Broken Windows

Economics Economics Questions
21

Marginal,

  1. TY for your detailed reply.

  2. Yes, Hayek said some wild irresponsible stuff indeed, not that I believe a word of it.

  3. Monetary History of US doesn’t prove anything but a correlation. http://en.wikipedia.org/wiki/Correlation_does_not_imply_causation

BTW, here’s a quote that I found interesting;

Milton Friedman and Anna Jacobson Schwartz, A Monetary History of the United States, 1867–1960 (Princeton: Princeton University Press, 1963), p. 15. The authors write, “Finally, the price level fell to half its initial level in the course of less than fifteen years and, at the same time, economic growth proceeded at a rapid rate…. And their coincidence casts serious doubts on the validity of the new widely held view that secular price deflation and rapid economic growth are incompatible.”

AKA hoisted on ones own petard.

In addition, later research has shown his correlation to be statistically insignificant, a fancy way of saying totally wrong. Wonder of wonders, inflation seems to be correlated with depression, not deflation. My source for this paragraph is this fine article from a respected economist, who in turn is expanding on the results of two mainstream economists in fat govt jobs. http://papers.ssrn.com/sol3/papers.cfm?abstract_id=495773

Let me quote their credential and their conclusions:

Deflation and Depression: Is There and Empirical Link?

Andrew Atkeson

University of California, Los Angeles (UCLA) - Department of Economics; National Bureau of Economic Research (NBER)

Patrick J. Kehoe

Federal Reserve Bank of Minneapolis - Research Department; University of Minnesota - Twin Cities - Department of Economics; National Bureau of Economic Research (NBER)

February 2004

NBER Working Paper No. w10268

Abstract:
Are deflation and depression empirically linked? No, concludes a broad historical study of inflation and real output growth rates. Deflation and depression do seem to have been linked during the 1930s. But in the rest of the data for 17 countries and more than 100 years, there is virtually no evidence of such a link.

Prof. Salerno in the aaove linked article points out that their waffling “seems to” is really saying “there is no link at all, ever, not even in the Great Depression, if you know a little math.”

  1. Freidman on the lying Fed: “We said then and believed then, and I still do, that the Federal Reserve had failed to do what it was originally set up to do.”

At any rate, they said they will sell those assets, and maybe they are unbelievably stupid enough to think they can sell them. [Would you buy a piece of paper that had imprinted on it the statement “Officially recognized by the Fed and the whole economic community as toxic, meaning worthless”? Because that’s what they will be trying to sell.] But I give them the benefit of the doubt and assume they are lying. Take your pick, as long as we agree that their silly exit strategy is but a fairy tale. Does your earlier silence on this matter indicate agreement?

  1. TY for clarifying what you meant by that TIPS argument. Will return to it soon, hopefully. [My main argument will be that people are stupid very often.]

But the night grows long, the fingers and mind tire. Will continue hopefully another time.

22

Dave,

Correlation may not be causation, but it does show that either it is causal, it’s reverse causal, or there’s something causing both. Now on top of that we have the volcker disinflation, which was a reasonably exogenous tightening of monetary policy, and the following recession gives you causality.

I’m pretty sure I said contractionary monetary policy will cause a recession due to short run non-neutrality. I recall mentioning deflation as being bad in the case of severe debt burden (eg, now, japan, the depression) due to debt deflation. But I never would have said secular deflation is always associated with recessions. Obviously not. If nominal income is near trend (ie, monetary policy is not too tight), then deflation will be associated with lower prices due to gains in productivity. Not a bad thing at all.

I think you’re misinformed on what exactly is on the Fed’s balance sheet.

http://www.federalreserve.gov/releases/h41/current/h41.htm#h41tab9

I wouldn’t call $1.675 trillion in US Treasuries toxic assets…

Also, they don’t even need to collapse their balance sheet to fight inflation (but they will) because they’ve adopted an interest rate corridor just like Australia, New Zealand, Canada, the UK… They can raise the fed funds rate when the recovery comes around without having to suddenly dump their balance sheet (which would crash the treasuries market).

23

Correlation may not be causation, but it does show that either it is causal, it’s reverse causal, or there’s something causing both.

You forgot the fourth possibility, the one that applies in this case. They are caused by two different things, aka coincidence. For example, if my lucky rabbits foot, when spun around on a table, points due north every time stocks go up, would you also say that “either it is causal, it’s reverse causal, or there’s something causing both”?

Now on top of that we have the volcker disinflation, which was a reasonably exogenous tightening of monetary policy, and the following recession gives you causality.

Begging_the_question

Short version:

Begging the question (or petitio principii, “assuming the initial point”) is a type of logical fallacy in which the proposition to be proven is assumed implicitly or explicitly in the premise.

The first known definition in the West is by the Greek philosopher Aristotle around 350 BC, in his book Prior Analytics, where he classified it as a material fallacy. Begging the question is related to the circular argument, circulus in probando (Latin, “circle in proving”) or circular reasoning, though these are considered absolutely different by Aristotle.[1]

I wouldn’t call $1.675 trillion in US Treasuries toxic assets…

They are going to sell $1.675 trillion in US Treasuries? To who? The only reason the Fed bought them in the first place is because nobody else will touch them with a ten foot pole, [and the Fed has therefore assumed the role of printing the money for the US govt to spend]. The Fed buys more Treasuries nowadays than the whole world put together, and there’s a reason for it [not a coincidence].

And of course they are toxic assets. As for why I am not shorting Treasuries, the reason is simple. The collapse will come, but I cannot say when. These things take time.

I still owe you a reply to your earlier post, and parts of this one.

24

Time for a detailed reply. I’ll quote you in full, and comment in bold

See: A Monetary History of the United States, 1867-1960, Friedman & Schwartz (1963)

Already replied to this, with sources. Thebook has been proven factually incorrect. We have also agreed that it does not present anything more than a correlation. Think pirates and global warming.

The most prominent examples would be the Great Depression and the Volcker Disinflation.

Yes, you may have an Austrian explanation for the cause of the 1929 recession, but the cause of the length and severity of the depression was excessively tight monetary policy.

The study I linked to shows this never happened.

So much for empirical refutation. On to theory.

Can you show me the flaw in Rothbard’s thinking?

On hoarding:

There is, for example, no warrant whatever for the common hostility toward “hoarding.” There is no criterion, first of all, to define “hoarding”; the charge inevitably boils down to mean that A thinks that B is keeping more cash balances than A deems appropriate for B. Certainly there is no objective criterion to decide when an increase in cash balance becomes a “hoard.” Second, we have seen that the demand for money increases as a result of certain needs and values of the people; in a depression, fears of business liquidation and expectations of price declines particularly spur this rise. By what standards can these valuations be called “illegitimate”? A general price fall is the way that an increase in the demand for money can be satisfied; for lower prices mean that the same total cash balances have greater effectiveness, greater “real” command over goods and services. In short, the desire for increased real cash balances has now been satisfied.
Furthermore, the demand for money will decline again as soon as the liquidation and adjustment processes are finished. For the completion of liquidation removes the uncertainties of impending bankruptcy and ends the borrowers’ scramble for cash. A rapid unhampered fall in prices, both in general (adjusting to the changed money-relation), and particularly in goods of higher orders (adjusting to the malinvestments of the boom) will speedily end the realignment processes and remove expectations of further declines. Thus, the sooner the various adjustments, primary and secondary, are carried out, the sooner will the demand for money fall once again. This, of course, is just one part of the general economic “return to normal.”
Neither does the increased “hoarding” nor the fall of prices at all interfere with the primary depression-adjustment. The important feature of the primary adjustment is that the prices of producers’ goods fall more rapidly than do consumer good prices (or, more accurately, that higher order prices fall more rapidly than do those of lower order goods); it does not interfere with the primary adjustment if all prices are falling to some degree. It is, moreover, a common myth among laymen and economists alike, that falling prices have a depressing effect on business. This is not necessarily true. What matters for business is not the general behavior of prices, but the price differentials between selling prices and costs (the “natural rate of interest”). If wage rates, for example, fall more rapidly than product prices, this stimulates business activity and employment.

To be continued next post.

25

On credit contraction taking the blame, and Hayek agreeing:

Once again, latest research shows this to be a fairy tale, as linked to in earlier posts.

So much for empirical disproof. Now for theory. Can you tell me the flaw in Rothbard’s thinking here. Note that he admits at the end that deflation may have a very minor, very temporary role. But blaming it for recessions is like blaming Hiroshima on a bee sting:

Deflation of the money supply (via credit contraction) has fared as badly as hoarding in the eyes of economists. Even the Misesian theorists deplore deflation and have seen no benefits accruing from it.12 Yet, deflationary credit contraction greatly helps to speed up the adjustment process, and hence the completion of business recovery, in ways as yet unrecognized. The adjustment consists, as we know, of a return to the desired consumption-saving pattern. Less adjustment is needed, however, if time preferences themselves change: i.e., if savings increase and consumption relatively declines. In short, what can help a depression is not more consumption, but, on the contrary, less consumption and more savings (and, concomitantly, more investment). Falling prices encourage greater savings and decreased consumption by fostering an accounting illusion. Business accounting records the value of assets at their original cost. It is well known that general price increases distort the accounting-record: what seems to be a large “profit” may only be just sufficient to replace the now higher-priced assets. During an inflation, therefore, business “profits” are greatly overstated, and consumption is greater than it would be if the accounting illusion were not operating—perhaps capital is even consumed without the individual’s knowledge. In a time of deflation, the accounting illusion is reversed: what seem like losses and capital consumption, may actually mean profits for the firm, since assets now cost much less to be replaced. This overstatement of losses, however, restricts consumption and encourages saving; a man may merely think he is replacing capital, when he is actually making an added investment in the business.
Credit contraction will have another beneficial effect in promoting recovery. For bank credit expansion, we have seen, distorts the free market by lowering price differentials (the “natural rate of interest” or going rate of profit) on the market. Credit contraction, on the other hand, distorts the free market in the reverse direction. Deflationary credit contraction’s first effect is to lower the money supply in the hands of business, particularly in the higher stages of production. This reduces the demand for factors in the higher stages, lowers factor prices and incomes, and increases price differentials and the interest rate. It spurs the shift of factors, in short, from the higher to the lower stages. But this means that credit contraction, when it follows upon credit expansion, speeds the market’s adjustment process. Credit contraction returns the economy to free-market proportions much sooner than otherwise.But, it may be objected, may not credit contraction overcompensate the errors of the boom and itself cause distortions that need correction? It is true that credit contraction may overcompensate, and, while contraction proceeds, it may cause interest rates to be higher than free-market levels, and investment lower than in the free market. But since contraction causes no positive mal-investments, it will not lead to any painful period of depression and adjustment. If businessmen are misled into thinking that less capital is available for investment than is really the case, no lasting damage in the form of wasted investments will ensue.13 Furthermore, in the nature of things, credit contraction is severely limited—it cannot progress beyond the extent of the preceding inflation.14 Credit expansion faces no such limit.

To be continued next post.

26

You wrote:

  1. The increase in the money supply is just to compensate for the change in the demand for money. It’s to prevent tightening of money and income from falling.

Yes increasing the money supply will prevent tightening of money. But tightening of money is not an evil. Thus increasing the money supply, a known evil aka inflation, is used to combat a nonexistent evil.

Printing money will not prevent income from falling except in nominal terms. But in real terms it causes incomes to fall. It’s called inflation.

I refer you to the earlier post which quoted Rothbard about all this.

  1. The expansion of money does not increase inflation at all, it just prevents deflation.

You assume some great genius exists who knows how to fine tune the money supply to just exactly counteract deflation. How absurd.

Add to this that there is a confusion of terms here. If by deflation we mean a contraction of the money supply, that can’t happen when the country is on a gold standard, as it was in the 20’s and early 30’s. If we mean a contraction of credit, that is a good thing, since the contractiomn is only of credit created by fractional reserve banking, a cause of malinvestment. If we mean a general lowering of prices, that is a good thing. Remember too, that not all prices lower at the same time and at the same rate. So how exactly will the expander of money, even assuming he knows that prices of A “have to” rise [in 23 of the 50states], but of B "have to’ fall [in 17 of the states], channel the money into the exact hands that need it? [Not to mention that of course he won’t even bother. Newly printed money always goes th the printer and his friends.]

  1. I’m impressed with your summary of the ABCT. Well done.

More time needed to get to the rest of your post. Meanwhile one of my replies has been swallowed up by the Moderators, sitting in limbo for now.

27

To Marginal: You refer to unemployment as “unnecessary suffering which can be alleviated by an increase in the supply of liquidity.” Austrian economics is value-neutral, and doesn’t regard unemployment as ‘suffering’ to be prevented. Rather, any suffering that befalls an unemployed individual is treated as a result of their own previous risk calculations and decisions: they’ve faced the decision “Should I consume more now, or should I save for times of uncertainty”, and taken the former option, aware that in the case of unemployment they’d suffer from not having sufficient savings to live on. So, they’re viewed as having chosen to suffer, by taking the risk involved in not saving, in exchange for greater present consumption at each time in the past when they made that decision. In the kind of society Austrian economics envisages, with no social security, people would have to save much more, to provide for their retirement and unemployment, and so most people would have at least enough savings in the bank to live on for 5-10 years, meaning they’d ‘suffer’ little from unemployment; at most, they’d maybe lose a couple months of retirement savings. It’d also mean unemployment had less of a negative effect on demand: if you had enough savings in the bank to last you a decade without work, then your consumption would likely drop less during unemployment than it would if you were just living paycheck to paycheck like most westerners today.

You say “Why do firms take only the current interest rate as a signal of the profitability of investment? Why don’t they look back and think “it’s likely that in the near future the interest rate will rise, rendering this project unsustainable.” and either not invest or at least take out some interest rate futures?” In Australia, when interest rates were lowered to below 3% to stimulate recovery from the 2008 slump, many people took out variable rate mortgages that they were later unable or only barely able to repay when interests rates returned to their recent historical average of around 4-5%. These borrowers should well have known that the low interest rates were only temporary, as the Central Bank had even stated so, yet they still made borrowings that they’d be unable to afford if rates rose. So if households can make such mistakes, why not firms? And to be clear, it doesn’t require all firms to make malinvestments in order for a bubble to occur, even a few is sufficient.

Which leads into your next question: “Why isn’t the bust confined entirely to the interest sensitive sectors? Why does it affect the broader economy, even sectors which aren’t especially capital intensive?” Because of the division of labour, and people’s hierarchies of preferences. Imagine an economy with just two goods: Food, and Luxury Services. People prefer Food to Luxury Services, but once their food needs are satiated then they use the rest of their purchasing power on Luxury Services. Food is extremely capital intensive, and Luxury Services isn’t remotely capital intensive. Now, imagine an artificially low interest rate causes malinvestment in the Food industry, leading people to believe food production was greater than it actually was (believe that they could afford more food than they actually could). The bubble bursts, and suddenly they realise there’s not as much Food being produced as they thought there was, that the current structure of production is not producing enough Food to satisfy their Food needs. Which means, the structure of production must switch to producing less Luxury Services and more Food, causing reduced production of Luxury Services, and so temporary unemployment of some of those previously employed in the Luxury Services industry, as they gradually transition to roles in producing Food. That’s a very simple example, but it conveys the basic idea: that if a malinvestment occurs in industry X, leading to an insufficient supply of good X, resources must be diverted from the production of goods Y and Z to the production of X, where Y and Z are goods less valued than good X, inferior to it on the average hierarchy of preferences. Hence even if industries Y and Z weren’t at all interest rate sensitive, they would still be affected due to the alteration of the structure of production that is necessary to correct for the malinvestments.

As to “why is the unemployment so persistent?”, I’ll assume you’re talking about the Great Depression? In which case, this paragraph from the wikipedia: “After the 1929 stock market crash, unemployment never reached double digits in any of the 12 months following that event, peaking at 9 percent, then drifted downwards until it reached 6.3 percent in June 1930. Then the federal government made its first major intervention in the economy with the Smoot-Hawley tariff. After that intervention the downward movement of unemployment rates reversed and shot up far beyond the level it had reached in the wake of the stock market crash hitting 11.6 percent in November 1930… The overall level tariffs under the Tariff were the second-highest in U.S. history, exceeded by a small margin only by the Tariff of 1828, and the ensuing retaliatory tariffs by U.S. trading partners reduced American exports and imports by more than half.” Imagine for a moment how much damage it would do to an economy to have its participation in the international division of labour reduced by literally over a half, and it’s not hard to think how unemployment could be so persistent. It’d be practically impossible for the economy to return to its prior structure of production and standard of living until it was again integrated to the same degree in the international division of labour.

As to the “Japanese lost decade”, in terms of GDP growth per capita Japan fared little worse than America. If America’s population growth had been hovering around zero, then it wouldn’t have done any better than Japan, assuming the American rate of GDP growth per capita remained the same. So, to attribute Japan’s lackluster GDP growth to economic factors, whilst ignoring the significant contribution population growth (or the lack thereof) can have to GDP growth (or the lack thereof), is misleading.

28

Wow, lot’s of stuff to reply to. I’ll try not to miss anything.

It has not been proven factually incorrect at all. Your sources discussed the association of deflation with recessions, not monetary tightening with recessions. http://www.nber.org/chapters/c7496.pdf

Again, money being a leading business cycle variable highly correlated with economic activity tells you that either money is causal, reverse causal, or there’s a confounding variable causing both. We have many rigorous models of how monetary shocks get transmitted into real shocks, which give you a hint that money is probably causal. Then the Volcker disinflation, an exogenous tightening of money, gives you causality.

Which study? I didn’t see any study showing that. Maybe I overlooked it. Could you post again specifically which study shows that?

Well the objective criterion for when monetary holding becomes a “hoard” is when the demand for money increases enough to cause a fall in nominal income. Holding those money balances isn’t “illegitimate” at all. But it has real effects on output. He’s assuming neutrality of money. And if neutrality of money holds, he’s right, the price level will fall, with no effect on employment, until people’s real money balance desires are satisfied. Since money is likely not neutral, you should increase the money supply to compensate for money demand (which will not be inflationary). Even if you try to say they’ll overshoot and cause some inflation, you think money is neutral anyway! Inflation doesn’t matter if you have monetary neutrality because wages and prices adjust at the same rate, and people who have savings will just increase the inflation premia on their loans, restoring the real rate of interest. Inflation is only an issue if there’s monetary non-neutrality. And if that’s the case monetary tightening causes output to fall.

29

Tightening of money is an evil with non-neutrality. And, like the argument I made before, if money is neutral then inflation doesn’t matter either.

Increasing the money supply is not inflation. Inflation is an increase in the general level of prices (it’s the increase in prices that makes money less valuable). This normally happens in response to a permanent increase in the money supply for a given level of money demand. So increasing the money supply just to maintain price stability can’t be an evil at all.

Well the point is to stabilise nominal income. Or what Hayek called the “total income stream”. Inflation doesn’t cause real income to fall at all. Not with neutrality of money (which you seem adamant about). The only way inflation causes you to lose income is where the increase in prices outpaces the corresponding increase in wages (ie, wage stickiness. ie, non-neutrality of money). And even then that’s only temporary. If this happened often people would just start indexing their wage contracts.

Yep. It’s called a Taylor rule. Inflation targeting central banks have done an amazing job of stabilising the underlying inflation rate around their given target (most of their work is done for them by expectations).

Deflation means a fall in the general level of prices. That absolutely happened frequently and in great magnitude on the gold standard. The gold standard had amazing short run price volatility because of swings in the demand for money.

It’s a good thing when nominal income is rising. Ie, it’s good when prices fall because of gains to productivity. If it occurs due to a fall in nominal income (a monetary contraction) then in the short run it’ll create significant unemployment, and in the long run it won’t give you any increased buying power at all because wages will adjust downwards also.

… Newly printed money goes into bank reserves and gets lent out to wherever it’ll fetch the highest return.

30

MadMiser,

Keep in mind I’m talking about involuntary unemployment. This isn’t just somebody affected by their personal reckless habits, it’s somebody affected by a general glut, not by anything they did personally. Unemployment is fine if it’s voluntary (ie, structural, frictional, or you just won’t lower your real wage). It’s not fine when it occurs due to an inability of the market to clear. This kind of unemployment is pareto-sub-optimal.

Those borrowers were (correctly) expecting that house prices would continue to rise. Even if you can’t meet the interest payments you can sell the house for a profit.

In your economy with Food and Luxury services, I understand the story that people who were diverted to producing luxury services now must go back to producing food once prices realign. What I don’t understand is how a bunch of people in the luxury service who did not come across from food during the boom must be unemployed now also. Example: there are 10 people producing food, 10 people producing luxury services. During the boom prices align such that production gets diverted to luxury services. Now there are 5 people producing food and 15 people producing luxury services. (this should create structural unemployment of 5 people during the boom while they’re being reallocated, no?). My question is, why is it that in the bust there are 10 people unemployed? There should only be 5 people unemployed from the luxury sector. Also, why is there any unemployment in the food sector at all? The unemployment from the bust should be confined to the parts where labour has been redirected to (ie, capital goods production). Instead, we see large unemployment throughout the whole economy. What gives?

Post hoc ergo propter hoc? Nobody disagrees that the '29 crash was mild. But in 1931 there was a monetary contraction.

Not sure what your point is on Japan…

31

OK, Marginal, I lack the energy to scale the high wall of govt propaganda built around you.

The arguments I could lay out have been better said by others in books and articles available for free here. They refute all you have said, from the definition of inflation to the effects of it.

The gap is too wide, my powers too poor, so I wish you well.

I can but ask, why do you believe what you have learned about economics from your sources? Isn’t it a little too pat, the govt explaining how wonderful its activities are?

In any case, you said yourself the Fed has $1.675 trillion! of treasuries. That’s the highest return? Zero?

Do you think Bernanke sits around all day cooped up examining what will give him the highest return? Is high return the only thing to think about? What about risk? Does he also examine whether that high return is accompanied by any risk? Is he buying Greek bonds exclusively now, which return close to 200%? Or is he buying Treasuries, which give a high return of close to zero?

Why is he lending money at zero interest, then reborrowing it at a higher interest? Did the Fed invest in Apple or Mirosoft or Google when they were just getting started? After all, those gave huge returns.

The point is, you are being lied to, the statistics that prove the Fed is doing a great job and always has are lies, the whole thing is a tissue of easily exposed lies.

And what does the govt do with those trillions the Fed gives it? Put them in banks to fetch the highest return? Does the name Solyndra mean anything to you? Or GM?

We can only learn the hard way, by thinking things through ourselves. The little I can do is to suggest you pay attention to what they are feeding you, and see if violates common sense. You have been lied to. Think how many libraries can be filled with pro communist books [like Samuelson], and how they are all baloney. Here in the US, too, you are being fed a big lie in your classroom and whatever other source you may have.

Luckily, there is still hope. You have stumbled on to this marvelous site. Of course, there is a prerequite to benefiting from it, mainly the intellectual humility that all great minds have.

32

“Thanks for taking the time to reply Neodoxy. Much appreciated.”

It’s my pleasure. It’s nice to see a non-Austrian around here who knows what he’s actually talking about (I’m not saying that those who disagree with Austrian Theory are stupid, I’m saying that most who show up here simply tend not to understand it. Just as in the same way many here don’t understand Keynesian theory)

“I don’t see any reason why a collapse of the money supply is inconsistent with Austrian theory either. Although, and this is just anecdotal, I find proponents of ABCT often object to the idea of any increase in the money supply at all, even if just to restore it after a contraction.”

As for the first sentence I know a fair number of Austrians who seem to utterly overlook any negative affects that deflation can have (one of Rothbard’s biggest crimes), but I’m merely stating that in my mind the Great Depression is one big chunk of evidence for Austrian theory. With this being said I am dubious that a corrusponding counter measure intended to account for the decrease in the money supply can actually bring about the intended result specifically because of the fact that money isn’t neutral. It’s not like a big pot that you can keep filling up with water, it’s more equivilent to a piece of land where dumping a large amount of water will make new streams and pathways, it’s exceedingly difficult to get prices to stay the same instead of simply changing the entire price structure by however much.

"Well most inflation targeting central banks seem to do a reasonable job of it. While it may not be possible to achieve perfect price stability, you get more violent swings in the price level without accomodating the demand for money. "

Yes but it’s quite hard to know what would have actually happened to prices in the absence of inflation or how severe the deflation would have actually been.

“But inflation doesn’t occur until the new money gets spent. You have to actually go and buy things with new money in order for the price of them to adjust upwards. So inflation should only occur when the new capital is being (mal)invested in. I’m saying the malinvestment shouldn’t occur in the first place.”

An inflationary increase in interests rates will, of course, in the short run favor those entrepreneurs who are worst at making wise predictions as the relative increase in funding helps to make new oppurtunities for failure. This, of course, can not explain for all or even for a particularly significant part of the problem. However, the role of an entrepreneur is exceedingly difficult, simply because entrepreneurs expect inflation does not mean they necessarily expect the areas in which inflation will hit the hardest or the extent. The inflation which occurs after the fact also helps to raise nominal profit margins and make stupid/foolish entrepreneurs believe that their ventures are more profitable than they really are, and intelligent entrepreneurs confused as to how much they are actually making. When exactly interest rates will increase is also a mystery to entrepreneur. In short, it adds a whole other level of uncertainty but at the same time promotes investment and obscures which investments are safe and which are not.
No matter what economic school you follow, the idea that the events surrounding credit expansion would not make businesspeople more likely to spend unwisely, waste theire resources, and increase real uncertainty, is foolish and therefore no matter what school you follow you must agree that credit expansion will exacerbate the problem.

“It affects the story because any time the central bank lowers the interest rate (again, this is anecdotal), I hear cries from ABCT proponents that it’ll create a recession in the next few years. It never seems to cross their mind that the natural rate of interest has dropped, and now the nominal rate has to fall also.”

The entire point of a central bank is that it helps to fix an interest rate at a point that the market would not have set it at. For instance, right now there’s no way in hell that with the savings rate at what it is that interest rates would normally be hanging at the rock bottom points which they currently are. There is little reason why it is that the government setting of the rates should corruspond with the market rate. However, I certainly agree that such a correlation, whenever it occurs (which admittedly it must approach half of the time) would either eliminate or alleviate the cycle. I also believe that Austrians often place to much credence in the extent of ABCT under all circumstances, there’s a plethora of factors which can help to alleviate it overall or delay it.

“I still don’t understand how capital malinvestment causes, for example, a seller of retail consumption goods, to become unemployed. Why does good capital and labour get underutilised? It should just be the bad capital and its operators/builders that are exposed to the bust.”

The retail store owner would likely overestimate the demand he could expect from his customers (as consumer demand then begins to change from savings, wiser spending, and a decrease in consumption ) in combination with the problem of increased factor prices and any expansions which he was in the process of performing. Consumption is necessairly distorted. Capital are unitilized because their prices have not adjusted and confidence has not been regained. The entire problem with the boom is that there suddenly is no such thing as “good” or “bad” capital investments, a huge deal of capital is overinvested in all areas. This also increases uncertainty as to the real spending patterns, and of course capital cannot be utilized until this has been determined.

“Exactly. So I don’t see why there’s so much animosity towards Keynesian theory. Rather than opposing it vehemently, the Austrian School should adopt it and just take a non-interventionist quasi-monetarist position.”

Oh I certainly agree that Austrian Joe is amazingly paranoid of Keynesian theory when much of the reasons for the eventual prescriptions match quite well with Austrian theory. This goes straight over the heads of many people around here. My problem is that I don’t believe that Keynesian prescriptions can really rectify the problem and will, in a lot of cases, make the problem worse.

“So if there’s a boom in investment, income must be being diverted away from consumption”

Ok, I believe that I understand what you’re saying now. I disagree with this simply because of what I just quoted, the entire thing about a boom that makes it different from a mere decrease in the interest rate through an increase in savings is that the entire pattern of consumption is aiming at making the system more based towards providing consumption goods rather than being invested in capital goods and the like.

“So this goes back to my point earlier about how the natural rate of interest can change.”

I think part of the problem here is that Austrians don’t agree with the way in which you are using the term “natural rate of interest”

33

What propaganda would that be?

Well that’s a cop-out. It either means “I don’t understand the arguments well enough to explain them simply to you” or it means “I could prove you wrong I just don’t wanna.”. Both of those cases are lame.

Because my sources (my university) didn’t just try to tell me the way it is. They never once said “this is what happens, there’s no argument over it, the government has to fix it, take my word for it”. What they did was, they gave me the tools to build economic models from the ground up; they made clear the assumptions that were being used in each model; and they left it up to me to decide, based on evidence, which model I think fits reality better. There was no dogmatism, no government propaganda. I don’t have to “believe what I learned about economics from my sources”. I can understand and criticise the models myself.

Not sure what all this is about. The Fed puts money in the reserve balances of private banks. And in the private banks it seeks out the highest return. Private banks do sit around all day examining what will give them the highest return. They also think about risk. And sometimes they invest in equities.

What statistics? I don’t think the Fed have been doing a great job at all. They’ve done a shitty job. They’ve let nominal income fall at least 10% below trend. The only central bank that’s faced this crisis with competent monetary policy is the Riksbank.

Trillions? The Fed gave the treasury about $75 billion last year.

Ok now you’re starting to sound like a dogmatist. I think it’s you that’s feeding me propaganda…

34

“OK, Marginal, I lack the energy to scale the high wall of govt propaganda built around you.”

Personally I don’t think that he has that much propaganda built around him. If so, it’s fairly short. It also seems to slip the minds of some of us that there are propagandas which are not created by the government…

“The arguments I could lay out have been better said by others in books and articles available for free here. They refute all you have said, from the definition of inflation to the effects of it.”

You might want to give him suggestions, I know I’m curious as to what they’ll be.

“The point is, you are being lied to, the statistics that prove the Fed is doing a great job and always has are lies, the whole thing is a tissue of easily exposed lies.”

The Federal Reserve is a fairly reliabl source in terms of what they actually do.

“We can only learn the hard way, by thinking things through ourselves. The little I can do is to suggest you pay attention to what they are feeding you, and see if violates common sense. You have been lied to. Think how many libraries can be filled with pro communist books [like Samuelson], and how they are all baloney. Here in the US, too, you are being fed a big lie in your classroom and whatever other source you may have.”

  1. Most of science violates ‘common sense’

  2. Any suggestions as to what he’s been lied to about?

  3. Please give me any significant number of books that have come out of mainstream American economics which support communism that have been printed in the past 20 years.

  4. I like how any sources which aren’t yours are baloney

“You have stumbled on to this marvelous site. Of course, there is a prerequite to benefiting from it, mainly the intellectual humility that all great minds have.”:

“The point is, you are being lied to”
“whatever other source you may have.”
“OK, Marginal, I lack the energy to scale the high wall of govt propaganda built around you.”

… OK.

35

I think of it more like a sink that isn’t plugged. Water running down the drain and water coming out the tap, but if turn the tap to the right place, the level of water in the sink remains constant.

I agree though that there could very well be problems with the price structure. That’s something I’d definitely like to see more empirical research done on.

I agree that excessive credit expansion is a very large problem. I guess I just think that, with following something like a Taylor rule, a central bank will be able to keep the interest rate (if it has to target the interest rate at all) reasonably close to its natural rate. I think that if a central bank is competent (I by no means think the Federal Reserve is competent), Austrian business cycles from excessive credit shouldn’t really be that much of a problem.

I don’t think that’s true. Most of the time central banks don’t go changing the interest rate on a whim. They react to the conditions of the market and change the interest rate accordingly. They don’t set it arbitrarily. In Australia, for example, our central bank left the interest rate unchanged at 4.75% for a whole year. They only lowered it by 25 basis points this month in response to extraordinarily low inflation figures.

If the retail store owner overestimates demand, then shouldn’t that mean that they’ll offer a higher wage to stop workers transferring over to the capital production sector? That is, if overestimating demand is the explanation for unemployment in the retail sector, then workers shouldn’t be reallocated to the capital goods sector in the first place.

Fair enough. But “Keynesian” prescriptions don’t necessarily go hand-in-hand with New Keynesian theory. John Taylor, for example, opposed the stimulus and the Fed’s early 2000s low interest rate policy, and he uses Keynesian sticky-price models.

I’m using it to mean “the rate of interest that equilibrates demand and supply for loanable funds”. Is that not what Austrians mean?

36

Well that’s a cop-out. It either means “I don’t understand the arguments well enough to explain them simply to you” or it means “I could prove you wrong I just don’t wanna.”. Both of those cases are lame.

  1. I have explained them, to the best of my ability. And yes, I cannot explain them more. If you feel it is a cop out, I’m sorry to hear.

  2. So you think your models have some validity?

Did they explicitly mention what is being ignored in the model? Was some explanation given for why what is being ignored can be safely ignored?

Which models have had any predictive value, and what did they predict correctly? Was there any talk about current events five years before they happened? A year?

Any model tell you that Greece is going to be bankrupted, that the Euro is a mess, that there would be a housing bubble that would burst, that unemployment would persist at high levels for four years and counting? Which models exactly predicted any of those basic earthshaking facts?

What else do they predict?

Note that Austrian economists have predicted all of the above, and are on public record doing so.

37

“the charge inevitably boils down to mean that A thinks that B is keeping more cash balances than A deems appropriate for B.”

In relation to society needs to be put here, otherwise it looks like it’s about governments telling individuals what’s best for their personal lives. The entire problem with hoarding is that it’s a societal phenomenon which, in theory, causes societal problems among people in general.

“Certainly there is no objective criterion to decide when an increase in cash balance becomes a ‘hoard.’”

Statistics about the time period in relation to GDP are what are usually utilized, however it is certainly true that no objective meaning can be determined. Without reference to the specific instance.

“A general price fall is the way that an increase in the demand for money can be satisfied; for lower prices mean that the same total cash balances have greater effectiveness, greater “real” command over goods and services. In short, the desire for increased real cash balances has now been satisfied.”

I would agree with this outside of a depression, however, during a depression this increases uncertainty as to what exactly the equilibrium level of money will be and results in businesses having a lack of money when they need it the most, especially as factor prices haven’t adjusted yet.

"A rapid unhampered fall in prices, both in general (adjusting to the changed money-relation), and particularly in goods of higher orders (adjusting to the malinvestments of the boom) will speedily end the realignment processes and remove expectations of further declines. "

This is of course, assuming that the process of hoarding in and of itself is indeed rapid, but it also looks over the uncertainty that the falling in the price level actually causes. It also assumes the flexibility of factor prices. I admitt, however, that they are far more likely to be flexible in a free market society, part of my problem with Keynesian theory.

Finally, the problem with swift hoarding is that it causes a general shock to businesses, and increases uncertainty for a short amount of time.

“it does not interfere with the primary adjustment if all prices are falling to some degree”

The non neutrality of money implies that prices will fall unevenly, leading to short term miscalculations

“what can help a depression is not more consumption, but, on the contrary, less consumption and more savings (and, concomitantly, more investment).”

How in the world does a credit contraction lead to more investment? If Rothbard is talking about a decrease in spending then the temporal difference causes a problem in the readjustment process if it doesn’t happen immeidiately. Imagine entrepreneurs running inbetween consumer’s goods and producer’s goods, well they have been running towards producer’s goods but when the bust occurs they sprint towards conumer;s goods, but now your saying that you want to make them run back towards producer’s goods again, this prolonges readjustment. Furthermore the changes in the pattern of consumer spending implies then that new production methods will be needed, implying that at most the bust will be only slightly alleviated.

“But this means that credit contraction, when it follows upon credit expansion, speeds the market’s adjustment process. Credit contraction returns the economy to free-market proportions much sooner than otherwise.”

Okay this makes a lot more sense, I now see exaclty what Rothbard was saying. This much is certainly true, however, despite that which he states an over contraction will certainly lead to more pain than is needed and increases uncertainty as to both the final rate of interest and the purchasing power of money which leads to uncertainty and hurts readjustment.

Rothbard plays off factors which increase uncertainty in a time where uncertainty is already greatly at work.

38

Yes, the shortcomings of the models were made clear.

With the Keynesian model regarding the liquidity trap has had amazingly successful predictive power. It correctly predicted that at the zero lower bound, a gigantic expansion in base money won’t lead to proportional increases is the price level, and that massive government borrowing won’t significantly increase the interest rate on treasuries.

Yes, it tells you that countries with high levels of debt denominated in a currency they don’t have control over will face solvency problems (this isn’t really the Keynesian model though, it’s just financial crises 101), whereas countries with high levels of debt which retain sovereignty of their currency won’t.

Bubbles are unpredictable by nature. If anybody could confirm that a bubble existed it would burst immediately as everybody started shorting it.

Yes, obviously it says that unemployment would be highly persistent.

Ever heard of a little thing called confirmation bias? If some economist makes a guess that there’ll be a housing bubble, the news will be all over it if there eventually is one. But do you hear about all the Austrian “predictions” which didn’t turn out to be true just through sheer probability? For example: http://www.google.com.au/search?gcx=w&sourceid=chrome&ie=UTF-8&q=peter+schiff+hyperinflation+2010

39

I unfortunately don’t have the time currently to fully participate in this thread (though I’m enjoying the reading), so I’ll just make a brief summary and then throw some links out. When I was first investigating the effects of deflation (an interest sparked by the thread surrounding the Catalan paper, actually), I found these and some others extremely helpful.

Marginal Interest, these are the errors I believe you are making in your analysis:

  • Assuming that inflationary forces and deflationary forces “cancel each other out”. This is an error of misaggregation; the technocrat’s conceit. In reality , the deflationary effects on prices and the inflationary effects on prices affect different people in different magnitudes and different times. (See Catalan, Mises, Hulsmann)
  • Grouping all forms of deflation together. Centralized, Fed-induced deflationary policy is no more a market action representing the preferences of consumers than a centralized, Fed-induced inflationary policy is. Discoordination results in either case. This also refutes the various Hayek quotes supporting deflationary policy. (See Catalan, Salerno)
  • Assigning special status to typical market forces. Price changes and output reductions occur in response to changes in consumer preferences all the time. We don’t call the effects of these changes “unfortunate suffering” even though the results to the employer or worker is the same as price changes caused by increases in the demand for money. (See Catalan)
  • Blaming things on deflation that are the result of tangentially related government interventions. Primarily in the realm of artificial price stickiness. (See Salerno)

Further explanation of these points can be found in these links:

An Autrian Taxonomy of Deflation - Joseph T. Salerno

Prices and the Demand for Money - Jonathan Michael Catalan

Deflation: The Biggest Myths - Jorg Guido Hulsmann - the intro itself is fantastic is especially pertinent

Money, Method and the Market Process Chapter 5 - Ludwig von Mises

40

Right, I don’t think the Austrians disagree with anyone that a suddent drop in aggregate demand will cause a general shock. But where Mises might differ is that he doesn’t call ‘hoarded funds’ idle, as far as I know. Perhaps the real difference is in how the macroeconomic schools attempt to fix this drop in aggregate demand.

Generally, Keynesians want to boost aggregate demand. However, from the Austrian perspective, that would only exacerbate the problem, since the reason we are seeing a drop in demand in the first place is that prices are rising due to an expansion of the money supply.