A Review of Hyman Minsky's 'Financial Instability Hypothesis in 'Can "It" Happen Again?' [PART I]

- By Chinedu Okoye 

Chapter 1: Can it Happen Again?

1933 saw the collapse of the US financial system, and implosion begining with the stock market crash of 1929 which saw a deflationary process leading to large defaults on contracts from both financial and non financial institutions, and falling income and prices.

In 1962, these fears were revisited with a stock market decline, but this didn't lead to a a deflationary scenario and thus an inquisition was necessary to be made to discover if the difference can be attributed to institutional changes or behavioral character of the markets.

Was it due to a more stable economy? Or that such deflationary process could not simply occur?

Consideration of The Council of Economic Advisers:

The council of advisers suggested that such monetary and institutional failures could never occur again due to the fundamental changes made during and since the 1930s, however they do not specify what these changes were.

Hyman reconciles this lack of precision with an "absence of a generally accepted view of the links between income and behavioral characteristics of the financial system.

Each debt deflation is unique and occured at  long intervals of time. But it is necessary to inquire whether there are indeed essential financial attributes of the system which breed conditions which increases the likelihood of a debt deflation.

Hyman looked at the institutional changes that "took place as a reaction to the Great Depression and which are relevance to the problem at hand". Institutions he said, were reformed "when the lack of effectiveness and perhaps even the perverse behavior of the Federal Reserve System during the great downswing was obvious".

The changes made created new support institution (deposit, mortgage and insurance schemes) which made some lender of last resort functions automatic and removed their administration from the Fed System.

But concerns remained that the "decentralization of essential central bank responsibilities and functions", was not an "efficient" way of"organizing the financial control and protection functions" especially as the defence against an impending  crises may require coordination and policy consistency amongst these various units.

Main viewpoint of the paper is that; essential characteristics of financial processes and the changes in the relative magnitudes during a sustained expansion (a period of full employment growth interrupted only by mild recession) have not changed".

Minsky argues that the initial conditions in 1962 were different from that if 1929.

Government Size and Financial Markets Stability:

The large increase in the size of the government relative to 1929 also changed the financial characteristics of the system, such that developments of financial instability sets off "compensating stabilizing financial changes".

The government essentially stabilizes income with associated increases in government debt, financed by instruments (bonds) that forces a change in the mix of assets held by the public, and somewhat restorers stability to the financial system. The increased debt-finance spending also puts a floor on declines in aggregate demand (jobs are created directly or indirectly to offset the losses of employment in the private sector).

The markets can de-risk by lodging their funds with safe haven assets and these monies are ploughed back into the system (keeping up aggregate demand), as calm is restored to the private securities (equity) segment of the markets — with investors fully hedged and not in a hurry to sell more equities than the frenzy has made them sell—the market finds a bottom.

The "built-in" stabilizers in themselves are not sufficient to force the return to "full employment" in themselves, but the "change in the composition of household and business portfolios that takes place tends to increase private consumption and investment to levels compatible with full employment".

A Sketch Model of how Conditions compatible with Debt-Deflation are Generated:

Minsky modelled how debt-defaltion is generated, and further presented observation of the effect of certain financial variables "affect the response of the economy to initiating changes".

Within a closed economy for any period;

I - S = T - G

This can then be re-written as;

S- I= T - G = 0

S-I is gross private sector surplus (the surplus of savings over investments), and T-G,  denotes the surplus of the government —i.e., the surplus of taxes over government expenditure).

Dent deflation Model Explained:

In a closed economy, the the private savings surplus be offset by an equal amount of government deficits.

When the private sector is has a large surplus than normal, it is essentially deleveragng —i.e., saving more and investing less —so S-I would be positive. If simultaneously, the government is trying to run a surplus (i.e., T > G), both sectors are trying to net save.

Since in a closed economy with no foreign capital inflows this is impossible, for one sector's surplus is another sectors deficit —if the private sector is net saving or deleveraging, thereby running a surplus, the government has to be doing the opposite and using the surplus savings to finance fiscal expansion.

Any attempt to save simultaneously by both sectors, would result in a recession or debt deflation, as output, employment and income falls with dis-saving or inadequate investments from both sectirsm For one sector of the economy to save the other needs to dis-save, per Keynes. In Minsky's world of endogenous instability, faiing to understand this leads to policy mistakes.

If income is to grow, then financial markets where various plans to save and invest are reconciled, must generate an aggregate demand that is ever rising —apart from brief disturbances at intervals.

For aggregate demand for money (or cash assets) to be increasing, it is also necessary that current spending summed across all sectors is greater than received income and that "some market technique exists by which aggregate spending in excess of aggregate anticipated income can be financed."

Thus, over a long period of time, in which this economic growth takes place, some sectors would finance a part of their spending by employing debt or selling assets. If such "planned deficits" are to succeed in raising income, it becomes necessary that "market processes do not result in offsetting reductions in the spending plans of other units".

(That is doesn't involve depriving another segment of capital, but taking from surpluses instead.)

It is therefore necessary for some spending to be financed by either drawing from idle balances, or the creation of new money.

In an enterprise economy, savings and investment process leaves two residuals;  (i) a change in the stock of capital, and (ii) a change in the stock of financial assets and liabilities. An increase in the ratio of liabilities to income would decrease the willingness —and ability– of other sectors to finance additional spending, in a similar fashion as an increase in the capital-income ratio would tend to reduce the demand for additional capital goods.

This is to say that the higher the debt (or cost of debt) the lower the profit margin and hence the priority for investment, just as the increase in cost of capital would reduce the desire of the entrepreneur to acquire more production goods.

A rise in the debt-income ratio reduces the ability of the "spending unit" to meet its commitments.

A Debt-defaltion Scenario;

If payments from the units income cannot meet the debt obligation, it is forced to borrow or sell assets. Borrowing in unfavorable terms, or selling assetss in distress usually leads to a capital loss in the form of higher interest payments or lesser sales proceeds realize, the former above market rates the latter below market rate.

But there is a limit to which an entity can take capital losses beyond which these loses are passed on to the creditor, by way of default (ie bankruptcy), or refinancing of contracts. Loses induced in this manner results in further construction of both consumption and investment "beyond that due to to the initial decline in income" and this can result in a "recursive debt-defaltion".

For every debt-income ratio of every sector, there exists a minimum threshold of income decline which must lead to a deflation, and a maximum income decline which cannot lead to a deflation. The latter is smaller than the former.

For a given set of debt-income ratios, these boundary debt-income ratios are determined by the relative size of the economy's ultimate liquidity (those assets with fixed contract value and no default risk) and the net worth of private units relative to debt and income [how much debt each individual or entity has relative to his income], as well as the way in which financial factors enter into the decision relations that determine aggregate demand"

(This means that, the treshold is dependent on the money supply (liquidity in the system), the networth of economic agents and units —which determines the supply side—and the decision making process in financial intermediation.)

If financial changes that accompany growth increases the debt-income ratio of the private sector or reduces the relative stock of liquidity, the tendency that a given percentage define in income will set-off a debt-defaltion increases.

And also, if "with a given set of debt-income ratio, the networth of units is decreased by capital or operating losses, then both the maximum decline which cannot and the minimum decline which must generate a debt-deflation process will decrease".

But if the economy experiences short-term declines in income in a regular and)or predictable fashion, then it is possible that the initiating decline in income does not trigger a sever reaction to set off a debt-defaltion process.

Empirical Inquisition: The difference between 1962 and 1929

Since the ultimate liquid assets in an economy consist of those assets whose nominal value is independent of the overall economic performance (bonds and Treasuries), he makes use of gross national product divided by the amount of total ultimate liquidity, to give the measure of relative ultimate liquidity access time periods.

This is called the Pigou Velocity , which can be compared to the conventional velocity (gross national product divided by demand deposits plus currency outside the banking system)..

A high Pigou velocity means a smaller percentage of total wealth is held in ultimate liquid assets, implying that the market is allocating capital to other financial or productive assets rather than just bonds.

This means if a stock market crash hits, capital flows into these highly ultimately liquid assets (bonds), offering both a hedge and returns (income and capital appreciation), thereby creating a buffer for the downturn as the government uses these funds on the fiscal side to stabilize aggregate demand.

This is the difference between 1962 and 1929 and why the former'  (1962) downturn didn't lead to a debt deflation as did the 1929 crash. In 1929, the Pigou Velocity was 25% above the conventional velocity, however in 1962, it increase to about 50% indicating that the stock of liquidity relative to income was much greater in 1962 than in 1929.

This is to say that there was much more liquidity in 1962 than in 1929. And that since the maximum minimum decline which cannot and must lead to a debt deflation depends on the liquidity in the system (amount of liquid assets) and also the Networh of individuals, an increase in the size of the ultimate liquidity, increases the maximum and minimum threshold beyond which a debt deflation cannot and must be triggered.

The Role of the Government:

Both trends in the debt-income ratios of households and business in both periods were similar, but the initial conditions prior to the 1962 crash were much more conducive to a stable reaction. Mindy chucks this difference in systemic behavior not to any change in financial processes, but the state of the system at the time the fall in prices occured.

The economy of 1962 was much more different from that if 1929 and a lot had to do with the size of the government. As whilst Federal government purchases of goods and services (government spending) was 1.2% of GNP in 1929, by 1962 it had risen to 11.3%.

This enormous increase means the government is able to stabilize income much more. For once income turns down, the switch to government securities (liquid assets) provides financing for public spending of a magnitude that makes the economy able to absorb the deflationary shock.

Chapter 2 Finance and Profits:  The Changing Nature of American Business Cycles.

Historical Perspectives on the Changes between both eras:

The great contraction of 1929-33 was the first stage of the Great Depression which lasted until the end of the 1930s. Though the 1960s saw economic turbulence, it was nothing close to the prior era. And throughout the first phase of  WW2 America experienced "consistent and fundamentally tranquil progress". The years (1946-1960) were characterized with full employment and stable prices.

This progress in the two decades took place in other advanced economies at the time. However the mid 1960s brought some turbulence with both unemployment and inflation in an upward trend through to the 1970s.

Crises also occured in the financial markets in this period and "the dollar-based international monetary system set up after WW2 had been destroyed". The "general price stability, financial strength, and international economic tranquility came to an end.

What followed, was an era of "sever business cycles, growth retardation, accelerating inflation, financial fragility, and international economic disarray." However this wasn't as bad as the 1930s depression.

After changes to the financial structure were made post the depression era, in 1966-67 the stability of this new financial structure was tested, and "the Federal Reserve fund it necessary to intervene omas the lender of last resort".

But two episodes occured afterwards (in 1968-70 & 1974-75) where the Fed found itself having to intervene in the same fashion. And in early 1980 "the Batch/Hunt silver crisis showed that there were serious domains of potential instability in the economic structure".

Hence the reason why the entire thesis of this book is that "an understanding of the American economy requires an understanding of how the financial structure is affected by and affects the behavior of the economy overtime".

The time path of the economy depends on the financial structure." And the financial relations that caused the instability of 1929-1933 (people holding more cash absent an alternative instrument and stabilizer per chapter 1) were of minor importance during the 1846-65 era. The reason the markets behaved in tranquil way.

 The dynamic behavior of the American economy in the 60's "reflects simultaneous existence of a structure of financial relations conducive to the generation of instability".

Alongside this was a structure of a government budgetary commitments (spending( and federal reserve interventions preventing the full blown development of a downward cumulative process.

The Six-Stage Business Cycle:

The result of the above was the emanation of a businesses cycle characterised by six stages;

(i) An accelerating inflation; (ii) a financial crisis; (iii) Sharp thrust towards lower income; (iv) an automatic and discretionary intervention by the government through the size of its budget (spending) and lending (or providing liquidity) to the markets through the Central Bank in its capacity as the lender of last resort; (v) a sharp breaking of the downturn (stability), and (vi) an expansion.

Stage six,  he says, leads us back to stage one. And in 1966 and onwards, the cycle seems to take place between a period of 3 to 6 years. With economic policies able to affect the duration and severity of particular stages, only at a price of excercebating other stages.

Minsky now goes in to address questions arsing from the above perspective;

(i) Why we haven't had a great or even serious "depression" since 1946?; (ii) why has 1946-66 been a period of tranquil progress and why has it been accompanied by turbulence?; (iii) is stagflation the price we pay for success in avoiding a great or serious depression?; and are there feasible policies —short of accepting a deep prolonged depression (which is what Mises and Austrian propose indirectly)—that would sustain the tranquil progress that took place in WW2?

 

Minsky on Keynesians and Monetarists Theories:

To address these questions, he says "we need an economic theory which explains why our economy is sometimes stable and sometimes unstable". Cause at the time no economic theory sufficiently explained Instability.

Both Keynesians and monetarist —both which had them dominated the debate and discussions around economic policy—use a common economic theory, even though they may differ in actual policy proposals.

This was termed the "Neo-Classical Synthesis" a concept to which instability of the kind identified leading to questions Minsky hoped to answer, were foreign. For it would be impossible —under the assumptions that rule the theories—"as a normal result of the economic processes".

Disagreement with the Neo-Classical Synthesis and the Keynesian and Monetarists Theories of Money and the Financial System:

Within the Neo-Classical Synthesis, a serious depression cannot occur as a result of internal operations of the economy. By this, only policy errors or non-essential institutional flaws can cause a depression of a magnitude as in 1929. Such is the Monetarists and Keynesians.

The former viewed it a the errors of the federal reserve and ommissions, and the latter hold the view that it was  the result of a decline in investment opportunities or a prior "unexplained" decline in consumption.

"The Neo-Classical Synthesis treats the complex system of financial institutions and instruments used to finance ownership of capital assets, in a cavalier way."

A detailed analysis on the behavior of financial relations, and the inter relationship between financing and operating units and how they affect the performance of the economy, is missing in the core of standard theory.

Minsky highlights that neither Keynesians nor Monetarists integrate the financial structure of our economy into the determination of income, prices and employment. In both, the financial structure is represented by money.

Monetarists use money as a variable that affects prices and Keynesians use money as a variable that affects nominal aggregate demand. But to both, money remains an outside variable and money in existence is independent of internal processes of the economy.

In the modern economy, Minsky posits that "money is created as banks acquire assets [issue loans], and destroyed as debtors fulfill their obligations [pay back debt]"

The economy is one with long-lived and expensive capital assets financed by a complex financial structure . The essential financial processes center around the mode of financing capital assets. "Investment decisions, investment financing, investment activation, profits and commitments to make payments due to outstanding debts are linked."

So to understand the behavior of the economy, it becomes necessary to integrate financial relations into an explanation of employment, income and prices.

 

The Significance of Finance [In Economic Growth]:

The integration of financial relations into an explanation of overall employment, output and prices necessitated a "framework for analyzing the relations between cash payment commitments due to outstanding liabilities and the cash receipts if organizations with debts".

This is to fully integrate the financial market activity into the theory of income and prices determination. This is because financial instability and it's impacts are facts and "any theory that attempts to explain the aggregate behavior of our economy must explain how it can occur".

Since financial instability is one facet If the business cycle in history, "a theory that explains financial instability will enable us to understand why our economy is intermittently unstable".

Composition of Debt and asset Portfolios in Various Companies:

Cash payments commitments on outstanding instruments are paid in two forms, (i) principal plus interest in the case of loans and; (ii) a share of income paid to equity holders —dividenss. This is the basic setup of the financial structure.

He goes on to say that "the relations amongst various business units in this regard, and the use of cash for various classes of economic units determine the potential for instability in the economy.

The economy (US) being one that employees complex and expensive long-lived capital assets (or production goods) does do with a complex financial structure. With the funds needed to finance capital assets purchases collected in various mediums (not just borrowing and lending through banking or clearinghouses as Mises posited in his time).

And a result, firms finance their operations with a diverse set of financial obligations. Small businesses and sole proprietorships without access to the capital markets would have to employ private business transactions on legal terms, making the debt that if the individual business owner.

Some firms hold strictly capital assets, and others (say Financial Institutions) hold financial investments. The typical FI portfolio consist of debts of these capital owning firms, debts of households and debts of other financial institutions.

This leads to a complex network of commitments to pay money. And borrowing and lending is as a matter of common practice, done in the basis of margins of safety. Balance sheets at any moment becomes "snapshots if how one facet of the past, the present and the future are related."

 

Money Supply as a Bond:

A deeper look makes it clear that the entire money supply is like a bond, Minsky states. Because it finances positions in capital assets. For "before one can speak securely of how changes in money supply affect economic activity, it is necessary to penetrate the financing veil to determine how changes in money supply affect the activities that are carried out".

That is to say that an investigating into the financial structure and how it links to the real sector is necessary before one can determine the possible effects of an increase in money supply. How these new monies circulate is more important than how much money is out in circulation.

The Certainty - Uncertainty Trade-off:

"Underlying all financing contracts is an exchange of certainty for uncertainty. The current holder of money gives up a certain command over current income for an uncertain future stream of money.". These are essentially ruled by expectations, and these expectations a conditional upon the current state of the markets.

Assumptions of intrinsic value are made as well. These are attempted t be projected by some sort of probability distribution, but Minsky said it is less "useful for economic life than it is for a roulette wheel" a sarcastic way if arguing against ithe reliability of forecasts due to unforseen circumstances and ever changing conditions.

The financial markets then becomes an apportionment of various units of potential gains and losses whose likelihood is uncertain. And with this uncertainty comes the certainly that results are likely to deviate from anticipated ones. Such deviation results in capital gains or losses.

With each experience in capital gains or losses, comes changes in the terms upon which the command of resources will be exchanged for a "conjectural future command of resources. The prices of capital assets and financial instruments [to finance these assets] will change as history affects views about the likelihood of various outcomes."

Every household, business or government issues financial liabilities. Each of these issuers have a primary source of income from which the financial commitment via the the instrument can be validated. For households it's wages, for businesses it's profits, and for governments it's revenue (taxes).

Each of these sources (wages, business profits and taxes) are related to the performance of the economy (though to different degrees and timing).

The link between financial markets and income, output and employment is the fact that some of the demand for current output is financed by issuance of financial instruments and a certain level of wage, profits and tax flows, is necessary to sustain the flow of this issuance of financial instruments —and by extension aggregate demand.

"A capitalist economy is an integrated financial and production system and the performance of the economy depends upon the satisfaction of financial as well as income production criteria."

 

Hedge, Speculative and Ponzi Finance:

There are three financial postures for firms, governments and individual units that are differentiated by the relations between contractual payments due to their liabilities and primary cash flow sources. The three postures are; Hedge, Speculative and "Ponzi" financing, and "the stability of an economy'd financial infrastructure depends upon the mix of financial postures."

The greater the weight of hedge financing in relation to the others, the greater economic stability experienced. However, the increasing weight of speculative and Ponzi financing invariably signals and unstable financial structure.

For hedge financing; cashflows from production activity are expected to exceed contractual payments in outstanding debts uses to fiannce the activity.

For speculative financing; the total expected cashflows exceed total outstanding debt, but near term payment commitments on these debts (as payments happen periodically) exceed near term expected or actual cashflows from production. But he made a note that, "near term cashflows, as measured by accounting procedures, exceeds near term interest payments on debt"

A Ponzi financing unit is s type of speculative one where the income component of near term cashflows falls short of near term interest payments on debt, and at sometime in the future the outstanding debt will increase due to the interest in existing debt (debt is basically being financed with debt).

In any case, both speculative and Ponzi financing units will have to pay their debt by borrowing more or disposing of assets. The amount the former will need to borrow is less than that required by the latter (Ponzi) who would have to increase it's total outstanding debt. This is usually done in hopes that some asset would be sold at a higher margin in the future to cover the costs incurred today.

Minsky now goes on to examine the cash flow, present value and balance sheet of hedge, soeculatibe and Ponzi financial positions for businesses.

This is because the focus is on payment commitments due to business debt, for the "generation and distribution of this broad concept of profits is a central determinant of stability in an economy where debts are used to finance investment and positions in capital assets"

The Abysmal Effect of Household and Government Expenditure Relative to Private Sector Investment:

Though household and government cashflows and liabilities is of great importance to the operations of today's capitalists economy. As household and government spending (G and C in the GDP equation [C+I+G+(X-M)] if you will) affect stability of the economy's output prices.

And employment through the course of time, "households and government spending aside from times of war, was small" and therefore they could modify, but not cause cyclical behavior of capitalist economies.

It follows that "if the debt generation and validation by governments becomes large relative to debt generation and validation by business the basic path of the economy is likely to be affected."

This is to say that if government spending outweighs private investment, there would be repercussions for the economy in the long-run –think crowding out.

The Structure of Business Forms; Minsky laid out the fundamental variables used to analyse the financial structure of a business. These he said, are "cash receipts and payments of economic units over a relevant time period".

The total cash receipts can be divided into two components; (i) payments for current labor and inputs, and (ii) a residual gross capital income. Gross capital income equals "gross profits/income before taxes plus interest paid on debt.

The cash payments made by any unit equals the spending on current labor and other inputs, tax payments; debt repayments and dividends. And over any time period, cash payments for the above could exceed cash receipts.

So the key relation between debt and income becomes "that between after tax capital income, and payment commitments debts."

Thus, a necessary condition for financial viability —though not sufficient—"is that expected gross capital income exceed the total payment commitments over time of debts now on the books".

Gross capital income becomes a reflection of; productivity of capital assets, the efficacy of management, the efficiency of labor, and the behavior of markets and the economy".

Minsky explains that the debt structure becomes a legacy of past financing decisions, the question arising from this which he deals with in the next section, is "whether future profitability of the business sector can support financial decisions that were made based on the current capital-asset structure of the economy"

Hedge Financing:

A unit can be said to be hedge financing when at the due date the expected gross capital income exceeds the payment commitments to debt, by a reasonable margin.  Liabilities are entered into the books with a margin of safety —"an excess of anticipated receipts over cash payments". The capitalized value of the flow of gross income will exceed that of the payment commitments at every interest rate.

For hedge financing units, insolvency cannot result from changes in interest rates. And even though the unit and it's bankers expect cash flow from operations to be sufficient in meeting debt payment commitments, "further protection for borrowers and lenders can exist by having a unit own excess money or marketable financial assets."

So a balance sheet of a hedge financing units will have money and money market assets in addition to capital assets.

The financial posture of a hedge financing units can therefore be described by an excess of cash receipts over debt payments in each period, an excess of the value of capital assets over debt, and the holding of cash or liquid assets.

It is "not directly susceptible to adverse effects from changes in the financial market". Only if revenues fall short abruptly can a hedge financing units go bankrupt.

Speculative Financing:

This is when for some periods of time, cash payment commitments on debt exceed expected gross capital income. The "speculation" here lies in the belief that debt refinancing would be available. This arises because "commitments provide for the repayment of debt at a faster rate than the gap between revenues and costs (profits) allow for the recapturing of the money cost of capital assets."

The sum of payments of debt obligations exceed the expected cash receipts. But in the long-run the reverse is the case. So a speculative unit has near term cash deficits and long-term cash surplus. The unit essentially finances long-term positions in assets with short-term liabilities.

Higher interest rates lower present value of all cash receipts but the decline is "proportionately greater for receipts more distant in time". So, the ability of a firm that participates in speculative financing to fulfill its obligations is susceptible to failures in the markets in which it sells (refinances) it's debts.

Ponzi Financing:

These are speculative units with special characteristics. Near term period payment commitments to pay interest on debt are not covered by (or exceed) income for the period in question. They must borrow to pay interests on outstanding debt, as their total debt grows with no new income yielding asset acquired.

Bankers and debt holders participate in Ponzi financing only if the present value of the sum of all future expected cashflows is positive, and can offset the negative present value of expected cash receipts in the short term. An extremely example is borrowing to hold an asset that is expected to appreciate enough in value to offset all outstanding debts and leav a sizeable gain.

Ponzi schemes depends on the present value on interest rates and future cash flow expectations. Whilst inflation bids up asset prices (and interest rates), and a decline in inflation expectations will lead to a drop in asset prices leading to debts exceeding the value of assets.

At every point in time the business environment involved with the three forms of financing, and thus, the stability of the economy would depend on the mixture of all three (Hedge, Speculative and Ponzi).

Changing Financial Structures 

Over time he weight of short-term debt in the business financial structure increases, as the weight in cash portfolios decreased. (Money is ploughed into business operations, debt repayments, and more debt acquired in the process). So there'd naturally be a shift in the proportion of units with different financial structure, and the number of units with speculative and Ponzi financing schemes increase as a result.

A decline in expected gross income or a rise of income protection required for hedge financing can turn hedge units into speculative ones a further rise in income protection for speculative financing and a rise in financing costs can turn speculative units into Ponzi units.

Interest costs do not affect solvency of hedge financing units but does that of speculative and Ponzi financing units. In a world dominated by hedge financing units, the authorities can almost disregard the course of interest rates.

However, large increases and wild swings in interest rates will affect the behavior of an economy with large propor tions of speculative and Ponzi finance. "In a world where speculative and Ponzi finance is important the authorities cannot disregard the effect of policies on the level and volatillty of interest rates."

Households:

The flow of income relevant to this unit is the difference between the disposable income and cash payment commitments on household debt. This is the first household financial relation.

The second is that which involves asset contracts and is a relationship between values of the asset and the face value of the outstanding debt.

Household debt can be fully amortized (series of paymets specified through to the end of the contract), partially amortized (a portion of payment made at the end of the contract and the rest before) or not armored at all (the full original principal amount is paid at the end of the contract).

For a fully armortized contract, it is assumed that the payments are less than expected wage income per period.  This conforms it to the definition of "hedge financing".

A partially armortized and unarmorized contract can have payments due at some dates that exceed anticipated wages. This the cashflows of that if partially amortized contracts corresponds to speculative financing and unarmorized debt similar to Ponzi financing.

Generally, consumption (credit cards) or mortgage debt are treated as Hedge financing. As these debts are fully armortized. But not so the financing of securities holding by the household.

[CHECK PART II FOR THE RMEAINDER OF CHAPTER 2 AND PARTS OF CHAPTER 3]