Minsky moment

[girl gone mad]

A Minsky moment is the point in a credit cycle or business cycle when investors have cash flow problems due to spiraling debt they have incurred in order to finance speculative investments. At this point, a major selloff begins due to the fact that no counterparty can be found to bid at the high asking prices previously quoted, leading to a sudden and precipitous collapse in market clearing asset prices and a sharp drop in market liquidity.

The term was coined by Paul McCulley of PIMCO in 1998, to describe the Russian financial crisis,<1> and was named after economist Hyman Minsky. The Minsky moment comes after a long period of prosperity and increasing values of investments, which has encouraged increasing amounts of speculation using borrowed money.

The concept has some parallels with Austrian Business Cycle Theory, although Hyman Minsky himself was known as a "radical" Keynesian.


http://en.wikipedia.org/wiki/Minsky_moment

[girl gone mad]

1. Liquidity trap

In monetary economics, a liquidity trap occurs when the nominal interest rate is close or equal to zero, and the monetary authority is unable to stimulate the economy with traditional monetary policy tools. In this kind of situation, people do not expect high returns on physical or financial investments, so they keep assets in short-term cash bank accounts or hoards rather than making long-term investments. This makes a recession even more severe, and can contribute to deflation.

In normal times, the monetary authority (usually a central bank or finance ministry) can stimulate the economy by lowering interest rate targets or increasing the monetary base. Either action should increase borrowing and lending, consumption, and fixed investment (although Austrian economists tend to believe this is simply a nominal illusion - real consumption and investment levels can only change if production and savings rates change <1>). When the relevant interest rate is already at or near zero, the monetary authority cannot lower it to stimulate the economy. The monetary authority can increase the overall quantity of money available to the economy, but traditional monetary policy tools do not inject new money directly into the economy. Rather, the new liquidity created must be injected into the real economy by way of financial intermediaries such as banks. In a liquidity trap environment, banks are unwilling to lend, so the central bank's newly-created liquidity is trapped behind unwilling lenders.

The liquidity trap theory applies to monetary policy in non-inflationary depressions. The theory does not apply to fiscal policies that may be able to stimulate the economy.