiences the 18 year business boom/bust cycle, due to periodic speculation in land values (see below).

    Six Aspects Affecting Land Owners:
    5. LVT is progressive–owners of the most potentially productive sites pay the most tax.
    6. The land owner pays his LVT regardless of how his site is used. A large proportion of the ground-rent from tenants becomes the LVT, with the result that land has less sales-value but a significant “rental”-value (even when it is not used).
    7. LVT stops speculation in land prices and the withholding of land from proper use is not worthwhile.
    8. The introduction of LVT initially reduces the sales price of sites, even though their rental value can still grow over a longer term. As more sites become available, the competition for them is less fierce.
    9. With LVT, land owners are unable to pass the tax on to their tenants as rent hikes, due to the reduced competition for access to the additional sites that come into use.
    10. With LVT, land prices will initially drop. Speculators in land values will want to foreclose on their mortgages and withdraw their money for reinvestment. Therefore LVT should be introduced gradually, to allow these speculators sufficient time to transfer their money to company-shares etc., and simultaneously to meet the increased demand for produce (see below).

    Three Aspects Regarding Communities:
    11. With LVT, there is an incentive to use land for production or residence, rather than it being unused.
    12. With LVT, greater working opportunities exist due to cheaper land and a greater number of available sites. Consumer goods become cheaper too, because entrepreneurs have less difficulty in starting-up their businesses and because they pay less ground-rent–demand grows, unemployment decreases.
    13. Investment money is withdrawn from land and placed in durable capital goods. This means more advances in technology and cheaper goods too.

    Four Aspects About Ethics:
    14. The collection of taxes from productive effort and commerce is socially unjust. LVT replaces this extortion by gathering the surplus rental income, which comes without any exertion from the land owner or by the banks– LVT is a natural system of national income-gathering.
    15. Bribery and corruption on information about land cease. Before, this was due to the leaking of news of municipal plans for housing and industrial development, causing shock-waves in local land prices (and municipal workers’ and lawyers’ bank balances).
    16. The improved use of the more central land reduces the environmental damage due to a) unused sites being dumping-grounds, and b) the smaller amount of fossil-fuel use, when traveling between home and workplace.
    17. Because the LVT eliminates the advantage that landlords currently hold over our society, LVT provides a greater equality of opportunity to earn a living. Entrepreneurs can operate in a natural way– to provide more jobs. Then earnings will correspond to the value that the labor puts into the product or service. Consequently, after LVT has been properly introduced it will eliminate poverty and improve business ethics.


  4. Maria Alejandra Madi said:

    Thanks for your comments. Nowadays, we need to re-think the guidelines of the Georgist suggestion in terms of high taxation on financial activities. The current “landlords” are banks and investment funds.

  5. David Chester said:

    When a landlord purchases a site he inevitably get the money to do so by borrowing it from a bank. The bank is happy to do this, because the value of the land is thought to be a satisfactory co-lateral, should the finances of the borrower fail. This is almost the same thing as if the bank purchase the site itself, and so Maria’s comment is partly justified. There are differences however, and not all the blame for our economic crisis (namely the inflation bubble of land prices, and its collapse when the land developers ceased to take advantage through the availability of “cheap money”), can be blamed on these banks.

  6. You don’t agree – yet you cannot (haven’t even tried to) disprove my facts, logic or arithmetic, all derived directly from Fed statistics and rules and corroborated by events as described in the document. That makes you the same as every other economist I have challenged since 2009.

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