Banking System and Financial Fragility in a Post Keynesian Model

Abstract: This paper develops a Post Keynesian model with Minskyan insights that places emphasis on the interaction between the banking sector and the real economy and investigates the conditions under which the latter is likely to be brought into financial fragility. The analytical framework used to describe the banking sector explicitly incorporates the impact of banks ’ ‘animal spirits’, of firms’ creditworthiness and of banks ’ expectations on the provision of loans. The financial fragility of the economy is defined by drawing on Minsky’s taxonomy and is assumed to rely both on the fragility of firms and on the fragility of the banking sector. Our dynamic analysis investigates how the interaction between the fragility ratio of the banking sector and the real output can generate financial structures that are susceptible to financial fragility. Furthermore, it briefly assesses the effect of institutional changes in the banking sector and of monetary policy on the emergence of financial fragility in the economy.