Hyman Minsky was an economist whose theories were made famous during the 2008 sub-prime crisis. Minsky’s work focused on the fragility of financial markets. It was, and still is, mostly ignored by the mainstream economic establishment.
The Cliff’s Notes version of Minsky’s work is that stability breeds instability. Calm markets encourage excessive risk taking which can lead to crisis.
After decades of stability in the housing market resulted in one of the most devastating recessions on record, one might have hoped Yellen & Co., the folk with the most control over financial markets, would be a little more focused on financial stability and instability.
Unfortunately, as the WSJ outlines, one of the Fed’s central tenets of monetary policy, transparency and predictability, may be laying the groundwork for yet another episode of financial instability.
A different debate could help the Fed out of this bind. Even if Ms. Yellen’s current, rather gradual pace is appropriate, the Fed can reduce the odds of a financial bust by tweaking the manner of its tightening.
To do so, the Fed should examine a tenet of the central-banking faith: that transparency is always virtuous. By being less transparent—and reserving the option of deliberately ambushing investors with a shock move—the Fed could discourage them from taking too much risk.
Such an ambush would unsettle markets, to be sure; but that would be the point. The painfully learned lesson from the late 1990s and mid-2000s is that excess financial serenity leads to excess risk-taking, which in turn increases the chances of a blowup. In the first case, that meant the tech bust of 2000; in the second case, it meant the planet-shaking subprime-mortgage meltdown. Since market convulsions caused the last two recessions, reducing the probability of the next one must be a Fed priority.
Read more here.
Jeremy Jones, CFA
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