With the previous chapter, we have introduced a banking sector and allowed for its operations to have an influence, but we now need to modify the treatment of firms’ behaviour to take into account the liquidity and balance sheet consideration that have been applied to the other agents.

Hyman Minsky

The financial instability hypothesis, proposed by Minsky in different guises over the course of his publishing career, can be considered one of the prime examples of how post-Keynesian theory starts from the seminal writing of the 1930s and builds on them to construct what can be genuinely considered a “monetary theory of production” (see Moggridge 1973a), in which money and finance enter into the motives, incentives and mechanics of how the economy can be understood to work. The hypothesis is, necessarily, in the form of a narrative and not of a closed model, which can be summarized by a couple of equations. This is both its strength and its expositional weakness, which may help explain why it has not been given wider attention. It is its strength because its very nature is to describe how any putative equilibrium is merely transitive and how stability is – in itself – destabilizing. Any formal (linear) mathematical model with a closed-form solution will not achieve this feature. Minsky himself is said to have experimented with non-linear models to try to capture the essence of his hypothesis in its initial stages, but he largely abandoned this format in the later formulations.

The absence of a formal model has proved to be a hindrance to the wider dissemination and influence of the hypothesis, however, because economists – rightly or wrongly ‒ find it difficult to focus without the help of equations and diagrams to anchor their thought. What follows is inevitably a compromise. The aim is to give a basic diagram that can support and illustrate the narrative of the hypothesis, but much of the driving action is actually in the exogenous variables that represent the intercepts of the various curves. It is also a suboptimal compromise, because Minsky's narrative is so much richer than a couple of diagrams can ever hope to capture.