You make more assumptions about expectations than you think, but I won’t get into that now. Interest rates may or may not be the actual transmission mechanism; my point is it doesn’t matter. It is the excess supply of money that sets off any transmission mechanism.
In my story, the increase in investment demand hapens at the same time as the increase in supply of credit because they are spurred by the same thing. Yes, if investment demand didn’t increase there might be a fall in rates but sometimes we don’t want to keep everything else equal.
With credit expansion interest rates are lower then they otherwise would have been. No one advocates measuring credit expansion by the interest rate, if for no other reason then because no one knows what the natural rate is in an interventionist economy.
You could say the same thing about prices - the fact that prices are at a given level doesn’t mean there was inflation or deflation because changes in supply and demand could have offset that, this is, in fact a point Austrians make every once in a while. But you’re going a step further, what you’re saying is akin to saying we should not point to rising prices as a consequence of inflation.
But it does make the insight of the theory simpler to grasp.
if you dont know the difference between “a falling interest rate” (as you put it), and an interest that is lower than it would have been had there not been credit expansion, then you might not yet be ready to debate with the big boys.
You don’t have to revert to insults if you’re having trouble understanding my point.
Increases in the supply of money CAN have an effect on both the supply and demand for loanable funds. We can’t tell a priori which it will affect more and therefore we can’t say that the interest rate would have been higher had it not been for the increase in credit.
I’m a real estate appraiser. I’ve found Roger Garrison’s macreconomic approach helpful with this question, because we can visualize both the entrepreneurial (developer/builder) side and the consumer side simultaneously.
As rates are suppressed by a lowering of the Federal Funds Rate (or, in Hulsmann’s version, loanable funds increased by sales of mortgage-backed securities), developer/builders read an opportunity to invest in higher order goods to produce more houses (or, e.g. retail shopping centers and their compliment, warehouse space, etc.). I treat the finished product as a consumer good. The higher order goods include the acquisition and preparation of building sites, zoning changes, permits, and building materials (whose costs have risen due to global demand, but with lower rates the builders get while the getting is good…). They also hire labor and go into production – all of this assuming that lower rates will also mean more prospective buyer/tenants for their finished products. It goes without saying, this is future oriented activity since develope/builders’ time preference has fallen.
Meanwhile, consumers read lower rates as an opportunity to (in the words of Bill Bonner) “bring future consumption into the present.” They aren’t saving for down payments or adjustable rates mortgage payments. They are consuming immediate lower order goods now, and going “to the wall” if you will in consumer debt. Lower rates offer a temporary escape route via refinancing and transferring debt to equity lines. Others borrow for home improvements, but not for new homes. As ABCT explains, they are not saving; therefore, there will be no future demand to meet the goods produced by developer/builders.
In the scenario I’ve painted a real estate bust is inevitable because the time preferences of producers and consumers have moved in opposite directions. Consumers eventually reach a point of “forced savings” (as we’re witnessing now) and there is pressure for interest to return to its natural market rate. Developer/builders run out of funds AND are left with inventories and vacancies.
This made sense to me when I thought back on Mark Thornton’s work on skyscrapers and recessions – there is a definite correlation.
Then you’re making the same mistake you were pointing out earlier.
Interest rates depend on the supply of savings and demand for credit, nothing else. Just like you came up with cute examples of lower interest rates leading to a shorter production process, or credit expansion ultimately not changing interest rates, I can show how supply and demand for credit can lead to almost any interest rate no matter what inflation and growth expectations are.
The fact that there also can be another reason for price movements doesn’t mean it’s wrong to say inflation causes rising prices, especially ceteris paribus.
Malinvestment doesn’t make sense without some notion of the time structure of production. Granted, one can still capture “overinvestment”, but this isn’t a particularly Austrian insight. Rather, it is the Austrian notion of capital and the related issues of complementarity & subsitutability and roundaboutness the make the ABCT what it is. If you wish to say why it makes “no sense”, go ahead, but I’ve not seen any support for such an assertion.
By the way, I don’t see how the interest rate is not relevant. If time could be traded in a market of its own then the interest rate wouldn’t matter, but given the Austrian conception of time it doesn’t have a market of its own (and because of transaction costs, the necessary capital goods can’t simply be traded). Since money is perfectly liquid, time is traded in the form of money. But given this, the market rate of interest is the only indicator of the natural rate of interest, even if it is subsidiary and secondary.
Why not? We can talk about a misallocation of resources without any reference to time structure. Misallocation can occur between production processes that take the same amount of time. Also, in a way it is an over-investment story. Resources are transferred from their desired use in producing consumer goods to an unsustainable use in producing capital goods. Is this overinvestment or malinvestment? The length of the process the investment is used for doesn’t add anything to the story. I think our disagreement stems from different interpretations of h the theory. I think your view is something like the Fed literally sets the interest rate at a point below the intersection of supply and demand. I think the rate falls due to actions by the Fed only indirectly related to the interest rate. The unsustainable aspect of the story is that the fall in rates is only a short-run phenomenon while the induced investment is expected to last for the long-run.
The notion of “length of process” doesn’t make much sense for other reasons as well. As I said before, the Cambridge Capital Controversy showed that the effect of interest rates on capital accumulation is ambiguous. Also, how do we measure roundaboutness? I don’t think there is any objective way to do it. Technology may reduce the overall time a process takes. Does the use of new technology by itself make the process more roundabout? It all depends on how you define these things, which means the concept because less usefull.
I think the best way to determine the difference between the market rate and the natural rate is through inflation expectations. Inflation results from an excess supply of money, or a market rate below the natural rate. If inflation expectations increase, we can determine that the market rate is too low. But since it is the excess supply of money itself that is the problem, we don’t really have to look at interest rates (yes, the way to gauge inflation is by looking at the spread between certain interest rates but you get the point).
This conversation might be easier if you atcually read all of my comments. I am NOT talking about an increase in QUANTITY DEMANDED due to a temporary increase in the real supply of money. I am talking about a shift in the DEMAND CURVE itself due to increased expectations of nominal growth. THE NOMINAL INCREASE IN THE SUPPLY OF MONEY CAN AFFECT BOTH THE SUPPLY CURVE AND THE DEMAND CURVE FOR LOANABLE FUNDS. This is caused by a difference in the rates of responses between investment goods and consumption goods. This isn’t some fringe theory I came up with. This has been part of mainstream macro for 25 years.
for a given shift in the demand curve due to increased expectations of any kind, (including thoughts on nominal growth and not excluding any other arbitrary reason) a scenario in which this change in demand is accompanied by coincidental flooding of the loan market with government produced money, as compared to one where change to demand is not accompanied by such flooding of the loan market will be characterised by the one having lower interest rates than the other.
what rot. if loans are cheaper you can afford to borrow the same amount of money over a longer period than if they are more expensive. in other words, if interest rates were only a bit lower I could justify building a fcatory that would start producing gidgits in five years. oh, interest rates have magically lowered due to the benevolence of the governments central bank! scratch the plan to build a small less productive factory over 4 years, the 5 year plan is now on…
Not understanding ABCT doesn’t make the theory wrong, it just means that you either haven’t spent enough time studying it, or are talking out of your ass. In fact, this current mess completely validates the Austrian school and its members. You’re right, lower interest rates do not always correspond to longer term investments; but it does make longer term investments more economically feasible, more profitable (what Austrians call “roundabout production process”), and nobody doubts the fact that longer investment projects yield more capital (that’s just common sense). It must also be stated that all of these longer-term investments are being crushed as we speak, while the economic community continues to focus only on the lower stages, on consumption (consumption is doing extremely well relative to investment). The industries which produce the necessary inputs for the car industry are being hit much harder than the actual car companies (Here in Europe this is a commonly understood and seen fact). It’s also pretty clear that you don’t know what the structure of production is: it’s the multi-tier production process inherent in all economic systems, no company produces any product from start to finish (there are vertical and horizontal dimensions). You should try actually reading Austrian economic literature before you make such claims, or at least ask questions and try to get information.
All of your talk about inflation not effecting interest rates is utterly meaningless, and you won’t find anyone explaining simple investment functions to you here.
The way the inflation and malinvestments manifest themselves cannot be known, nor is the entire picture visible. America’s inflation has permeated throughout the entire world due to the USD status as the world’s reserve currency. As Mises explains, inflation does not affect everyone the same, nor does it occur instantaneously; those who get the inflation first see their purchasing power rise relative to those who get it later. This is why the U.S was able to run massive current account deficits while continuously inflating its currency (neo-classical international economic theory would tell you that inflation translates into current account surpluses as your domestic products are made cheaper on the international markets). The malinvestments spread through the entire economy; it not only created gluttony of real-estate investment, but allowed for pure bubble types of investments such as cold-stone, starbucks, ect, ect. All while higher stages of production, all over the world, specialized in the inputs required for these final consumer goods (this is why it’s an international crisis). But all of this really ignores the crux of the ABCT; the fact of the matter is that the liquidation process has not been allowed to take place (why the commercial real-estate market has yet to collapse), the massive monetary stimulus has kept this artificial international economy going, and the reswitching process has been delayed (similar to what happened towards the end of the 90s with the dot com bubble and Greenspan’s 1% interest rates). Of course this has serious theoretical ramifications; inflation cannot continue forever, it must eventually stop (according to the Austrians). Once it stops, the entire financial system and investment sector should collapse; if it doesn’t, the dollar will become hyper-inflated, and the world economy should come crashing down (again, the dollar is the international currency). This is why China, Japan and Saudi Arabia are currently in a game theory type of position; they’re all trying to figure out a way to git rid of their dollar denominated assets before it’s too late.
I am very familiar with ABCT. I didn’t say I don’t understand the theory. Parts of the theory don’t make sense in light of modern insights. In fact, if you read all of my comments, you would see I am actually attempting to strengthen the theory by removing these weaknesses but leaving the basic conclusions intact. Besides, it’s not as if the things I am saying are entirely original. Garrison and others accept most of what I’ve said and I cited a paper somewhere that attempted to reconstruct ABCT on the grounds of rational expectations.
Oh really? Where is you evidence for that claim. As far as I can tell, unemployment didn’t increase until a year and ahlf after the housing collapse. Financial institutions didn’t start failing until after nominal GDP started to drop. These two facts make the Austrian theory less viable in terms of the current situation. I would actually be interested in hearing you try to explain them.
Again, read my other comments. I was introduced to economics through the Mises Institute and I attended last year’s Mises University. I’ve read Human Action and Garrison’s book. It is possible to have studied something and stil disagree with it.
The second part of your comment (the part that isn’t adressed at me) shows that you do not understand my position. There is no inflation currently (where inflation is an excess supply of money). In fact, there is delfation going on. There is no ever increasing rate of money supply growth. Markets are not worried about inflation and the most China and others have done is demand a higher interest rate on debt payments. I am not going to get into a major discussion about this here. I have posted comments adressing this in the Blame Greenspan thread and the Why Infltion is in America’s Future thread.
That’s the point.. The crises doesn’t really begin until the restructuring process, when the structure of production contracts and capital is re-allocated towards warranted investment projects. We haven’t even felt the real crises yet due to massive monetary growth (something you deny: http://mises.org/markets.asp); we just saw signs of it. This housing mess is not important; it’s just an indicator for what’s about to happen (since our economy is so dependent on the real-estate market and MBS). The higher stages of production all around the world are collapsing at alarming rates while the financial guru’s continue to look at retail numbers (the industry least effected). We know that Keynes was wrong due to the stagflation crises, and the collapses in Eastern Europe (Yugoslavia namely), and we know Friedman was wrong (really we always knew he was wrong due to the major disaster caused by his mentor, Fisher) because we’ve had only mild price inflation and still experience major economic fluctuations. Inflation does cause relative price distortions leading to major vertical and horizontal shifts, arbitrarily so, creating false expectations and major malinvestments. The numerical data shows that recessions mean a drop in investment activity, more so than in the consumption sectors (why Khaldor was wrong).
I’ve dealt with this already.
People in Europe are taking bets on when the Dollar will collapse (along with the Pound), and are starting to ponder which currency will replace it. The dollar traded for .68 against the Euro recently. Unfortunately, Europeans don’t know that the Euro is falling as well, a fact concealed by the rapid depreciation of both the dollar and English Pound.
You’re right about one thing though, the rate of interest may remain the same during an inflationary period due to a proportionate increase in demand. Austrians focus on the divergence between the market rate and natural rate. But interest rates will fall if the creation of fiduciary media outpaces investment demand, and this is what we’ve seen for a long time. America has a 4% savings rate.
The game ends when monetary pumping becomes ineffective. You could date that around start of 2008. In summer of 2008. the game was over 100% and banking sector collapsed few months later. Once the liquidity dries and interest rates reset, unemployment quickly follows as lot of businesses are now suddenly underwater.
If there were no monetary intervention, economy would have probable crashed somwhere around the end of 2007.
Banking sector should actually collapse first, as financial markets are known to discount future conditions. However, that was prevented with massive state intervention. So it backfired again in 2008. with yet more intervention following.