Structural financial instability and cyclical fluctuations

This paper introduces and discusses an heuristic model meant to clarify why and how economic instability may play a crucial role in a modern sophisticated monetary economy. In this model economic instability is specified in terms of structural instability rather than in the usual terms of dynamic instability. This different view of instability implies a different approach to the analysis of the dynamic behaviour of the economic system and of its structural changes. In particular, the qualitative changes in the economic behaviour of the economic system are seen not as purely exogenous as in the received view but as essentially endogenous. This approach is applied to the analysis of financial crises and of their impact on the fluctuations of a sophisticated monetary economy. The crucial variable, the degree of financial fragility of the economic units, is specified in terms of structural instability, and this implies that, beyond certain thresholds of its value, the qualitative characteristics of their dynamic behaviour change radically in such a way to produce cyclical, though fairly irregular, fluctuations. The interplay between these microeconomic fluctuations is sufficient to produce cyclical macroeconomic fluctuations whose characteristics and implications for policy are briefly examined. © 2000 Elsevier Science B.V. All rights reserved. JEL classification: B41; E12; E32; E52