2.Minsky's financial instability hypothesis restated

Minsky（1975,1982,1986）asserts that the process of endogenous business cycles inevitably entails the endogenous changes of the form of investment financing such that“Hedge finance → Speculative finance → Ponzi finance”.Minsky interprets the meanings of these forms of financing as follows.

“If realized and expected income cash flows are sufficient to meet all the payment commitments on the outstanding liabilities of a unit, then the unit will be hedge financing. However, the balance-sheet cash flows from a unit can be larger than the expected income receipts so that the only way they can be met is by rolling over or even increasing debt;units that roll over debt are engaged in speculative finance and those that increase debt are engaged in Ponzi finance.”（Minsky,1986, p.203）

Under the depression process, economic agents become quite pessimistic so that they refrain from investment expenditure, and the repayment of the existing debt and hedge finance dominate in such an environment.As the amount of debt decreases, investment activities become more vigorous, and more bold speculative finance becomes dominant.At the last stage of the prosperity, economic agents become excessively optimistic and they become to be engaged in the Ponzi finance that heavily relies on large amount of borrowing. However, the default of a part of economic agents triggers off the financial crises and the economy rushes into the serious depression.Under the depression process, the hedge finance becomes dominant again.In this way, the waves of the pessimism and the optimism are repeated reciprocally.This is the essence of Minsky's financial instability hypothesis. Minsky's hypothesis forms a striking contrast to the mainstream“rational”expectation hypothesis.Let us quote from Minsky's writings again.

“Financing is often based on an assumption‘that the existing state of affairs will continue indefinitely'（GT, p.152）, but of course this assumption proves false.During a boom the existing state is the boom with its accompanying capital gain and asset revaluations.During both a debt-deflation and a stagnant recession the same conventional assumption of the present always ruling is made; the guiding wisdom is that debts are to be avoided, for debts lead to disaster.As a recovery approaches full employment the current generation of economic soothsayers will proclaim that the business cycle has been banished from the land and a new era of permanent prosperity has been inaugurated.…But in truth neither the boom, nor the debt-deflation, nor the stagnation, and certainly not a recovery of full-employment growth can continue indefinitely.Each state nurtures forces that lead to its own destruction.”（Minsky,1975, p.128）

Such a typical scenario of the process of financially-driven business cycles that was presented by Minsky is called“Minsky cycle”.