ABSTRACT
This chapter discusses financial instability and reviews three greatest economists' analyses to this central problem. These economists are John Maynard Keynes, Friedrich von Hayek and Milton Friedman. It is no coincidence that a theory of asset pricing is absent in the work of Friedman and Hayek, because asset prices reveal a degree of human fallibility, and a tendency towards instability that markets can reinforce. Keynes, by contrast, put asset prices centre stage in his explanation of economic booms and busts. People's inability to understand asset prices and the existence of principal-agent problems provides a strong case for regulating the amount of leverage financial firms can be permitted. Like Hayek and Friedman, Keynes saw the advantages of the free market for human creativity, freedom and the use of resources, but he believed that recession and depression were entirely consistent if not inevitable properties of the capitalist system left to its own devices.
