1 A Theory of Minsky Moments: a Restatement of the Financial Instability Hypothesis in the light of the “subprime ” crisis

This paper aims to bridge the gap between theory and facts on the so-called “Minsky moments ” and “Minsky meltdowns ” by revisiting the “financial instability hypothesis ” in the light of the subprime financial crisis. We argue that we need an approach different and broader than the mainstream’s, not only to understand Minsky moments but also the periods of financial calm between them. This approach, inspired by Minsky, leads us to interpret crucial stylized facts exhibited by recent financial crises through an elementary model of financial fluctuations that endogenously generates instability and fragility. The model here suggested builds on Minsky’s contributions but introduces a few crucial modifications. In particular, we address a constructive criticism to the well-known Minskyan classification of financial units in three categories (hedge, speculative, and Ponzi) and suggest a different classification that allows a continuous measure of units’ financial conditions. We show that this continuum of financial conditions may be aggregated into six categories of financial units that have a clear relation with Minsky’s trinity. We use the suggested classification of economic units to explain the cyclical fluctuations of their financial conditions and the circumstances that lead to Minsky moments and, under given conditions, eventually to a Minsky meltdown. Finally, we use the approach here suggested to shed some light on the causes and consequences of financial crises and their policy implications