Request for feedback on critique of AD-AS model.

Economics Economics Questions
1

I wrote an analysis of the AD-AS model, and I would appreciate any comments. Is there some mistake, something I left out? Is it deserving of a Nobel Prize [= hand me the check, please] , an Ignoble Prize [=tell me why, please] , or merely restating what has already been noted [= link, please]?

Here it is:

  1. What is the austrian solution to our current ‘liquidity trap’?

The problem, as stated by Keynesian. People want cash so badly that any new cash created by the Fed will just be hoarded away. And the problem with that is that nobody will buy what is being offered and nobody will invest in businesses, meaning they will have no money and will be forced to fire people.

This whole problem is certainly possible if there is just one giant company that makes only one thing. If nobody buys that one thing, you have to fire workers. Since there is only one company, nobody else will hire them, because there is nobody else to do the hiring.

Looking at things in terms of aggregates is only an accurate model for one company making one product. That’s exactly what the model is doing. It’s saying let’s look at everything being made as if it was made by one company, the Aggregate Supplier, making one product, which the Aggregate Demander no longer wants.

But once we break up the model into something that correspond to reality, where there are many companies, each competing with each other for available resources, and that if one company makes more of product A that means another has to make less of product B, the whole situation changes. If, when looking at the numbers, you find that Aggregate Demand is down, you can then ask yourself, down for which particular products? Surely the answer will never be, down for every last thing offered for sale in the market. Even in the worst of recessions, some companies make money.

There will certainly be a demand for some things. The problem is that they cannot increase production because the unprofitable companies were, until now, competing with the productive ones for resources, the most obvious example being workers who were working for the unprofitable companies instead of the profitable ones. This also explains the hoarding. To the extent that people are not spending, it’s because they wanted to spend on the good stuff, but not enough of it is being made.

Once we grasp that this is the correct picture of things, the the solution is immediate. Do nothing. As a result, the unprofitable companies will have to let go of the resources and labor they have been taking, and they will be transferred to the profitable ones.

Note that this is a two step process. First, the unprofitable business has to let go of its workers. Only then can they find employment with the profitable companies. The first step is called a recession. Unhampered it will quickly lead to a recovery, which is the second step.

Now, instead of doing nothing, you can try to “end the recession”. This would mean making every effort to keep the workers and resources attached to the unprofitable company, and this indeed can be done by artificial means, aka monetary and fiscal “stimulus” of the zombie companies. Basically, this is an elaborate mechanism for imposing slavery on the populace. They work not for themselves, but to keep alive an unprofitable company, since the money to support it has to come from them.

Research has shown that slavery has always failed as an economic system, and explained why [= reluctance on the part of the slaves to work]. Now maybe if you hide from them that they are slaves, they will keep on working enthusiastically. After all, those pyramids got built somehow, right? But it’s certainly not the most productive way of running your economy.

2

  1. I think that the current structure of your article is rather jumbled. While it is passable, if I were reading this then I would start off by thinking that this was a critique of the liquidity trap, and it is in a way, but not a straightforward way. A better title would, in my opinion, be something like “what is the answer to a recession?”. At the same time this also acts as a critique of AS-AD, but at the same time it isn’t very thorough. So if sheer brevity is what you’re going for then it works fairly well, but there’s a lot more you could go into. It’s also hard to call this the solution to “our” liquidity trap since it doesn’t talk too much about the specifics of what’s going on today, nor why we are in a liquidity trap and why things aren’t getting better.

  2. I think that you misinterpret what fiscal stimulus does. There is no guarantee that it will merely prop up the “bad” companies (although this is a possibility), instead it is just as likely to change the demand structure of current companies and divert production away from consumer demand. This is my basic critique of government stimulus: fiscal stimulus crowds out both private investment and increases and decreases private consumption as some of the prices of the goods they were buying rises. Now this could be counteracted by the multiplier effect, there’s nothing inherently wrong with that, but the problem with this is that recessions are precisely when the multiplier is likely to be the lowest. Furthermore if taxes increase then this decreases the multiplier and leaves us with the “tax multiplier”, which puts a massive amount of pressure on the production structure to reflect government demand, rather than private demand. So even if this does return spending back to normal, then what? Well a dramatic decrease in demand will cause the business cycle again, a slow decrease in demand will “increase” the period of the recession since real private output will be dramatically lower than it otherwise would be. Therefore the recession may well be lengthened by this action.

Monetary policy fails because it inevitably results in ABCT. I don’t buy that the stimulus would disproportionately affect the “bad” companies over the “good” companies because the whole flaw with AS-AD is that it looks at aggregates, not at specifics. The government can’t specifically step in and “fix” the bad industries, it can only realistically target the whole economy, if for no other reason than the multiplier effect. Therefore it’s more likely to be good and bad companies producing bad things than bad companies being propped up for their current production.

  1. “This also explains the hoarding. To the extent that people are not spending, it’s because they wanted to spend on the good stuff, but not enough of it is being made.”

I find this extremely dubious. If this were the case then demand for the good stuff would just increase and production of the good stuff would increase regardless of what the government did. The whole point of a recession is that a fall in demand in some sectors is not immediately made back up by an increase in demand in other sectors. A much simpler description is the basic narrative that people are uncertain about the future and afraid of losing their jobs. That’s the narrative that Rothbard explicitly told, and I think that Mises believed exactly the same time (otherwise I don’t see why he believed that wages would have to fall)

3

I want to ask you a few questions about what you wrote, Neo, but aliens are currently in the process of abducting me. Look for my reply later. I need the econ practice; it’s been too long.

4

Neo,

Indeed I should have omitted the subtitle, “What is the Austrian solution to our current liquidity trap.” That was the question someone asked that I responded to. But when thinking about this question, it occured to me that the whole AS-AD model is inadequate to describe an economy that has many producers and many products. And that is the point that I was asking about.

So let’s put aside govt actions and proposed solutions to recessions and liquidity traps. I am wondering about the description of the problem using the AS-AD model. So here’s what I’d like your opinion on, please.

  1. Is the critcism correct that the AS-AD model simplifies into one product from one producer, but the moment one recognizes that there are many producers of many products, then the description “lack of aggregate demand” it totally inadequate? That the correct description of the situation is “some companies suffering from lack of demand, others are making money, and still others would make [even more] money if they were able to draw resources from somewhere”? And the reason this is true is that in a large economy, surely there are companies of the second and third type, even during a recession.

  2. If 1. is true, does it not immediately follow that it is mad to take action to support unprofitable companies, who by definition [of unprofitable] are making things nobody wants? And that the problem will solve itself, as the unprofitable companies will reduce production, and the third group mentioned in 1, the ones that are dying for more and cheaper resources, will pick up the unprofitable company’s workers and resources and increase production? And surely the increased production will also lower prices, allowing for more sales, meaning taking care of the hoarding?

  3. Maybe I shouldn’t go into this, because I would like to focus on the two previous points. So after due emphasis that this isn’t my main focus I’ll toss this in parenthetically:

About your final paragraph. Production of the good stuff would be hampered by the govt propping up the bad stuff. And demand for the good stuff would be hampered for the same reason. The pie is finite. Whatever slice the govt diverts to the bad stuff means less of the pie for everyone else, is the basic problem with govt action.

Now you may argue that the govt may accidentally divert from the bad company to the good comapny also. But that would have happened anyway. So the net difference the govt makes is in the opposite direction.

I’m not sure where people being afraid of losing their jobs fits in. If they have jobs, they are presumably working for a profitable company, or else they’d be laid off. So it’s perfectly fine if they sit tight.

Wages having to fall is a solution to chronic unemployment, when people get fired from the bad companies and can’t find work in the good companies. If the particular reason for their failure to find new jobs is the law restricts them from accepting a lower wage, then the solution is to take care of that bottleneck by allowing wages to fall.

5
  1. Generally I’m in agreement here, however, the one thing that I disagree on is that I think that even though it’s a radically oversimplified vision of the economy, that doesn’t mean that there isn’t a grain of truth in there. AS-AD can explain certain events such as inflation, hoarding, and increases in productivity, but it’s a mistake to take that particular model too seriously since it’s super simplistic. If people are/have hoarded money and prices haven’t adjusted then demand is effectively too low compared to what consumers really demand. Once prices adjust, and in the Keynesian model AD moves to the right and we retain the old equilibrium condition. However, in the mean time there is a lack of demand in that some firms will either be unduly running at a loss or unemployment/unemployed resources where everyone would be better off if prices had simply adjusted.

Another error that I think that you are falling into, and something that I think that a lot of Austrians do, is the belief that the “good” firms are in no danger of running losses during recessions. Consumer spending during such periods are likely to be extremely volatile and risk premiums in interest rates are probably going to escalate pretty dramatically. For these reasons it is by no means entirely obvious who is “safe” or “unsafe”, nor who is even really profitable. Furthermore firms at the margin who are running “thin” profit margins will run into especially severe problems. Firms that are running at losses also may or may not be able to restructure in such a way as to start running profits.

  1. “does it not immediately follow that it is mad to take action to support unprofitable companies, who by definition [of unprofitable] are making things nobody wants?”

Well there’s a few problems here. The first is that, as I indicated above, it may not always be only bad companies who are running losses in recessions, and this is greatly exacerbated if there is hoarding. This is also a point that I’ve stressed before, but it’s incorrect to call malinvestments the production of “things nobody wants”

  1. “And demand for the good stuff would be hampered for the same reason. The pie is finite. Whatever slice the govt diverts to the bad stuff means less of the pie for everyone else, is the basic problem with govt action.”

This is less the case with government spending with a high multiplier and generally idle resources, but the problem with this in a recession is a low multiplier. Remember that the multiplier effect is production of what private citizens want, only the initial payment is the only part of this that is truly “government” spending.

“Now you may argue that the govt may accidentally divert from the bad company to the good company also. But that would have happened anyway. So the net difference the govt makes is in the opposite direction.”

What do you mean by this?

“I’m not sure where people being afraid of losing their jobs fits in. If they have jobs, they are presumably working for a profitable company, or else they’d be laid off. So it’s perfectly fine if they sit tight.”

Firms running at a loss don’t go out of business instantly, nor is it wholly obvious what companies will and will not go out of business, particularly if you are a normal worker without a great understanding of economic conditions.

“Wages having to fall is a solution to chronic unemployment, when people get fired from the bad companies and can’t find work in the good companies. If the particular reason for their failure to find new jobs is the law restricts them from accepting a lower wage, then the solution is to take care of that bottleneck by allowing wages to fall.”

But if payroll hasn’t fallen for workers in general there is no reason that wages have to fall, workers could be immediately employed into other industries. Without deflation (in the sense of a fall in the purchasing power of money) wages could remain constant by and large since the problem is where the workers are, not how much they are being paid.

I have a few questions that I’ve found problematic with ABCT, I might post them here later.

6

Dave, how is the average employee to know what kind of straits his company is in? Maybe they could do the research, but I think that it’s a pretty natural and prudent reaction of normal people to cut back on expenditures in the case of an economic downturn.

7

^

Pretty much how I feel on the matter.

8

Back to the drawing board.

Thanks, guys.

9

Well NAA, if you ever get returned by aliens then you might as well ask whatever you want to ask

10

Smiling Dave,

I agree with some of your arguments and some of Neodoxy’s responses. They do illustrate good economic thinking.

But I am not sure what the original argument is that you are trying to refute.

  1. Are you trying to take on mainstream economists on their own field using their own formulas to disprove their own faulty explanation of why things happen the way they say?
  2. Or do you dispute the whole mainstream economist theory, formulas and all?

It sounds that you start off by assuming there is such a thing as a valid “Aggregate Demand- Aggregate Supply theory” and that “hoarding” and multiplier effects exists and needs a formulaic explanation and it can be used to argue that there is a “liquidity trap” that should be handled differently but within their definitions.

What if the AD-AS argument is bogus to begin with?

What if there is no such thing as “hoarding” or “liquidity trap” What if the liquidity trap is just a manifestation of individual value scales?

All those terms require you to accept certain Keynesian arguments as sound. Why give them so much credit?

What if the fake boom caused regular Joe citizen to malinvest .The artificial “boom” causes people to have extra credit and sometimes extra cash laying around. The gossip from the neighbor tells him he can get a higher return on his savings by buying Beanie Babies, or Dotcom companies or investment real eastate or whatever. His value scale reference tells him to try this with some of his money.

For a while the neighbor is proven right. He profits.Word of mouth spreads and soon credit is used to “invest” in this new craze. It creates not only new jobs in this industry but those workers buy more shoes and pizzas. The eggheads do the math and claim proudly the GDP has grown.

Sometime or another the Ponzi zcheme gets to it’s limit. Mainstream economists and Keynesians are of the illusiion that this “boom” is the real economy and should be maintained.

When the correction comes and the bubble bursts and things return to where they belong, they bemoan this needed loss and blames it on all sorts of “animal spirits” or greed or price gouging or other strange names. We don’t have to name it or give it a formula, we know it is a correction.

People and companies in the “fad” industries go bankrupt and lose their jobs. But not only them, the shoe salesman, pizza shops and millions of other vendors shrink or die. It is a correction. Credit dries up and people have less “mad money” to waste on frivilous projects. It has nothing to do with liquidity trap or “hoarding” except in mainstream economists eyes.

Sure everybody now sees these malinvestments for what they were and does a quick re evaluation of their priorities. The out of work ones might only spend on food and shelter. The employed ones might immediately decide to stop frivolous investing. They might pay off debt, they might imrove their education, they might not run up a credit card but pay cash.They might buy a new machine for the factory or service the old machine instead of buying a new company or hiring 100 new employees. Thousands of different choices but certainly not the same as during the boom. Some millions buy gold.Yes some of them might decide to start a rainy day fund by saving- which is not the same as hoarding. (depending on each persons value scale)

NONE of this can be callede hoarding. Hoarding is a derogatory term usede by Keynesians to vilify savers and succesfull businessmen that do not blow their profits immediately.

Even keeping money under the mattress or in a low yield CD or savings account is “investing” according to that person’s value scale. And ALL of these are good for the economy.

“Cash will just be hoarded away” is a misguided mainstream thought. Even money sitting in a lowly savings account releases more credit back to another entrepeneur to improve capital goods. Even money hidden under the mattress shrinks the money supply and increases the value of the currency and counteracts inflation. No need to deride these people (yes we all agree the government should not bail out, but that has nothing to do with the fact that we or rather I, dispute the Keynesian calculations in the AD-AS argument.)

So I see no need to think of alternatives to handling the liquidity trap if I dispute that such a thing exists.

11

Albert,

I don’t disagree with anything you said.

I’ll explain what was going on in the Smiling Dave brain factory. While thinking about a question someone asked on reddit, about how Austrians would deal with a liquidity trap, I got sidetracked into exploring another idea, the AS-AD model. I had previously written about something else entirely the following homely parable:

Imagine trying to model marriage with a simplified universe of Robinson Crusoe alone on island. It doesn’t work like that. Marriage requires two people minimum. You can’t model marriage with just one person.

Forgetting completely about the original question, it just popped into my mind that maybe an AS-AD model is making the same mistake. Maybe it, too, is essentaily pretending there is one producer creating one product and selling to one consumer, and maybe such a model is as flawed as modeling a marriage with only one person.

If we assume only one of everything, the Keynesian story is inevitable. Less consumption means the one company in existence has to cut down on production and fire people, who have nowhere to go.

But if you have tens of thousands of producers, surely many of them would be making money hand over fist, and are only hindered from making even more because they are being outbid for resources by the unproductive companies. So that all you need do is not interfere, and let nature take its course. The companies losing money will cut down on production, lay off workers, and those workers will be picked up by the productive ones, who are dying to get their hands on them, but until now were blocked by the fact that the losing comapnies hired them.

OK, so where do we stand now? Basically, that last paragraph is what [I think] Mises wrote would happen. I’ve seen others quoting Hayek as saying the workers laid off would go into working for companies that produced higher order goods, not consumer goods, a variation on the last paragraph. It has the advantage of being able to promise those jobs would be there waiting, because the very fact that consumers are not spending now means they are interested in buying later on in the future instead of now [surely they do not intend to hoard forever], which is a need that will be met by putting more resources into higher order goods.

Now the question becomes, am I sure that is what will happen? Am I sure there will be enough good companies to pick up the slack? Can I prove they will be there in sufficient quantity, these employment opportunities? At this humble stage of my knowledge of AE, I have to answer no.

But something has been accomplished. Because we have to ask ourselves, on whom is the burden of proof? Answer: On Keynes. He claimed to have a sure fire proof that a rich economy will lead to hoarding which will lead to unemployment and other idle resources, and that such a thing is inevitable, over and over, until the economy is “poor enough” once again.

Well, here we have shown a hole in his proof. His proof assumes, for all intents and purposes, one producer of one product. Once we allow many producers of many products, the events he outlines as happening are no longer sure to happen.

What about the multiplier effect, and the propensity to consume, and the liquidity trap, and all the other stuff? Even if we grant it all for the sake of argument as being true, it is all besides the point. All that stuff is justification for assuming hoarding, or for assuming great unemployment from small hoards. But even if we grant that, the flaw we pointed out above remains.

Note that all this stays the same whether we assume malinvestments, or animal spirits, or whatever. In other words, it is an attempt to hoist the Keynesian framework on its own petard, granting all its assumptions but one. We merely do not grant that the economy has one producer, and his proof crumbles to dust.

Note also that the discussion is not about his proposed solutions. We are addressing something prior to that, his argument that rich countries will get poor, inevitably, if left alone.

There is one thing that is still not clear to me. I have elaborated on Mises reply to the hoarding problem elsewhere. I’m still trying to figure out how his reply fits in with the ideas here.

TL;DR version of what Mises wrote. A hoarder is basically doing two things. First, he is working for free, which benefits the economy. Second, he is decreasing the money supply, which is neutral to the economy, [merely shifting prices here and there, but otherwise not doing anything]. Those rich people who used to light their cigars with hundred dollar bills thought they were merely showing off. In reality they were also giving us free gifts by the very act of burning that cash.

Whew, that was a long one. Thanks to anyone who got to here.

12

I guess the idea here is an elaboration of what Mises wrote, that reduction of money supply does no harm.

13

OK S Dave I get it,

I agree with you if you want to talk to mainstream economists and refute their claims in their own language your point is certainly well taken. They believe in this “equilibrium” and “evenly rotating economy” so they can “aggregate” everybody together and do statistical analysis on the whole economy as a single unit. Us Austrians believe in human action and we know that there will be as many variations as there are humans. That is why we can predict what will happen, but not if it will happen to any particular company or person.

In their own language then, here are a few other things that bother me in their formulas.

They equate everything to “THE HOLY GDP” a nebulous number that can be manipulated and reconfigured to please the reigning politicians.

In their formula for Agregate Demand they include government spending as if it is a legitimate contributor to “the economy” or GDP as they like to measure it.

That is why they so easily conclude that if producers and sellers slow their production the GDPor “economy” will slow unless the government increases their spending. That is the faulty conclusions you will get if you allow their definitions and formulas to stand.

Because of the broken window fallacy we know that the government has no money, that it has to plunder the “economy” to get its money before it can “spend” it on infrastructure, or stimulus or “saving” this sector or that.

If we were to write a formula for “the economic value” we would take all production and the prices of all products and services and then from it we would SUBTRACT government spending and taxes. In our formula it would be clear that the more the government spends, the weaker the economy gets.. no matter what spirit or boogyman you care to name it after.

Henry Hazlitt wrote a whole book full of further examples

14

Albert,

I think that this is an important thing to note, but at the same time it’s a non-answer:

“What if there is no such thing as “hoarding” or “liquidity trap” What if the liquidity trap is just a manifestation of individual value scales?”

There is nothing wrong with this per se, but it doesn’t disprove the negative repercussions or existence of anything above. What constitutes, or doesn’t constitute “hoarding” for instance, is ultimately very subjective, but this doesn’t mean that the concept has no importance. The question here is of a mass change in value scales, and therefore the behavior of economic actors, and how that affects a changing, uncertain, and imperfect economy. Furthermore in your examples you overlooked the very case that we were talking about: plain savings caused by the very conditions of the recession. The fact that this is caused by changes in value scales don’t change these conditions since value scales are exactly what cause the conditions in the first place. Regardless of whether you’re saying that it’s positive or negative, hoarding is still a phenomenon that is theoretically possible. Replace it with “mass savings” or “happy goodness savings”, and the affects should still be the same.

Furthermore the problem that I have with the basic theorem that an increase in plain savings will merely cause an increase in capital is just that this, while occurring very rapidly, alongside great uncertainty and resource reallocation, it may well result in shortfalls in demand in general, enough demand to buy back the entire product at “full employment”, which will cause a rise in unemployment. Price flexibility is always key, in inflationary and deflationary situations, but also in mass reallocation. Because there are frictions on these fronts and on the matter of reallocation of resources, there will always be shortfalls as a result of business cycles and especially rapid changes in consumer demand

15

OK Neo,

I have to concentrate a bit before answering you. I mostly agree but will give a better thought out reply tomorrow.

16

Neodoxy,

I have to know what you believe and what you disbelieve in order to debate with you.

Where did you get your economic training? You sound like you have had some formal schooling in economics . Is your theory mainstream economics? Keynesian?

Which part of ABCT do you subscribe to and which part do you doubt?

Not knowing that I have to read between the lines and make some assumptions.

It seems you believe that “bad moods/fear/negative vibes” causes people to change their value scales and save more (or hoard as some like to call it). You feel that this contributes to unemployment. Sounds like a very Keynesian view.

Their argument further goes: "therefoere the government has to step in until there is so called “full employment.”

Yes a recession does impact peoples moods, I grant you, yes many tend to spend less and save more I grant you.

What I think we disagree on is which is cause and effect and whether or not it creates mass unemployment.

ABCT and me believe the overstimulation with credit expansion caused the boom. Sooner or later that has to end. So it creates a bust. People loose their jobs and businesses close - I think we both agree here.

THEN their moods change and “animal spirits” or whatever cause them to feel scared- fine so far. But this is a SYMPTOM not the cause of the depression as Keynes says. Yes because there is less credit expansion available, there is a protracted period of market clearing.

What I say is that hoarding or saving has negligible effect on this unemployment. It is the credit contraction that causes it, nothing to do with the act of saving even though they often happen simultaneously and therefore people think they are cause and effect. Mass reallocation as you call it will absolutely cause depression in the areas that get evacuated but by definition it causes stimulus in the recipient areas. Sure there might be a lag period not always instantaneous. The money does not disappear, it goes somewhere at some time.

But the savings money employs bankers and bank tellers and accountants and ATM repairmen and mortgage brokers and stock brokers and venture capitalists. It is not left in banks to rot. It is picked up by somebody that has insight in where to use it more efficiently. It creates new businesses or expand old ones that employ new people eventually.

What cause the unemployment to linger is not the mass change in mood but government interference with stimulus, unemployment assistance and minimum wage amongst others.

17

“Where did you get your economic training? You sound like you have had some formal schooling in economics . Is your theory mainstream economics? Keynesian?”

I’m an Austrian with Keynesian sympathies. I’ve had about 2 years of formal economic education (kind of). My primary source of economic knowledge comes from thorough readings of Man, Economy, and State, and Human Action, although I’ve read a number of other works, both Austrian, mainstream, and even some exposure to Marxism.

If I weren’t an Austrian I’d be a Keynesian with New Classical (not Neo-Classical) influences. Monetarism is dumb with the exception of the Taylor Rule.

“Which part of ABCT do you subscribe to and which part do you doubt?”

I think that ABCT gives a perfectly intelligent explanation of why business cycles occur, and moreover its nice to see an actual business cycle theory, since realistically on the Austrians, Marxists, and post-Keynesians actually have a theory of why business cycles happen (the traditional Keynesian explanation as well as bubble theory are both non-answers). What I do doubt is the “smoothness” of the Austrian vision of recoveries, as well as the possibility of somewhat circular business cycles. I do think that my aggregate demand argument was actually invoked by Hayek (Mises?) but it seems to have been lost in some of the cheerier modern explanations of the theory

Now once again, I think that you make some good points, but I don’t think that you fully appreciate the significance of certain factors, for instance:

“But this is a SYMPTOM not the cause of the depression as Keynes says. Yes because there is less credit expansion available, there is a protracted period of market clearing. What I say is that hoarding or saving has negligible effect on this unemployment.”

I’ve always had a hard time buying that the only affect of the credit contraction is market clearing. There are going to be negative affects even to decent firms, and it isn’t always obvious which firms are and are not stable. Furthermore this inevitably incentivizes savings on the part of individuals. You can also get into how susceptible a fractional reserve vs. a full reserve system would be to this, but part of the reason why this isn’t as likely to be a problem in a fractional reserve system is exactly because the government itself guarantees deposits, and therefore people don’t have to worry as much about bank failure. Nonetheless, a refusal on behalf of banks to lend does decrease overall payroll and increases costs

“Mass reallocation as you call it will absolutely cause depression in the areas that get evacuated but by definition it causes stimulus in the recipient areas. Sure there might be a lag period not always instantaneous. The money does not disappear, it goes somewhere at some time.”

I agree, but a decrease in overall demand alters this affect. This is also where the degree of price flexibility greatly affects the length of business cycles, because if banks hold onto their money then it’s not circulating, decreases in payroll and employment result and demand for even healthy firms decrease. With increases in uncertainty the affective interest rate might exceed the time preference equilibrium rate which exacerbates the business cycle and then benefits consumer good industries to a disproportional degree. This in turn necessitates additional adjustment and falls in payroll, employment, and demand. Eventually wages have to fall to meet the new payroll and production returns, but I could see the adjustment taking quite a long time.

“But the savings money employs bankers and bank tellers and accountants and ATM repairmen and mortgage brokers and stock brokers and venture capitalists. It is not left in banks to rot. It is picked up by somebody that has insight in where to use it more efficiently. It creates new businesses or expand old ones that employ new people eventually.”

Sure it does, that is a version of what’s happening now (liquidity trap combined with uncertainty in borrowing). Regardless, you can’t argue that credit both contracts and that it is used to employ people.

“What cause the unemployment to linger is not the mass change in mood but government interference with stimulus, unemployment assistance and minimum wage amongst others.”

Of course in our day government actions are a much more active cause of recession, uncertainty, and radical changes in demand, however, arguing that unemployment insurance and minimum wages have a large affect on the speed with which recessions ends is dependent on price flexibility and that payroll is very likely to decrease.

18

WOW Austrian with Keynesian tendencies- no wonder it feels like herding cats when I debate you. So at least I know I cannot assume you agree with my Austrian version automatically.

OK in my opinion. one of the biggest difference between Keynes and Austrians is; Keynesians believe we are the government, the government is us, society is us and society is the government. Therefore when “we” have to do something, Keynesians automatically imply government. Somehow the state must make sure “healthy” businesses survive and make sure things “run smoothly” etc.

Clearly Austrians don’t see themselves as “the state”, but individual actors that have to put up with what the state is doing..

You say you find it hard to believe that the ONLY thing that happens is that the market clears. Its not an “only” thing, it is a huge horrible all encompasing thing…So you think that my theory doesn’t believe recessions impact so called “healthy or decent” businesses. Sure they do! It affects all businesses to some extent, but mostly the marginal ones of whatever kind, it just doesn’t care if you classify them as “healthy” or “sick” or decent or bad- there is no such thing. There are only businesses with a desired product and ones without it.(when all the crack addicts die, even the decent doctors will make less money and have fewer patients). Market clearing is market clearing. It does not play favorites Only the market will tell who will and won’t survive, we cant.

You make it sound that I claim that credit expands and contracts at the same time. I think that is because you think of fractional reserve banks and inflation caused by the government the same as you think of the moves made by individual actors.

The government stimulated the mortgage industry with counterfeit money like crazy and the banks further expanded that counterfeit money like crazy. That is like winning a lottery and creating histeria and delusions of grandeur.

When they stop, those jobs go away and even other salaries drop because big daddy is no longer throwing gas on the fire. In the meantime real life people shuffle their honest money around like you said by reallocating. That is just like taking money out of your left pocket and putting it in your right pocket- it does not make you richer or poorer. PRIVATE saving pays for some alternative jobs- but I am not claiming it will be the equivalent of a government stimulus, only that it is not the dragging effect people think. You have to examine these two acts differently.

The crash happened because the government sources of run-amok credit dries up (Regardless of what individuals are doing) Neither I nor the ABCT claims that there will be no credit markets left in the free enterprise system. I just made that point because I don’t believe saving or hoarding is a bad or harmful thing or leads to longer or further unemployment - it does not. I am not claiming that it alone will be the saving grace of the recovery. You say you find it hard to believe that the only effect of the contraction is market clearing. That seems to apply to any business that used to be popular and is now less so because of people’s value scales, not just the good ones. ALL factors have to make a correction to clear the market. And yes prices and salaries will have to drop because the government is no longer feeding the beast, not because people save or hoard..

But remember you only perceive them as dropping because you compare them to what they were at the hight of the crack cocaine crazed boom. If you compare prices and wages to what they were in maybe 2002 before the crack boom- and now, there is not such a huge drop. People have just been brainwashed to expect different.

I don’t exactly believe the ABCT promises a smooth recovery or a fast recovery, just faster than if there is government interference. and multiple government interference piled on top of each other has a huge compounding negative effect on the recovery.

Personally I believe that one of the biggest factors determining the length of recovery depends on what industries the boom was in. How long it will take factories to retool or actors to reeducate and redirect themselves. In the recent real estate boom there were millions of people employed by the banking and mortgage industries. Their skills are useless elsewhere.The money these people spent made other industries that they frequented also overexpand (even the ones you call decent businesses- they were puffed up because of wrong signals.They could not hire fast enough so now these out of work employees cannot just step out from being a mortgage salesman and become something completely different. Non skilled jobs are already filled so they have to gain skills but it takes time to watch the market to even start guessing at which industries will be worth pursuing.

19

“OK in my opinion. one of the biggest difference between Keynes and Austrians is; Keynesians believe we are the government, the government is us, society is us and society is the government. Therefore when “we” have to do something, Keynesians automatically imply government. Somehow the state must make sure “healthy” businesses survive and make sure things “run smoothly” etc.”

What you’re really talking about is modern liberalism, but this is generally an adequate explanation of the Keynesian disposition. Keynesians tend to assume that the government is generally positive and a relatively efficient institution, but even if this is false then their world vision can still be generally true. Almost all liberal economists are Keynesians, but not Keynesians are necessarily liberal, nor is this built into the system. I feel that Austrians tend to unfairly lump in all liberal economic policy with Keynesianism, when they are separate things.

“it just doesn’t care if you classify them as “healthy” or “sick” or decent or bad- there is no such thing. There are only businesses with a desired product and ones without it.(when all the crack addicts die, even the decent doctors will make less money and have fewer patients). Market clearing is market clearing. It does not play favorites Only the market will tell who will and won’t survive, we cant.”

I think that your analogy is a little unclear here, but nonetheless the market ultimately does dictate who and who doesn’t survive, but this doesn’t mean that under all conditions it is who “should” survive if we use this term in the sense of satisfying consumer desires, since short run spending and price trends in recessions may be very different than their long term post-recessionary counterparts.

When I was talking about FRB I meant that people in the modern day are much more likely to stick their savings in a bank for a rainy day than they are to stick it under the mattress. This is in large part because of FDIC and governments making it clear that banks won’t fail. Now if we had a 100% system then this wouldn’t matter as much because all banks wouldn’t be facing the chronic threat of crumbling at the smallest sign of trouble, but because no one thinks banks will fail they still trust banks with their money. One could interpret this as a government coming in and fixing a problem that it already made. Nonetheless, if we know that savings go into banks, not into mattresses, then the matter becomes different because either banks can sit on the money until conditions improve, or the bank can lend out the money and aggregate payroll won’t fall.

“I just made that point because I don’t believe saving or hoarding is a bad or harmful thing or leads to longer or further unemployment - it does not”

Why?

“And yes prices and salaries will have to drop because the government is no longer feeding the beast, not because people save or hoard..”

Why would this cause a fall in wages and prices? Popped bubbles should deflate, and the original factors should fall in value, but this should be made up by an increase in the prices of goods in the later stages of production. Cutting off government spending shouldn’t cause aggregate prices to fall, merely the rate of price increases in the economy should fall and the price structure as a whole should be rearranged.

“If you compare prices and wages to what they were in maybe 2002 before the crack boom- and now, there is not such a huge drop. People have just been brainwashed to expect different.”

Your first sentence is necessarily inconsistent with your claims. Prices rises in the economy as a whole without a partial degradation of the production structure (a leftward shift in AS) or because of an increase in the effective money supply. Therefore, since the money supply as a whole has not shrunk, you have to be saying that hoarding does indeed occur and is a major part of what happens in a recession. If the money supply was made permanently stable in 2007 then the money supply would still be much larger than in 2002. It would take several years for prices in general to fall to their approximate 2002 level as supply-side deflation occurred. Your second point here is a very important one to explain how the government has prevented price flexibility.

“I don’t exactly believe the ABCT promises a smooth recovery or a fast recovery, just faster than if there is government interference. and multiple government interference piled on top of each other has a huge compounding negative effect on the recovery.”

I agree with the latter statement and I disagree with the former. Mises and Hayek were unclear as to the speed of recovery, but I feel like modern Austrians, particularly people like Tom Woods argue that in a free market recessions would end very rapidly. Rothbard also appears to have shared a similar level of optimism. I’ve also never heard an Austrian economist talk about something of the circular pressure I addressed in my previous post.

“In the recent real estate boom there were millions of people employed by the banking and mortgage industries. Their skills are useless elsewhere.The money these people spent made other industries that they frequented also overexpand (even the ones you call decent businesses- they were puffed up because of wrong signals.They could not hire fast enough so now these out of work employees cannot just step out from being a mortgage salesman and become something completely different. Non skilled jobs are already filled so they have to gain skills but it takes time to watch the market to even start guessing at which industries will be worth pursuing.”

Hmm… While I actually don’t think that this would affect the rate of recovery, but this would actually be a reasonable way to describe why wages would need to fall without resorting to changes in the effective money supply.

Edit

On further consideration I’m having trouble seeing why prices wouldn’t fall in aggregate as a result of the business cycle… On one hand it’s a fact that prices will fall if the utility of a good changes. During a bust the utilities or the derived demand for many goods goes down and therefore prices must fall, however on the other hand new goods rise in price with the rise in the interest rate… I think that perhaps the overoptimism and excess profits caused by recessions might explain this. Prices are bid up, not just to what they would be if originary interest justified the artificial rate, but also past this to a certain degree. This could inflate prices in general and necessitate a fall in the price level… Nonetheless, I think that your assertion that prices in 2008 when the bubble burst should have fallen to to approximately what they were when (at absolute minimum) the money supply was only four fifths of what it was in that year is really overstating things.

20

I really enjoy sparring with you but again.,it’s like trying to corner a jellyfish.

It’s like I am talking German and you are talking French and we can forever correct each others grammar.

In my opinion it is intellectually impossible or inconsistent to be Austrian with Keynesian tendencies. You say you accept the ABCT but you use Keynes against me when I argue it. Are you well enough versed with ABCT because in it it handles Keynes. If you think Keynes is right, then you have to think Austrians are wrong and tell me where and we can chat.

If you think Keynes is wrong about the business cycle then you cannot dispute my arguments with Keynesian angle questions.

I thought I made an argument why saving does not cause unemployment but you disagree on Keynesian grounds and you keep bringing up the “money circulating” point

So as I see it this is a sticking point. None of our arguments herafter will hold until we get past that.

As I understand it the Keynesians believe that -money has to circulate to keep the economy moving and that hoarding somehow takes money out of circulation and therefore shrinks the economy.

I thought we were on level ground as far as ABCT but apparently not

I do not ascribe to the “money circulating” argument so I find it hard to defend myself against a fallacy in my mind.

I believe saving contributes to the economy. I dispute that it takes it out of circulation. As I see it Austrians believe it is not possible to take money out of circulation by saving.

  1. Read “Economic Depressions Their Causes and Cures” by Rothbard digital version available for free- very short book
  2. On the front page watch the video interview of G P Manish about “Whats wrong with Keynes”
  3. In the search engine on LvMI put “hoarding” and " money circulating"and find out why Hayek and Mises and Rothbard refute the existence of those arguments

Then tell me what you believe and don’t believe and then I will be able to defend my position.