I’m not as familiar with the ins-and-outs of the Mises-Hayek theory of the business cycle as some are - perhaps Jon Irenicus. So I’m wondering how you explain some of the critiques of the theory from other economists, like Gordon Tullock who say there should only be minor transitional unemployment with GNP numbers actually increasing in recession.
I see Gordon Tullock considers that in the boom “funds that they would prefer to spend on consumption were being diverted to investment”. I don’t get that, because in the boom phase, both consumption and investment increase, actually.
He also states:
“At the very least, one would assume that a well-informed business person interested in important matters concerned with the business would read Mises and Rothbard and, hence, anticipate the government’s action.”
Of course they should read Mises and Rothbard, but that knowledge doesn’t give a clue to what the government action will be. One can certainly know that the government is pushing the interest rates down, but entrepreneurs don’t know the real market interest rate (because that signal is being hidden from them) and they also don’t know how long will this artificially created interest rate last.
He also says:
“First, it should be noted that if the business people are now building more factories than they were before, which is what Rothbard says, then, in fact, savings that are available for building factories must have increased. In fact, they have. What has happened is that the government by inflationary measures is transferring a certain amount of money from the general citizenry into the investment accounts and, hence, the money for building these additional factories is made available.”
I just don’t understand this. What the government really does is depreciating the value of money by inflating its supply, that doesn’t mean a “transfer” of money from the general citizenry into the investment accounts. Maybe he is thinking of it as a static model, and leaves aside all the distortions caused by the new money being pumped into this new loans with decreased interest rates. As no new real savings exist (in fact, the opposite occurs, just because the interest rate is lower than the market time preference, people are induced to consume more, and savings are consumed), most new investment projects are doomed to fail.
He then goes on to say:
“The second point that must be emphasized is his (Rothbard’s) argument that investments in “lengthy and time consuming projects” are made.”
Rothbard is pointing out this especially because this investments are which ones are more affected by the artificially set interest rate.
Then he says a lot of stuff regarding that many investments will be certainly finished anyway, because they are “sunk costs” and is still more profitable to finish them than to liquidate them. We should notice that we’re talking about capital goods, and, even that they would be finished, in the bust phase, consumption will fall, which will make this capital goods not productive, as there are no real savings in the economy to consume anything.
I should go on but I’m tired. 
Anyway, I don’t see his critique strong enough to disprove the ABCT. In fact, I’ve never found any successful refuting attempt. And I’ve read many.
I think that might be Tullock’s point though.
Maybe he considers consumption and investment as additive, which Austrians don’t do.
“During the depression however, their living standard would benefit, first, because with more capital goods, the demand for complementary services (mainly labor) is greater than it otherwise would be and, second, because prices for consumer goods are lower.”
This deserves some attention. While I see why many workers (those still employed) are benefited because of lower prices for consumer goods, I don’t see why the demand for labor would increse. In fact, the economy has been distorted, and most “incorrectly” employed workers had been laid off, and it takes time for the economy to readjust. So unemployment appears.
Perhaps this http://mises.org/daily/3155 will help. Check the part of the sushi economy.
He is referring to the fallacious concept of “forced” savings. He is saying that the loss of purchasing power from inflation can be seen as a transfer (involuntary I may add) of savings to investors, so that the claim that new money out of thin air doesn’t amount to real savings is false.
Of course, the problem with that argument is that it completely ignores the role of time preference in savings. He is misunderstanding the nature of savings, that is that they are generated by a curtailment of immediate consumption. Credit expansion doesn’t change the time preference of individuals, therefore t his new money does not constitute real savings. This will be discovered as soon as the credit expansion seizes.
Ivan,
Gordon Tullock in the article is taking the position of the Austrians, he’s basically paraphrasing the Austrian arguments and showing why he think they’re false - and apparently why most people do also.
Are you sure? I think that he’s trying to “fix some errors” in the ABCT as formulated by Mises, Hayek, Rothbard and Block.
block thinks he could do a better job.
Oh, I see he raised the same points I did…
I don’t really pay into any of Tullock’s minor questions, so I don’t really find the arguments against them that interesting - just as a reply to Ivan for “saying the same thing Block did.”
On the increase/decrease in consumption, however, I think Block’s point about the rigidities involved in labour markets is the best defense he makes of the Mises-Hayek theory. I’m perfectly fine with that explanation given some of my post-Keynesian leanings.
However, I’m still questioning the consumption itself. Why doesn’t consumption for consumers goods boom after a recession? If low interest rates induce investment in capital goods, why do consumer goods not increase in investment during the bust? Maybe they do and I haven’t seen the data.
All this said, I think overall Block’s reply was a very good one - though it doesn’t address my most curious question. I still think, however, that the Mises-Hayek theory is insufficient to explain the entire business cycle - despite being the most comprehensive theory of it I’ve yet to see.
The trigger of a recession is that factors of productions, capital and labor, have been allocated to produce goods that are not needed. These factors of production must go idle instead of consuming wealth that is needed elsewhere. But so long as they have not been reallocated, there cannot be an increase in consumption as the supply of consumer goods has not changed. There are still only as many consumer goods being produced as there were at the height of the boom. It is the recovery, the reallocation of idle factors of production to the production of consumer goods, that makes more consumption possible.
During the bust, everyone is trying to save money (and that’s the best thing they should do if they want the economy to recover fast), so they consume less (and investment doesn’t increase in consumption goods). In a few words, during the boom both investment and consumption are induced. During the bust, is when the economy reveals that many investments were in fact malinvestments, so many of them close or will have to find another ways of being productive. Also, this brings transitional unemployment (which can be made more “frictional” by the government trying to fix the level of wages, prices and so on) and diminishes the confidence in the economy. This factors make consumption not to increase, but decrease instead.
Maybe you’re asking what happens after the bust?
I don’t understand that Stranger. Why can’t be an increase in consumption as the supply of consumer goods has not changed? It’s possible that an increase in consumption occurs, and that increases the price of them, and encourages investment in consumer goods. In fact, in the boom consumption also increases, not only investment. The consequence of this (increase in consumption) is less savings that otherwise should have been, but that doesn’t have any cyclical consequence at all.
ivanfoo, i think stranger has noted the differnce between consumptive spending. i.e. money amounts spend on purchasing consumption goods.
versus the consumption of the consumer goods themselves.
you are right that more dollars can be spent to buy the same quantity&quality of consumption goods, but this is necessarily not the same things as consuming more.
What you are describing is that demand for consumer goods increases as the bank credit expansion makes it appear that there are much more savings available than there truly are. This increase in demand, not matched with a corresponding increase in supply, results in prices going up and “price inflation” to appear.
Ok, I get that, but how is it possible to an increase in supply not to occur? In the boom, they will invest in consumption goods production also.
I am a bit more satisfied with this entry.