Daniel Kuehn draws a distinction between Minsky and Rothbard. I’ve made the comparison on this blog, as well — well, I’ve compared it to Mises–Hayek business cycle theory, more generally. Kuehn’s point regarding both economists’ views on risk is a good one, and I’d agree that Minsky is more sophisticated in that regard. But, on the other hand, I think when we look at the Mises–Hayek theory and focus on the effects on the financial sector, it is far more complete than the Minsky cycle.
I don’t know Minsky very well (I’ve only read part of his John Maynard Keynes — I will have to get back to it this summer); what I do know, I know through Steve Keen’s Debunking Economics. From what I understand, Minsky’s position is that credit cycles are self-feeding, as continuing credit expansion is needed to maximize profit. Greater credit expansion implies falling lending standards, in turn increasing the risk of banks’ loan portfolio. From a macro perspective, the greater the credit expansion, the greater the risk of a financial shock. The banking system cannot self-regulate, because there’s no incentive to do so, and therefore the government needs to regulate the industry in a way to achieve an optimal amount of risk.
I don’t find the theory, at least framed in that way, very convincing. First, it’s not clear why growing risk (e.g. a growing probability of loss) doesn’t act as an incentive to restrict a loan portfolio. Second, empirically, there is little evidence that banks disregarded risk. What there is evidence of is that risk was mis-appreciated. Banks heavily invested into assets that were considered to be some of the safest. They required low capital reserve requirements, and their liquidity made them useful as information insensitive collateral for wholesale credit. The realization of just how risky these assets were came ex post.
I think Austrian business cycle theory provides a better explanation of this phenomenon. The key question is why economic agents consistently underestimated the risk associated with certain assets. That is, why were risk signals distorted (why did they provide information different from that which we would associate with a “healthy economy”)?
What drove the MBS market was the increasing housing price index. Austrian theory can explain this feedback mechanism between credit expansion, rising prices, and increasing asset values, which in turn created room for further credit expansion. The emphasis on rising prices is synonymous with Hayek’s concept of “false profits,” which arise out of changes in relative prices. I think you can get the same narrative without knowing Austrian business cycle theory, but the evidence does fit the “typical” features of the theory rather well.
This being said, I don’t think Rothbard’s views on banking are very helpful with understanding financial crises and dramatic fluctuations in output. Rothbard believed that all credit expansion is harmful. There is an optimal volume of fiduciary media which is greater than zero. The real question is why certain banking frameworks don’t restrain the volume of credit expansion. Clearly, though, Minsky doesn’t really provide a better theory than Rothbard’s. He thought unstable credit expansions were inherent in the capitalist economy. That was a view that was widely held during the inter-war period (for example, Hayek said as much in his early business cycle work), but in retrospect is not obviously correct. George Selgin’s theory of banking provides a better answer: important disciplining mechanisms (the inter-bank clearing mechanism) are eliminated when currency is monopolized.
In short, there are a lot of parallels between Minsky and Austrians. But, I don’t think these parallels make Minsky any more useful. Austrian theory is far more comprehensive; I think it offers a much more complete model by which we can explain the business cycle. This being said, I don’t think Austrian business cycle theory is the end all, be all. There is a rich, non-Austrian literature on the financial dynamics that led to the crisis. Selgin’s banking theory is not specifically Austrian, and there have been other non-Austrian contributions to the theory of free banking and market-based regulation. But, I think all of this is complimentary, and when fit together gives a pretty good explanation. I guess my point is that Minsky’s theory just doesn’t seem necessary — what it does explain, other theories explain better. Of course, only an Austrian would say something like that.