One of the main arguments about Austrian Business Cycle Theory is concerning growth. Austrians claim that demand falls because of inflation, and since demand falls, capital investments will not be successful. However, Say’s Law tells us that increased production increases demand (but not all production is desirable!).
So, there’s some kind of balance. I mean, creating $.01 out of thin air probably will not cause a crash, but creating trillions will. This is because the increase in production from the trillions in new money will not be enough to curb the drop in demand because of the inflation that will occur. So there comes an idea of risk. At some point, the increase in capital will not be worth it. Basically, once you are into the realm of forced savings, you enter into risk. The more forced savings you have, the more risk you have. This is achieved though government inflation in which to give those bills they print value, you necessarily have to have a lower command of goods (control you think you have minus control you actually have is forced savings, roughly). This is also achievable through fractional reserve banking, in which you get multiple claims to the same dollar.
The risk is due to the fact that we do not know when the rise in demand from new capital will be equal to the fall in demand from inflation. At no forced savings, there is absolutely no risk because there is no inflation.
And this is the crash, when people finally realize that they have a lower command of goods than they previously thought. So yes, inflation and fractional reserve banking may be worth it, but to a certain extent. Obviously we have been inflating too much because we keep getting crashes.
I think that this would resolve some of the debates that we have over stimulus. Yes, to some extent they will work, but only to the point at which the induced demand from capital investments can outstrip the fall in demand from inflation.
I dunno, one of us has got this all wrong. I await elightenment from the pros. Here is my take:
“Austrians claim that demand falls because of inflation?” Nopers. Here’s how it works: The govt prints up a lot of new money. The act of printing more money is, by definition, inflation. It either uses the money to gobble up resources, or GIVES the money to good friends, who use it to gobble up resouces. By gobble up I mean of course using the resources in unproductive ways. Meanwhile the new paper is now out there, given to people in exchange for gobbled resources. They have more paper to spend on less things, so the price of everything goes up. This is a consequence of inflation.
When the smoke clears, resources have been wasted, so people have to be laid off. I can’t hire bakers if there is no wheat.
The problem with inflation is not that it reduces demand. Inllation is just a clever way of taking away people’s purchasing power. It’s a reverse Robin Hood, robbing from the poor to give to the rich. Moral considerations aside, what does this do to an economy? Does it increase or decrease the wealth of the nation? Well, it depends. If the rich use their newly stolen wealth to produce things which the poor would not have done, then in some way it may be considered good. But that is never the case. The govt always uses inflation to waste resources, not use them productively.
I think you are starting off with a very Keynesian assumption, that lack of demand is the root of all evil, and assuming Austrians think so too. Nope. Lack of supply is the root of all evil.
“And since demand falls, capital investments will not be succesful.” Traditional Austrain Business Cycle Theory says capital investements are unsuccessful not because there is a prior lack of demand, but because inflation [=govt printing money] causes capital investments to be done wastefully. [Read up on why this is so, too involved for my poor powers to explain.] Investments are made in unproductive things, houses nobody will buy, dot.com stocks that will never turn a profit.
Of course, serious inflation is a problem in and of itself, unrelated to capital investments. If the country is impoverished by the thefts of inflation, with everyones wallets suddenly emptied [but for a very small number], and yet prices rising, that is doing people harm right there.
“However, Say’s Law tells us that increased production increases demand (but not all production is desirable!).” All very true. And the key to the whole thing is what you wrote in parentheses. According to ABCT, the problem is that undesirable production happens. Things are made that nobody wants, and therefor resources were wasted making them. Naturally the producers won’t turn a profit either.
Trillions of new money will not create an increase in production. It will create malinvestments, meaning wasteful use of resources.
There’s a Keynesian assumption hiding here, too. That at the heart of a reccession is the problem that for some mysterious reason, people just don’t want what the factories are making. The country is not producing all it could, with bad results all round. Trillions of new money given to the factories to produce will bring them to full capacity, with good results all round.
No. people aren’t buying what the factories are making because the factories have been making what people don’t want. The factories messing up is caused by inflation, as mentioned above. The solution is to shut down those factories, and start making things that people DO want. This is difficult and expensive, but there is no other way.
The proposed solution of printing money and giving it to the factories to make things nobody really wants is not a good idea. They will make still more of what people don’t want, wasting resources. And let’s not forget, somebody is paying for all this. Inflation is emptying the wallets of the country to pay for those useless hula hoops nobody wants. As you so wisely pointed out, not all production is good.
Well, I think the rest of the post sort of collapses from the above discussion.
The fall in demand happens because of inflation indirectly. If people knew inflation as it occurred, then there would be no crash. As it is, while the inflation is happening, people are buying as though the purchasing power of that money has not fallen. Once they realize it has fallen, there is a crash. Before this crash, those investments aren’t malinvestments technically because they are profitable. Once the inflation has been realized, it is a malinvestment.
However, my assertion is that just because it is funded through inflation does not necessarily mean that it is a malinvestment. The production may actually be desirable, which would increase the total value of goods. Expected value of goods minus actual value of goods is what fuels the boom. However, if the increases in total value of goods from the new capital investments outstrips that affect of inflation, then would you actually have a crash?
But a thought occurs to me as I write this. Does the increased production add to the expected value of goods? Probably. So then this means there necessarily is a bust no matter what amount of inflation is introduced?
I guess I have it all wrong then. Could you show me a link that explains or claims or substantiates the statements you make?
In particular, I’m interested in:
“If people knew inflation as it occurred, then there would be no crash.” Is this Austrian economics, or your personal insight?
“while the inflation is happening, people are buying as though the purchasing power of that money has not fallen.” I’m not sure how, if the purchasing power has fallen, they don’t know it as soon as they walk into the store and see that everything is more expensive.
“Before this crash, those investments aren’t malinvestments technically because they are profitable.” If someone buys a house for half a million dollars, thinking it will double in price in ten years, and it never will, how is this profitable? If someone buys a dot.com stock assuming it will make millions, but it cannot possibly, how is this profitable? If someone starts building a steel mill thinking there will be enough money available to finish building it, but he erred and there won’t be, how is this profitable?
“it is a malinvestment. However, my assertion is that just because it is funded through inflation does not necessarily mean that it is a malinvestment. The production may actually be desirable, which would increase the total value of goods.” I totally agree. But a business cycle is where many many productions are started up that are doomed to fail, even though a few will make it.
With regard to the rest of the post, like I say, I have no idea where you are coming from. Could you perhaps link me to the background info needed to understand you?
I’ve considered myself a follower of Austrian economics for a while now, and I’m still trying to figure everything out. Most of this questioning that I’ve come up with is due to reading the intro to Contra Keynes and Cambridge by Bruce Caldwell.
It’s my personal insight. As the boom is occurring, everything is fine. Investments are paying off and incomes are rising. But of course, there is a shortage of goods relative to the command of goods that people think that they have. This results in a rise in prices, hence a fall in demand, and hence a crash. This is why a fall in consumer purchases precedes the bust.
That’s the thing though. During inflation, prices wouldn’t rise immediately. Inflation is the rise in the money supply, not a rise in CPI. The inflation is not fully realized until the bust occurs.
It was profitable for the people who sold before the bubble popped, wasn’t it? Look, I’m not saying that just increasing demand will not solve anything. It won’t, it would just exacerbate the real problem which is a shortage of goods. That problem can only be corrected with increased production which can only happen with more savings. Believe me, I’m not a Keynesian. I am saying, though, that things are profitable before the crash, but these profits may not be sustainable depending on how severe the inflation is.
Yes, so what I’m saying is that the chance a bust occurring is relative to the amount of inflation that is introduced. This is because those best investments will be pursued first, and the not-so-good later. The risk of crash really depends on the value of those not-so-good loans.
So, I’ll try to summarize this before it gets overly complicated. Inflation creates over-consumption. We try to buy more than there really is, and so at some point, you get a shortage of goods. This is when the crash occurs, when you get a shortage of goods. The shortage of goods occurs because of a believed purchasing power is above actual purchasing power. What I’m saying, though, is what happens if the inflation you introduce via loan creates production that outstrips that difference. Would a crash still occur? Keyensians would say no, but through this thread I’ve gotten the idea that it wouldn’t matter. People would consider this value and the problem of inflation is still there, that no matter how much you raise production by, you still have the problem that believed purchasing power is higher than actual purchasing power. That even with this claim, that you can’t avoid the problem you get by introducing inflation.
Tony - “One of the main arguments about Austrian Business Cycle Theory is concerning growth.”
Really? What argument?
Your post is similar to this one. You and I previously discussed capital formation and the structure of production. These concepts are still missing from your analysis.
Your post is a mixture of mostly Keynesian / interventionist economics dabbled with Austrian terminology. If what you say is accurate, maybe someone can enlighten me.
“I think that this would resolve some of the debates that we have over stimulus. Yes, to some extent they will work, but only to the point at which the induced demand from capital investments can outstrip the fall in demand from inflation.”
Disagree. Stimulus is simply “taxing”, “printing”, “government spending”, “government borrowing”. None of this can possibly “work”. Impossible. Then, at what point do “austerity programs” come into play?
I think the post from March 31st addresses some of the ideas you present here.
I can’t find it right now, but it was in Contra Keynes and Cambridge. I think the argument was put forward by Piero Sraffa. So if you have the text, maybe you can find it there. I don’t have the time to search it out or type it up, I’ve got a molecular biology final tomorrow.