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Toward
an Institutional Macroeconomics: the Ontological Uncertainty and
Irreversibility as a Bunch of Bads and Business Cycle* [June 2005] One
of the widespread explanations of capitalism instability implies the
uncertainty-related variability of investment activity to be its main
cause. At the same time, the instability takes the form of business cycle
that allows the conclusion that the chaos of variable and unpredictable
behavior transforms into the order and regularity in time by which the
cycle featured. The purpose of this paper is to consider a possible
transmission mechanism between the uncertainty and business cycle. In the
beginning the views on uncertainty are classified to specify the
ontological uncertainty as a basis for variability of business activity.
Then economic behavior implying necessity to cope with uncertainty is
analyzed by means of the indifference map presenting uncertainty and
irreversibility as a bunch of bads to be chosen. Finally, definition and
classification of the institutions are presented within the framework of
which money and financial market as well as rules, routines and contracts
are treated to be a source of, on the one hand, cyclicity as such and, on
the other hand, the temporal order of business cycle. Classification
of approaches to analysis of uncertainty
The
proposed here classification is based on two criteria. The first is
relation between uncertainty and risk so that uncertainty either reduces
to the expected utility or implies ignorance of set and probability
distribution of the future events. The second criterion is understanding
of the nature of probability so that probability is either objective
feature of the real world or mental construction which at the best has
only indirect relation to the reality.
The first criterion allows breaking all approaches to uncertainty into
“certaintist” and “uncertaintist” ones (Figure 1). In the first
case uncertainty reduces to risk. This case can be named as certainty due
to existence of an opportunity to choose optimal alternative. At the same
time the nature of both certainty and uncertainty can be perceived
differently. The certainty is ontological if the probability distribution
is considered as object of knowledge, and visa versa if the probability
distribution is assumed to be the construction of knowledge such certainty
can be labeled as epistemological. The latter implied an opportunity to
make rational decisions by means of the mental constructions.[1] The “uncertaintist” approach while distinguishing uncertainty and
risk implies two views on the nature of uncertainty as well. At the first
case the source of uncertainty is the human boundedness as to gathering
and processing information. So, this is the epistemological uncertainty.
At the second case uncertainty is the inherent feature of the world as
such regardless of the human cognitive faculties. The inherentness of
uncertainty to the world is related to the fact that the future doesn’t
exist until it arrives, and one cannot know what doesn’t exist. It is
worth noting that the epistemological version of “certaintist”
approach also implies absence of the future before its arrival but the
source of certainty is human mental constructions themselves. The
ontological “uncertaintist” view, although admits the ordering effect
of the human constructions, but not as much as necessary to derive the
certainty of the future. The
nature and significance of the expectations as to the future
In
the world of uncertainty and surprises the expectations have significant
effect on economy (Keynes, 1936; 1937; Davidson, 1972; 1980; Rozmainsky,
1997; Skorobogatov, 1998; 2002). In what extent the human constructions
solve uncertainty problem? In world of the ontological uncertainty they
solve the problem only in part. It follows from the three features of the
social expectations — namely, constructivity and heterogeneity as well
as generativity (Palley, 1996, p. 101).
Constructivity of the social expectations means their intellectual
origin, i.e. they are result of mental reasoning. Expectations are
heterogeneous in the sense that there are formed different expectations as
to the future and at margin all of the individuals may differ in their
expectations. Finally, generativity of the social expectations implies
that the constructed expectations determine further course of history so
that the future is generated by these expectations. So there is not the
future itself but its various images. Realization of these images
determines the direction of the future changes. The constructivity and
generativity of the expectations imply the individuals’ freedom (Skorobogatov,
1997). Beside the adaptive and rational elements, arational factors matter
as well.[2]
Personal features of individuals cause element of freedom in the
construction of the future image. There is freedom also in both firmness
of the belief in their constructed images and accordance of their behavior
to these images. The heterogeneity of the expectations implies that future
is generated by mixture of various images, constructed in the past. There
doesn’t exist the ontological future but the epistemological future.
However, the latter’s forming, realization and transforming into the
ontological future involve the freedom element.[3]
Since decision-making is determined by the future’ image and firmness
of the decision depends on adequacy of the image, the ontological
uncertainty implies variable and unpredictable economic behavior. In the
world of the ontological and epistemological certainties the image is
formed on the scientific foundation that guarantees optimality of the
choices. In the environment of the epistemological uncertainty, or bounded
rationality, the world as before remains to be fully determinate where the
future exists before its arrival but is unknown due to difficulties of
gathering and processing information. So, there remains an opportunity to
use rational rules of decision making — namely, marginal principle of
benefit maximization that in this case implies equity of marginal utility
of additional unit of information to marginal cost of its getting and
processing. Thus in both certainty and the epistemological uncertainty there can be
found the firm basis on which one can form expectations whatever. It is
the ontological uncertainty that implies the variability and
unpredictability of economic behavior. Uncertainty as to the future and
irreversibility of the past as a bunch of bads to be consumed
Bergson pointed to “the continuous progress of the past which gnaws
into the future and which swells as it advances…, (and by this way) in
its entirety, probably, it (the past) follows us at every instant”
(1911, p. 4-5). It is admitted by most of economists that uncertainty of
the future matters only being coupled with the past irreversibility.[4]
Under uncertainty “where no precise numerical value can be objectively
assigned decisions need to be made” (Minsky, 1975, p. 65), and at the
same time when it is possible to estimate adequacy of a decision made it
will not be playable again. These two features of the historical time can be considered as two
complimentary bads. Consumption of any bad alone doesn’t create any
disutility for an individual.[5]
At the same time, an individual has every time to consume the both bads.
This consumer choice can be analyzed by the indifference curves apparatus.
The indifference map illustrates the choice among uncertainty of the
future
The indifference curves present sets of the bads, providing equal
disutility. The curves are convex to the origin like the standard ones but
here are featured by an increasing rate of substitution. The latter here
means quantity of one bad which will be agreed to consume by an individual
in exchange for the unit of nonconsumption of the other bad. So, the shape
of the indifference curves corresponds to the Cobb-Douglas utility
function. The aim of an individual is reaching an indifference curve
nearest to the origin, i.e. one solves the minimization task:
for
given budget constraint where
Here
the institutions are assumed to be a driving force of business cycle. They
set the budget constraint that given the indifference curves determines
the disutility minimization point (Figure 2). However if we assumed the
preferences to be changeable one could suppose variable a
to decrease progressively as business cycle advances which would reflect
the more importance of irreversibility as against uncertainty in total
disutility (Figure 3).[6] The theory of asset choice: extended version
That
the best indifference curve is reached under various combinations of the
bads depending on the slope of the budget curve can be related to the
theory of asset choice (Keynes, 1936, ch. 17) according to which economic
activity is treated as choice of assets for getting the most favorable
wealth dynamics. The rational choice implies maximization of the own-rate
of interest:
where
q is the prospective yield, c
is the carrying-cost, l is
the liquidity-premium and a is
the expected appreciation. In accordance with a main variable determining
an asset’s own-rate of interest one can distinguish three types of
assets — namely, real, financial and money ones.
For
the real assets the main variable is
As
to the financial assets their main variable is assumed to be
The
money assets’ main variable is
Table 1 Influence of the four variables on the own-rate of interest of the three
types of assets
The
inequality
Role
of institutions as to the effective choice in consumption of uncertainty
and irreversibility Rousseas
poses that “how we try to cope with uncertainty defines the system under
which we live” (1998, p. 17), and the above-stated allows to extend this
proposition by stating that the system is defined by the way individuals
make choice as to uncertainty and irreversibility combination. Thus as
regard to this choice the institutions can be treated as structures
designed for organization of economic activity for the sake of ensuring
rational choice between uncertainty and irreversibility. The institutions
by this definition include any coordination mechanism that enables to make
this rational choice.
In
line with the described-above the classification of the institutions can
be proposed. The first criterion for distinguishing the institutions is a
bad for the consumption minimization of which they are designed.
Accordingly, some institutions — the
liquidity institutions — largely decrease irreversibility, and the
others — the certainty institutions — are designed to reduce uncertainty. The
next criterion — now for the liquidity institutions — is the presence
or absence of possible positive relation between their use as a liquidity
institution and financing of investment. According to this criterion use
of some institutions — the bearish
institutions — doesn’t generate financial flows into real
investment sphere. This kind of institutions makes the best bads
combination to be minimization of irreversibility at the expense of high
uncertainty that means relatively low value of the real assets own-rate of
interest and hence inactive real investment. Other institutions — the
bullish institutions — as a by-product of individuals striving for
decreasing irreversibility allow them to have positions in capital stocks
and through it create an extra source of finance for real investment.
These institutions make the best combination of the bads to be somewhere
between the two minimizations that reflected in high relative value of the
financial assets own-rate of interest.[8]
The
certainty institutions are distinguished on the basis of such criterion as
available durability of their beneficial implementation. According to this
criterion some institutions — the
one-phase institutions — enable to decrease uncertainty during one
or two phases of business cycle whereas others — the
one-cycle institutions — do the same during one or more cycles. Money as a bearish institution “Only
in an uncertain world would holding money be rational” (Wray, 1995, p.
471) as being such investment that allows preservation of wealth when the
yield prospect is negligible and in this sense money can be considered as
a bearish institution. There are two kinds of using money as a bearish
institution: the one is related to precautionary motive and the other is
with speculative one. The former takes place in real sector where “cash
is needed to fulfill [contractual] commitments” (Minsky, 1986, p. 69).
In the economy in which the economic relations are mediate with debts and
contracts basis for the precaution is necessity to be solvent for the
fulfillment of commitments facing insolvent debtors. The speculative
motive is related to pessimistic estimate of future dynamics of stock
prices. Money as both the precautionary and the speculative bearish
institution creates an opportunity for maneuver and so minimizes
irreversibility. During
business cycle money is used now mainly as a bearish institution (precautionary
and speculative motives) now as a transaction cost minimizing institution
(transaction and financial motives).[9]
In the robust expansion phase the stock of debt is small because of
repayment and failure in the last recession and depression and hence role
of money as a precautionary bearish institution now is decreasing. At the
same time, there is created condition for growth of the financial demand
for money, i.e. more use of money as a transaction cost minimizing
institution in investing activity. The transaction demand for money is
assumed to lag behind the financial demand by a cycle phase so that in the
next phase transaction demand repeats the current dynamics of the
financial demand and so here it is fixed. Since financial market is
considered here as autonomous economic world (see below) money as a
speculative bearish institution is only partly related to the cycle phases
and now is assumed to vary with a zero resultant. In
the fragile expansion phase use of money as a precautionary bearish
institution ceases to decrease because of gradual debt accumulation in the
last and, in particular, current phases. Here there is supported and
strengthened the urge to invest in both real and financial assets, i.e. in
creation and achievement “of positions in the stock of capital assets”
(Minsky, 1988, p. xii). Hence financial demand for money related to both
real and financial assets grows while speculative demand decreases. The
transaction demand continues to repeat the last phase dynamics of
financial demand. The
recession starts as a result of excessive accumulation of debt in economy
making it more and more fragile and incapable to stand negative shocks.
Therefore role of money as a bearish institution — both precautionary
and speculative — now increases while financial demand falls and
transaction one stops increasing. Finally, the depression is featured with
fixation of money using as both the bearish institution and the
transaction cost minimizing institution, except for transaction demand
component that is here assumed to adjust to the last change of the
financial demand gradually. Table 2 The two institutional functions of money during business cycle
Financial market as a bullish institution The
role of financial market as a bullish institution is related to creating
by it “a frequent opportunity to the individual (though not to the
community as a whole) to revise his commitments” (Keynes, 1936, p. 151)
and so facilitating investment. At the same time, the relation of
financial market with business cycle is controversial issue. Here three
views on financial market are considered: 1.
Financial
market as an investment accelerator:
This approach was formulated by Keynes who wrote that “with the
development of organised investment markets, a new factor of great
importance has entered in, which sometimes facilitates investment but
sometimes adds greatly to the instability of the system” (1936, pp.
150-151). A financial market makes individual investment liquid and so
stimulates individuals to invest. Obviously, any investment in real assets
is illiquid but being splitted into many shares any real investment for an
individual investor is no longer illiquid and irrevocable. So the role of
financial market is to facilitate real investment by making individual
investments reversible. Instability created by financial market is here
consequence of reducing all the investing activity to speculation so that
there is not difference between investment of an entrepreneur and that of
a stock jobber. Both try to “to beat the gun” (1936, p. 155) and
don’t trouble themselves by calculations of real investment yield
prospect. 2.
Financial
market as an indicator of demand prices for production assets:
This, Minsky’s, approach implies the two levels of prices where some are
determined by current cost-benefit calculations, and the others are by the
future expectations. The former is identified with supply price of capital
assets while the latter is with demand price of them. At the same time
this view implies some treatment of relation between financial market and
business cycle. The investment is described as a “financing… of
positions in the stock of capital assets” (Minsky, 1988, p. xii) and its
main result
here is “control over… needed capital assets” (Minsky,
1975, p. 107). However, financing of “positions in the stock” is just
investment in financial market. The two kinds of investment aren’t
apparently distinguished. So both real and financial investors are assumed
to use the same calculations in the expectations formation and the
financial market is no more than an indicator of real assets yield
prospects. Here there is not such feature of the future expectations as
heterogeneity and, more specifically, homogeneous are calculations as a
basis for both real and financial investments. In this sense the both
approaches are the same while the main difference between them is related
to a kind of expectations determining all investments so that in the
former case these are expectations of financial investors and in the
latter case they are those of real ones. More specifically, Keynes’
theory excludes any real component of investing calculations while
Minsky’s approach implies financial market as just reflection of real
investors’ expectations to be neutral to real investment. Though here
the capitalist economy is considered to be inherently unstable due to
“centrality of financial structure” (Pollin, 1997) Minsky’s
instability isn’t related to financial market dynamics as such. 3.
Financial
market as an autonomous economic world:
Here — in the Palley’s model — the expectations heterogeneity is
assumed and
according to this assumption the conclusion is drawn about
neutrality of financial market for real investment. Managers control firms
investment and so “it is their expectations that matter in the
determination of investment” while shareholders’ “expectations
matter for valuation of firms as expressed in stock prices” (Palley,
1996, p. 156). Thus real investment is determined by managers’ decisions
and is independent on stock market’s “average opinion” and isn’t “a by-product of the activities of a
casino” (Keynes, 1936, p. 159). Their investment creates
demand for real goods, increases the aggregate output and generates stock
of capital growth. On the other hand, investment of firms‘ owners are
quite different. Specifically it doesn’t make anything but shift of the
property rights to results of the last investment. Hence in stock markets
there are traded the property rights to an existent capital stock and so
real sector business activity doesn’t depend directly on financial
market. Direct effect of the financial market functioning is revaluation
of existent assets. Of course, financial market facilitates investment by
making it liquid for individuals, and if we imagine two economies where
one includes financial market and the other doesn’t, in the former there
will be more real investment. However, an existing financial market
doesn’t influence investment dynamics. There takes place revaluation of
investment but this doesn’t anything to do with amount of real
investment since managers make decisions independently on the jobbers’
speculative anticipations. Thus all of the three approaches to relation between real sector and
financial market exclude any effect of the latter on the real investment.
Financial market and real sector are either a single whole (Keynes, Minsky)
or independent on each other economic worlds (Palley).
It is clear, however, that there may take place some positive
correlation between dynamics of financial market and that of real sector.
Firstly, decrease of interest rates must have positive effect on both
financial assets quotations and real investment because acquiring both
financial and real assets is a portfolio decision. Secondly, expectations
of jobbers and managers may be determined by the same factors. Thirdly,
financial assets may have positive influence on aggregate consumption
through the wealth effect. At the same time, negative correlation may be
observed as real investment is financed out of proceeds of loans which
will increase interest rate and this in turn will weaken incentives to
invest in financial assets and visa versa. Now one can propose some integrating considerations on the relation
between financial system and business cycle. Firstly, financial market
dynamics is determined largely by the bubbles. Financial investors act on
the basis of their estimates of the average opinion as to the future
quotations dynamics. Information considered to be able to affect the
average opinion is taken into account and as a result does influence the
quotations dynamics. Since this information may have nothing to do with
real assets yield prospect and depends on various casual factors the mass
speculative behavior is variable and unpredictable.
Secondly, the Minsky’ theory implies the two price levels. The
above-stated allows distinguishing the three levels of prices — namely,
prices determined by current state of affairs, prices determined by yield
prospect and those determined by speculative dynamics of financial market.
As for variability the first prices are not featured with any significant
variations, the second vary along with business cycle, and the third
manifest serious variations which may have no counterparts in the real
sector. So the first level prices correspond to the Minsky’ supply
prices of capital assets, the prices of second level do to the demand
prices of them and the third level prices are the market valuation of
investment made.
Thirdly, the financial market and the real sector are independent
on each other. Expectations of managers and owners are formed on different
bases. The former estimate the yield prospect of capital equipment by
taking into account supposed magnitude of demand for an item and their
expectations are by their very nature long-run. The latter value the
future quotations dynamics on the basis of observing the mob behavior and
their calculations and activities are short-run.
Fourthly, though financial market and real sector are autonomous to
each other there are some influences of financial market on real sector.
Specifically, on the one hand, financial market increases financial flow
into real sector and so facilitates investment. On the other hand, the
financial market while being driven by speculative behavior is at some
extent isolated from economic reality, and both overvaluation and
undervaluation of firms may be dangerous for their prospects since the
former may reallocate finance from real investment and the latter can make
expensive additional loans so that a potentially beneficial investment
project may failed as it depends on external financing.
One can ask: what dynamics of financial market is more favorable
for real investment? The point is that unambiguous answer cannot be given.
The overvaluation reallocates finance into speculative sphere but promotes
firms reputation and by this way facilitates getting loans while the
undervaluation frees finance but lower firms credit status. It follows
that the main effect of financial market dynamics on real sector is the
systematic supply shocks.
An additional support of this thought could be received by
comparative empirical analysis of the securities-based systems and the
credit-based ones (Ĉapoglu, 1992). The proposed concept of the
bullish institutions would be justified if the credit-based system
manifested less inclination to variability and instability.
Summarizing the above described as to the liquidity institutions
and business cycle one can make two propositions: a) the liquidity
institutions are source of systematic shocks for real economy, b) they
facilitate fragilation of an economy. The one-phase institutions The
one-phase institutions create a unified image of the future and by this
way tie individuals together. This, in turn, makes the expectations
homogenous. The unified image of the future is like a mirror in which
everybody sees the same. Existence of the unified image here is treated as
the sign of the institutional conditions under which the rational choice
is minimization of uncertainty that is reflected in high own-interest rate
of the real assets. When the existent unified image shows signs of
progressive collapse it is treatable as the institutional conditions
implying the rational choice to be some intermediate bads combination
reflected in high own-rate of interest of the financial assets. In some
time the image of the future is destroyed, and its fragments are like
pieces of the broken mirror so that everybody looks in a piece and sees
something own. Lack of the unified image can be considered as the
institutional conditions under which the rational choice is
irreversibility minimization reflected in high own-rate of interest of the
money assets. This
cyclicity of the one-phase institutions beneficial use can be explained by
both their own nature — in this case they are autonomous driving force
of the cycle — and external causes like accumulation/use of capital
stocks (Keynes, 1936, ch. 22) or dynamics of debt accumulation (Minsky,
1975; 1986) — then they should be considered only as a cycle amplifier.
The first could be related to accumulation of the errors in reproduction
of the one-phase institutions. So in the beginning correct use of the
unified image of the future would create some kind of economic harmony.
However accumulation of the errors in the institutions reproduction would
promote gradual break-up of the image of the future with the image
collapse in the end. Formation of a new image of the future would mark the
next cycle. Thus at the heart of business cycle here would be a special
image of the future whose gradual collapse determines change of the cycle
phases. The second explanation would imply some external cause to promote
the one-phase institutions collapse. Here the special emphasis is placed
on the first explanation, i.e. the one-phase institutions are assumed to
have internal cause for the cyclicity of their beneficial use in the form
of the error accumulation. This is manifestation of temporal limitation of
the one-phase institutions that, at the same time, allows considering the
one-phase institutions to be the mechanism transforming chaos of variable
and unpredictable expectations into the regular business cycle. Here
the one-phase institutions can be identified with the three fundamental
kinds of the institutions distinguishable within the contemporary
Institutional economics — namely, rules, routines and contracts. A rule
(North, 1990) can be considered to be the institution if it generates the
order in human relations while being known to every member of a community
as conventional and hence making human behavior understandable and
predictable. The routines (Nelson et al., 1982), in fact, may be
considered as a kind of conventions, taking into the account the
difference of comprehension so that the rules govern overall societies
while the routines regulate performance of organizations. Understanding
the institutions as contracts implies the rules to take a passive part of
“institutional environment” that influences the choice and result of
the consciously constructed and selected institutions labeled as
“institutional arrangement” (Williamson, 1985). These institutions can
be considered as contracts under extended understanding. Unlike rule
institutions, contract institutions are made and implemented as a result
of conscious choice oriented to minimization of transaction cost or
creation of effective incentive system or solving agency dilemma or
strengthening the market power and/or getting additional benefits from it
et cetera. The three kinds of the institutions imply their nature and role
to be related to microeconomic problems — namely, results of
institutions implement are estimated by resource allocation efficiency.
Here an attempt is made to relate institutions to such field of
macroeconomics as business cycle theory as well. Accordingly,
here as the one-phase institutions the rules (conventions), the routines
and any binding contracts[10]
are considered.[11] Among
the rules institutionalization of decision making can be placed (Crotty,
1994) that implies creation of conventional norms as to rationality which
include conventional expectations as well. In overall economy the
conventional expectations as a kind of agreement to act in a certain way
at some extent substitute knowledge of the future because “the future
depends on our expectations of it and the actions one takes in the light
of these expectations… agents know this and therefore quite rationally
form their own expectations by trying to guess the expectations of others
in an endlessly iterative process” (Crotty, 1994. p. 128). People while
not knowing the future create it themselves. Uncertainty is an obscurity
as to people’s future behavior. It hampers decision making and
investment. To solve the problem an economy spontaneously generates some
rules for expectation formation which are agreeable to stick to by
everyone. The conventional expectations decrease cost of decision making
and generate predictability of the others’ behavior that creates stable
and recurring conditions. In due course these conditions disappear when
the conventions collapse gradually and people grow unpredictable for each
other. That is why “the relation between conventional decision making
and stability is dialectical and contradictory” (Crotty, 1994, p. 127). The
corporate routine as a usual way of doing is at some extent unique for
each firm (Nelson et al., 1982). The routine makes a firm behavior more
predictable. Since uncertainty is largely related to the immediate
environment use of the routine decreases it. Thus the corporate routine
can be considered not only as a way to minimize cost of decision making
but as a certainty institution as well. The corporate routine here is
considered to be a one-phase institution in the sense that it is likely to
decrease uncertainty during a limited period and as the errors are
accumulated it stops to decrease and begin to increase uncertainty. There
can be also the external cause related to the cycle dynamics as such. This
cause is the cycle-determined rational considerations to stick to the
routine under recurring conditions and in the absence thereof serious
threats. These conditions take place in the robust expansion phase
and as long as most of firms stick to the routines they are a certainty
institution. However when an economy grows fragile there increases
sensitivity of firms to negative shocks and they more and more often have
to react to undesirable surprises. The conditions under which firms
operate grow unstable, and significance of the routines decreases. Thus
the more fragile is an economy the less predictable is firms’ behavior
and the corporate routine may be the factor increasing instability. When
firms’ managers plan to act taking into account certain behavior of the
other firms implied by their corporate routines and in some time these
plans are broken off as other firms depart from their routines the
instability increases more than had no routines taken into account. Significance
of the contracts as a one-phase institution is related to the fact that
the main channel through which uncertainty influences economic life is
long-run investment (Keynes, 1936; 1937; Davidson, 1972; Rozmainsky,
1997). Since profitability of the latter depends on the future managers
try to take under their control the possible factors which will determine
the future results. With a view to facilitate a smooth project realization
managers try to make their consumers and suppliers to act in the future in
a predictable way that would be some guarantee from a project failure. So
the most of economic relations upon which business developments and
investment’ results depend are mediate with contracts. The resulting
overall importance of the contracts is at the same time the possible
channel through which uncertainty may have destructive effect on an
economy because these omnipresent contracts give an economy debt character
in the sense that everybody permanently owes something to the others as a
result of contractual agreements. Whether someone can fulfill commitments
depends on whether his debtors fulfill their commitments. A
kind of contract is made under such market structure as oligopoly. The two
standard forms of oligopolistic interrelation are rivalry and cooperation.
Cooperation is beneficial for oligopolists as it is compared with rivalry.
However, any cooperation is unstable because of the potential opportunism
of a contractor since maximization of an individual’s profit will take
place when he violates agreements alone while they are kept by the rest.
Such fragility of the contract relations may cause regular breaks and
renewals of cartels which may manifest some cyclicity. So rivalry and
cooperation can be brought in line with the cyclical expansions and
recessions. According to Minsky’s hypothesis, there is progressive
financial fragilation of an economy as business cycle advances. At the
same time the regular shocks generated also by the liquidity institutions,
hamper raising loans, that may follow that it is violation of a cartel
agreement which is only way to raise cash necessary for a project
realization. It is clear for any firm planning to violate a cartel
agreement to raise cash that it will exemplify for the rest and by this
way just make it worse. There may be two considerations to violate the
agreement. Firstly, the rest cartel members will discover the violation in
some time during which the violator will raise money necessary for
continuation of a project and/or clearing off. Secondly, it may anticipate
the same behavior of the rest in the future, and for the sake of taking
advantage it may be reasonable for it to violate first. So, the
cooperation while decreasing uncertainty in the robust expansion phase
increases it as the crisis approaches. The
“dialectical and contradictory” (Crotty, 1994, p. 127) is likely to be
role of not only the conventions but all of the one-phase institutions as
well. As a whole, the one-phase institutions generate stability in an
economy in a period of the robust growth while stopping to take the
stabilizing part in a fragile expansion phase and then being source of
instability. This
feature of the one-phase institutions can be illustrated using prisoners’
dilemma. All of the one-phase institutions are related to choice between
cooperation and rivalry. In the case of contract it is choice between
keeping to and violating contractual agreements. Cartel as a special case
of contract implies choice between keeping to the cartel agreement and
breaking it. As to the corporate routines and conventional behavior it is
choice between to stick to some rules of behavior and not to stick. In
usual case depending on both players’ strategies each player may face
the four situations which are ranged by the utility for a player as follow: ·
To cooperate while another rivals. Now
there is a player’s loss. ·
To rival while another rivals. There
are neither benefits nor losses. ·
To cooperate while another cooperates.
There are mutual benefits. ·
To rival while another still
cooperates. There is maximum benefit for a player. Here
the choice between cooperation and rivalry illustrates choice between use
of the one-phase institutions and giving to use them up. The prisoners’
dilemma implies the three possible cases as to the one-phase institutions: ·
The institutions are not used, i.e.
both players rival, and there are neither benefits nor losses. ·
The institutions are used, i.e. both
players cooperate, and there are benefits. ·
The institutions are used by one of
players while the other’s given up to use them, i.e. one still
cooperates while the other already rivals. The
second case presents the robust expansion phase while the third does the
fragile one. Here the prisoners’ dilemma implies that when a firm shifts
to rivalry it causes damage to the other firms which wouldn’t be happen
hadn’t the firm started with cooperation. At the same time here the
violator doesn’t get any positive advantage since in the fragile economy
it is not striving for any benefits but urge to survive that induces him
to shift to rivalry. Table 3 Creation and distribution of the benefits and losses as to use of the
institutions during business cycle
So
here there is illustrated the follow situation. Under the depression the
one-phase institutions are not used and hence don’t create benefits. In
the robust expansion phase their use increases the inducement to invest
and by this way creates benefits. In the fragile economy the cooperation
revealed in use of the one-phase institutions is replaced with rivalry. As
a result those are late in this shift have loss while those are in time in
it just escape the losses. So in overall economy there are positive total
losses. Then under the next depression the one-phase institutions are not
used again. Thus
in the robust expansion phase the one-phase institutions increase
stability (create benefits), in the fragile expansion phase they reinforce
instability (create losses) and after the crisis they are not used (create
neither benefits nor losses). The one-cycle institutions The
one-cycle institutions are the means of decreasing business cycle
amplitude. At the same time according to the Minsky paradox they create
the prerequisites for increasing the cycle amplitude in the future. As
one-cycle institutions there may be considered countercyclical fiscal and
monetary policies. Since the countercyclical policies are designed to
smooth business cycle they are certainty institutions. Unlike the
one-phase kind of the certainty institutions these decrease uncertainty
during longer period, i.e. one or more cycles. They are used to prevent
the depression but “the depression itself creates the conditions for a
return to financial robustness and recovery… [and therefore] depressions
are functional: they are destructive but necessary mechanism — the
“slaughtering of capital values”… that returns capitalist financial
structure to balance” (Pollin et al., 1994, p. 372). The point is that
if cyclicity is the inherent to capitalism dynamics, each phase is
necessary for coming of the next phase. That is why without depression
there will be not recovery. So when the crisis is prevented the fragile
state of an economy is prolonged. So crisis and depression are the cost of
periodical recoveries. Thus the crisis and policies are alternative ways
— natural and artificial — to arrive at recovery, and there is point
to compare them by the cost amount. One
can suppose that the crisis’ cost of arriving at recovery is decreasing
because of the adaptive rationality of individuals. They will keep in mind
succession of events in the last cycles and draw conclusion about
necessity to be cautious in investment so that one can expect natural
decrease of the cycles’ amplitude. On
the contrary, cost of the policies is to increase from a cycle to the next
one. The point is that a by-product of the policies facilitating shift to
recovery is accumulation of experience of the last cycles that makes the
next shift to recovery more expensive. Since the policies are designed to
support the fragile economy, there are weakened incentives for firms
making the economy fragile to be cautious in investment.[12]
The speculative and Ponzi firms are supported by both fiscal policy that
ensures the demand and by this way cash flows and monetary policy due to
which there are available additional loans. Thus at the course of
successive cycles the more risky projects completed and admissible level
of riskiness as to both investment projects and financial structure
increases so that cost of countercyclical policies grows. When it is clear
that the policies are needed to be given up the experience of the last
cycles makes the crises much more destructive than had no such policies
pursued at all. The
“dialectical and contradictory” role of these institutions is termed
as the Minsky paradox that is a special case of the moral hazard problem.
Here a kind of investment insurance takes place, and it implies the hidden
actions of investors, i.e. their lack of the proper care as to the
investment riskiness as a result of the insurance. The
common feature of all the above-described institutions is their
dialectical nature that allows to generalize the Minsky paradox by
applying it to the one-phase institutions as well and to formulate an
additional paradox as to the liquidity institutions. The generalized
Minsky paradox, or the certainty institutions paradox, is that these institutions
decrease uncertainty for a limited period (one or two phases or some
cycles) at the same time creating prerequisites for the more uncertainty
in the future. The liquidity
institutions paradox is that these institutions, while making the
individual decisions revocable and ensuring the more stability for
individuals, intensify the overall instability. Conclusion Presented
in this paper concept and classification of institutions is an attempt to
specify interrelation between uncertainty and business cycle. The proposed
classification of approaches to uncertainty allows distinguishing the
ontological uncertainty as that immediately relating to inherent to
capitalism cyclicity. It is emphasized that it is the ontological
uncertainty and irreversibility as a bunch of bads which pose problem of
the choice. This choice reveals itself in investment decisions implied by
the theory of asset choice and is facilitated by the institutions. So the
institutions are defined as means that enable to make the rational choice
in consumption of these two bads in line with which they are broken into
the liquidity institutions and the certainty institutions. The former’
main effect is amplifying of the cycle amplitude and, to considerable
extent, creation of the cyclicity as such. A kind of the latter is stated
to be the transmission mechanism between the ontological uncertainty and
business cycle. Thus both cyclicity and the cycle’s temporal order are
at least in part explained by use of the liquidity and the certainty
institutions. What follows can be called as the institutional theory of
business cycle. Since the institutions are assumed to be cyclical by their
very nature that is related to gradual accumulation of the institutions
reproduction errors they can be considered to be one of the autonomous
driving force of the cycle. REFERENCES 1.
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(4), 470-477. * In this paper there are outlined and partly developed main
theses of the author’s doctoral dissertation completed for the [1]
The ontological and epistemological kinds of certainty can be brought
into line with “logical” and “instrumentalist” versions of the
economic positivism (Boland, 1991, pp. 93-94). [2]
The
arationality may be understood as a kind of behavior that isn’t
founded on any calculations because of absence of any basis for it. It
is arationality that is mentioned by Keynes as to necessity to “regard…
to the nerves and hysteria and even the digestions and reactions to
the weather of those upon whose spontaneous activity… (investment)
largely depends (Keynes,
1936, p. 162). [3]
In the methodological literature there pointed the fact, that “acts
of free will cannot be predicted ” and the free choice includes some
element that “has been created from nothing… [or] has created
itself” (McKenna et al. 1997-98, pp. 238, 241). At the same time it
is emphasized that ”if action in some such way is rule-determined,
there is no freedom of choice at all” (Vickers, 1997, p. 98). [4]
The past irreversibility has got various names and associations —
namely, Keynes’ low asset liquidity (1936), Williamson’s asset
transaction specificity (1985), and path dependence and lock-in effect
in Evolutionary theory and post Keynesian economics (Nelson et al.,
1982; Setterfield, 1995, pp. 14, 16). [5]
Here and below one means by an individual the averaged investor whose
decisions represent prevailing in an economy choice in favor of any
combination of the two bads. [6]
If preferences as to the bads combination change or are constant
during business cycle is a separate question which deserves a special
research. If they changed one could relate business cycle to this
change as in Figure 3. Here the preferences are supposed to be
constant for the sake of consideration of the cycle-generating role of
the institutions on the assumption of ceteris paribus. [7]
The liquidity-premium would be zero for idiosyncratic assets. [8]
This intermediate combination may imply the “investor myopia” (Rozmainsky,
2001) as well. [9]
Treating money as transaction cost minimizing institution is related
to New Institutional approach to genesis and institutional nature of
money as means of exchange. [10]
Any contract, but classical one, creates interrelation between
contractors through mutual contractual commitments and the asset
transaction specificity (Davidson, 1972; Williamson, 1985). [11]
As the one-phase institution could be considered regulation of
competition as well because as it was expressed by Crotty,
“institutions and practices that regulate competition (are one of)…
institutional sources of order” (1996, p. 134). However in this
paper regulation of competition isn’t assumed to be a one-phase
institution since it is likely to be usable in any phase of the cycle. [12]
As it is explained by Pollin and Dymski, “potential costs associated
with risky financial practices are, to considerable extent, socialized”
(Pollin et al., 1994, p. 373).
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