Article Dynamic Economic Systems

Article Dynamic Economic Systems

Running Head: An Analysis of the Article Dynamic Economic Systems by John M. Blatt and the Financial Instability Hypothesis by Hyman Minsky

An Analysis of the Article Dynamic Economic Systems by John M. Blatt and the Financial Instability Hypothesis by Hyman Minsky

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Article 1: Investment decisions under uncertainty

Summary:

The article entitled investment evaluation under uncertainty analysis investment decisions under uncertainty by Blatt highlights the importance of investment in the economy, The article

Article Dynamic Economic Systems

introduces a model that is practically applied by businessmen in the economy ignoring the existence of monopolies and oligopolies in the economy, under uncertainty investment decision will be based on predictable and certain rate of return and this involve using risk free option rate of return such as government securities. The article highlights three main concepts used in investment decision and they include the present value concept, the payback period and the probability of outcome.

Discussion:

This article is the best given that it demonstrates how investment decision are made in the economy, investment decision today are made based on the above mentioned methods which include the present value method, the payback period and the probability of outcome method. The article also highlights other theories associated with investment decisions which include the money market valuation theory, Modigliani and Miller theory, neoclassical and Keynesian theories of investment. The article also clearly demonstrates methods used when making investment decisions in the economy and this include the introduction of the discount factor, discounted future cash flow and discounted present value concepts into the discussion.

The article highlights three methods of determining investment decisions under uncertainty, the first method is the present value concepts whereby the article states that given that the risk free interest rate is R and cash flow is X (T), the discount factor of the investment will be 1/ (1+R) t w hereby t is time, when we multiply each future cash flow X (T) by the discount factor this yields the discounted present value, adding all these values of the discounted present value yield the gross discounted present value C(X) and in order to achieve the net discounted present value the initial investment is subtracted. The investment is profitable if the net discounted present value is positive and unprofitable if the value is negative.

The second method used in investment decision under uncertainty is the pay back period, this is the period it takes for accumulated cash flows to equate to the initial investment value, the pay back period is set by the management of a firm and if the payback period is greater than the set period then this investment option is rejected. The third way in which investment decisions are made under uncertainty is analysis of probability of outcomes, the probability of success will

Article Dynamic Economic Systems

depend on the expected outcome and the probability of success of that outcome, stated as Q = F(D, E(C)) where D is the probability that an outcome will occur and E ( c) is the expected outcome.

The article also provides mathematical explanations and calculation in the determination of these investment models, the article also uses data collected from 560 companies in the year 1947 and 1948 and demonstrates the investment decisions made by these companies with reference to the payback period method of investment decisions under uncertainty. The article provides an appendix which highlights the mathematical transformation of the models discusses in the paper.

Article 2: The financial instability hypothesis

Article Dynamic Economic Systems

Summary:

This article by Hyman Minsky introduces the concept of instability in the financial sector in the economy. Analysis of this article is based on the Keynesian general theory. The article states that Keynes theory does not given explanation to financial crises, output fluctuations and employment fluctuations. He states that financial instability should be viewed as systematic processes and not an accidental occurrence.

Discussion:

The article only criticises the Keynesian general theory and does not given a clear solution to the problems faced in an economy, the author does not have supportive data to support his analysis and only states how the govenermnt should respond to financial crises. The article does not provide any mathematical explanations to the analysis of financial markets equations.

Hyman ignores the existence of time lags in an economy, he states that during a recession the government should implement expansionary monetary policies, the existence of time lags sometimes makes thing worse whereby it takes time for the policy makers to realise the economy is in a recession and also takes time for the economy to respond to a change in money supply. Given this time lag the expansionary policy measure may affect the economy when the economy is already in a boom and this will increase the inflationary pressure.

Hyman concentrates on the analysis of business debts in the economy where he states that firms should earn surpluses in order to pay debts or refinance, refinancing occurs only when profits are expected to be high. However he does not provide the solution to ways in which investment decisions can be made in order to determine whether investments will be profitable in future in order to refinance.

Article Dynamic Economic Systems

He also distinguishes between the speculative and hedge market whereby he states that the speculative finance occurs when the cash flow of investment are expected not to meet the payment commitment while hedge finance occurs when the cash flows are expected to meet payment commitments, despite this distinction he does not provide a clear solution to the problem of reinvestment, firms in the economy are faced with uncertainty about the future and in order to determine the profitability of a business in future certain measures are undertaken, Hyman does not provide these methods of determining the profitability of a business in order to determine whether speculative financing or hedge financing occurs.

He states that during economic stability the use of private debt and speculative finance is valid, also that in a regime that is dominated by hedge financing and speculative finance increases then monetary policies aimed at increasing money supply will not be valid. By stating this he does given a clear explanation on to why speculative finance is valid and private debt is valid during economic stability, He only states that spending by consumers financed by debts when an economy has just recovered from a debt deflation will result into a decline in income but does not given a clear connection of debt deflation and income.

Regarding government spending Hyman also states that government role in recession is to run into budget deficits in order to fine tune the economy, he also acknowledges that this may lead to inflation, by stating this he does not provide a clear indication of what should guide government spending, there are certain methods that government should use in order to determine the level of spending that is appropriate to fine tune the economy that are not highlighted in this article.

References:

Hyman Minsky. The financial instability hypothesis: an interpretation of Keynes and an alternative to standard theory

Article Dynamic Economic Systems

John M. Blatt. Dynamic economic systems: a post Keynesian approach,