Let’s abstract a bit.
Lowering short-term interest rates allegedly fools investors into creating “roundabout” production that will not actually sate consumer preferences in the long-term.
Investors fall for this trick.
Even though the reaction is maladaptive and results in loss, they never learn.
Given that some investments may fail, does each individual investor know that his will fail?
Its a collective action problem… just like how price ceilings cause shortages.
I already said I think that the market could beat the fed if it were just a free market + federal reserve… but legal tender laws/capital gains taxes block the most obvious solutions to the Austrian-Interest-Rate-Problem.
Neoclassical,
Let’s abstract a bit.
No! Respond to our criticism of your argument. There is no need to abstract. I understand where you’re coming from. I made my case. Stop ignoring it.
Yes. Although I prefer I slightly different description: additional money injections into the time market facilitate, and hence make profitable, long term projects which would otherwise not be profitable in the absence of the money injections; the lowered interest rate is merely a manifestation of the additional money injections into the time market.
A bad way of putting it, but yes. How are they to know whether the success of their business venture is a consequence of the additonal money injections or not? They merely calculate whether their venture has been profitable and move on.
The reaction is only maladaptive in the sense that it is not consistent with consumer desires. However, as has been explained, it is consistent with incoming price signals. And since there is no way of deciphering whether these signals are consistent with consumer desires or the additional money injections, there’s now way that the system can learn.
Once again, you don’t grap what it means to learn in a system. You’re still stuck in thinking it’s the same thing as some individual consciously grasping some concept and then using it appropriately. Learning within the economy has little do with overtly conscious decisions (the light bulb type) by individuals. Learning by a system is merely selection of variation, and then imitation of that selection.
At any moment of time millions of investors are taking on a great variety of projects without much foresight about which will be profitable. It’s more than anything, a gamble. It’s not that they’re tricked in the sense that you’re thinking. It’s merely that, of that great variety of projects, those which would not be profitable according to consumer’s desires have become so.
Austrian theory has not as much to do with satisfying the consumer in the long-run, but with a distortion of the price mechanism which otherwise signals the scarcity of capital-goods (or economic goods, in general). So, the problem is not that the investment in and of itself may be bad (although, there is the possibility that it is), but that given the distortion of the price mechanism the profitability of lengthening and widening the structure of production is therefore skewed, as well.
Can someone provide me with empirical evidence of what “interest rate” businessmen use to determine long-term decisions?
Can someone provide me with empirical evidence of what “interest rate” businessmen use to determine long-term decisions?
What about the rate of interest you borrow money at? Doesn’t it make sense to borrow when it’s cheaper, than to borrow when it’s more expensive? The idea is that the less it costs you, the less cost you discount from final profits. Credit expansion, therefore, can make capital-goods seem cheaper (and more abundant) than they actually are, or another way of putting it is that the marginal revenue from capital-goods will increase.
Can someone provide me with empirical evidence of what “interest rate” businessmen use to determine long-term decisions?
You know that would be an interesting business thesis. And you can tie it back to ABCT!
http://ares.metapress.com/content/d35750572573n583/
“Interest-Rate Sensitivity of Real Estate Investment Trusts”
Millenium internet stocks was a bubble.
The housing market is a bubble.
The Dubai real estate project was a large bubble.
etc. etc.
Rob, what is a “bubble” exactly? What observable traits allow me to distinguish one?
P.S. Was the “Dubai real estate project” a malinvestment created by central bank inflation?
Do investors expect “low interest rates” to produce more risk for their long-term projects? Or are they oblivious to the risk you all are emphasizing?
First, it is important to point out that general/relative price inflation is solely a function of monetary growth (in the broader sense); that is, in a perfect theoretical economy (where there is monetary and inter-temporal equilibrium), an elevation in the price of a single economic good must, ipso facto, lead to a corresponding and proportionate diminution in the price of another economic good.
Thus, a bubble is defined as the rapid acceleration in the price of an economic good that is not offset by a corresponding diminution in the price of another good or other goods. They are asymmetric alterations in the price mechanism which lead to structural imbalances, i.e., a misallocation of resources, (land, labor, durable capital, circulating capital, et al.) towards unwarranted and unsustainable productions (cannot be completed on time, at all, or will be completed at the expense of other, more warranted (profitable) productions).
Bubbles vary in degree and in severity, and you can have many bubbles simultaneously. They cannot be predicted before the fact nor can you identify, with absolute certainty, already existing bubbles. You cannot know where the inflation will flow or how it will manifest.
Again, the ABCT is not about central banks. But yes, the Burj Khalifa is the result of massive worldwide monetary expansion (artificially lower market interest rates).
Out of curiosity, how does the mainstream neoclassical economist, who adheres to RE, explain the massive amount of investment in real-estate projects that turned out to be unprofitable in the long-run, many of which could not be completed at all?
Do investors expect “low interest rates” to produce more risk for their long-term projects? Or are they oblivious to the risk you all are emphasizing?
This question has already been answered countless times in this thread.
EDIT:
An older reply of mine,
What you propose is tantamount to having entrepreneurs, and all market agents alike, completing stopping meaningful and purposeful action because of the possible threat of malinvestment. It ignores that even despite an entrepeneur knowing and accepting Austrian theory, an entrepreneur might still believe he can reap profit before the bubble pops. Or, perhaps, he can survive the bubble thanks to his superior product (as many entrepreneurs have done). Not all investment during a period of credit expansion is malinvestment, and this is what your argument presupposes.
Entrepeneurs do factor in interest rate-related risk, to some degree, but given the nature of the type if disequilibrium Austrian capital theory predicts it’s clear that at some point it’s really difficult for an entrepreneur to quantify what is malinvestment and what is not.
Just to add to that,
He also ignores the very fact that that lending institutions themselves have been cartelized for precisely this reason of transferring those risks and potential losses, due to credit expansion and low interest, to others. Therefore, for many institutions it becomes “rational” to invest in projects that would be deemed foolish absent of government intervention.
What is even more fascinating about Neoclassical’s position is that he closes his eyes to trillions of dollars of liquidity provided by the Fed to banks, the bailouts of the big wall street banks, etc… and he doesn’t for one moment pause and rethink that perhaps, just maybe, investing billions in malinvestments can actually be very rational to many people.
In Neoclassial’s fictious world, no perverse incentives can possibly be introduced by the central bank, FDIC, etc… He fails to see that “rational expectations” of actors don’t just go away in light of artificial low interest rates, but that what is “rational” and what is not becomes different in the realm of government run banking and countless of other agencies and regulations.
DD5, you’re not getting “rational expectations”; I know, for instance, that it is rational for a corporation to receive a subsidy, and I still am aware that such a subsidy is a suboptimal allocation.
One point to be clear: being “answered” is not necessarily being “satisfactorily answered.” I’m sure in an argument between evolution and intelligent design, the creationists can offer countless “answers,” as well.
Here’s my point: wouldn’t the added risk be calculated by rational investors, thus curbing the temptation for “malinvestment”? That is, it’s not rational to use cheap money for roundabout projects that are more likely to fail. The risk is a disincentive and it also shapes expectations.
Neoclassical,
One point to be clear: being “answered” is not necessarily being “satisfactorily answered.” I’m sure in an argument between evolution and intelligent design, the creationists can offer countless “answers,” as well.
I agree, but you’ve hardly addressed these arguments before, and so how are we to know whether your questions were satisfactorily answered or not?
Here’s my point: wouldn’t the added risk be calculated by rational investors, thus curbing the temptation for “malinvestment”?
This point misses what I brought into consideration. I’m sure that rational investors would calculate for malinvestment, but how would they know whether their investment is a malinvestment or is a good investment? If one were to accept Austrian capital theory, it doesn’t follow that all investment made during the boom period is malinvestment (indeed, there is still healthy economic growth, to some degree or another). How would an entrepreneur, with a distorted price mechanism, know whether the particular line he is investing in is in heavy disequilibrium?
To a degree, investors can know and do know due to strange price movements. For example, it’s fair to say that there were probably a few entrepreneurs that did not invest into the housing market as prices skyrocketed. Those that did were probably unaware that a bubble even existed, and the big companies that bundled the risks were also aware (as DD5 notes) that their risk was abetted by government policy.
That is, it’s not rational to use cheap money for roundabout projects that are more likely to fail.
How do you know that your investment is bound to fail? Not all investment is malinvestment.
Answer this. First, how do they calculate the added risk; i.e., quantifiy it rationally? Second, how do they know their project will be doomed to fail (not all projects will be unprofitable when to bust comes)?
Well there you have it! Artificial low interest rate is a form of subsidy. Subsidy for higher order goods. Higher order goods for which later necessitate more subsidy (more credit at lower interest rate) in order to be sustained.
From this perspective then, you should have no problem in reconciling rational expectation with ABCT, provided that you take the time to understand capital theory.