Aggregate Determinants of Financial Instability

Abstract

There is a growing body of theoretical literature which analyzes the connections between financial factors and macroeconomic stability. Following Minsky (1982), some authors (Franke and Semmler, 1989; Taylor and O’Connell, 1985) emphasize the importance of expectations. They connect expectations of future profitability to endogenously determined interest rates. For some configurations of parameters, the effects of expectations on aggregate demand can create instability and self-reinforcing declines in aggregate activity.