10. A Catastrophe Model of Commercial Banks’ Finance Within the Loanable Funds Cycle

This chapter has been extensively re-written to apply the key technique of modern portfolio theory from the previous chapter, together with the concept of certainty equivalence from stochastic control theory, to a catastrophe theory model of the function of perceptions risk and uncertainty. This allows the theory to expose the full effect of the credit phases of Minsky’s theory and the possibility of the catastrophic moment leading to recession or depression, triggered by changing perceptions of risk and uncertainty by commercial banks. This links to the deposit base embodied in the components of the money multiplier, which is driven by the mechanism of credit creation (or extinction) of loans. The variability of the deposit base is largely dependent on perceptions of default risk by commercial banks and the state of the economy in terms of the cyclical growth of GDP, intertwined with the credit cycle, which arises from the multiple equilibria of catastrophe theory. The assignment of variables here is quite different to what it was in the first edition.