A Minsky-Kindleberger Perspective on the Financial Crisis

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    J. Barkley Rosser, Jr. (contact)

    Professor of Economics, James Madison University

    Tel: 540-568-3212, email:

Marina V. Rosser, Professor of Economics

    James Madison University

    Tel: 540-568-3094, email:

Mauro Gallegati, Professor of Economics

    Università Politecnica delle Marche, Ancona, Italy


January, 2012


     Hyman Minsky and Charles Kindleberger discussed three different patterns of speculative bubbles. One is when price rises in an accelerating way and then crashes very sharply after reaching its peak. Another is when price rises and is followed by a more a similar decline after reaching its peak. The third is when price rises to a peak, which is then followed by a period of gradual decline known as the period of financial distress, to be followed by a much sharper crash at some later time. All three patterns occurred during the financial crisis of 2008-09. Oil prices during 2008 showed the first pattern (peaking in July, 2008); housing prices over nearly a decade showed the second (peaking in 2006), and stock markets showed the third pattern (peaking in October, 2007). Policy directed at containing such bubbles should not use overly broad tools such as general monetary policy, but should be crafted to aim at specific bubbles. Whereas buffer stocks may be useful for commodity bubbles, limits on leverage or taxes on transactions may be more useful for financial markets.

JEL Codes: G01, G12, G18

    Keywords: speculative bubbles, period of financial distress, financial crisis, leverage limits, Tobin taxes


Introduction: The Three Types of Bubbles

    The three types of speculative bubbles are most clearly laid out in Charles Kindleberger’s Manias,

    Panics, and Crashes (1978, 2000), with the first explanation of the most widespread third type based on work of Hyman Minsky (1972, 1982), whose discussion more generally underpinned Kindleberger’s discussion of the nature and pattern of how speculative bubbles develop and end. Minsky laid out a general framework, and Kindleberger supplied numerous historical examples to fill out this general framework, with the subsequent editions of his book expanding this set of examples and providing yet more supporting details for the more general story.

     The first is that most commonly found in theoretical literature on speculative bubbles and crashes (Blanchard and Watson, 1982; DeLong et al, 1990). In this pattern prices rise rapidly, usually at an accelerating rate in most of the theoretical literature, then to drop very sharply back to a presumed fundamental level after reaching the peak. The general argument is that speculative bubbles are self-fulfilling prophecies. Price rises because agents expect it to do so, with this ongoing expectation providing the increasing demand that keeps the price rising. If due to some exogenous shock the price stops rising, this breaks the expectation, and the speculative demand suddenly disappears, sending the price back to its fundamental (or thereabouts) very rapidly where there is no expectation of the price rising. In the case of the stochastically crashing rational bubble model of Blanchard and Watson, the price rises at an accelerating rate. This occurs because as it rises the probability of a crash rises, and the

    i rational agents require an ever rising risk premium to cover for this rising probability of crash.

     In the second type the price rises, reaches a peak that may last for awhile, and then declines again, sometimes at about the same rate as it went up. There is no crash as such, in contrast with other types of bubbles in which there is a period when the price declines much more rapidly than it ever rose, often characterized by panic among agents as described by both Minsky and Kindleberger. In this type


    of bubble, many agents may be quite unhappy as the price declines, but there is no general panic. Some might argue that such a pattern is not really a bubble in that how one truly identifies a bubble is precisely by the occurrence of a dramatic crash of price. However, in this case one observes a price that

    ii appears to be above the fundamental and then moves back down towards that fundamental.

    The main problem then becomes whether or not one can define or observe such a fundamental, which is particularly difficult for assets that do not generate an income stream, such as many collectible items. Indeed, some have argued that all attempts to identify fundamentals face the problem of the misspecified fundamental, that what an econometrician or other observer may think is the fundamental

    iiiis not what agents in the market think is the fundamental, which cannot be determined for sure.

    The third type of bubble is that which exhibits a period of financial distress, a type first identified and labeled by Minsky (1972). In this the price rises to a peak that is followed initially by a gradual decline for awhile, but then there is a panic and crash. According to Kindleberger (1978, 2000, Appendix B), this is by far the most common type of bubble, with most of the larger and more famous historical ones conforming to its pattern, including among others the Mississippi bubble of 1719, the South Sea bubble of 1720, the US stock market bubble of 1928-29, and the same which crashed in 1987, even as this has been the least studied of bubble types. What is involved is heterogeneous behavior by agents, with some insiders getting out at the peak while others hang on during the period of financial distress until the panic and crash.

    Rosser (1991, Chap. 5; 1997) initiated efforts to mathematically model such bubbles using models of fundamentalists and chartists, with Gallegati et al (2011) showing that one can generate such patterns using agent-based mean field models of a Brock and Hommes (1997) type in which heterogeneous agents change their trading strategies over time according to their performance. The behavior of such systems depends critically on how readily agents change their strategies and also the


    degree to which they tend to herd in imitation of each other. In this model, a crucial element for obtaining the period of financial distress element is assuming a wealth constraint, something argued by many as indeed triggering or aggravating crashes as with margin calls in stock markets, with these particularly prominent in the 1929 US stock market crash (Galbraith, 1954).

The Three Bubble Types in the Financial Crisis of 2008-2009

     The great financial crisis of 2008-2009 that put the world deep into its Great Recession exhibited all three bubble types, with the heart of the crisis being precisely the collapse of various speculative bubbles. In considering these we can see some tendencies for certain sorts of markets to be more likely to follow one bubble type or another.

     The leading example of the first bubble type would be the oil market. Given that oil does not generate a direct financial flow in a way that most financial assets do, it is essentially impossible to determine whether what happened was truly a speculative bubble or not. However, there is no doubt

    st century, that after a long period of gradually rising price through most of the first decade of the 21there was an acceleration of the price rise in early 2008 reaching a dramatic peak of $147.29 on July 11, only to be followed by a nearly uninterrupted sharp decline to a low of $30.28 for West Texas Intermediate (WTI) crude on December 23, 2008. This latter may well have been an overshoot as the price has since risen back to the general range of $100 per barrel, although not reaching the previous peak. Figure 1 shows the price of West Texas intermediate crude oil per barrel with monthly trading ranges for 2003-2011.