Minsky's Financial Instability Hypothesis

Minsky's Financial Instability Hypothesis (FIH) is best summarised as the idea that "stability is destabilizing". As Laurence Meyer put it:

"a period of stability induces behavioral responses that erode margins of safety, reduce liquidity, raise cash flow commitments relative to income and profits, and raise the price of risky relative to safe assets--all combining to weaken the ability of the economy to withstand even modest adverse shocks."

Meyer's interpretation highlights two important aspects of Minsky's hypothesis:

  • It is the "behavioral responses" of economic agents that induce the fragility into the macroeconomic system.
  • After a prolonged period of stability, the economy cannot "withstand even modest adverse shocks".

Holling's "Pathology of Natural Resource Management"

Minsky's idea that stability breeds instability is an important theme in the field of ecology. The "Pathology of Natural Resource Management" is described by Holling and Meffe as follows:

"when the range of natural variation in a system is reduced, the system loses resilience."

Resilience and stability are dramatically different concepts. Holling explained the difference in his seminal paper on the topic as follows:

"Resilience determines the persistence of relationships within a system and is a measure of the ability of these systems to absorb changes of state variables, driving variables, and parameters, and still persist. In this definition resilience is the property of the system and persistence or probability of extinction is the result. Stability, on the other hand, is the ability of a system to return to an equilibrium state after a temporary disturbance. The more rapidly it returns, and with the least fluctuation, the more stable it is. In this definition stability is the property of the system and the degree of fluctuation around specific states the result."

The relevant insight in Holling's work is that resilience and stability as goals for an ecosystem are frequently at odds with each other. In many ecosystems, "the very fact of low stability seems to produce high resilience". Conversely, "the goal of producing a maximum sustained yield may result in a more stable system of reduced resilience".

Forest Fires: An Example of the Resilience-Stability Tradeoff

One of the most striking examples of the resilience-stability tradeoff in ecosystems is the impact of fire suppression over the last century on the dynamics of forest fires in the United States.

From Holling and Meffe:

"Suppression of fire in fire-prone ecosystems is remarkably successful in reducing the short-term probability of fire in the national parks of the United States and in fire-prone suburban regions. But the consequence is an accumulation of fuel over large areas that eventually produces fires of an intensity, extent, and human cost never before encountered (Kilgore 1976; Christensen et al. 1989). Fire suppression in systems that would frequently experience low-intensity fires results in the systems becoming severely affected by the huge fires that finally erupt; that is, the systems are not resilient to the major fires that occur with large fuel loads and may fundamentally change state after the fire."

For example, fire suppression "selects" for tree species that are not adapted to frequent fires over species like the Ponderosa Pine that have adapted to survive frequent fires. Over time, the composition of the forest ecosystem tilts towards species that are less capable of withstanding even a minor disturbance that would have been absorbed easily in the absence of fire suppression.

The similarity to Meyer's interpretation of the FIH is striking. In an ecosystem, it is natural selection rather than adaptation that induces the fragility but the result in both the economic and the ecological system is an inability to absorb a modest shock i.e. a loss of resilience.

Comments

Friday Links « Open Economics

[...] Minsky and Ecology- (Macroeconomic Resilience) [...]

The Resilience Stability Tradeoff: Drawing Analogies between River Flood Management and Macroeconomic Management at Macroeconomic Resilience

[...] an earlier post, I drew an analogy between Minsky’s Financial Instability Hypothesis (FIH) and the ecologist [...]

The Cause and Impact of Crony Capitalism: the Great Stagnation and the Great Recession at Macroeconomic Resilience

[...] core insight of the Minsky-Holling resilience framework is that stability and stabilisation breed fragility and loss of system resilience . TBTF protection [...]

“Stability is destabilizing”: Why consolidations lead to trends? « Market Curiosity

[...] but high amplitude. - Put sellers are well advised to cover for seemingly small reasons. Macroeconomic Resilience blog: …a period of stability induces behavioral responses that erode margins of safety, reduce [...]

Forest Fire Suppression and Macroeconomic Stabilisation at Macroeconomic Resilience

In an earlier post, I compared Minsky’s Financial Instability Hypothesis with Buzz Holling’s work on ecological [...]

Evolvability, Robustness and Resilience in Complex Adaptive Systems at Macroeconomic Resilience

[...] uncertainty for macro-economic outcomes that is the focus of this blog – In previous posts (1,2) I have elaborated upon the resilience-stability tradeoff and its parallels in economics and [...]

è un mondo difficile, e vita intensa … di più, è un mondo complesso « Henry Spearman – Il blog di Edoardo Gaffeo

[...] della bio-diversità e un aumento della connettività. Altri esempi illuminanti li trovate qui, qui e [...]

interfluidity » Forcing frequent failures

[...] the slightest spark might be catastrophic. Stability breeds instability. (See e.g. Parameswaran here and here. Also, David Merkel.) We must deliberately set financial forest fires to prevent [...]

Forcing Frequent Failures | The Big Picture

[...] the slightest spark would be catastrophic. Stability breeds instability. (See e.g. Parameswaran here and here. Also, David Merkel.) We must deliberately set financial forest fires to prevent [...]

Safety Differently | Sheep boosting

[...] As often seems to be the case when changing resources to increase adaptive capacity or making system.... Introduced species may escape with unintended devastating effects. It is difficult to know beforehand how it’s going to play out. Likewise, it may be scary for leaders in command-and-control organisations to give more discretion to workers to adapt locally. A step by step approach seems feasible. [...]