The financial instability hypothesis advanced by Minsky (1975, 1982, 1986) is not compatible with the rational expectations hypothesis in that firms persist in adopting liability structures which give rise to outcomes which in turn violate the assumptions on the basis of which those liability structures were chosen. This occurs both in the case of excessive caution following a period of instability, and excessive boldness following a long expansion. However, within the context of a formal model, it is shown that such behavior need not result from irrationality or myopia, but may arise instead from the fact that agents do not have sufficient information to compute the RE magnitudes, and must therefore rely on a learning process that makes use of publicly observable data. The dynamics of two commonly used learning processes are examined, one of them Bayesian. Both generate trajectories which differ sharply in their qualitative properties from the RE trajectory, and are in fact quite consistent with the predictions of the FIH.
This is a preview of subscription content, access via your institution.
Buy single article
Instant access to the full article PDF.
Price includes VAT (USA)
Tax calculation will be finalised during checkout.
Bernanke, B. S. (1983): “Nonmonetary Effects of the Financial Crisis in the Propagation of the Great Depression,”American Economic Review 73: 257–276.
Blume, L. E., Bray, M. M., and Easley, D. (1982): “Introduction to the Stability of Rational Expectations Equilibrium.”Journal of Economic Theory 26: 313–317.
Bray, M. M., and Kreps, D. M. (1987): “Rational Learning and Rational Expectations.” InArrow and the Ascent of Modern Economic Theory, edited by G. R. Feiwel. London: Macmillan.
Border, K. C. (1985):Fixed Point Theorems with Applications to Economics and Game Theory, Cambridge: Cambridge University Press.
Cooper, R., and John, A. (1988): “Coordinating Coordination Failures in Keynesian Models.”Quarterly Journal of Economics 103: 441–463.
DeGroot, M. H. (1970):Optimal Statistical Decisions. New York: McGraw-Hill.
Eckstein, O., and Sinai, A. (1986): “The Mechanisms of the Business Cycle in the Postwar Era.” InThe American Business Cycle, edited by R. J. Gordon. Chicago: University of Chicago Press.
Flemming, J. S. (1982): “Comment.” InFinancial Crises: Theory, History, and Policy, edited by C. P. Kindleberger and J.-P. Laffargue. Cambridge: Cambridge University Press.
Friedman, B., and Laibson, D. (1989): “Economic Implications of Extraordinary Movements in Stock Prices.”Brookings Papers on Economic Activity 2: 137–172.
Frydman, R., and Phelps, E. S. (1983): “Introduction.” InIndividual Forecasting and Aggregate Outcomes: “Rational Expectations” Examined, edited by R. Frydman and E. S. Phelps. Cambridge: Cambridge University Press.
Guttentag, J., and Herring, R. (1982): “A Framework for the Analysis of Financial Disorder.” InEconomic Activity and Finance, edited by M. Blume, J. Crockett, and P. Taubman, Cambridge, MA: Ballinger.
— (1984): “Credit Rationing and Financial Disorder.”Journal of Finance 39: 1359–1382.
Kindleberger, C. P. (1989):Manias, Panics, and Crashes: A History of Financial Crises. New York: Basic Books. (Revised edition).
Marcet, A., and Sargent, T. J. (1989): “Convergence of Least Squares Learning Mechanisms in Self Referential Linear Stochastic Models.”Journal of Economic Theory 48: 337–368.
Melitz, J. (1982): “Comment.” InFinancial Crises: Theory, History, and Policy, edited by C. P. Kindleberger and J.-P. Laffargue. Cambridge: Cambridge University Press.
Meltzer, A. (1964): “Comment.”American Economic Review, Papers and Proceedings 54: 340–343.
Minsky, H. P. (1964): “Financial Crisis, Financial Systems, and the Performance of the Economy.” InPrivate Capital Markets, edited by I. Friend, H. P. Minsky, and V. L. Andrews. Englewood Cliffs, NJ: Prentice Hall.
— (1975):John Maynard Keynes. New York: Columbia University Press.
— (1982):Can “It” Happen Again: Essays on Instability and Finance. Armonk, NY: M. E. Sharpe.
— (1986):Stabilizing an Unstable Economy. New Haven, CT: Yale University Press.
— (1989): “Comments on Friedman and Laibson.”Brookings Papers on Economic Activity 2: 173–182.
Simonsen, M. H. (1988): “Rational Expectations, Game Theory and Inflationary Inertia.” InThe Economy as a Complex Evolving System, edited by P. W. Anderson, K. J. Arrow, and D. Pines. Redwood City, CA: Addison Wesley.
Sinai, A. (1977): “Discussion.” InFinancial Crises: Institutions and Markets in a Fragile Environment, edited by E. I. Altman and A. W. Sametz. New York: Wiley.
Skott, P. (1991): “Financial Innovation, Deregulation and Minsky Cycles.” Unpublished Manuscript. University of Aarhus, Denmark.
— (1992): “On the Modeling of Systemic Financial Fragility.” Unpublished Manuscript. University of Aarhus, Denmark.
Taylor, L., and O'Connell, S. A. (1985): “A Minsky Crisis.”Quarterly Journal of Economics 100: 871–886.
West, M., and Harrison, J. (1989):Bayesian Forecasting and Dynamic Models. Berlin-Heidelberg-New York: Springer.
Wojnilower, A. M. (1980): “The Central Role of Credit Crunches in Recent Financial History.”Brookings Papers on Economic Activity 2: 277–339.
Wolfson, M. H. (1990): “The Causes of Financial Instability.”Journal of Post-Keynesian Economics 12: 333–355.
For useful comments and suggestions I would like to thank Duncan Foley, Peter Skott, Anwar Shaikh, Toichiro Asada, Reiner Franke, and two anonymous referees, without implicating them in errors that remain.
About this article
Cite this article
Sethi, R. Dynamics of learning and the financial instability hypothesis. Zeitschr. f. Nationalökonomie 56, 39–70 (1992). https://doi.org/10.1007/BF01239491
- Learning Process
- Economic Theory
- Observable Data
- Formal Model
- International Economic