I’ll give it a shot. A star * means I don’t know or am unsure. My comments in bold type.
this still doesn’t answer what causes the boom and subsequent crash, which is Krugman’s point.
As he says, Austrian’s implicitly assume a rise and fall (whether asymmetric or not) in aggregate demand
instead of explaining why there is a fall in aggregate demand
Sure there is an explanation. Let’s take the housing boom as an example. There were too many houses built. People bought houses assuming they could sell them at a profit. When the time came for them to sell [because their ARM was about to go up] everyone who wanted a house already had one. There was no one to sell to. Not to mention the new unsold houses. No one to sell those to either. So people suddenly realized they had no money. Their million dollar house could not be sold. The mortgage was still due though. So obviously it’s time to NOT buy new TVs and stuff.
or how we can combat this fall
It’s like asking “How can we combat the fall of a meteor?” You can’t.
(it’s also assumed here that the demand was “fake”
If by “fake” he means people bought houses not because they needed them, but mainly because they intended to seel it on to the next sucker when the time comes, then yes, it was a fake demand.
- a common morality play Austrians use).
Ah, the slander! Austrians don’t make moral judgements [that’s for libertarians, which is NOT the same as Austrian Economists]. They merely tell it like it is. If htis happens, then that will follow.
Austrian’s also assume that this “misallocation” is caused by low interest rates which is caused by the Fed and the Government.
Yes, and I’d like to see you refute this with facts. [Rubbing hands eagerly to see what facts will be presented].
Another morality play.
Oh, you disappoint, Sir!
Mr. Kling has even said before that he does not believe monetary policy to be particularly effective even in normal times -
And of course, Mr Kling [whoever he is] is such an expert that his “beliefs” clearly are proof of whatever he believes in. Nope.
“In fact, I think that it is almost always true that monetary policy is ineffective, because it is almost always true that money and other assets are close substitutes. In Can Greenspan Steer?, I pointed out that long-term interest rates were falling (this was August of 2002) even though Fed policy was to hold rates steady.”
First, how do we know what Fed policy really is? They may be lying, right? Second, LONG TERM interest rates are not influenced by the Fed. Short term ones are. Long term interest rates are influenced by people’s expectations of inflation [Peter Schiff].
Finally, this whole argument is mind boggling in it’s being beside the point.
Let’s summarize the Austrian position and its rebuttal here:
AE postion: Sometimes the Fed tries and succeeds in lowering interest rates. Their success causes a business cycle.
Rebuttal: Aha, but sometimes the Fed tries and fails.
So you then go back and realize that the Austrian story of business cycles doesn’t hold water or is trivial because of 3 things
- Implicitly assuming increases and decreases in aggregate demand coincide with booms and busts in investments
This is just mind boggling. Austrians say there is no such thing as an increase and decrease in aggregate demand. Demand is always there, if the price is right. Maybe he means demand at a given price. Then yes, an increase in investments which IS NOT ACCOMPANIED by a decrease in demand for consumer goods [meaning consumers are willing to pay the same high price for what they want] causes a boom. Prices of everything goes up, cause investors and consumers want everyting, and the govt has printed the money to allow prices of everything to stay high.
When the investors lower their demand for new materials [because they wake up and see that the houses they built are unwanted, to use the latest example], they also fire people. So that everyone sits back and wants things cheaper.
but if we’re to believe in Hayekian triangles aggregate demand should fall as (over)investment increases.
* I don’t know about Hayekian triangles.
In other words, a drop in I should be replaced by an increase in C,
No. This is the mistake. C cannot increase, because THERE IS NOTHING LEFT TO BUY. Resources have been diverted to building houses. Nobody wants the houses. No new consumer goods can be made, because there are no resources to make them.
and vice versa, but clearly that isn’t the case. Both C and I increase lockstep
Yes.
and eventually a drop in C
No more houses being bought. Because everybody has one.
leads to a bust in I
So no new ones will be built.
as C can no longer keep up with I.
Very true. But this does not refute the Austrian explanation, as explained above.
2)The Fed is not so powerful at controlling long-term rates. Short-term rates, sure, but long-term rates, hardly, even given QE it can be difficult without sufficient liquidity.
* Don’t know what QE is. In any case this is irrelevant, as short term rates are what count according to AE. He admits this later on.
Not to mention, that with the Fed printing money like there is no tomorrow, smart people soemtimes grasp that this will lead to inflation, which makes long term rates shoot up.
And finally, even though they don’t always succeed in controlling interest rates [which I am not sure about at all], in the cases where they DO succeed a cycle is born.
But there is more to it than that. Low interest rates are not the only thing that causes a cycle. Printing money can do it nicely as well [although usually the two go hand in hand].
Tyler Cowen also writes -
"Basically he’s [Krugman] right, as I’ve argued in my book Risk and Business Cycles. Here’s a bit of what he is serving up:
What happens, instead — or at least that’s how I read it — is that Austrians slip Keynesianism in through the back door. Implicitly, they associate booms and slumps with rising or falling aggregate demand — utterly unaware that their own theory doesn’t actually make room for such a thing as aggregate demand to exist, or at least to affect overall employment. So Austrians are basically Keynesians in denial — self-hating Keynesians? — pretending to themselves that they’re not using ideas that are in fact essential to their story.
Yep, same ole same ole. Show me exactly where Austrians assume anything about aggy demand. Like he says, Austrians don’t use aggy demand.
Sraffa first made a related point in 1932, though without reference to Keynesianism of course. The strongest defense of the Austrians is something like the following. The simplest IS/LM or AD models are models of flows, not stocks. Arguably the Austrians could be pointing to a longer-run stock condition – concerning capital, savings, and the like – which means that the flows of the boom eventually must be reversed into a bust. The Austrians could (though many don’t) buy into Keynes as a good short-run theory while addending these longer-run considerations of sustainability.
I dunno what he means here, but I smell irrelevance.
Krugman’s point is harder to rebut if you ask the simple questions of why Austrians a) start from an assumption of full employment,
Huh? What is he talking about? Where is this assumption made?
b) postulate that in a boom capital goods production rises at the expense of consumer goods production,
Because times of low interest rates are great times to invest in capital goods production. Those things are expensive, and take time. The lower the interest rate for getting them going, the better.
and c) argue that real wages rise during the boom.
Who said that? Of course it might happen, since there may be a demand for labor to build the new factories, at the same time that there is still a demand for making consumer goods.
Those can’t all happen together.
Why not?
A separate question is why investors don’t see inflation, get scared, and contract the structure of production immediately, rather than first expanding it.
Because inflation does not drop down from the sky full blown. It takes time, and creeps from sector to sector.
Or why unforeseen inflation (if indeed it is unforeseen) does not significantly lower the real interest rate that is paid ex post on borrowed funds (no Fisher effect!), thus supporting long-term investments.
Because investors may be paying a low “real” interest rate, bu they don’t have “real” money. They have inflated money, and it is slipping through their fingers at the high interest rate.
Or why investors so respond to the short-term interest rate but are so oblivious to the information contained in the broader term structure.
Aha, so you knew this all along, that AE says it’s the short term that counts. And so you practiced sophistry earlier, going on and on about the long term rates.
Because short term interest rates tell us what is going on right now. Long term rates tell us what people imagine the future will hold, as explained above.
Or just ask how much investors estimate future consumer demand by looking at interest rates – usually not much at all
How do you know this? What is your evidence?
and so they are not so strongly tricked by monetary influences on intereest rates."
- The expansion and huge boom of credit derivatives and advanced financial products (the greatest sources of credit - and CDS’s being the major cause of failure in AIG) by financial institutions was not made possible from government intervention. It was made possible by there being very little intervention in that market.
Totally false. Here is the appropriate info. Bottom line, this whole fiasco required the FDIC to make the banks willing to gamble.
As always, any comments are appreciated.