Question

1) During a pandemic, private sector financial behaviour becomes more risk-averse would like to move into surplus. Suppose that the foreign sector also runs a surplus. What does this imply for the government financial balance? Under what circumstances is it possible for a country to run a government surplus and a domestic private sector surplus at the same time?

2) Explain Hyman Minsky’s Financial Instability Hypothesis, using a balance sheet approach. How can stability breed instability, according to Minsky?

Answer 1

1. When private sector financial behaviour becomes surplus and Foreign sector also run in a surplus in pandemic its shows that the both sector generating and creating surplus before pandemic both sectors think that they may sold all products but due to pandemic they neither exports and imports this leads to surplus and due to pandemic citizens / consumers not able to buy the product of manufacturing sector it leads to surplus and due to surplus production of things they causes damage of sector of production and surplus product not sold and sell . so it causes less of money and capital to both sectors.

In circumstances when government surplus and domestic private sector surplus run when government invest and increase the liquidity of money in peoples when peoples have money then they able to buy the surplus production of goods and they invest their money in consumptions due to lower money in peoples they may not able to invest so the government needed to invest and increase the money liquidity in market.

2.The hypothesis of financial instability was developed by the economist Hyman Minksy. He argued that financial crisis are endemic in capitalism because periods of economic prosperity encouraged borrowers and lender to be progressively reckless. This excess optimism creates financial bubbles and the later busts. Therefore, capitalism is prone to move from periods of financial stability to instability. This is a type of market failure and needs government regulation.

In a balance sheet recession the banking sector is unwilling to lend because it needs to improve its balance sheet and increase bank reserves.

A balance sheet recession also usually involves falling asset prices and deflationary pressures.

Stability breed instability according to Minsky are:

1. Traditionally, bank lending is secured against assets. The lending is hedged against default.

2. However, if house prices rise and there is economic growth, both lenders are borrowers become more optimistic and willing to take on greater risks.

3. Banks insist on smaller deposits and are willing to lend bigger multiples of income.

4. Lending becomes more leveraged.