The financial instability hypothesis: A stochastic microfoundation framework

Abstract

a b s t r a c tThis paper examines the dynamics of financial distress and in particular the mechanism of transmission of shocks from the financial sector to the real economy. The analysis is performed by representing the linkages between microeconomic financial variables and the aggregate performance of the economy by means of a microfounded model with firms that have heterogeneous capital structures. The model is solved both numerically and analytically, by means of a stochastic approximation that is able to replicate quite well the numerical solution. These methodologies, by overcoming the restrictions imposed by the traditional microfounded approach, enable us to provide some insights into the stabilization policies which may be effective in a financially fragile system.

Debt Deleveraging and Business Cycles: An Agent-Based Perspective

“…On the contrary, the agent-based approach is able to emphasize the role of the investment-finance link not just as a propagator of exogenous shocks but as the main source of financial instability and business cycles, in line with Minsky's financial instability hypothesis (Minsky, 1986;Fazzari et al, 2008)) A number of agent-based macroeconomic models have been developed in the last few years with the aim to focus on credit and financial factors as key driver of the business cycle, see e.g. Delli Gatti et al (2005Gatti et al ( , 2009); Raberto et al (2008a); Chiarella and Di Guilmi (2011), but they still do not offer a complete understanding of the economy as a set of interrelated markets, i.e. credit, financial, labor, consumption and capital goods.…”

Minsky Models: A Structured Survey

“…The expected rate of return on equity plays a key role in generating instability or endogenous cycles (see, e.g. Taylor and O'Connell, ; Ryoo , ; Chiarella and Di Guilmi, ). When the expected rate of return increases, the price of equities goes up and this affects positively economic activity via investment and/or consumption.…”

“…Chiarella and Di Guilmi () propose a heterogeneous agents model that builds on and extends Taylor and O'Connell () in several ways. On the financial side, they allow investors to hold equity, debt and money as financial assets.…”

Debt Cycles, Instability and Fiscal Rules: A Godley-Minsky Model

“…In this paper, B P d is deemed constant 9 For a similar formulation that focuses on the endogeneity of the desired margins of safety of firms and banks see Nikolaidi (2014). 10 For recent Minskyan models that incorporate explicitly this role see Ryoo (2010Ryoo ( , 2013a, Di Guilmi (2011) andPassarella (2012 In our model the dynamic behaviour of g is determined by fiscal rules. Fiscal rules have been widely adopted over the past two decades or so.…”