Alternative monetary institutional policies of H. P. Minsky and F. A. Hayek The comparison of two alternative theories of inherent financial instability in a capitalistic economy Universität Hamburg Fakultät Wirtschafts- und Sozialwissenschaften Fachbereich Volkswirtschaftslehre Dissertationsschrift zur Erlangung des akademischen Grades Doctor rerum politicarum (gemäß der PromO 17. Juni 1998) Vorgelegt von: Frank Felgendreher StR, Dipl.-Handelslehrer, Dipl.-Kaufmann (FH) aus Elmshorn Hamburg, 12.05.2015 Mitglieder der Prüfungskommission: Vorsitzender: Professor Dr. Thomas Straubhaar Erstgutachterin: Professor Dr. Elisabeth Allgoewer Zweitgutachter: Professor Dr. Harald Hagemann Datum der Disputation: 28.April 2015 1 Content Acknowledgements ....................................................................................................... 4 List of figures................................................................................................................ 6 1 Introduction ........................................................................................................... 8 2 The financial instability hypothesis of H. P. Minsky ............................................ 14 2.1 Economic theory foundations by Keynes, Schumpeter and Fisher ................. 15 2.1.1 Keynes's monetary economy .................................................................. 16 2.1.2 Schumpeter's innovation ........................................................................ 40 2.1.3 Fisher's debt deflation ............................................................................ 49 2.1.4 Conclusive remarks on the theoretical foundations ................................. 56 2.2 The model of the financial instability hypothesis by H. P. Minsky ................ 57 2.2.1 Profits and investment............................................................................ 58 2.2.2 The business cycle ................................................................................. 66 2.2.3 Characteristics of modern capitalism according to Minsky ..................... 78 2.3 Minskyan policy recommendations for the resolution of the crisis ................. 88 2.3.1 Big government prevents volatility ........................................................ 88 2.3.2 Financial regulation provides sound financing ..................................... 112 2.4 Assumptions regarding prices, rate of interest, and rational behaviour ......... 127 3 The business cycle theory of F. A. Hayek .......................................................... 136 3.1 Economic theory foundations by Böhm-Bawerk, Wicksell, and von Mises . 136 3.1.1 Böhm-Bawerk's capital theory ............................................................. 137 3.1.2 Wicksell's natural rate of interest and the cumulative process ............... 146 3.1.3 Von Mises's malinvestment .................................................................. 152 3.2 The business cycle theory by F.A. Hayek in the passage of time ................. 163 3.2.1 Hayek's business cycle theory 1.0 ........................................................ 164 3.2.2 Hayek's business cycle theory 2.0 ........................................................ 185 3.2.3 Modern Austrian macro and the business cycle .................................... 199 3.3 Austrian policy recommendations for the resolution of the crisis ................. 225 2 3.3.1 A hundred percent gold reserve free-banking ....................................... 227 3.3.2 A fractional reserve free-banking ......................................................... 233 3.3.3 Hayek's free-banking ........................................................................... 247 3.4 Assumptions regarding prices, rate of interest, and rational behaviour ......... 257 4 Common aspects and crucial differences between Hayek and Minsky ................ 277 5 Hy or Hayek? ..................................................................................................... 295 5.1 The Austrian-post-Keynesian synthesis ....................................................... 304 5.2 A central bank backstopped free-banking system ........................................ 319 6 Conclusive remarks ............................................................................................ 327 Bibliography ............................................................................................................. 334 3 Acknowledgements At this point I would like to thank all those persons and institutions who have supported me on my quest to successfully finish this doctoral thesis. First and foremost I would like to thank Professor Dr. Elisabeth Allgoewer of the University of Hamburg who supervised me in my work most excellently and supportively. I am particularly indebted to her as she always kept an open mind for my ideas and provided me with the freedom to pursue them, whilst furnishing me with important impulses for my understanding of the Great Depression. Furthermore my gratitude goes to my secondary supervisor Professor Dr. Harald Hagemann of the University of Hohenheim to whom I am indebted in receiving vital impulses for my understanding of Hayek's theory. Furthermore I was given the chance to participate in an additional number of seminars which provided me with an array of new impulses. For their constructive feedback on my presentation at the University of Hamburg I would like to thank Dipl.-Vw. Peter Kowyk and Dipl.-Vw. Ulrich W. Hoffmann. For the opportunity to receive a further insight into the Minskyan theory I would like to thank the Levy Economics Institute of Bard College in New York for inviting me to their summer school in 2012 as well as to the Minsky conference of the same year in Berlin. In this regard I particularly would like to thank Professor Dr. Jan Kregel of the Levy Economics Institute of Bard College as well as Professor Dr. L. Randall Wray of the University of Missouri-Kansas City. I also would like to thank my fellow participants in New York, namely Associate Professor Dr. Gökçer Özgür of Hacettepe University in Ankara and M.A. James Andrew Felkerson of Bard College, for many fruitful discussions and impulses. For the invitation to the seminar of the Wilhelm Röpke Institute in Erfurt in 2013 I would particularly like to thank Professor Dr. Stefan Kolev of the University of Applied Sciences in Zwickau as well as Professor Dr. Joachim Zweynert of the University of Witten/ Herdecke. Additional insights into the Austrian economic theory I was able to gain at the summer school of the Ludwig von Mises Institute in Auburn Alabama in 2013. Here I 4 particularly would like to thank Professor Dr. Roger W. Garrison of Auburn University and Professor Dr. Peter Klein of the University of Missouri. A further understanding of financial markets and central banks was provided to me at the winter school of INET in Paris in 2014 as well as at the summer school of the Goethe University Frankfurt of the same year. In this regard I owe my gratitude to Professor Dr. Brigitte Haar of the Goethe University in Frankfurt, Professor Dr. Katharina Pistor of the Columbia University in New York, Associate Professor Dr. Dan Awrey of Oxford University, Professor Dr. Ulrich Bindseil, the Director General of Market Operation of the ECB, and his predecessor on this post Dr. Francesco Papadia. As I was an external Ph.D. candidate, the endeavour of research for this thesis as well as the writing process itself had to take place in parallel to my main occupation as an economics teacher at the vocational college in Elmshorn (Berufliche Schule Elmshorn). I herewith would like to thank all of those at my workplace who supported me. In particular are to be mentioned the college's deputy principal StD Dipl.-Hdl. Klaus Weide, who most helpfully reorganised my teaching load whenever there was a seminar which I had to attend; as well as the college's principal OStD Margarete Weber without whose consent and support the entire endeavour would have been a lot more difficult to master. The same amount of gratitude in this regard goes to all the heads of departments who also paved me the way by organising my teaching load in such a manner that I was able to pursue my research. Therefore, I would like to thank StD Dipl.-Hdl. Sven Lange; StD a. D. Dipl.-Hdl. Karin Samaga; StD Michael Brinkmann; StD Dipl.-Hdl., Dipl.-Vw., M.Sc. Frank May, StD Peter Schenk and OStR Dipl.-Ing. (FH) Michael Gehrke. For the advice regarding questions of grammar and syntax I am especially thankful to my colleague B.A. Rachel Kuhn. Finally a very special kind of gratitude goes to my family and friends who supported me all the way for the past five years with their kindness and understanding. In this regard I particularly would like to thank my dear parents Erika and Hans Felgendreher for their love and support as well as my loving fiancée Tania de Loayza Díaz, who usually was the first to listen attentively to my ideas and concepts. Therefore, I also would like to thank her in her capacity of a Lic. en Economía y Sociología for her constructive feedback as well as for her tender and cheerful attitude whenever I felt a bit overwhelmed by the task at hand. 5 List of figures Figure 1: Exogenous money supply curve Figure 2: Endogenous money supply curve (horizontalist) Figure 3: Endogenous money supply curve (structuralist) Figure 4: Price mechanism under monopolistic competition: A long term analysis Figure 5: "Banking innovation and the money market rate" Figure 6: "Total Costs Allowing