Question

1. Explain in detail the sectoral balances approach to macroeconomic analysis, and its implications for the fiscal balance when the foreign and domestic private sectors both have positive net savings desires.
2. Explain in detail Hyman Minsky’s Financial Instability Hypothesis, using a balance sheet approach. How can stability be destabilising, according to Minsky?

Answer 1

Ans 1 Sectoral balance is a macroeconomics analysis of budget/surplus of three sectors in the economy. These are government sector, private and public sector. Sectoral balance says that when one of the sector have deficits or is in the loss. From rest one or two sectors that loss must be compensated i.e. when government sector is in deficit, that deficit must be compensated by non government sector of the economy. The government fiscal balance is one of the financial sectoral other being private financial sector and foreign financial sector. According to the sectoral balance,

Government sector + private sector + public sector = 0 (surplus or deficit of all the three sectoral must be zero.)

If there is any positive value it says that there is surplus or savings in the economy and deficit or disavings in the economy.

When foreign and private sector have net positive savings, fiscal balance can be negative in that case. In this case government could be facing many reason through which they are operating in loss, either they could have invested in such a sector whose return will come in long run, providing huge subsidies, investing for social causes.

Ans 2 The theoretical argument of the Financial instability hypothesis(FIH) emerges from the characterization of the economy as a capitalist economy with extensive capital assets and a sophisticated financial system. The FIH incorporates a view in which aggregate demand determines profits. Hence, aggregate profits equal aggregate investment plus the government deficit. The FIH, therefore, considers the impact of debt on system behavior and also includes the manner in which debt is validated.

Minsky's core model is known as "Financial Instability Hypothesis" [FIH], which simply declares stability is inherently destabilizing, he argued that these swings, and the booms and busts that can accompany them, are inevitable in a free market economy, unless government steps in to control them, through regulation, central bank action and other tools.

There are three income-debt relations for economic units: hedge, speculative, and Ponzi finance. For hedge financing units, the income flows from operations are enough to fulfill debt commitments outflows in every period. For units involved in speculative finance, the income flows are only enough to meet the interest component of their obligations and they will have to roll over debt because they cannot repay the principal. For Ponzi finance, the income flows from operations are not enough to cover the interest costs of their loans or the repayment of principal. Ponzi units highly depend on the possibility of refinancing their debt, otherwise they have to resort to the liquidation of assets or issuing new liabilities in order to meet their obligations. The idea that stability is destabilizing” is summarized by Minsky’s two theorems of financial fragility in the FIH: (I) the economy has financing regimes under which it is stable (hedge) and financing regimes in which it is unstable (speculative and Ponzi); and (II) over periods of prolonged prosperity, the economy transitions from financial relations that make for a stable system to financial relations that make for an unstable system