Hyman Minsky and the IS-LM obfuscation

26 Jan, 2023 at 16:38 | Posted in Economics | 3 Comments

As a young research stipendiate in the U.S. yours truly had the pleasure and privilege of having Hyman Minsky as a teacher. He was a great inspiration at the time. He still is.

The concepts which it is usual to ignore or deemphasize in interpreting Keynes — the cyclical perspective, the relations between investment and finance, and uncertainty, are the keys to an understanding of the full significance of his contribution …

miThe glib assumption made by Professor Hicks in his exposition of Keynes’s contribution that there is a simple, negatively sloped function, reflecting the productivity of increments to the stock of capital, that relates investment to the interest rate is a caricature of Keynes’s theory of investment … which relates the pace of investment not only to prospective yields but also to ongoing financial behavior …

The conclusion to our argument is that the missing step in the standard Keynesian theory was the explicit consideration of capitalist finance within a cyclical and speculative context. Once capitalist​ finance is introduced and the development of cash flows … during the various states of the economy is explicitly examined, then the full power of the revolutionary insights and the alternative frame of analysis that Keynes developed becomes evident …

The greatness of The General Theory was that Keynes visualized [the imperfections of the monetary-financial system] as systematic rather than accidental or perhaps incidental attributes of capitalism … Only a theory that was explicitly cyclical and overtly financial was capable of being useful …

If we are to believe Minsky — and I certainly think we should — then when people like Paul Krugman and other ‘New Keynesian’ critics of MMT and Post-Keynesian economics think of themselves as defending “the whole enterprise of Keynes/Hicks macroeconomic theory,” they are simply wrong since there is no such thing as a Keynes-Hicks macroeconomic theory!

There is nothing in the post-General Theory writings of Keynes that suggests that he considered Hicks’s IS-LM anywhere near a faithful rendering of his thoughts. In Keynes’s canonical statement of the essence of his theory in the 1937 QJE article there is nothing to even suggest that Keynes would have thought the existence of a Keynes-Hicks-IS-LM-theory anything but pure nonsense. So, of course,​ there can’t be any “vindication for the whole enterprise of Keynes/Hicks macroeconomic theory” — simply because “Keynes/Hicks” never existed.

To be fair to Hicks, we  shouldn’t forget that he returned to his IS-LM analysis in an article in 1980 — in Journal of Post Keynesian Economics — and self-critically wrote:

sir_john_hicksThe only way in which IS-LM analysis usefully survives — as anything more than a classroom gadget, to be superseded, later on, by something better — is in application to a particular kind of causal analysis, where the use of equilibrium methods, even a drastic use of equilibrium methods, is not inappropriate. I have deliberately interpreted the equilibrium concept, to be used in such analysis, in a very stringent manner (some would say a pedantic manner) not because I want to tell the applied economist, who uses such methods, that he is in fact committing himself to anything which must appear to him to be so ridiculous …

When one turns to questions of policy, looking toward the future instead of the past, the use of equilibrium methods is still more suspect … It may be hoped that, after the change in policy, the economy will somehow, at some time in the future, settle into what may be regarded, in the same sense, as a new equilibrium; but there must necessarily be a stage before that equilibrium is reached …

We now know that it is not enough to think of the rate of interest as the single link between the financial and industrial sectors of the economy; for that really implies that a borrower can borrow as much as he likes at the rate of interest charged, no attention being paid to the security offered. As soon as one attends to questions of security, and to the financial intermediation that arises out of them, it becomes apparent that the dichotomy between the two curves of the IS-LM diagram must not be pressed too hard.

In his 1937 paper, Hicks actually elaborates on four different models (where Hicks uses I to denote Total Income and Ix to denote Investment):

1) “Classical”: M = kI   Ix = C(i)   Ix = S(i,I)

2) Keynes’ “special” theory: M = L(i)   Ix = C(i)    I = S(I)

3) Keynes’ “general” theory: M = L(I, i)   Ix = C(i)   I = S(I)

4) The “generalized general” theory: M = L(I, i)   Ix =C(I, i)  Ix = S(I, i)

It is obvious from the way Krugman and other ‘New Keynesians’ draw their IS-LM curves that they are thinking in terms of model number 4 — and that is not even by Hicks considered a Keynes model! It is basically a loanable funds model, that belongs in the neoclassical camp and which you find reproduced in most mainstream textbooks.

Hicksian IS-LM? Maybe. Keynes? No way!


  1. May I quote Minsky in “Financial Factors in the Economics of Capitalism” (linked on Wikipedia’s Minsky page)?
    《The alternative to beginning one’s theorizing about capitalist economies by positing utility functions over the reals and production functions with something labeled K (called capital) is to begin with the interlocking balance sheets of the economy.》
    Can financial balance sheets expand (and contract, in a panic) independently of real production? Can I cite data from the Fed’s balance sheet, and supplement with BIS statistics, in support of a disconnect between financial balance sheet growth and real production swings?
    In “The Financial Instability Hypothesis” (again, linked on Wikipedia), Minsky quotes Keynes:
    《There is a multitude of real assets in the world which constitutes our capital wealth – buildings, stocks of commodities, goods in the course of manufacture and of transport, and so forth. The nominal owners of these assets, however, have not infrequently borrowed money (Keynes’ emphasis) in order to become possessed of them. To a corresponding extent the actual owners of wealth have claims, not on real assets, but on money.》
    If we try to quantify the extent, do we find BIS statistics, etc. reporting money volumes something like ten times, at least, actual real assets?
    @Bruce Wilder
    Is logging a productive activity? Why do I want to use finance to pay loggers not to log, after walking through clearcut after clearcut of wasted wood?

  2. 《the explicit consideration of capitalist finance within a cyclical and speculative context. Once capitalist​ finance is introduced and the development of cash flows … during the various states of the economy is explicitly examined, then the full power of the revolutionary insights and the alternative frame of analysis that Keynes developed becomes evident …》
    Can we start by looking at BIS statistics and drawing balance sheets rather than IS-LM graphs?

    • Minsky, to his great credit (or perhaps to Schumpeter’s credit), read into Keynes’ model return on capital as an economic rent. In Minsky’s reading, “quasi-rent” is applied to class returns on capital.
      The inherently risky nature of returns to capital and their extraction from the stream of all income as quasi-rents, therefore dependent for their realization on such political power as the creative entrepreneur can devise from property rights and institutional gamesmanship (“monopoly”, price-discrimination, etc) is implicit in Minsky’s version of Keynes.
      Profitable opportunities to invest may emerge on the horizon, as time and development progress goes on, but enterprises with the institutional capacity to collect an economic rent in the anticipated future combined with cash flows in the form of quasi-rents from past investments will be in a privileged position.
      Whether financialization of industrial investment enables or disables the productive capacity of the economy depends, I would think, on whether anticipated cash flows attached to financial securities and contracts are coming from investment or disinvestment. Casual observation of the U.S. economy, at least, suggests that disinvestment prevails for the moment and adds to the long-term risks of depleting productive capacity.

Sorry, the comment form is closed at this time.

Blog at WordPress.com.
Entries and Comments feeds.